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Cost and Management Accounting
Session 1
Chapter No 1- Management Accounting Fundamentals
and
Chapter No 2- Materials Cost Control
Overview of the Course
Session Topic (including subtopics)
1. Management Accounting Fundamentals & Materials Cost Control

2. Labor cost and Overhead Cost control
3. Cost concepts, Cost classification and Unit cost analysis
4. Cost Analysis: Job Order, Batch and Contract Costing & Income
Recognition under Marginal and Absorption costing
5. Process Costing and Joint costing

6. Standard Costing and Variance Analysis
7 Standard Costing and Variance Analysis
8 Management Accounting in Global Perspective
2
Before we start …
• This session is for YOU… so participate and lets
make it interactive !
• I will keep my Chat window open – students are
requested to post queries on Chat
• I shall allocate time towards the end of the
session to respond to your queries
• Please point out in chat in case the “recording” is
off at any time !!
3
Session 1
1.1 Management Accounting Fundamentals
1.2 Materials Cost Controls
4
Chapter No 1- Management Accounting
Fundamentals
Concept of Management and Cost accounting – An introduction
All businesses are concerned about revenues and costs
o Managers at companies, small and large must understand

how revenues and costs behave or risk losing control of the
performance of their firms
o Managers use cost accounting information to make decisions

about research and development, budgeting, production
planning, pricing and the products or services to offer
customers. Sometimes these decisions involve trade-offs.
Management accounting assists Managers in taking such

decisions to optimize the revenues and minimize the costs
Financial accounting: Financial Accounting focuses on reporting
financial information to external parties such as: investors, government
agencies, banks and suppliers based on Generally Accepted
Accounting Principles(GAAP).
Cost accounting: This is the process of measuring, analysing and

reporting financial and non-financial information related to the costs of
acquiring or using resources in an organization.
Management accounting : Management Accounting is the process of

measuring, analysing and reporting financial and non-financial
information that helps managers make decisions to fulfil the goals of an
organization.
Managers use management accounting information to:
o Develop, communicate and implement strategies
o Coordinate product design, production and marketing decisions and
evaluate a company’s performance
Financial accounting and Management accounting – A comparison
Financial Accounting Management Accounting
It helps in finding out the results It helps in computing cost of
of an accounting year in the production/ service in a
Objectives
form of P&L account and systematic manner to control
prepares the Balance sheet cost
It is concerned with reporting the
It is an internal reporting
results and position of business
system for an organisation's
to persons and authorities such
own management for decision
as Government, Creditors,
making
Reporting Investors and Others
Data is not only historical but
Data is historical in nature
Data Analysis also futuristic in approach
Classification is on the basis of
Major emphasis is on cost Functions, activities, products,
classification based on type of Process and on internal
transactions - Salaries, repairs, planning and control and
Cost Insurance, stores etc information needs of the
Classification organisation
Financial accounting and Management accounting – A comparison
Financial Accounting Management Accounting

Only those transactions are
It uses both monetary as well
Accounting recorded that can be expressed
as quantitative information
transactions in monetary terms
It aims at presenting " true and It aims at computing " true and
fair" view of the profit and loss fair" view of the cost of
position and financial position of production/ services offered by
Effective
the organisation the firm
purpose
Financial accounts are subject Management accounts are
to statutory audit to verify subject to cost audit that
whether they disclose " true and verifies whether the cost
fair" view of the profit and loss accounts disclose " true and
position as well as financial fair" view of the cost of
Statutory
position of the organisation production of the company.
requirements
Comparison between cost accounting and management
accounting
Basis Cost Accounting Management Accounting
It is mainly concerned with allocation,
distribution and accounting aspects It evaluates the impact and effect of
Concerning Issue of costing costs on operational decisions
The costing data is the basis of It uses both the Financial accounting
Data management accounting decisions and cost accounting data
It has a narrow scope in Business It has a broader scope in analyzing

Scope operations managerial decisions
It is concerned with both, short term

Term It is for short term planning and long term planning
It assists only in Management It also helps in performance evaluation

Functions functions of managers and workers
Approach It is a historical approach It is a futuristic approach
It can be installed without the It cannot be implemented without the

Interdependence Management accounting system Cost accounting system
Financial Accounting Functions on Well-Defined Concepts and
Conventions
1. The concept of “separate entity” implies that the owner (person) is

different from business.
2. The concept of “double entry system” explains that each and every
transaction has two-fold effects. It simply means that in a transaction, two
accounts are affected.
3. Another concept called “money measurement concept” means that only
those transactions that can be expressed in monetary terms will be
recorded in the books of accounts.
4. According to International Accounting Standards, an enterprise is normally
viewed as “going concern” if it continues to remain in business for the
foreseeable future.
5. The “matching concept” has been defined by International Accounting
Standards as, “an accounting practice whereby expenses are recognized
in the income statement on the basis of a direct association between the
costs incurred and the earnings of specific items of income.
Cost Accounting
Cost accounting is a technique to optimize cost of production/services by using

different costing techniques and reaching a competitive stage in a given
business scenario.
1. Cost can be described as the resources that have been sacrificed or must
be sacrificed to achieve a goal. This is a sort of investment made to
produce a product or service. As long as this product remains in the firm, it
is treated as an investment or asset.
2. Costing is the systematic procedure of ascertaining the cost of a product or
service. Costing broadly deals with the cost of production, selling and
distribution.
3. Cost accounting is a system of accounts for determining the cost of
products or services. It deals with preparing budgets; monitoring standard
costs and actual costs; and costing of processes, activities or products. It
also analyzes cost accounting information and data for various managerial
decisions.
Cost Accounting - Functions
The essential functions of cost accounting are as follows:
1. Ascertaining the cost of production on per unit basis.

2. Determining selling price.
3. Controlling and reducing cost.
4. Arriving at division-wise, activity-wise and unit-wise
detail of cost.
5. Finding out inefficiencies and other weaknesses in the
processes, making available relevant data for decision-
making and estimating future costs.
Build consensus and commitment on scope and goals
Select the right methodologies
Determine how efficient and effective the organization is

and set targets for change
Steps to Deliver Cost
Excellence
Develop a plan to hit the targets
Drive implementation of the changes
Make the change sustainable

Objectives of Management accounting:
There are four broad objectives that Management accounting

accomplishes in an organisation:
1. Planning: Preparing a Plan and ensuring its execution to achieve

short and long terms goals. This is basically done through Budget
preparations.
2. Allocation of resources: The resources in terms of raw materials,

workforce and other requirements to facilitate production and
services efficiently are allocated to various divisions/units duly
assessing their requirements
Objectives of Management accounting:
1. Z
3. Direction and Motivation: Once the resources are allocated in a
required manner, there is a need to direct and motivate people for
optimum contribution. Since the efficiency is linked to incentives, the
managers at different levels are engaged in providing required direction
and motivate people to contribute in optimum manner.
4. Monitoring and Control : Proper monitoring at different intervals is

very much essential to achieve goals and optimize the cost. The
management reviews the targets in relation to the actual state and
assesses the reasons for the gap to take corrective actions in the future
Practical applications of Financial, Cost and Management
Accounting
Financial accounting: It presents the position of assets, liabilities,
income and expenditure of a firm for comparative periods. It only reflects
the information as available in Books of accounts. It represents past
financial data and provides consolidated information only.
Cost accounting: It helps in preparing product wise statement of cost,

revenue and profit or loss by allocating various costs according to the
existing policy of the firm. It also indicates which product is making profit
and which ones are in loss.
Management accounting: It analyses different cost elements by

allocating them in a very scientific manner to arrive at correct contribution
from different products. Based on an in-depth analysis of costs, revenue,
capacity utilization and contribution, it also decides whether to buy a
particular product from the market or produce on its own. It also suggests
if various strategies can make a product profitable and if not, whether it
will be wise to shut down a plant or product.
To Summarize :
Financial Accounting is Reporting
Cost
accounting is Implementation
Management accounting is
decision making
Management Accounting – Definition and Features
According to the Chartered Institute of Management Accountants , the

definition of Management Accounting is prescribed as “ The process of
identification, measurement, accumulation, analysis, preparation, interpretation
and communication of information used by Management to plan, evaluate and
control within an entity and to assure an appropriate use of and accountability
of its resources. Management accounting also comprises the preparation of
financial reports for non-management groups such as shareholders, creditors,
Regulatory agencies and tax authorities.
1. MA is a decision making process based on various financial and accounting

information and data analysis.
2. It ensures adequate resources for operational units
3. It involves perfect monitoring and control through responsibility management
4. It primarily focuses on achieving future strategies and goals of the

organisation
Management
Accounting Information
and Their Use
Monitoring and Facilitates decision-

Cost measurement
control making
Management Accounting Information & Use
1. Cost Measurement: It measures full cost including Direct and Indirect cost
Direct Costs – Those costs that are identifiable or traceable and can be
directly apportioned to the products or services.
Indirect costs – These costs are not allocated directly to the product or services.
The measurement of full costs serves different purposes and is used in

different decisions
2. Monitoring and Control: Another important use of management accounting

information is to monitor closely the cost aspect of a product or process and
implement important effective control measures to optimize the cost while not
compromising on quality.
This is done through the process of budget and budgetary control. The targeted
allocation of cost and actual is compared at different time intervals
Management Accounting Information & Use
3. Facilitates Decision Making: It generates appropriate and required information

for future decision making relative to various operations of a firm.
The decisions may involve :
• Make or Buy
• Further processing
• Shutting down operations
• Increasing production capacity
• Determining selling process
• And other related decisions
Management Accounting Tools and their Significance
Component Uses
Creating value for the customer through Proper planning
Strategy Formulation and implementation of the strategies. The ultimate target is
to reduce costs and improve efficiency
The flow of goods, services and information enhances the

performance of the firm. Tools such as Standard costing
Efficient Supply chain
and Target costing are effective for cost control and cost
reduction and thus ensure enhanced customer satisfaction
Techniques such as Marginal costing help generate

information that is useful for taking managerial decisions
Decision Making Science
such as Make or buy, drop a product line, additional
Working shift, Capital expenditure decisions etc
Several tools such as Budgets and budgetary control,
Analysis of Performance standard costing and marginal costing are used in
measuring actual performance
Fixing responsibility by creating different centers such as
Responsibility Centres
cost, profit, investment etc
Decision making process in a Firm
Decision-making Process
Planning
Management
Business Goals Directing
Decisions
Controlling
27
Decision making process in a Firm
• Planning:- Planning represents different phases of the planning process
in a firm which are:
o Strategy
o Positioning
o Budgets
• Directing:- It is the process of directing the operations for effective use of

resources. The three stages of directing are:
o Costing
o Production
o Analysis
• Controlling:- The process of controlling can be defined as a process of

monitoring and controlling measures to achieve the desired goals
effectively. The tools of monitoring and control are:
o Monitor through MIS/ reports etc
o Score card
Planning
Phase Description
Strategy Selecting the best alternates in terms of cost,
quality, etc , to fix the optimum selling price
and achieve goals
Positioning Where to place the product in terms of
geographical coverage (existing-new, domestic-
international), how to organise and utilise
resources at best cost to bring efficiency and
cost-effectiveness
Budgets Preparing short-term and medium-term
budgets based on past data and information
and keeping in mind the organisational goals
Directing
Stage Description
Costing Use and develop the relevant costing technique
to identify & allocate correct costing to a product
Production Providing necessary resources keeping in view
the cost of resources. Managers provide
necessary directions to optimise cost and bring in
efficiency.
Analysis Analysing actual versus budgeted to ascertain
gaps and to take corrective actions
Controlling
Tools Description
Monitor Regular monitoring at intervals to ensure desired
goals are achieved.
Scorecard Strategic Management Accounting has developed
the concept of Balanced Scorecard to effectively
monitoring and control
Some Innovative Management Accounting practices
• The management accounting policies and practices have changed

significantly depending on how accounting and trade policies and
practices have evolved across the globe.
Some of the new innovations in the field of management accounting

are:
1. Total Quality Management (TQM):-
o Focuses on maintaining the quality of a product or service
o It has significant impact on cost savings and bringing efficiency
in a product or service
2. Just- in-Time:-
o It is an approach developed in modern management
accounting to control the inventory holding cost by minimising
the level of inventory in hand
Video links
https://www.bing.com/videos/search?q=videos+on+toyota+jit&vie
Toyota JIT w=detail&mid=5805A9DC4E1F036526975805A9DC4E1F03652697&
FORM=VIRE
TQM https://www.youtube.com/watch?v=uJ_dX7gL5hk
Some Innovative Management Accounting practices contd….
3.Value Chain:- Many business firms define their mission to become one of
the prime brand in product or services line in which they operate. In this
approach the following analyses have been undertaken:
a. Internal Cost Analysis

This is to asses different sources of profitability and the related cost aspects
for the purpose of creating internal value in various processes.
b. Internal Differentiation Analysis

This is to further investigate and understand the sources of differentiation
(including the cost) within internal value creating processes.
c. Vertical Linkage Analysis

This is to identify the relationships and relevant costs among external
suppliers and customers so as to maximise the value delivered to customers
and to optimise the cost.
Value Chain Analysis contd….
Value Chain Analysis Explained : The value chain is the sequence of business
functions by which a product is made progressively more useful to customers.
Let us illustrate these functions with Sony Corporations’ Television division :
1. Research and Development ( R&D) : Generating and experimenting with ideas

related to new products, services or processes. At Sony, this function includes
research on alternative Televison signal transmission and on the picture quality of
different shapes and thickness of television screens.
2. Design of products and Services : Detailed planning, engineering and testing

of products and processes. Designing in Sony includes deciding on the number
of component parts in a televison set and determining the effect alternative
product designs will have on the set’s quality and manufacturing costs
3. Production: Procuring, transporting and storing (“inbound logistics”) and

coordinating and assembling (“operations”) resources to produce a product or
deliver a service. The production of a Sony television set includes the
procurement and the assembly of the electronic parts, the cabinet and the
packaging used for shipping.
Some Innovative Management Accounting practices contd….
4. Marketing ( including Sales) : Promoting and Selling products or services

to customers or prospective customers. Sony markets its televisions at Trade
shows, via advertisements in newspapers and magazines, on the internet and
through its salesforce
5. Distribution : Processing orders and shipping products or services to

customers (“outbound logistics”). Distribution for Sony includes shipping to
retail outlets, catalogue vendors, direct sales via the internet and other
channels through which customers purchase new televisions
6. Customer Service: Providing after sales service to customers. Sony

provides customer service on its televisions In the form of customer-help,
telephone lines , support on the internet and warranty repair work
Value Chain Analysis contd….
Different companies create value for customers in different ways :
1. Gucci: It creates value for its customers by creating a prestigious

brand. It does so by focusing on marketing, distribution and
customer service to build its brand
2. Toyota: Focuses on Quality to create value for its customers
3. Ebay: Fast response times create quality of the online auction

giant’s customers
4. Nestle: It continuously innovates to make new products which are

healthier and tastier thereby striving to improve the quality of health of
their customers
Finance
Marketing
Management
Accounting as
Profession
Human resources
Strategy and
operations
Quiz Time
Q1 . Which of the following are tools of management Accounting ?
a. Decision Making
b. Standard Costing
c. Budgetary Control
d. All of the Above

Quiz Time
Q1 . Which of the following are tools of management Accounting ?
a. Decision Making
b. Standard Costing
c. Budgetary Control
d. All of the Above

Quiz Time
Q2 . Planning, Resource allocation, Direction, Motivation and Monitoring

and Control are the four broad objectives of:
a. Cost Accounting
b. Management Accounting
c. Financial Accounting
d. Costing system
Quiz Time
Q2 . Planning, Resource allocation, Direction, Motivation and Monitoring

and Control are the four broad objectives of:
a. Cost Accounting
b. Management Accounting
c. Financial Accounting
d. Costing system
Quiz Time
Q3. Cost accounting emerged on account of :
a. Competitive markets
b. Statutory requirement
c. Wage rate Solution
d. Limitations of financial Accounting

Quiz Time
Q3. Cost accounting emerged on account of :
a. Competitive markets
b. Statutory requirement
c. Wage rate Solution
d. Limitations of financial Accounting

Chapter No 2- Materials Cost Control
Learning Objectives
• Importance of Materials in a firm
• Arrangements for proper upkeep of materials
• Functions of Stores Department
• Process of materials receipt and issue
• Material Control techniques
• Practical application of materials control measures and Methods

Essential Features of Material Control Process
1. Coordination amongst departments: There has to be a perfect

coordination and cooperation among the other major departments,
such as production, procurement, warehouse, etc.
2. Organized: The material control process should be well organized
with inbuilt supervision systems. It should be managed by a
professional.
3. Standard schedules and formats: For an effective materials
control process, there has to be proper schedules and formats of
indent, placing orders and for maintaining other inventory records.
There has to be a dual control system to maintain all records both
in the soft form, as well as in the physical form.
4. Verification and Monitoring: An internal mechanism for
verification and monitoring needs to be developed for bringing more
efficiency.
Essential Features of Material Control Process contd…..
5. Modern and new techniques should be adopted, like bin cards, to

have timely monitoring and control over the inventory management.
6. Inventory level management: The minimum inventory level and

reorder level must be maintained.
7. Controls: The inventory recording system should be online with an

inbuilt control mechanism.
8. MIS: The firm should develop a sound management information

system (MIS) for better reporting, evaluation and control on various
aspects of inventory control.
Essential Features of Material Control Process contd…..
9. Cost efficiencies: The perfect inventory management system in a

firm can help to save the maximum cost if a well-organized system and
mechanism are established. This will reduce the cost at different levels.
10. Material Purchase policy: The material purchase policy should be

more planned and systematic. There should be well-managed logistic
systems to ensure that the material is received well in time and at the
most effective cost.
Functions of Material Control Department
Functions of Material Control Department
For having an effective control over the materials-related issues, a firm

usually has a well-established material control department. The following
are the it’s major functions:
1. Procurement of raw materials, keeping in the view time to procure the

materials, reasonableness of prices, quality of materials used, and
quantity of the materials
2. The raw materials are received and inspected to ensure the required
quality as per pre-specifications.
3. Storage of raw materials and maintaining the records of material

received in the store register. It also makes all the required
arrangements to prevent loss of materials due to leakage, pilferage,
theft, mis-handling, etc.
Functions of Material Control Department contd….
4. The raw materials are issued for the use of production on receiving
indent from the production department
5. The department also ensures adequate inventory control through

maintaining the proper records.
6. It is also responsible for timely supply of the required materials and

ensuring that the production process does not stop for want of
materials.
7. The overall responsibility of material’s price, quantity, inventory

control and recording lies with the production department.
Responsibilities of the Purchase Department
Responsibilities of Purchase Department
1. Developing a mechanism for timely receipt of materials requirement

indents from all the departments to facilitate timely supply. The
department may prepare detailed guidelines and appropriate indent
formats.
2. Once the indents for materials requirement are received, there should be
proper mechanism of recording and follow-up of the indents with pre-
determined time limits for control at different stages. This can be
maintained by allocating appropriate codes and description for different
items.
3. Empaneling the suppliers for requirements of different types of materials.
This is done by inviting tenders and finalizing them based on price,
quality, discounts, reputation, etc. This is done very judiciously as the
suppliers are not frequently changed.
4. All the records of price, terms and conditions, discounts, etc., are
recorded in the book for individual suppliers. The agreements and
contracts are also properly filed.
Responsibilities of Purchase Department contd….
5. Preparing purchase-order formats, which is contractual agreement,

should be prepared incorporating all terms and conditions as per the
agreement.
6. The orders for the purchase of relevant materials should be placed in
time to ensure that the materials are received on time. Once the orders
are placed, they should be followed at different levels.
7. Receiving materials at the store physically and storing them after due
inspection at appropriate places.
8. Returning back the defected pieces, if any, to the supplier and follow-up
for replacement or reducing the bill amount.
9. Verifying the invoices and sending them to accounts department for
payment to suppliers.
Material Control Techniques
Material
inspection report
Goods received
advice
Material Control
Techniques
Materials
transfer note
Materials return
note
Material Pricing Methods First in First Out Method
(FIFO)
Last in First Out Method
(LIFO)
Highest in First Out Method
(HIFO)
Average Cost Method

Material Pricing
Methods Weighted Average Cost
Method
Periodic Average Cost
Method
Standard Cost Method
Market Price
Material Pricing Methods
1. FIFO:- Under this method of pricing, the materials received in the
store first are issued first and accordingly the pricing is done. In, other
words, the materials received in the first batch, are first issued and only
after all the items are issued from the first batch, the second batch is
used.
2. LIFO:- Under this method of pricing, the materials received last are
issued first. Therefore, materials issued carry the latest cost of material
acquisition.
3.HIFO:- Under this method of costing, the materials having the highest
price are issued first. Over here, it is not important when the materials
were purchased. The concept behind this approach is that, in increasing
and inflationary market, the cost of the material is immediately absorbed
into the product cost to cover the risk of inflation. Since the material is
issued at the highest prices, the product costs also increases. However,
this may affect the product to gain competitive prices in the market.
4.Average cost method : Materials are issued at the average process of

the material purchased
5.Weighted average cost method: Here, both, the price as well as the
quantities of materials purchased are considered.
6.Periodic average cost method: The average cost is calculated on the

basis of the materials received in a particular time period rather than
calculating the simple or weighted average cost every time the material is
received. The average may be calculated for the entire period.
7.Standard Cost method: Under this method, the materials are priced at
a pre-specified standard price determined for the issue of the materials.
8.Market price method: Materials are priced at the cost currently existing
in the market place as of the date of issue of the materials
There is no standard rule as to which of the methods should be used for pricing of
materials
A firm may use any pricing method suitable to it. However, some of the
considerations may be :
• Method of production process
• Nature of materials used by a firm
• Frequency of purchases
• Economic Order Quantity
• Accounting practices acceptable in valuation of inventory etc

Economic Order Quantity
This is a technique to determine how much should be the quantity
to hold which is economic in terms of cost. This helps the
purchase department to assess the quantity to be purchased at
any one time. This in essence is a measurement of how much
quantity is to be ordered at any one point of time.
Number of orders to be placed ( Based on EOQ) = Annual Usage
-----------------------
EOQ
Minimum level =
Ordering Level – (Average material consumption rate * Reorder period)
Reorder level =
(Maximum usage of material for specific period *

Maximum Reorder period)
Maximum level = Reorder Level + Reorder Quantity –
(Minimum consumption * Minimum reorder period)
Average Level of material holding =
(Maximum Level of material + Minimum level of material) / 2
Cost of Materials =
Purchase Cost +Total Ordering Cost + Total Carrying cost

Solved Problems
Q1. A materials Manager has the following data for procuring a particular items:
Annual Demand = 1000
Ordering Cost = Rs 800/-
Inventory Carrying Cost = 40%
Cost per item = Rs 60/-
a. Calculate Economic Order Quantity
b. If the order quantity is more than or equal to Rs 300/-, a discount of 10% is given.
For how much should the order be placed to minimize the total Variable cost ?
• Annual Demand = 1000
• Ordering Cost = Rs 800/-
• Inventory Carrying Cost = 40% = 60 * 40% = Rs 24
• Cost per item = Rs 60/-
• Solution
Number of Orders = Annual Order
EOQ = 2AO Units per order
C
= 2 x 1000 x 800 = 1000 = 4 orders
258
24
= 16,00,000 Variable Cost
24 = Purchase + Ordering Cost+ Carrying Cost
= (1000 * 60) + (800 * 4) + (258/2 * 24)
=258 units = 60,000 + 3,200 + 3,096
= 66,296
With 10% discount if order > 300 units
• Cost per item = Rs 60/- * 90% = Rs 54/-
• Inventory Carrying Cost = 40% = Rs 54/- * 40% = Rs 21.60
• Solution
EOQ = 2AO
C
• Inventory Carrying Cost = 40% = Rs 54 * 40% = Rs 21.60
• Solution
Number of Orders = 3 orders of 300 + 1 order of 100
EOQ = 2AO
C
= 2 x 1000 x 800 Variable Cost (with 10% discount)
= Purchase + Ordering Cost+ Carrying Cost
21.60 = (900 * 54) + (100 * 60) + (800 * 4) + (300/2 * 21.6)
= 16,00,000 = 54,600 + 3,200 + 3,240
21.60 = Rs 61,040/-
=272 units
Variable cost without discount : Rs 66,296/-
SAVINGS of Rs 5,256 if discount is availed

• Annual Demand = 1000 (purchase of 1002) Per Order quantity : 334 units
• Solution
Number of Orders = 3 orders of 334
EOQ = 2AO
C
= 2 x 1000 x 800
21.60
= 16,00,000
21.60
=272 units
• Solution
EOQ = 2AO
C
21.60
= 16,00,000
21.60
=272 units
• Solution
EOQ = 2AO
C
21.60 = (1002 * 54) + (800 * 3) + (334/2 * 21.6)
= 16,00,000 = 54,108 + 3,200 + 3,607
21.60 = 60,115
=272 units
• Solution
EOQ = 2AO
C
21.60 = (1002 * 54) + (800 * 3) + (334/2 * 21.6)
= 16,00,000 = 54,108 + 3,200 + 3,607
21.60 = 60,115
=272 units
Variable cost without discount : 66,296
• Solution
EOQ = 2AO
C
21.60 = (1002 * 54) + (800 * 3) + (334/2 * 21.6)
= 16,00,000 = 54,108 + 3,200 + 3,607
21.60 = 60,115
=272 units
Variable cost without discount : 66,296
SAVINGS of Rs 6,181/- if discount is availed

Solved Problems
Q2. M/s Automotive Motors purchase 9000 spare parts for its annual requirements, ordering
1 month usage at a time. Each spare part costs Rs 20/-. The ordering cost per order is Rs 15/-
and the carrying charges are 15% of the average inventory per year.
You have been asked to suggest a more economical purchasing policy for the company.
What advice would you offer and how much would it save the company per year ?
Solved Problems
Q2. M/s Automotive Motors purchase 9000 spare parts for its annual requirements, ordering
1 month usage at a time. Each spare part costs Rs 20/-. The ordering cost per order is Rs 15/-
and the carrying charges are 15% of the average inventory per year.
You have been asked to suggest a more economical purchasing policy for the company.
What advice would you offer and how much would it save the company per year ?
Solution:
Annual Demand = 9000
Cost per item = Rs 20/-
Ordering Cost = Rs 15/- per order
Inventory Carrying Cost = 15% of average inventory

Per Order = 1 month usage

= 9000 / 12
= 750 units
Ordering Cost = 12 * 15
= 180
Carrying Cost = Average inventory * 3

= 750/2 * 3
= 375 * 3
= 1,125
Present Cost = 180 + 1,125

= 1,305
Ascertaining Ordering & Carrying
• Annual Demand = 9000 cost under EOQ Method
Number of Orders = Annual Order

Units per order
EOQ = 2AO
= 9000 = 30 orders
C
300
Ordering Cost + Carrying Cost under EOQ
= 2 * 9000 * 15
= Ordering Cost+ Carrying Cost
3
= (30 * 15) + (300/2 * 3)
= 450 + 450
= 90,000
= 900
= 300 units
Existing order + carrying cost : 1,305
SAVING of Rs 405
Material Management at Stores
The following functions are undertaken by the storekeeper as regard to
efficient management of materials:
1. Maintaining a buffer in case of emergency and ensuring timely
availability of materials.
2. Providing safety and security of the materials.
3. Maintaining just sufficient quantity to avoid over/under stocking of the
materials.
4. Designing and developing a proper system for ensuring control over
usage, with proper recording system of issues and receipts of material
inputs.
5. Minimizing material losses on account of mishandling, wastage,
evaporation, breakage, etc.
6. Proper up-keeping of records and documentation for recording the
receipts and issues.
Inventory Control Techniques Perpetual Inventory
System
ABC System of
Inventory Control
Inventory Control Just-in-Time Inventory

Techniques Approach
VED Analysis of
Inventory Control
FSND Analysis
Inventory Control Techniques
1. Perpetual Inventory System:- The continuous stock taking system is known
as the Perpetual Inventory System. According to the definition of CIMA, The
Perpetual Inventory System is “the recording, as they occur, of receipts, issues
and the resulting balances of an individual items of stock in either quantity or
quantity and value”.
2. ABC System of Inventory Control:- Under this system, The items of

inventory are categorized according to the value of usage of material inputs.
Broadly, the materials are classified into three categories as A, B and C
according to their values. Items under category A constitute the most important
class of inventories in the overall proportion in the total value of inventory. The
A items constitute between 5-10% of the total items but value maybe almost
80% of the total value of inventory. Category B items constitute an
intermediate position, i.e. 20-25% of total items and 15% of total value.
The philosophy behind this system is that the items having highest value should
be controlled more carefully as they involve higher cost of holding. On the other
hand, items having medium and small values in terms of costs, despite large in
quantity can be controlled periodically
Inventory Control Techniques contd….
3. Just-In-Time Inventory Approach:- Just in time inventory (JIT) approach of
inventory management was developed by Japanese firms with the concept of no
inventory holding and therefore avoiding completely the inventory holding costs.
This is the more recent trend in inventory management. This principle focuses on
total elimination of the intermediate stages like score-keeping, maintenance, etc.
The materials ordered and purchased from supplier should directly reach the
assembly line exactly when they are required for the production process. There is no
need of storing the materials and then carrying them to the assembly unit.
4. VED analysis of Inventory control:- The analysis known as vital, essential and
desirable (VED) is based on the degree of criticality of the raw materials in a firm.
According to this approach the materials are divided into three categories in the
descending order depending on their criticality.
‘V’: is an indication of vital items and their stock analysis requires prime focus.
‘E’: signifies the essential items required by a firm in the production process.
‘D’ : relates to desirable items.
Inventory Control Techniques contd….
5. FSND analysis:-The holding period of materials which is known as age of the

inventory is also an important element based on which the materials can be
controlled.
This analysis categories the material based on their movement
F : Category F denotes fast moving items and those stocks which are consumed in a
short span of time
N: These are normal moving items of the stock and are generally utilized over
relatively longer period from 6 months to 1 year.
S : Is an indication of slow moving items. The stock holding period in such cases is
more than 1 year. The holding is reviewed periodically and in case they are not
required , they can be eliminated
D : D is dead stock. This means that there will not be any further demand for such
items. Therefore, the firm identifies such items and eliminates from the stores or
makes alternate arrangements
Lets test our understanding !
1. In ABC analysis, high cost items are most likely to fall in Category A and
least cost items are likely to fall in Category C. State whether True or False.
Ans 1: The statement is not correct because in ABC Analysis , the categorization
of A, B and C is done on the basis of their annual usage value (consumption
value) and not on their cost.
2. EOQ is based on a balance between Inventory carrying costs and shortage

costs. State if this statement is right, Why ?
Ans 2 :This statement is not correct because EOQ is based on balancing

between ordering cost and carrying cost of inventory. It does not take into
account Shortage cost
Do you feel you have a good understanding of the
Material cost control process ?
Do you feel you can choose the right material pricing

method for controlling costs and increasing Revenues?
…and similar such decisions ?

Key Words
Material Control : To exercise effective control on Material movement
Material Requisition slip : A slip devised for giving orders by the departments to issue materials
BIN card : Maintaining quantitative record of materials
FIFO: Material priced on the basis of receipts in the stores first to be issued
LIFO: The materials received in the last are issued first and priced accordingly
ABC: Categorization of materials inputs based on their importance
JIT : An inventory management system where inventory are received directly in the assembly
just in time.
Bill of Materials : A schedule of details of materials received and issued
EOQ : Optimum level of quantity to be ordered at a time
VED : Categorization of material inputs as vital, essential and desirable

LET US SUM UP
Raw Material Costs and management process :
Raw material inputs are the most significant in a manufacturing unit as they form
approximately 60% of the total cost of production
It is very important to have an adequate control on the cost of material acquisition
Efficient Materials issue process is a fundamental requirement to ensure timely

availability of materials by the concerned departments
Appropriate pricing policy for issuance of materials from Stores to Production

department
LET US SUM UP
Bin card:
a. It is the quantitative record of all receipt of the materials, issue of materials and
the balance of materials on a particular day
b. This record is kept for each and every material and entries are made daily
after every receipt and issue
c. It contains quantity and other details
Inventory Control:
a. It is one of the most important aspects in effective material management of
inventory and its control
b. Both Under-stocking and over-stocking are undesirable. Hence assessment of
Maximum level, minimum level and reorder level is imperative for efficient cost
management
c. Inefficient management will result in higher cost and losses to the firm
89
Session 2
Chapter No 2- Labour Cost and

Overhead cost Control
Reshma Narang Bathija

Before we start …
off at any time !!
2


3
Learning Objectives
1. Different concepts of labour cost.
2. Labour turnover and its impact.
3. Mechanism of time recording of the workers.
4. Applying Method Study
Methods of Work Study
5. Techniques of job evaluation.
6. Methods of wages to the workers.
7. Various incentives to the workers.
8. Concept of overheads.
9. Difference between direct costs and overheads.
10. Overhead allocation process.
11. Overhead absorption.
1. Labour Cost
Concept of Management and Cost accounting – An
introduction



Labour Cost control – An introduction
3 major components involved in the manufacturing

process of a product are :
• Materials
• Labour
• Overheads
The control of labour cost is a sensitive issue as it

involves human factor and even slight mishandling
may create a problem for the organisation
Classification of Labour
Cost
Labour Cost Controls
Process and Production

Planning
Issues Concerned with

Labour Budget
Labour cost Control
Standard Labour Cost
Job Performance Report
Work Performance
Incentives
1.1 Classification of Labour Cost
1. Direct Labour Cost: It is the amount of Remuneration that can be
identified and attributed directly to a product or service unit.
2. Indirect Labour Cost: Remuneration payable to the workforce where

their skills and contributions are not directly related to the particular
product or service unit. Eg: Salaries and wages paid to supervisors,
security staff , stores staff etc
Eg : Consider labour costs for programming at companies such as Apple

where programmers work on different software applications for products
like the iMac, the iPad and the iPhone.
• Direct programming costs that can be traced to individual products
• Indirect Labour compensation for :
Office Staff
Office Security
Salaries for Department Heads, supervisors and Managers
Payroll Fringe costs eg: Health care insurance, pension costs etc
1.2 Labour Cost Controls
Various methods of controlling labour costs are :
• Hiring workers as per Budget allocated by the company

to Labour cost
• Proper time recording systems
• Allocating standard labour cost for the job or the

product
• Proper maintenance of job profile of individual

employees
1.3 Process and Production planning
• This can be achieved by proper planning of the production process in

a scientific manner.
• The production planning process may involve activities like planning,

scheduling, routing, machine loading, product and process
engineering, work study through well laid down norms.
• Time and Motion study is a significant mechanism which helps in

fixation of standard time for a particular job
• Once the standards are fixed, the monitoring process becomes simple
as you have to analyse the actual costs with the pre-determined
standards
1.4 Labour Budget
A firm prepares various budgets to have effective control on various

operations
The labour budget is prepared to forecast the budgeted expenditure on

workforce activities like recruitments, wages and salaries and other
remunerations.
It helps in Budgetary control.
At the end of a particular time period, an analysis can be made to

assess the variances between budgeted levels and actual costs under
different components
1.5 Standard Labour Cost
An organisation may determine the labour costs on a per unit basis to

compare with the actual labour cost.
The standard labour cost is the cost which is determined based on the
past trends, industry practices, technological aspects etc
This is determined under optimum working conditions and helps a firm

to adhere to adequate controls in the future
The standards can also be fixed based on time and motion study
This has been an effective way to monitor and control the labour costs
1.6 Job Performance Report:
A firm may introduce individual job performance report

which can be used for performance evaluation
periodically.
This will indicate labour efficiency and time utilization

by the individual workers
This is an important tool in measuring the efficiency

and productivity of workers
1.7 Work Performance Incentives
• Incentives related to work performance have a significant impact on the
productivity of workers
• There are 2 aspects to it :

• Costs
• Increased Productivity
• An organisation has to decide the balance between incentives and

productivity i.e determine the amount of incentives that will bring
efficiency in the production process vis a vis the additional cost of such
incentives
• Improving labour productivity has a direct impact on labour cost per unit
• Incentives may be Monetary or Non-Monetary
• Incentive schemes should be reviewed from time to time to understand

their efficacy and impact on productivity
2. Labour Attrition / Turnover
Labour Attrition
Labour Attrition rate or Labour turnover is the

frequency of Labour exit from one Organisation to
another in a given period of time.
Factors Affecting Labour Turnover
Internal Factors for Labour Turnover
1. Labour may not be satisfied with the type and process of job.
2. There may be problem with the scheduled working hours which
may not be suitable.
3. The working environment prevailing in the factory may not be
conducive.
4. Lack of cooperation among the workers.
5. Unhealthy relations with the superiors and management.
6. The remuneration policies may not be suitable as compared to
other firms. There may be lack of incentives and motivations.
Factors Affecting Labour Turnover
Internal Factors contd….
7. This apart, there may be other causes like inadequate facilities in

terms of health insurance, inadequate safety measures, high risk in
operations, lack of suitable promotion policy, inadequate
arrangements for training and absence of other incentives.
External Factors
1. Turnover due to retirement, death and other family and personal

reasons.
2. Continuous ill health, accident and other physical problems.
3. Location change of a worker.
4. Other social and family circumstances.
Labour Turnover & Its Costs
Co-relation
Higher the labour turnover, higher will be the cost of the product to a firm.
Hence, Firms set strategies to minimise the labour turnover.
The costs related to labour turnover are :
Preventive Costs
• Prevention is better than cure
• Costs of personnel management
• Costs of providing better medical facilities
• Costs for providing transport, housing, other facilities
• Costs related to pension, gratuity schemes and post-retirement benefits
Replacement Costs
• Cost of recruitment & training a new worker
• Loss of output due to lower efficiency of new worker
• Loss on account of increase in wastage
• Costs of machine breakdown
Measurement of Labour Turnover
1.Addition Rate :
Under this method, the number of employees inducted during a particular
time period are considered for the measurement of labour turnover ratio. The
formula is as follows:
2.Separation Rate :
In this method, the number of employees who left during a particular time
period are considered for the measuring the separation rate. The formula is
as follows
Measurement of Labour Turnover
3.Replacement Rate:
Under this method, the number of employees replaced during a period is
taken into account for computing the labour replacement rate. The formula is
as follows:
4.Flux Rate :
Slightly different method whereby labour turnover is computed by considering
the additions of workers during the period and also separations during the
period. It is computed as follows:
3. Time recording
Recording of Timings - Significance
Following is the significance of maintaining proper record of time for
each of the worker:
1. Measurement of Productivity: The total number of hours worked

by each workman can be ascertained for the purpose of calculations of
wages, salaries, incentives, etc. This is more relevant in the firms
where workers are paid wages as per the time rate plan.
2. Punctuality and Discipline: This is also required to keep a track on

punctuality and discipline among the workers. Each worker remains
conscious about the punctuality and timings.
3. Calculation of Benefits: There are certain mandatory requirements

to receive benefits like pension, gratuity, leave with pay, provident
fund, promotion and salary scale on the basis of continuity of service.
In that case, attendance records are required to properly verify to
ascertain eligibility for such benefits.
Recording of Timings – Significance…. contd
4. Calculation of Overheads:
In cases where the firm follows the policy of overhead
allocation based on labour hours, a proper record of
time keeping is very much required to measure the
exact number of hours consumed for the product.
5. Labour Efficiency Ratio:

There is also significance of maintaining time records
for workers to ascertain the standard time for work and
thus calculate the idle time spent by workers. We can
also calculate the labour efficiency ratio by maintaining
proper time records.
4. Method Study
Method Study
1. This method is more appropriate where jobs are complex and
operations are costly.
2. It is necessary to have all the related information about a job, like
purpose, location, sequence, relationship with other works, methods
of working, operators, requirement of skilled workers, facilities
required, etc.
3. The working systems are modified and redesigned after studying the
relevant aspects of the job in details. This may help a firm to change
the location and sequence of the work, methods of production and
the layout for the job, depending on the study results. This will bring
more efficiency, effective way of completing a job and quality
improvements.
4. There is a need for close monitoring and follow-up to evaluate the
modified systems. Thus, method study is more significant for utilizing
resources more efficiently and to achieve higher level of production
with reduced costs.
5. Job Evaluation
Job Ranking Method
Point Ranking Method
Grade Description Method

Evaluation of Job
Factor Comparison
Method
Merit Rating
Time and Motion Study

Evaluation of Job
1. Job ranking method:
• Under this method, jobs are ranked according to the importance on

the basis of skills required, education, experience requirements,
working conditions, etc.
• A ranking is done by comparing the other jobs.
• The different jobs are rearranged in the similar order. The wages,
salaries and other compensations are decided on the basis of ranks.
• This method is simple and can be used when the size of the
organization is small.
Evaluation of Job
2. Point ranking method:
The jobs under this method are analysed in terms of job factors or
characteristics.
The job factors may include skills required, efforts involved, working
conditions, etc.
Thereafter, each job factor is given weight or points based on its value
to the job.
The jobs are ranked according to the total score and placed under pre-
decided grades.
Evaluation of Job
3. Grade description method: as a matter of policy, a firm

decides, in advance, certain grades according to education,
experience, skills, etc. and the jobs are placed in a suitable grade.
4. Factor comparison method: In this case, a firm identifies

some key jobs and ranks them according to different factors. The
jobs are ranked and evaluated skills, responsibilities, working
conditions, etc. The jobs are evaluated and compared with other
jobs and a factor scale is constructed.
Evaluation of Job
5. Merit Rating:
Job Evaluation is concerned with the rating of a job to establish

rationality to design wages and salary structure in an organisation.
Merit Rating is the process of comparative where analysis of merits of

individual workers assumes significance.
Thus Merit rating aims at evaluation and ranking of Individual workers
This helps in designing and implementing rational promotional policies.

Evaluation of Job
Objectives of Merit Rating:
1. To evaluate merit of workers for promotions, increments,

rewards and other incentives.
2. To establish and develop a wage system and incentive

scheme.
3. To identify and allocate appropriate and suitable jobs for the

workers.
4. To develop a self-designed system enabling a worker to

evaluate own merits and identifying areas needing
improvements and developing capabilities and competencies.
Evaluation of Job
6. Time and Motion Study :

Two studies (Time and Motion) need to be performed
Motion study precedes Time study
In Motion Study, a job is divided into fundamental elements or basic
operations. It is a study of all movements in a job, process or operation to
find out the most scientific and systematic approach of performing a job.
Time Study measures the time required to be spent on a job as per pre-
determined standards (derived from Motion Study). The work to be
performed is observed under specified conditions by direct observation
using a time measurement device to rate individual elements.
The standard time is fixed after considering normal idle time.
Time and Motion Studies help in designing efficient incentive systems.
Evaluation of Job
Objectives of Time and Motion Study :
1. Bringing more efficiency in the production process by removing
undesired motions in the process.
2. Designing and developing improved methods, techniques and
processes for completing the job.
3. Effective and efficient utilization of resources.
4. Developing a conducive work environment through proper layout
of plant.
Advantages of Motion Study :
1. A well designed motion study will have the following benefits:
2. Proper assessment of labour requirement
3. Promoting incentive systems by fixing suitable standard time.
4. More realistic labour budget and production budget
5. Bringing about improvements in labour productivity by designing
more scientific methods for job performance.
6. Wages & Incentives
Wages = Number of hours worked x
Flat Time Rate System wage rate per hour
Time Rate at High Day Wages = Number of hours worked x
Rate Plan High day rate per hour
Graduated Time Rate Plan
Piece Rate Method
Taylor’s Differential Piece
Rate System
Methods of Gantt Task Bonus Plan
Wage
Payment Halsey Premium Plan Total earnings = H × R +[50%(S − H)× R]
Halsey-Weir Plan Total earnings=H × R +33.1%(S − H)× R]

Rowan Plan
Group Bonus Plan
Priestman’s Bonus Plan
Towne Profit Sharing Plan
Non-Monetary Incentives
Methods of wage payment
1. Flat time rate system:
Under this method, the workers are paid on an hourly, daily or weekly
basis based on the time spent on the job. The overtime is paid as per the
requirements of the act. The workers under this system receive a fixed
minimum income irrespective of the output produced by them. This
method is useful in a job where in the quality is a concern, where an
individual worker has hardly any control over the job and the speed of
production is governed by time.
Wages= Number of hours worked x wage rate per hour
The benefit of this method to a worker is that the worker is assured
of minimum income irrespective of the output produced.
Therefore, the quality of product becomes a focus.
The limitations to this method are that it doesn’t offer any incentives to
the efficient workers.
2.Time day at high day rate plan:
Under this system, the workers are paid at time rate but the rate is
much higher than that is normally paid in the industry.
The workers who are efficient, skilled and experienced are selected
to work.
The wages are paid according to the time taken to complete a job.
This method offers high incentives to the talented workers.
A very less degree of supervision is required under this method.
However, ensuring that a high day rate is really brought, the
desired results are difficult
Wages = number of hours worked x high day rate per hour

3. Graduated time rate plan:
Under this method, wages are paid at different time

rates.
The wage rate varies according to the efficiency of the

workers.
The normal wage rate is paid for standard efficiency and

a higher wage rate for increased efficiency.
4.Piece rate method:
Under this method, the workers are paid according to
the production performed by them.
A worker who produces greater output, earns higher
wages. This can be a straight piece rate system where
rate per unit is fixed and the worker is paid according to
this rate.
There can also be a differential piece rate system
where standard rate per hour of production is
increased as the output level also increases.
The increase in rates maybe proportionate to the
increase in output or proportionately more or less than
the pre-determined.
5. Taylor’s differential piece rate system: @ 120% of Normal Piece rate
This system presumes that there are only two classes of workers,
efficient and inefficient.
The model suggests that while efficient workers must be encouraged
to the maximum level possible, inefficient workers should be
penalized.
Therefore, two different rates have been suggested for the two
different classes of workers.
According to this system, if the worker is efficient, he should be paid
120% of the normal piece rate while the inefficient workers they
should be paid at 80% of the normal piece rate.
The standards of production are pre-fixed. If the production exceeds
the standards, it is considered efficient (and if not, it is considered @ 80% of normal piece rate
inefficient.)
5. Taylor’s differential piece rate system – continued - example :
The standard production is 10 units per day
There are 2 workers – X & Y and the Piece Rate is Rs 20 per piece
X produces 11 units and Y produces 8 units
As per Taylor’s Differential Piece Rate System :

Payment to X (above standard)
= 11 * 20 * 1.20 (@ 20% premium since production > standard)
= 264
As per Taylor’s Differential Piece Rate System :
Payment to Y (below standard)
= 8 * 20 * 0.80 (@ 20% discount since production > standard)
= 129.60
6. Gantt task bonus plan: This model was developed combining time
rate, bonus and piece rate plan. This model suggests the following
remuneration system given in the table:
Assessment of remuneration under Gantt Task Bonus Rate

Output Payment
Below standard Guaranteed wage rate
Standard output 20% bonus of time rate= 120%

of time rate
Above standard Standard high rate for the
whole output
6.Gantt task bonus plan (continued…)
Therefore, the model provides sufficient opportunities

to incentivise the workers. The advantages of this plan
are as follows:
➢The workers who are below average receive
guaranteed time wages.
➢It differentiates efficient and non-efficient workers due
to extra bonus for efficiency.
However, the limitation of this plan is that it segregates

the workers on the basis of their efficiency which is not
a good policy for developing better relationship among
the workers.
7. Halsey premium plan: The wages plan under this model was
developed by F.A. Halsey, an engineer in the U.S.A.
• Under this plan, a standard time is calculated for each unit or job an
50% of time saved is allotted as bonus.
• If the actual time taken by the worker to perform a job is lesser than
the standard, the worker becomes entitled to a bonus.
• The bonus is paid equal to the wages of 50% of the time saved. A
worker remains assure of the time wages if longer time is taken than
the standard time.
Total Earnings= H x R + [50% (S-H) x R]
Where ‘H’ is the number of hours worked,
‘R’ is the rate per hour and
‘S’ is the standard time.
8.Halsey Weir-Plan:
Under this method, only 33.33% of the time saved instead
of 50% as suggested in the previous model. Accordingly the
formula for this method is modified as follows:
Total Earnings= H x R + [33.1% (S-H) x R]
Where ‘H’ is the number of hours worked, ‘R’ is the rate per
hour and ‘S’ is the standard time.
8.Halsey Weir-Plan:
• The advantages are as follows:
➢It guarantees time wages to the workers
➢Differentiates efficient and non-efficient workers and
provides incentives accordingly
➢It reduces the labour cost
➢When production increases, fixed overhead per unit
gets reduced
➢Overall production cost is minimize
• However, the major limitation of this method is that, the

workers work in hurry to save more time and thus acquire a
higher bonus which may result in poor quality of the product
or service.
9.Rowan Plan:
This is the premium bonus plan where bonus hours are
calculated in proportion to the time taken, where the
proportion of time saved to the time allowed is
calculated and they are paid for, at time rate.
(𝑺−𝑯)
Over here: Total Earnings= (H x R) + x (H x R)
𝑺
Where ‘H’ is the number of hours worked,
‘R’ is the rate per hour
and ‘S’ is the standard time.
9.Rowan Plan contd:
• The advantages of this plan are as follows:
➢The worker receives guaranteed time wages
➢Since the bonus increases at decreasing rate and
efficiency, it ensures the quality of the work receives
importance at each level.
➢The wages saved in terms of time is shared between
both worker and employer and thus it helps in reducing
the labour cost per unit.
➢It also helps in reducing fixed overhead per unit due to
increased production.
• The limitation of this plan is that workers do not receive full
advantage of the time saved and a highly efficient worker is
not equally compensated.
10. Group Bonus Plan:
At times the output in a firm is measured in terms of group
performance. In such cases, group bonus system is
implemented.
The total amount of bonus is determined according to
productivity. This can be shared equally or in agreed proportion
among the group members.
• The advantages of this plan are as follows:
➢Developing team spirit among workers
➢Most effective utilization of materials and time
➢Group efforts receive better focus and help in productivity
• The group bonus can be budgeted expenses bonus where the
bonus is determined based on the savings in actual total
expenditure as compared with the budget level expenditure.
10. Group Bonus plan… contd
• Another category can be cost effective bonus where standards are pre-
decided for expenses like material, labour and overheads.
• The actual expenditure against the standards is measured and if there is
a savings in actual expenditure, cost effective bonus is applied and a
proportion of such savings is distributed among the workers.
11.Priestman’s Bonus Plan:

• Under this method, the standards for output are pre-determined and if
actual production exceeds the standard level of output, a fixed
percentage of bonus is paid on the excess output.
• The amount of bonus is distributed among the workers in the particular
production unit.
• The limitation of this is that it doesn’t differentiate amongst efficient and
inefficient workers.
• This method is generally implemented in foundries.
12.Towne Profit Sharing Plan:

• Under this plan, the standards are fixed
particularly for labour costs and then actual costs
are compared with the fixed standards.
• If there is a saving in the cost, the saving is
shared by the workers and the supervisors in an
agreed proportion.
• The concept is that if there is a saving in the cost,
not only the workers but also the supervisory staff
must be rewarded since the cost reduction
occurred due to joint efforts.
13.Non Monetary Incentives:
• Many firms introduce non monetary incentives.
These incentives are given in addition to the
monetary incentives to encourage the workers and
motivate them to contribute more effectively.
• The benefits may not result in additional
remuneration to workers but they certainly help to
improve better participation.
• Some of the usually practiced non-monetary
incentives include free education and training,
medical benefits, subsidized canteen facilities,
superannuation benefits like pensions, gratuity, life
insurance schemes, sports and recreation facilities,
housing facilities, etc.
Summary
Type Features
Time rate at high day Very high time rate used to incentivise workers.
Graduated time rate Wages are paid at different time rates
Taylor’s differential piece Workers are classified as efficient and
rate inefficient
Gantt Task Bonus Plan Combination of Time Rate, Bonus and Piece
Rate
Halsey Premium Plan Bonus on 50% of time saved through efficiency
Rowan Plan Premium bonus plan for the time saved
Group Bonus Plan Measures performance of a group of workers
Key Words
• Indirect Labour Cost: Expenses incurred on the workers who are
not directly connected with the production process
• Labour Turn Over: The frequency of the movement of the workers

from one organization to another
• Idle Time: The time spent by the workers without work
• Clock- Card: A time recording mechanism of the workers
• Piece Rate System: A wage rate system where workers are paid
on the basis of output
Key Words
• Incentive Wage Plans: A process which links incentives to the

production
• Payroll Department: A department in a firm involved in preparing

payrolls for workers
• Time rate System: A system of wage payment where wages to

workers are paid according to time spent in factory
• Group Bonus Plan: A plan whereby bonus for productivity is paid to all
in group
• Job evaluation: A process of measurement of performance of a

worker based on job
Quiz
Quiz Time
Q1. Which department prepares Wage sheet ?
a. Time – Keeping Department
b. Personnel Department
c. Payroll department
d. Engineering department
Quiz Time
Q1. Which department prepares Wage sheet ?
a. Time – Keeping Department
b. Personnel Department
c. Payroll department
d. Engineering department
Quiz Time
Q2. Which of the following plans does not guarantee

wages on time basis ?
a. Halsey plan
b. Rowan plan
c. Taylor’s differential piece rate system
d. Gantt’s task and bonus system

Quiz Time
Q2. Which of the following plans does not guarantee

wages on time basis ?
a. Halsey plan
b. Rowan plan
c. Taylor’s differential piece rate system
d. Gantt’s task and bonus system

Quiz Time
Q3. Method of wage payment is crucial for :
a. Offering appropriate Incentives
b. Providing Minimum wages
c. Reducing cost per unit of production
d. All of the above

Quiz Time
Q3. Method of wage payment is crucial for :
a. Offering appropriate Incentives
b. Providing Minimum wages
c. Reducing cost per unit of production
d. All of the above

Problems and Solutions
Solved Questions :
1. A worker takes 6 hours to complete a job under a scheme of payment
by results. Standard time allowed for the job is 9 hours. His wage rate is
Rs 150 per hour. Material cost of the job is Rs 1600 and factory
overheads are recovered at 140% of total direct wages. Calculate factory
cost of the job using :
1. Rowan system of incentive payments
2. Halsey system of incentive payments

Solution:
We know :
Time allowed (hrs) TA 9
Hours Worked HW 6
Time saved (hrs) TS 3
Rate per hour RH 150
Material M 1600
Solution:
TA 9
Rowan System : HW 6
E= HW * RH + (TS * HW * RH) TS 3
TA RH 150
= 6 * 150 + (3 * 6 * 150) M 1600
9
= 6 * 150 + (300)
= 900 + 300 = 1200

Solution:
TA 9
Rowan System : HW 6
E= HW * RH + (TS * HW * RH) TS 3
TA RH 150
= 6 * 150 + (3 * 6 * 150) M 1600
9
= 6 * 150 + (300)
= 900 + 300 = 1200
Halsey System :
E= HW * RH + (50% * TS * RH)
= 6 * 150 + (0.5 * 3 * 150)
= 900 + 225 = 1125

Solution:
TA 9
HW 6
TS 3
RH 150
M 1600
Rowan 1200
Halsey 1125
Factory Cost Rowan Method Halsey Method

Material 1600 1600
Labour 1200 1125
Factory overheads* 1680 1575
Total 4480 4300
* Factory overheads @ 140% of Labour
Solved Questions :
2. Two workmen, Jai and Veeru produce the same product using the
same material. Their normal wage rate is also the same. Jai is paid
bonus according to the Rowan System while Veeru is paid bonus
according to the Halsey system. The time allowed to make the product is
100 hours. Jai takes 60 hours while Veeru takes 80 hours to complete
the product.
The factory overhead rate is Rs 10/- per manhour actually worked. The
factory cost for the product for Jai is Rs 7,280/- and for Veeru it is Rs
7,600/-. You are required :
1. To find the normal rate of wages
2. To find the cost of materials
3. To prepare a statement comparing the factory cost

of the products as made by the two workmen.
Solution:
In this problem, we have to find out the normal rate of wages and cost of
materials by means of simultaneous equations
Cost of Materials = M
Labour cost = L
Factory Overheads (FOH):
Jai = 60*10= Rs 600/-
Veeru = 80*10= Rs 800/-
Factory cost of the Product = M+L+FOH
Factory Cost of Product - Jai = Rs 7,280/-
Factory Cost of Product - Veeru = Rs 7,600/-

Solution:
Labour Cost (Normal rate of wages) :
Jai is paid bonus using the Rowan System

Jai : Time Saved = 100 – 60 = 40 (hrs)
Rowan System :
E= HW * RH + (TS * HW * RH)
TA
= RH * (HW + TS * HW)
TA
= RH * (60 + 40 * 60)
100
= RH * (60 + 24)
= 84 RH (Labour cost of Jai)

Solution:
Labour Cost (Normal rate of wages) :
Veeru is paid bonus using the Halsey System

Veeru : Time Saved = 100 – 80 = 20 (hrs)
Halsey System :
E= HW * RH + (50% * TS * RH)
= RH * (HW + TS * 50%)
= RH * (80 + 20 * 0.50)
= RH * (80 + 10)
= 90 RH (Labour cost of Veeru)

Solution:
Factory Cost of Product - Jai = Rs 7,280/-
Factory Cost of Product - Veeru = Rs 7,600/-
For Jai : Labour cost = 84 RH and FOH = 600
For Veeru : Labour cost = 90 RH and FOH = 800
Therefore,
M + 84 RH + 600 = 7280
M + 90 RH + 800 = 7600
Solving these, we get :

RH = Rs 20 (normal rate of wages per hour) and
M = 5000
Solution for equations (reference) :
M + 84 RH + 600 = 7280
M + 90 RH + 800 = 7600
-M - 84 RH = -6680 (multiplying by -1)

M + 90 RH = 6800
0 + 6 RH = 120
RH = 120 / 6 = 20
M + 90RH = 6800
M + 90 * 20 = 6800
M = 6800 – 1800 = 5000
Solving these, we get :

RH = Rs 20 (normal rate of wages per hour) and
M = 5000
Solution:
We know : Material Cost and FOH (Jai) and FOH (Veeru)

We need to ascertain Labour Cost for respective worker
Labour Cost for Jai = 84 RH = 84 * 20 = 1680

Labour Cost for Veeru = 90 RH = 90 * 20 = 1800
(you will arrive at the same result if you apply in the Rowan & Halsey formula)
Cost Product made by Product made by

Jai Veeru
Material 5000 5000
Labour 1680 1800
Factory overheads 600 800
Total 7280 7600
Take-aways
Classification of Labour
Cost
Labour Cost Controls
Process and Production

Planning
Issues Concerned with

Labour Budget
Labour cost Control
Standard Labour Cost

Take
aways
Job Performance Report
Work Performance
Incentives
Take-aways
• Labour Turnover is co-related with costs of a Firm

• Labour Turnover has costs : Preventive and Replacement
• Measuring Labour Turnover : Addition Rate / Separation Rate /
Replacement Rate / Flux Rate
• Significance of Recording of Timings
Take
aways
Job Ranking Method
Point Ranking Method
Grade Description Method

Evaluation of Job
Factor Comparison
Method
Take
Merit Rating aways
Time and Motion Study

Wages = Number of hours worked x
Flat Time Rate System wage rate per hour
Time Rate at High Day Wages = Number of hours worked x
Rate Plan High day rate per hour
Graduated Time Rate Plan
Piece Rate Method
Taylor’s Differential Piece
Rate System
Methods of Gantt Task Bonus Plan
Wage
Payment Halsey Premium Plan Total earnings = H × R +[50%(S − H)× R]
Halsey-Weir Plan Total earnings=H × R +33.1%(S − H)× R]

Rowan Plan
Take
Group Bonus Plan aways
Priestman’s Bonus Plan
Towne Profit Sharing Plan
Non-Monetary Incentives
Type Features
Time rate at high day Very high time rate used to incentivise workers.
Graduated time rate Wages are paid at different time rates
Taylor’s differential piece Workers are classified as efficient and
rate inefficient
Gantt Task Bonus Plan Combination of Time Rate, Bonus and Piece
Rate
Halsey Premium Plan Bonus on 50% of time saved through efficiency
Rowan Plan Premium bonus plan for the time saved Take
Group Bonus Plan Measures performance of a group of workers aways
Do you feel you have a good understanding of the Labour
cost control process ?
Do you feel you can choose the right Wage payment

method for controlling costs and increasing Revenues?

86
Overhead Cost Control
What are Overheads?
• Overheads are those costs which are not identified with

any product
• Overheads are a common cost comprising of indirect
material, labour and expenses
• The overheads are apportioned to the Cost units
Classification of costs into Fixed and Variable
Advantages :
1. Controlling expenses: Classification into Fixed and Variable

components helps in controlling expenses. Fixed costs are generally
policy costs which cannot be easily reduced. They are incurred
irrespective of the output and hence are more or less non-controllable.
Variable expenses vary with the volume of activity and the responsibility
for incurring such expenditure is determined in relation to the output.
The management can control these costs by giving proper allowances
in accordance with the output achieved.
2. Preparation of Budget estimates: The segregation of overheads

into fixed and variable part helps in the preparation of flexible budget. It
enables a firm to estimate costs at different levels of activity and make
comparison with the actual expenses incurred.
Advantages :
3. Decision Making: The segregation of semi variable costs between
Fixed and variable overhead also helps the management to take many
important decisions.
For eg : The decisions regarding the price to be charged during
Depression or Recession or for export market
Likewise decisions regarding Make or Buy, Shut down or continue are also
taken after separating Fixed cost from Variable cost
When any important change is contemplated, for eg increase or decrease

in production/ change in the process of manufacture or distribution ,
segregation of Fixed and Variable cost enables us to ascertain the total
impact on cost or revenue.
The technique of marginal costing, cost-volume-profit relationship and
Break-even analysis are all based on such segregation
Invoices
Stores requisition
Estimation and collection of
manufacturing overheads
Wage analysis
book
Cost allocation
Journal entries
Cost apportionment
Manufacturing
Overheads
Re-apportionment
Absorption
Treatment of over- and under-

absorption of overheads
Difference Between Allocation and Apportionment
1. Allocation deals with the whole items of cost which are identifiable with any one
department. For example, indirect wages of three departments are separately
obtained and hence each department will be charged by the respective amount
of wages individually.
2. On the other hand, apportionment deals with the proportions of an item of cost,
for example, the cost of the benefit of a service department will be divided
between those departments which has availed those benefits.
3. Allocation is a direct process of charging expenses to different cost centers,
whereas apportionment is an indirect process because there is a need for the
identification of the appropriate portion of an expense to be borne by the
different departments benefited.
4. The allocation or apportionment of an expense is not dependent on its nature,
but the relationship between the expense and the cost center decides that
whether it is to be allocated or apportioned.
5. Allocation is a much wider term than apportionment.
Methods of Absorbing Overheads to Various Products or
Jobs
1. Total amount charged (or recovered) in a period does not differ

materially from the actual expenses incurred in the period.
2. Amount charged to individual jobs or products is equitable. In case
of factory overhead, this means that:
a) The time spent on completion of each job should be taken into
consideration.
b) A distinction should be made between jobs done by skilled
workers and those done by unskilled workers.
c) Jobs done by manual labor and those done by machines
should be distinguished.
Percentage of Direct Material Cost
Percentage of Prime Cost Method
Percentage of Direct Labour Cost
Labour Hour Rate
Machine Hour Rate
Rate per Unit of Output Method

Types of Overhead Rates
Normal Rate
Pre-Determined Overhead Rate
Blanket Overhead Rate
Departmental Overhead Rate

96
Session 3
Chapter No 3- Labor Cost and

Overhead cost Control

Before we start …
off at any time !!
2


3
Learning Objectives
1. Different concepts of labour cost.
2. Mechanism of time recording of the workers.
3. Methods of wages to the workers.
4. Various incentives to the workers.
5. Production cost and incentives.
6. Labour turnover and its impact.
7. Techniques of job evaluation.
8. Concept of overheads.
9. Difference between direct costs and overheads.
10. Overhead allocation process.
11. Overhead absorption.
Overhead Cost Control
What are Overheads ?
• Overheads are those costs which are not identified with

any product
• Overheads are a common cost comprising of indirect
material, labour and expenses
• The overheads are apportioned to the Cost units
Advantages :
1. Controlling expenses: Classification into Fixed and
Variable components helps in controlling expenses. Fixed
costs are generally policy costs which cannot be easily
reduced. They are incurred irrespective of the output and
hence are more or less non-controllable. Variable expenses
vary with the volume of activity and the responsibility for
incurring such expenditure is determined in relation to the
output. The management can control these costs by giving
proper allowances in accordance with the output achieved.
2. Preparation of Budget estimates: The segregation of

overheads into fixed and variable part helps in the
preparation of flexible budget. It enables a firm to estimate
costs at different levels of activity and make comparison
with the actual expenses incurred.
Advantages :
3. Decision Making: The segregation of semi variable costs
between Fixed and variable overhead also helps the management
to take many important decisions.
E.g. : The decisions regarding the price to be charged during
Depression or Recession or for export market
Likewise decisions regarding
• Make or Buy,
• Shut down or continue
are also taken after separating Fixed cost from Variable cost
When any important change is contemplated, for eg increase or
decrease in production/ change in the process of manufacture or
distribution , segregation of Fixed and Variable cost enables us to
ascertain the total impact on cost or revenue.
The technique of marginal costing, cost-volume-profit relationship
and Break-even analysis are all based on such segregation
Invoices
Stores requisition
Estimation and collection of
manufacturing overheads
Wage analysis
book
Cost allocation
Journal entries
Cost apportionment
Manufacturing
Overheads
Re-apportionment
Absorption
Treatment of over- and under-

absorption of overheads
Accounting and Control of Manufacturing Overheads
Overheads: Costs which, by nature, are such costs

which cannot be directly related to a product or to
any other cost unit. Yet for working out the total
cost of a product or a unit of service, the
overheads must be included.
Hence, we have to find out a way by which the
overheads can be distributed over the various
units of production.
Manufacturing Overheads
Generally, manufacturing overheads form a substantial portion
of the total overheads. It is important that such overheads
should be properly absorbed over the cost of production to
arrive at the Factory cost of the unit.
Let us understand about Factory Overheads :

1. Estimation
2. Cost allocation
3. Cost Apportionment
4. Cost Re-apportionment
5. Absorption
6. Under-absorption and Over-absorption treatment
1. Estimation and collection of manufacturing
overheads:
The first stage is to estimate the amount of overheads,

keeping in view the past figures and adjusting them for
known future changes. There are four main sources
available for the collection of factory overheads, viz.:
(a) Invoices
(b) Stores requisition
(c) Wage analysis book
(d) Journal entries
2. Cost allocation:
The term "allocation" refers to assignment or allotment of an entire

item of cost to a particular cost center or cost unit. It implies relating
overheads directly to the various departments.
The estimated amount of various items of manufacturing overheads

should be allocated to various cost centers or departments.
For example: If a separate power meter has been installed for a
department, the entire power cost ascertained from the meter is
allocated to that department.
The salary of the works manager cannot be directly allocated to any

one department since he looks after the whole factory.
It is, therefore, obvious that many overhead items will remain

unallocated after this step.
3. Cost apportionment:
There are some items of estimated overheads (like the salary
of the works manager) which cannot be directly allocated to the
various departments and cost centers.
Such un-allocable expenses are to be spread over the various
departments or cost centers on an appropriate basis.
This is called apportionment.
Thus apportionment implies
"the allotment of proportions of items of cost to cost
centers or departments."
After this stage, all the overhead costs would have been either
allocated to or apportioned over the various departments.
4· Re-apportionment:
All overheads are allocated and apportioned to all the departments,
both production and service departments.
Service departments are those departments which do not directly
take part in the production of goods.
Such departments provide ancillary services.
E.g. boiler house, canteen, stores, time office, dispensary etc
The overheads of these departments are to be shared by the
production departments since service departments operate primarily
for the purpose of providing services to production departments.
“The process of assigning service department overheads to
production departments is called reassignment or re-
apportionment “
At this stage, all the factory overheads are collected under production
departments
5. Absorption:
• After completing the distribution, the overheads charged to

the department are to be recovered from the output produced
in respective departments.
• This process of recovering overheads of a department or any
other cost center from its output is called recovery or
absorption.
• The overhead expenses can be absorbed by estimating the
overhead expenses and then working out an absorption rate.
• When overheads are estimated, their absorption is carried out by
adopting a pre-determined overhead absorption rate.
• There are different methods basis which this rate can be
calculated ( to be discussed later)
6. Treatment of over- and under-absorption of overheads:
After a year ends, the total amount of actual factory overheads is
known.
There is bound to be some difference between the actual amount

of overheads and the absorbed amount of overheads. So the
overheads are generally either under-absorbed or over-absorbed.
The difference has to be adjusted keeping in view of such

differences and the reasons thereof. This serves the following two
purposes:
1. To charge various products and services with an equitable
portion of the total amount of factory overheads.
2. To charge factory overheads immediately as the product or
the job is completed without waiting for the figures of actual factory
overheads.
Basis of Overhead Allocation
Overhead Cost Bases of Apportionment
Rent and other building expenses Floor area or Volume of each
Lighting and Heating Department
Fire safety
Air-conditioning
Perquisites Number of Workers
Labour Welfare
Time-keeping
Personnel Office
Supervision
Compensation to workers Direct Wages
Holiday pay
ESI & PF contribution
Perquisites
General Overheads Direct labour hours / Direct
Wages / Machine Hours
Basis of Overhead Allocation
Overhead Cost Bases of Apportionment
Depreciation of Plant and Capital Values
Machinery
Repair and maintenance of P&M
Insurance of stock
Power / Steam consumption Technical estimates
Internal transport
Managerial Salaries
Lighting Expenses Number of lighting points or area or
metered units
Electric power Horse power of machines or
number of machine hours or value
of units consumed
Material Handling Weight of materials or volume of
Stores overhead materials or value of materials or
units of material
1. Allocation deals with the whole items of cost which are
identifiable with any one department. For example, indirect
wages of three departments are separately obtained and hence
each department will be charged by the respective amount of
wages individually.
2. On the other hand, apportionment deals with the proportions of
an item of cost, for example, the cost of the benefit of a service
department will be divided between those departments which
has availed those benefits.
3. Allocation is a direct process of charging expenses to different
cost centres, whereas apportionment is an indirect process
because there is a need for the identification of the appropriate
portion of an expense to be borne by the different departments
benefited.
4. The allocation or apportionment of an expense is not
dependent on its nature, but the relationship between the
expense and the cost centre decides that whether it is to be
allocated or apportioned.
5. Allocation is a much wider term than apportionment.
Methods of Absorbing Overheads to Various
Products or Jobs
Products or Jobs
1. Total amount charged (or recovered) in a period does not differ

materially from the actual expenses incurred in the period.
2. Amount charged to individual jobs or products is equitable. In
case of factory overhead, this means that:
a) The time spent on completion of each job should be taken
into consideration.
b) A distinction should be made between jobs done by skilled
workers and those done by unskilled workers.
c) Jobs done by manual labour and those done by machines
should be distinguished
Some Terms
1. Prime cost:
It is the sum of total direct costs and includes cost of material

actually consumed for a product in a particular time period.
Direct labor cost including the amount payable (due but not paid) and
other direct expenses incurred during the period.
2. Factory cost or works cost
If factory overheads are added to Prime cost, we arrive at the total

Factory cost. It means cost of the product upto process at Factory.
This is also known as Factory cost gross. In this gross factory cost, if we
add Opening stock of WIP and subtract closing stock of WIP, we will the
value of the net Factory cost.
Products or Jobs
Several Methods are commonly employed, either individually
or jointly, for computing the appropriate overhead rate. The
more common of these are as follows:
1. Percentage of Direct materials
2. Percentage of Prime cost (Direct Materials + Direct Labour)
3. Percentage of Direct Labour cost
4. Labour Hour rate
5. Machine hour rate
6. Rate per unit of output
• This method is based on the fact that material cost is the
most significant cost in raising factory overheads.
• Hence, Direct Material cost should be taken as base for

absorbing the factory overhead.
• The over head rate in this method is computed by the

following formula:
• This method is based on the fact that both materials as well
as labour contribute in raising factory overheads.
• Hence, the total of the two, that is, prime cost should be
taken as base for absorbing the factory overhead.
• The over head rate in this method is computed by the

following formula:
Formula to be used in this method is computed by the
following formula:
Labour Hour rate
• This method is an improvement on the percentage of direct
wage basis, as it fully recognizes the significance of the
element of time in the incurring and absorption of the
manufacturing overhead expenses.
• This method is mostly suited to operations which do not

involve any large use of machinery.
• To calculate labour hour rate, the amount of factory

overheads is divided by the total number of labour hours.
• Formula to be used is as follows :
Machine Hour rate
• The manufacturing overhead expenses are charged to
production on the basis of number of hours machines are
used on jobs or work orders.
• Formula to be used is as follows :
There is a basic similarity between Machine hour rate and

Labour hour rate method so far as both are based on the time
factor.
The choice between the two methods depends on whether
machines or physical labour pre-dominates the process.
Machine Hour rate
• In case Machines pre-dominate the process, machine
hour rate is relied upon to correctly absorb the
manufacturing overhead to different units of absorption.
• Usually, the computation is made on the basis of the

estimated expenses or the normal expenses for the
coming period. Thus, the machine hour rate usually is a
pre-determined rate.
• It is desirable to work out a rate for each individual

machine; where a number of similar machines are working
in a group, there may be single rate for the whole group.
Rate per unit of output Method
• This is the simplest of all methods. In this method

the overhead rate is determined by the following
formula:
Labour Hour Rate
Machine Hour Rate
Rate per Unit of Output Method

Normal Rate
• This rate is calculated by dividing the actual overheads by
actual base. It is also known as the actual rate. It is
calculated by the following formula:
Pre-Determined Overhead Rate
This rate is determined in advance by estimating the amount of the
overhead for the period in which it is to be used. It is computed as follows:
• The amount of overhead rate of expenses for absorbing them to

production may be estimated on the following three basis:
• 1. The figure of the previous year or period may be adopted as the
overhead rate to be charge to production in the current year. The
assumption is that the value of production as well as overheads will
remain constant or that the two will change proportionately.
• 2. The overhead rate for the year may be determined on the basis of
estimated expenses and anticipated volume of production activity.
• For instance, if expenses are estimated at Rs. 10,000 and output at
4,000 units, the overhead rate will be Rs. 2.50 per unit.
• 3. The overhead rate for a year may be fixed on the basis of the normal
volume of the business
Blanket overhead rate refers to the computation of one

single overhead rate for the whole factory.
It is to be distinguished from the departmental over head
rate which refers to a separate rate for each individual cost
center or department.
The use of blanket rate may be proper in certain factories
producing only one major product in a continuous process
or where the work performed in every department is fairly
uniform or standardized.
This over head rate is computed as follows:
37
A blanket rate should be applied in the following cases:

1. Where only one major product is being produced.
2. Where several products are produced, but
a) All products pass through all departments
b) All products are processed for the same length of
time in each department.
Where these conditions do not exist, departmental rates
should be used.
38
Departmental Overhead Rate
• It refers to the computation of one single overhead rate for
a particular Production unit or department.
• Where the product lines are varied or machinery is used to a
varying degree in the different departments, that is, where
conditions throughout the factory are not uniform, the use of
departmental rates is preferred.
• The overhead rate is determined by the following formula:
39
Quiz
Quiz Time
Q1. The allotment of whole items of cost of centres or

cost unit is:
a. Cost allocation
b. Cost apportionment
c. Overhead absorption
d. None of the above

Quiz Time
Q1. The allotment of whole items of cost of centres or

cost unit is:
a. Cost allocation
b. Cost apportionment
c. Overhead absorption

Quiz Time
Q2. Which of the following methods of absorption of

factory overheads is suitable for a firm that produces single
and uniform type of product ?
a. Percentage of Direct wages basis
b. Direct labour rate
c. Machine hour rate
d. Rate per unit of output

Quiz Time
Q2. Which of the following methods of absorption of

factory overheads is suitable for a firm that produces single
and uniform type of product ?
a. Percentage of Direct wages basis
b. Direct labour rate
c. Machine hour rate
d. Rate per unit of output

Key words:
Overhead: Indirect expenses incurred in production process.
Factory overhead: The expenses in the production process.
Selling overheads: Expenses incurred on selling and distribution process.
Absorption: The allocation of overheads.
Absorption rate: The rate at which overheads are absorbed as per unit basis.
Direct labor hour rate: When actual overheads are divided by actual labor
hours.
Over absorption: When overheads absorbed in a product are more than the
actual overheads incurred.
Administration overheads: Expenses incurred in carrying out

administrative functions.
• Question 1 : The following particulars relate to the production
department of a factory for the month of Jan 2020 :
Description Rs. Hours

Material used 80,000
Direct Wages 72,000
Direct Labour hours 20,000
Machine operation hours 25,000
Overhead charges allocated to the department 90,000
• Cost data of a particular work order carried out in the above

department during January 2020 are given below :
Description Rs. Hours
Material used 8,000
Direct Wages 6,250
Direct Labour hours booked 3,300
Machine operation hours booked 2,400
• What would be the factory cost of the work order under the
following methods ?
1. Direct Labour Cost Rate
2. Machine Hour Rate
3. Direct Labour Hour Rate
S Overhead charging rate = Overheads incurred
O
Basis
L
U The 3 methods we need to ascertain for are :
T 1. Direct Labour Cost Rate = Overheads incurred * 100
I Direct Wages (Rs)
O
N
= 90,000 * 100 = 125%
72,000
2. Machine Hour Rate = Overheads incurred
Machine Hours
= 90,000 = 3.60 per hour
25000
3. Direct Labour Hour Rate = Overheads incurred
Direct labour Hours
= 90,000 = 4.50 per hour
20000
S Overhead charging rate = Overheads incurred
O
Basis
L
U The 3 methods we need to ascertain for are : Lab Cost Rate : 125%
T Machine Hr Rate : 3.60
1. Direct Labour Cost Rate = Overheads incurred * 100
I Direct Wages (Rs) Labour Hr Rate : 4.50
O
N
= 90,000 * 100 = 125%
72,000
2. Machine Hour Rate = Overheads incurred
Machine Hours
= 90,000 = 3.60 per hour
25000
3. Direct Labour Hour Rate = Overheads incurred
Direct labour Hours
= 90,000 = 4.50 per hour
20000
S
O Machine Hrs booked : 2,400 Lab Cost Rate : 125%
L Labour Hrs booked : 3,300 Machine Hr Rate : 3.60
U Labour Hr Rate : 4.50
T
I Computation of Factory Cost of the Work Order
O
Method of Charging Overheads
N
Description Direct Labour Machine Hour Direct Labour
Cost Rate Rate Hour Rate
Material 8,000 8,000 8,000
Direct Wages 6,250 6,250 6,250
Overheads - rate 125% of Wages 3.60 per Mch Hr
Overheads compute 6250 * 125% 3.60 * 2,400
Overheads allocated 7,812.50
Factory Cost 22,062.50
(Mat + Wages+ OH)
S
T
O
N
Material 8,000 8,000 8,000
Direct Wages 6,250 6,250 6,250
Overheads - rate 125% of Wages 3.60 per Mch Hr 4.50 per Lab Hr
Overheads compute 6250 * 125% 3.60 * 2,400 4.50 * 3,300
Overheads allocated 7,812.50 8,640
Factory Cost 22,062.50 22,890
(Mat + Wages+ OH)
S
T
O
N
Material 8,000 8,000 8,000
Direct Wages 6,250 6,250 6,250
Overheads - rate 125% of Wages 3.60 per Mch Hr 4.50 per Lab Hr
Overheads allocated 7,812.50 8,640 14,850
Factory Cost 22,062.50 22,890 29,100
(Mat + Wages+ OH)
S
T
O
N
Material 8,000 8,000 8,000
Direct Wages 6,250 6,250 6,250
Overheads - rate 125% of Wages 3.60 per Mach Hr 4.50 per Lab Hr
Overheads allocated 7,812.50 8,640 14,850
Factory Cost 22,062.50 22,890 29,100
(Mat + Wages+ OH)
Question 2 :
We have the following information for January 2020:
BRANDS
Description A B C D
Actual Production (units) 6,750 18,000 40,500 94,500
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
Direct Material Cost (Rs.) 50,000 92,500 127,500 380,000
Selling Price Per Unit 20 15 10 8
Factory overhead expenditure for the month : 162,000

Factory overhead expenses to be allocated to each brand on the
basis of Direct Labour Cost Rate
Selling and Distribution cost : 20% of Works Cost
We need to compute the Brand-wise Direct Cost, Works Cost, Total
Cost and Profit for the month (assuming all units are sold)
S • Computation of the Factory Overhead allocation based on the
O Direct Labour Cost Rate :
L
(Overhead / Total Direct Wages) * 100
U
T = (162,000 / 185,000) * 100 = 87.567%
I • Computation of Costs for each Brand :
O
BRANDS
N
Description A B C D
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
Direct Cost 65,000 120,000 165,000 485,000
Factory Overhead @ 13,135 24,081 32,838 91,946
87.57% of Direct wages
Works Cost 78,135 144,081 197,838 576,946
Selling & Distbn @ 20% 15,627 28,816 39,568 115,389
of Works Cost
Total Cost 93,762 172,897 237,406 692,335
S • Computation of Costs & Profit for each Brand :
O BRANDS
L Description A B C D
U
T
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
I
O
N Direct Cost 65,000 120,000 165,000 485,000
Works Cost 78,135 144,081 197,838 576,946
Selling & Distbn @ 20% 15,627 28,816 39,568 115,389
of Works Cost
Total Cost 93,762 172,897 237,406 692,335
S • Computation of Costs & Profit for each Brand :
O BRANDS
L Description A B C D
U
T
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
I
O
N Direct Cost 65,000 120,000 165,000 485,000
Works Cost 78,135 144,081 197,838 576,946
Selling & Distbn @ 20% 15,627 28,816 39,568 115,389
of Works Cost
Total Cost 93,762 172,897 237,406 692,335
Selling Price per unit 20 15 10 8
Revenue (SP * Units) 135,000 270,000 405,000 756,000
Profit 41,238 97,103 167,594 63,665
Take-aways
Take-aways
• Besides Material and Labor cost, Overhead costs form an important

part of total product cost
• Overhead costs are indirect expenses involved at every stage of the
product lifecycle including production process, administrative stage
or selling and distribution activities
• The proper categorization of Overheads is important to allocate and
absorb them under the most relevant category as this directly affects
Take
the cost of the product aways
• The overhead absorption policy of a firms impacts the costing of a
product thereby impacting the pricing and consequently the
profitability of the product
62
Session 4
Chapter No 4- Cost concepts, Cost

classification and unit cost analysis
Before we start …
off at any time !!
2
Chapter Topic ( including sub-topics) Session
1 Management Accounting Fundamentals & 1
2 Materials Cost Control 1
3 Labor cost and Overhead Cost control 2&3
Cost concepts, Cost classification and Unit
4 cost analysis 4
Cost Analysis: Job Order, Batch and Contract
5 Costing & 5
Income Recognition under Marginal and
6 Absorption costing 5
7 Process Costing and Joint costing 6
8 Standard Costing and Variance Analysis 7
Management Accounting in Global Perspective
9 8
3
Learning Objectives
1. Different notions about cost concept

2. Rationale behind cost classification for decision-
making purposes
3. Significance of statement of cost and cost sheet
4. Utility of cost sheet in business decisions
5. Cost flow and cost utility
6. Fixing selling price based on cost calculations

o Managers use cost accounting information to make

decisions about research and development, budgeting,
production planning, pricing and the products or services to
offer customers. Sometimes these decisions involve trade-
offs.

Cost – A few Basic terminologies
Cost : In the normal parlance, cost is the expenditure incurred on a
particular product or service.
However, according to the Cost accounting system, cost is defined

as the resources sacrificed or given up to achieve a goal or defined
purpose.
It can also be defined as the expenditure incurred or attributable to a

given object
Expense: An expense is an element of cost incurred and is measured

when an asset is sold or disposed off, for generating revenue out of it.
As long as the product remains as an inventory, it is called value of

inventory or cost of inventory. The moment it is sold, the product cost is
recognised as an expense and is called “ Cost of Goods Sold”.
Cost – A few Basic terminologies
Revenue : It is the total sales value a firm generates from the sales of
products and services in a particular period of time.
It is also known as Sales revenue. The total revenue equals sales

revenue plus receipts from sale of other assets.
Income: Revenue less expenditure is equal to income. Depending on

the nature of Income, it is further classified into different categories.
Overhead : These are commonly shared costs such as maintenance,

depreciation, utilities and other common costs.
The overheads are allocated to different products based on certain

criteria.
According to Its
Components
According to Nature
According to Behaviour
According to Function
Cost
Classification
Based on Conversion
Controllability
Management Decisions
Based on Expiry
Classification of Costs – According to its Components
1. Material Cost:
It is the cost of acquiring raw materials to be used for a finished

product or the materials consumed in the process. This helps to
produce a product for sale.
It can be direct material that is consumed in the manufacturing

process and physically used for the finished product. It can be traced
out to the product.
It can also be indirect material cost . This is also required for the
production process, but cannot be directly attributed to the product.
The expenses on cotton waste, lubricating oil, etc., can be

classified as indirect materials. If the cost of materials is insignificant,
it can also be classified as indirect.
2. Labour Cost:
The amount paid to workers as wages and salaries are classified as

labor cost.
It also involves all the benefits passed on by the firm to the workers
when wages are paid to the workers who are directly involved in the
production process, that is, converting , materials into finished products
is called direct labor cost.
This involves all kinds of workers, skilled and unskilled.
There is another component which may include salary/wages being paid

to workers who do work directly on the product, but their services are
necessary for production process. This is termed as indirect labor cost.
Wages salaries paid to supervisors, security guards, purchase and store

staff etc., are indirect labor costs.
3. Expenses:
The amount spent for completion of manufacturing

process other than Materials and labour cost are
classified as expenses.
Direct expenses can be directly allocated to the specific

process, product or service.
The expenses that cannot be directly attributable to a

product or service are called indirect expenses.
Eg : Factory rent
Store expenses
Factory Manager’s salary
Classification of Costs – According to Nature
Classification of Costs – According to Nature
The costs can be classified as Direct and Indirect costs .
Direct Costs :
• The costs that are identifiable or attributable to a particular
product/unit are direct costs.
• The costs such as purchase of material, direct wages to

labour and direct expenses associated with a product or
process are Direct expenses.
Indirect costs:
• These are not identifiable or attributable with the product /
unit.
• These are allocated, apportioned and absorbed in the

production cost on the basis of their use.
Classification of Costs – According to Behaviour
Fixed Vs Variable Costs

1.Fixed Costs:
• The costs that remain fixed up to a
particular level of Production irrespective of
changes in the production volume are
known as fixed costs.
• The peculiarity of fixed cost is that the total

costs remain same while per unit fixed
cost comes down with the increased
level of production.
• Examples of fixed costs are depreciation,

salaries, insurance, rent, etc.
2.Variable Costs:
• These costs change according to the volume of
production.
• If the production volume is higher, the variable cost will

be more and vice versa. This change occurs in
proportion.
• The features of variable costs are that per unit variable

cost remains the same whereas the total variable cost
will change with production.
• Some of the examples of variable costs are direct

materials, direct labor and direct expenses.
3.Semi - Variable Costs:

• When certain components of the total cost of a unit/activity are
fixed and remaining components depend on the use of that
activity, it is called semi-variable cost.
• In other words, semi-variable cost contains the features of both,
fixed and variable costs.
• In this case, the fixed part does not change while the variable
component depends on the use.
Examples of semi variable costs:

• Telephone bill
• Electricity bill
• Contractual salaries to supervisors, etc.
• Salary of Salesmen, Fixed plus incentives
4.Stepped Fixed cost :

When costs are fixed up to a certain level of activity and
then increased by fixed amount with further rise in the
level of activities, it is called stepped fixed cost.
For example, the fixed cost upto 1000 units of output of

a product is Rs 5,000 and thereafter for the next level
up to 1,000 units, the cost will rise by Rs.2,000.
Classification of Costs – According to Function
Prod
Production
and
andMftg
Mftg
1. Production or Manufacturing Costs:

All costs incurred in the production process and producing a finished
product are called production costs.
The elements of production cost mainly include:
• Direct materials
• Direct labor
• Direct expenses and overheads in connection with the production
or manufacturing activities
2. Administration Costs:
Costs that are incurred in managing general administration activities
and that cannot be directly related to production marketing and other
activities are called administration cost.
3.Selling and Distribution Costs:

The costs incurred on publicity, advertising, salesman’s
salaries and travelling expenses etc are examples of selling
costs.
Costs incurred on delivering products and other related
activities are called distribution costs.
Distribution cost involves transport cost, packaging, etc.
Sometimes in case of electricity and gas, the distribution cost
includes cost of distribution of pipes, etc.
4. Finance costs :
The costs associated with external borrowed funds such as
interest paid or accrued on borrowed funds
5. Research and Development costs:

The cost incurred on research and Development activities for new
innovation and techniques, which result in increased efficiency of
the products and processes are called research and development
costs.
6. Pre-production Costs:
The preliminary cost incurred on trial, testing and production
before normal and regular production is called pre-production
cost. This is different from research and
Development cost and basically incurred on testing a product
before going into final production
Classification of cost based on Conversion
The total of direct wages, direct expenses and

overhead costs for converting raw materials into
finished products or converting materials from one
stage of production to the next stage are called
conversion costs.
These do not include material costs.

Classification of cost based by controllability
Under this category, costs are classified as controllable and

uncontrollable.
Controllable:
• The costs that can be influenced by decisions of management and
can be controlled are known as controllable costs.
• It means the management can reduce, minimize or avoid this cost
base on its own decisions.
• Direct costs generally fall under this category.
Uncontrollable:
• The costs that cannot be influenced by the decisions of the
management are uncontrollable costs.
• Short-term commitments such as salaries and maintenance are
uncontrollable costs.
Classification of Costs – By Management Decisions
1. Marginal Cost :
• The cost incurred in producing one additional unit is called
marginal cost.
• It is total variable cost as when we produce one additional

unit, variable cost alone is incurred as the fixed component
remains the same.
• Marginal revenue and marginal cost, both are significant for

taking a decision to produce or not to produce .
• The rule is as long as marginal revenue is equal or more than

the marginal cost, a firm goes on producing .
2. Opportunity Cost:
• The amount sacrificed or foregone to achieve a better option

is called opportunity cost.
• It is used when a firm needs to make a choice between more

than one option and has to choose the best.
• If a firm has surplus funds for a short-term period, it has

different options to invest in. It chooses the best one by
sacrificing or foregoing the others.
· 3.Differential Cost:
· It is also known as incremental cost, which is required to

be incurred if a firm needs to choose other alternatives of
production or any other changes in the level of production
etc.
· What will be the difference in the total cost if the firm wants
to add or drop out a product?
· Such decisions are taken keeping in view the increased

costs.
· Even vital decisions to buy a product from the market or to

produce on its own are also influenced by the differential
cost concept.
· 4.Imputed or Notional Cost :

· When a firm utilizes its own resources such as building and
capital, the cost of these components is not accounted for.
· For example, rent on own building or interest on own

capital in not considered when we prepare profit and loss
account.
· But these kinds of costs are considered while taking

managerial decisions because in that scenario
alternative investment decisions can be considered.
· Therefore, the cost that does not appear in financial

accounting but is considered only for managerial
decisions is called imputed or notional cost.
5. Discretionary Cost:
This cost is fixed in nature and incurred on the basis of
policy decisions of the management.
It does not affect the current level of production.

The examples of discretionary costs are:
• Training to employees
• Additional research and development activities,
• Advertisement costs etc.
Since all these costs to be incurred or not to be incurred

depend on the discretion of Management, they are called
discretionary costs.
These are also known as programmed costs or managed

costs or policy costs.
6. Out-of-pocket cost:
All costs that involve cash outflow are called out-of-pocket costs.
There are certain costs like depreciation that does not require any cash
outflow and therefore is not termed out-of-pocket cost.
The significance of this cost is that it helps management in deciding the

level of cash to be arranged at different intervals.
7. Sunk costs:
The cost committed in the past due to wrong managerial decisions does
not yield any revenue in the present is called sunk cost.
Suppose a young engineer entrepreneur, who is enthusiastic and

optimistic, wishes to establish a unit of production. For this purpose, he
avails a piece of land at a rent of Rs 2 lakhs p.a . Later on he realizes, just
50% of the land is sufficient to continue the production for the next 3 years.
In this case, the rent being paid on the vacant piece of land is called sunk
cost.
8. Relevant Cost:
All costs may not be relevant for taking future decisions as under
different alternatives and scenarios, certain existing costs may not be
relevant.
We can think of a firm deciding about acquiring an automated plant
that may not have any manual work. In this case, all existing costs
relating to manual operations become irrelevant.
Therefore, the management decides which of the costs are relevant
and they alone are considered for future decisions.
9. Replacement cost: The cost associated with replacing a present

asset is called replacement cost.
Suppose a firm wishes to replace its existing machinery and plant and
if the cost is Rs. 20 lakh and the present machine has a saleable value
or Rs. 4 lakh, the replacement cost will be Rs 16 lakh.
10. Abnormal cost:

When a cost occurs on account of reasons or
circumstances beyond control, not in normal or routine
course, it is called abnormal cost.
There may be instances of additional production cost

due to fire in the plant, break down of machinery, power
failure etc., that may cause an increase in the cost.
The abnormal cost is not included in the production

cost but is adjusted in profit and loss account.
It is because the product manager is primarily responsible

for normal loss only.
11. Shutdown cost:

Sometimes a unit remains shut without any operation for a temporary
period on account of strikes by the workers, recession demand or any
other reason.
After some time; the unit starts functioning again.
The costs, such as wages to security, depreciation and sheltering of

plant, that are incurred during this period when the unit remains closed
and the cost, such as oiling and overhauling of machines and parts,
incurred again when the unit starts functioning are called shutdown
costs.
12. Capacity Cost :

A fixed cost in nature that is incurred in creating certain facilities on
long-term basis for smooth functioning of various operations such as
plant, machinery, building warehouses and distribution arrangements, is
called capacity cost.
Classification of Cost based on Expiry
All historical costs are either classified as expired costs or unexpired

costs.
Unexpired costs are the costs incurred in acquiring resources and

creating facilities and capacities to generate revenues for a firm in
future.
These costs are a part of assets in the balance sheet of a firm.
The examples of unexpired cost are costs of machinery and
equipment. This cost becomes expired cost when rneasured in terms
of expenses to compare revenue.
Therefore, as long as an inventory of finished stock remains as
closing inventory in the balance sheet, it is unexpired cost but the
moment it generates revenue for the firm, the historical cost becomes
expired cost.
Cost is also defined as resources sacrificed to achieve a goal.
Therefore, cost incurred in creating facilities is unexpired cost.
Product and period costs:
Product costs:
Product costs are attached to, and carried over with the particular
product.
For example, consider Cellular products, manufacturer of Cellular
phones.
The cost of the company’s direct materials such as computer chips,

direct labor costs and manufacturing overheads create new assets
They start out as Work in process inventory and become finished
goods inventory ( the cellular phones)
When cellular phones are sold, the costs move from being assets to
cost of goods sold. This cost is matched against revenues, which
are inflows of assets received for products purchased by customers
Product and period costs:
Period Costs:
All costs that are accounted for in a particular time period and not
carried over to another time period with the product are called period
costs.
These are recorded in the current year's profit and loss account.
Period costs such as Marketing, distribution and customer service
costs are treated as expenses of the accounting period in which
they are incurred because Managers expect these costs to increase
revenues only in that period and not future costs
For manufacturing sector companies, period costs in the income

statement are all non-manufacturing costs ( for eg: Design and
distribution costs)
Product Costs Period Costs
Part of Inventory Not part of inventory
Expensed when sold Expensed when incurred

• The manufacturing cost of finished goods include direct materials, other direct
manufacturing costs such as direct labour and manufacturing overhead costs such
as supervision, production control and machine Maintenance.
• All these costs are inventoriable; they are assigned to Work-in-process inventory until
the Goods are completed and then to finished goods inventory until the goods are
sold.
• All non manufacturing costs such as R&D, design and distribution costs are period
costs.
This concept will be explained better when we deal with absorption and marginal costing
concept in Chapter 5 of this book.
Classification of Cost – Summary
Basis of
Classification Types of Costs
Components of Cost Material, Labour , Overheads and other expenses

Nature of Cost Direct and Indirect
Behaviour of Cost Fixed, Variable and Semi Variable, Stepped Fixed Cost
Production or Manufacturing, Administrative, Selling
and Distribution, Research and Development, Pre-
Functions of Cost Production, Conversion
Controllability Controllable and uncontrollable
Normality Normal and Abnormal
Marginal, Differential, Imputed or Notional, Opportunity,

Relevant, Discretionary, Sunk, Replacement,
Management Decision Abnormal, Shutdown, Committed, Capacity, Urgent
Periodicity Historical and Future
Expiry Expired and Unexpired
Product/ Period Cost Product/ Period
COST SHEET
Cost Sheet
1. Prime cost: Direct Material Consumed

+ Direct Labour Cost
+ Direct Expenses
= Prime Cost
2. Factory/ Works cost:

Prime Cost
+ Factory Overheads
+ Value of opening WIP
- Value of Closing WIP
= Factory Cost (Net)
3. Cost of production:
Factory Cost
+ Admin Expenses
= Cost of Production
Cost Sheet
4. Cost of Goods Sold (COGS) :

Cost of Production
+ Value of opening Finished Stock
- Value of closing Finished stock
= Cost of Goods Sold
5. Cost of sale: COGS

+ Selling and Distribution Expenses
= Cost of Sale
6. Selling price = Cost of Sale per Unit * Profit Margin (%) per Unit
Cost Sheet
1. Prime cost:
It is the sum of total direct costs and includes cost of material actually
consumed for a product in a particular time period.
Direct labor cost including the amount payable (due but not paid) and other
direct expenses incurred during the period.
If factory overheads are added to Prime cost, we arrive at the total

Factory cost. It means cost of the product upto process at Factory.
This is also known as Factory cost gross. In this gross factory cost, if we
add Opening stock of WIP and subtract closing stock of WIP, we will the
value of the net Factory cost.
Cost Sheet
3. Cost of production
So far we have arrived at factory cost as discussed previously but there are
administrative expenses also attached to a product and therefore these are also
considered while arriving at the cost of production. Therefore, we add all
administrative expenses in the factory cost. Thus,
Cost of production = Factory cost + Administrative expenses
This gives the total units produced during the period and the total cost thereof.
These units are also called "finished goods." Remember every firm has the
opening stock of finished goods (which is the closing stock of the last period) and
also retains certain units as closing stock from the total production . Therefore, to
arrive at the net value of finished goods that can be sold or are available for
sale for the particular period, we add the units and value of opening finished stock
and reduce the number units and value of closing stock. Thus,
COGS or Cost of goods sold = Cost of production + Value of
opening finished stock- Value of closing finished stock
Cost Sheet
4. Cost of Sale
It can be noticed that COGS attaches the value of finished stock available for sale
and so far we have not considered the selling and distribution expenses that are
required to be incurred in selling the available units for sale. To arrive at the cost of
sale, all the connected
Selling and distribution expenses are added to the value of COGS.
Thus, Cost of sale = COGS + Selling and distribution expenses

Cost Sheet
5. Selling Price
Once the final value of cost of goods is available per unit we add the profit
margin to fix the selling price. Therefore
Selling price= Cost of sale per unit x Profit margin (percent) per unit.
Suppose the cost of sale per unit is Rs.40 and as per the firm policy, profit
margin is 15%, the selling price per unit will be R.s 46. Sometimes the
profit is calculated at the selling price. In that case, the percentage of
profit is increased on cost per unit.
Advantages of the Cost Sheet
1. A firm can monitor the cost of product at each stage of production
as break-up figure of total cost as well as per unit cost is available in
the cost sheet statement.
2. The cost sheet also provides information of the cost in a particular
time period. This helps a firm to compare the cost in different
intervals of time and check whether the cost escalation is justified.
3. Based on the trends of cost available over a period of time, future
projections can be made with certain accuracy.
4. More importantly, it helps a firm to determine selling price in a more
reasonable manner as cost sheet considers all components of
actual costs.
5. Cost sheet consists of all adjustments such as WIP, opening and
closing finished, scrap value from wastage, etc. The cost arrived at
on the basis of this is fairly accurate.
Value of scrap
Loss of material
Bad debts
Trade discount
Treatment and
Adjustments of Certain Packing charges
Cost Components
Octroi, customs duty, etc.
Factory stores
Donations
Interest on capital
Treatment and Adjustments of certain cost components
There are some costs related to transactions that need to be treated separately in
the cost sheet to arrive at a far more accurate cost of the product. Some costs
and their adjustments in the cost sheet are given below:
1. Value of scrap: Generally scrap or wastage occurs at two places, either at

the materials storage place or in the production process. The scrap so occurs
is sold and that is called scrap value. The scrap value reduces the cost of
production to an extent.
Therefore, the value of scrap is deducted from the direct material cost if the
wastage had occurred at material storage place and from the factory cost if the
wastage occurred in the production process.
Thus, more accurate cost is obtained. If it is not specified where the wastage
occurred, the scrap value is deducted from the factory cost as it is generally
assumed that wastage happens in the production process. Suppose the
factory cost of a product is Rs.12.55 lakh and the scrap is sold for Rs. 2 lakh
of a particular product, in that case the treatment will be as follows:
• Factory cost: Rs. 12.55 lakh
• Less: Scrap value Rs. 2 lakh
• = Net factory cost: Rs. 10.55 lakh
2. Loss of Material:
There may be instances of losses of raw material.
Such losses are categorized into two categories:
1) Normal loss that occurs in natural process of materials handling
Normal loss is automatically charged to material cost as no

separate treatment is needed
2) Abnormal loss that occurs due to fire, accidents, etc.
Abnormal cost should be deducted from the value of raw

material purchased so that effective cost of raw material consumed
could be obtained.
3. Bad Debts:
• When a sale is made on credit, there happens to be bad
debts.
• The amount of bad debt should be absorbed in selling
overheads. Sometimes, bad debts may occur on account of
abnormal reasons.
• In that case, the amount should be debited to profit and loss
account.
4. Trade Discount:
It is a part of sales revenue, and the discount offered brings
down the value of sales revenue to that extent that it should be
deducted from the sales revenue to obtain net sales value.
5. Packing charges:
Treatment of packing charges depends on the purpose of packing.
Packing cost important for the

Material cost
product
Packing for movement of stock from

one place to another during Factory Cost
production process
Packing cost for transportation of Selling and distribution

goods costs
If it is not specified, then it should be added to selling expenses.
6. Octroi, Customs duty etc:

All costs associated with the purchase of materials including taxes,
octroi, customs duty, etc., and carrying costs are included in direct
material costs.
7. Factory Stores:
A factory store is a storage room where necessary production

process equipment, lubricants and other components
required in a routine manner are stored.
These components are stored on an ongoing basis to
continue the production process.
Therefore, the treatment of factory store overheads is done in
the following manner:
Opening stock of factory stores

Add: New purchases during the period
Less: Closing value of factory stores components
= Net factory stores to be added to factory overheads
8. Donations:
The treatment of donations is done depending on the

purpose of donation .
If it helps in boosting the sales of the product, it will be

added to selling and distribution expenses otherwise
it should be accounted in profit and loss account.
9.Interest on Capital:
Not to be included in the cost sheet.

It should be accounted for in the profit and loss account
Valuation under first-in
first-out (FIFO) method
Valuation under last-in

first-out (LIFO) method
Valuation of Closing
Stock
Average cost method
Weighted average
method
Valuation of Closing Stock
1. Valuation under First in First Out method (FIFO):
• Under FIFO method of valuation, it is presumed that units of finished
stock received first ( closing stock of last period) are sold first.
• Therefore, the total cost of production is divided by the number of units
produced during the period and then it is multiplied by the units of closing
inventory during the current period since the units received as opening
stock are already out.
2. Valuation under Last in First Out method (LIFO)

• Under this method, it is assumed that units produced last are sold out first.
Therefore, the closing stock units of current period consist of both, the
units received as opening stock from the last process and remaining for
this period.
• Suppose the closing units of finished stock in a particular time period are
1,000 and opening units of finished stock are 400. In this case, while
measuring the value of closing stock, the 400 units will be valued at the
opening stock valued carried over from the last process and remaining 600
units will be valued at the current period cost.
Valuation of Closing Stock
3. Average cost method:
In this case, the closing inventory is valued at an average rate,
that is, per unit cost of opening inventory plus per unit cost of
current closing inventory divided by two.
4.Weighted average method:

Under this method, weighted cost of opening and closing
inventory is considered.
The value of closing inventory can be arrived at in the following
manner:
Value of closing inventory = Value of opening finished goods +
Total cost of production in the current period/Number of units
under opening finished stock +
Number of units in current production x Number of closing units of
finished stock
Quiz Time
Quiz Time
Q1 . Which of the items is not included in preparation of Cost

sheet ?
a. Carriage Inward
b. Purchase Returns
c. Sales Commission
d. Interest Paid
Quiz Time
Q1 . Which of the items is not included in preparation of Cost

sheet ?
a. Carriage Inward
b. Purchase Returns
c. Sales Commission
d. Interest Paid
Quiz Time
Which of the following are Direct Expenses ?
a. The cost of drawings, special designs or layouts?
b. The hire of tools or equipment for a particular job
c. Salesman’s wages
d. Rent, rates and insurance of a factory
• A and B
• A and C
• A and D
• C and D
Quiz Time
Which of the following are Direct Expenses ?
a. The cost of drawings, special designs or layouts?
b. The hire of tools or equipment for a particular job
c. Salesman’s wages
d. Rent, rates and insurance of a factory
• A and B
• A and C
• A and D
• C and D
Problem 1
The following details have been extracted from ABC Co’s books of accounts for the year ending
March 31, 2019
Particulars Amt (Rs) Particulars Amt (Rs)
Stock of Materials : Opg 1,88,000 Rent , rates and taxes: Factory 12,000
Closing 2,00,000 Office Expenses 6,400
Materials purchased during the
year 8,32,000 Travelling expenses 12,400
Direct wages paid 2,38,400 Sales men's and commission 33,600
Depreciation written off: Plant and
Indirect Wages 16,000 machinery 28,400
Salaries to administrative staff 40,000 Furniture 2,400

Freight Inward 32,000 Director's fees 24,000
Outward 20,000 Electricity Charges 48,000
Cash discount allowed 14,000 Fuel for Boiler 64,000
Bad debts written off 18,800 General charges 24,800
Repairs to plant and
machinery 42,400 Manager's salary 48,000
Problem 1
The time spent by the Manager is shared between the

Factory and Office in the ratio of 20: 80
You are required to Compute :
a) Prime Cost
b) Factory Overhead
c) Factory Cost
d) Overhead cost
e) Cost of Sale
Cost Sheet
1. Prime cost
3. Cost of production
4. Cost of sale
5. Selling price
Solution 1
Let us calculate the Factory Overheads and Other Overheads
Factory Overheads Amt (Rs)

Indirect Wages 16,000
Repairs to Plant and Machinery 42,400
Rent, rates and Taxes- Factory 12,000
Depreciation - P&M 28,400
Electricity Charges 48,000
Fuel 64,000
Manager's Salary (20%) 9,600
2,20,400
Solution 1
Overheads Amt (Rs)
Salaries to Admin Staff 40,000
Freight outward 20,000
Office expenses 6,400
Travelling 12,400
Salesman's salaries and commission 33,600

Depreciation- Furniture 2,400
Director's fees 24,000
General Charges 24,800
Manager's salary (80% of 48,000/-) 38,400
2,02,000
Solution 1
Particulars Amt (Rs) Amt (Rs)
Opening Stock of Materials 1,88,000
Add : Purchases 8,32,000
10,20,000
Add: Freight Inward 32,000

10,52,000
Less: Closing Stock -2,00,000
Raw Material Consumed 8,52,000
Direct Wages 2,38,400

a) PRIME COST 10,90,400
Add: Factory Overheads 2,20,400

b)FACTORY COST 13,10,800
Add: Overheads 2,02,000

c) COST OF SALE 15,12,800
Please Note : Amount of Cash discounts and Bad Debts will be subtracted from Sales Revenue
Do you feel you have a good understanding of the
various types of costs and their classifications ?
Do you feel you can……………………?

Key Words
1. Cost Sheet : A statement of details of costs at different

operating levels.
2. Prime Cost : The aggregation of direct materials, direct labor

and other direct expenses.
3. Conversion Cost: The cost incurred in converting raw material

into finished product.
4. Factory Cost : Total cost incurred to produce a product till the

factory point.
5. Administrative expenses: The administrative expenses

incurred in supervision and managing other administrative tasks
relating to a product.
Key Words
6. Selling and distribution expenses: The costs incurred in selling and

marketing of a product.
7. Cost per unit: Total costs for the period divided by total number of
units.
8. Work-in-progress: The inventory under use while the product is not

complete but under process of completion.
9. Cost of goods sold: All costs associated with a product except

selling costs.
10. Scrap: The wastage of a product which is sold as scrap. It generates

revenue for the product.
LET US SUM UP
• In a firm, business decisions are mainly taken on the basis of cost as cost
optimization can
• bring competitive advantages to the firm
• Understanding cost concepts and classifications enables cost control and

monitoring thereby enabling cost optimization
• The concepts of Marginal cost, opportunity cost, sunk costs etc help
managements in taking important business decisions
• The statement of cost or cost sheet is an important statement which enables an

organisation to monitor the cost of the product at each stage of production
• It provides total cost as well as per unit cost thereby enabling the firm to fix the
ideal selling price
76
Session 5
Chapter No 5- Cost Analysis: Job Order, Batch and

Contract Costing

Nov’20
Before we start …
off at any time !!
2
Cost concepts, Cost classification and Unit cost
4 analysis 4
5 Costing 5
6 Absorption costing 5
9 8
3
Learning Objectives
1. Understand the concept of job costing in manufacturing

units.
2. Understand measurement of costs in job costing system.
3. Determine economic batch quantity in batch costing
system.
4. Understand the concept, measurement and estimation of
cost under contract costing system.
5. Understand the contract plus cost system.
6. Calculate the cost for certified and non-certified works
under contract costing.


Management accounting assists Managers in strategic

decision making such as make or buy, enter new markets,
change process flows etc
1. Job Order Costing
Job Order Costing - Overview
A job is a customer specific order that is accepted and carried out at
different levels in a workplace through different processes and
operations for completion.
Work involved in each unit’s process on a particular job is identifiable

and cost associated with it can also be measured.
Once a particular job is completed, the cost of all activities/ units on

this job is compiled to arrive at the Total cost of the job.
Job order costing is typically used in :

• Printing works
• Automobile servicing
• Engineering works
• Fabrication works etc
In the Job Costing system, an order or a unit, lot or batch of a

product may be taken as a Cost unit
Receiving
production/Job
order
Acquiring
materials
Process of Job Organizing

Order Costing labour
Overhead costs
Completion of
final job
Job Order Costing - Features
1. It is a customer-specific order costing.
2. The job is carried out as per the specific requirements of the

orders and according to desired specifications.
3. It may involve a single unit or a batch of similar units.
4. It is concerned with the cost of an individual order or

batch orders.
5. Cost details of all processes involved in job completion are

collected after the end of all processes.
Job Order Costing - Features
6. The cost of each job is measured by collecting details of materials

used, labour and overheads from different processes.
7. The common overheads are apportioned to each job based on

the overhead absorption method.
8. Work-in-progress may or may not be at the end of the accounting

period.
9. Sometimes a job order may extend to the next accounting period.

In such cases, cost will be limited to only one particular accounting
period.
10. Each job is treated as a separate accounting unit; therefore,

separate production numbers are allocated.
Assembly
Orders
Production order
Production
Orders
Material cost
Labour cost
Methodology
Used in Job
Costing
Direct expenses
Manufacturing
and other
overheads
Completion of job
Advantages of Job Costing
1. Detailed analysis: The cost data generated is useful for further

analysis and control.
2. Ascertaining Profit or Loss: The firm can evaluate profit or loss
made on each job and compare the price tendered for the job.
3. Comparison with Standard cost: The cost so arrived can be
compared with standard costing.
4. Price Negotiation: If the firm is able to know the fair cost of a
particular job, it can bargain on the price of that job with the customer.
5. Comparison: It helps in making a comparison with performance on
other jobs.
6. Cost control measures: As the expected cost data is available, the
firm can take collective measures to control the cost before the job is
completed, as any mistakes or excessive costs show up at an early
stage.
Limitations of Job Costing
1. Since implementation of job costing needs all

details of resources, records and cost details, it is
time consuming as well expensive.
2. Keeping detailed records of individual jobs is a

complicated process.
3. It is useful only for small and short-term job orders

where too many processes or components are
not involved. Fabrication
Examples of Job Costing in Service,
Merchandising and Manufacturing sector
Manufacturing Sector:
• Assembly of individual aircrafts at Boeing
• Construction of ships at Mazgaon Dock
Merchandising Sector:
• Sending individual orders by mail order
Service Sector:
• Audit Engagements done By Price Waterhouse Coopers Consulting
• Individual legal cases argued by Wadia Ghandy
• Movies produced by RK Studios
Fabrication
• Question 1 : The following data has been taken from the books of Rockstar Ltd
for the year ending 31st Mar 19.
Particulars Amt (Rs)

Direct Materials cost 1,80,000
Direct Labour Cost 1,50,000
Profit 1,21,800
Selling and Distribution
overheads 1,05,000
Administrative overheads 84,000
Factory overheads 90,000
You are required to compute:

1. Job cost sheet detailing therein Prime cost, Works cost, Production cost,
Cost of Sales and Sales Value.
2. PTO…
• Question 1 : The following data has been taken from the books of
Rockstar Ltd for the year ending 31st Mar 19.
You are required to compute:
2. For the year 2019-20, the firm has received an order for a number of
jobs. However, it is expected that the direct materials would cost Rs
240,000/- and direct labour would cost Rs 150,000/-.
Compute the value for these jobs assuming that the firm targets to earn
the profit at same rate as in 2018-19 on Sales. Also, consider that the
S&D overheads will increase by 15%. The firm recovers Factory OH as
a % of Direct Wages and Admin and S&D OH as a % of Works cost,
based on the cost rates that existed the previous year.
Solution:
Job Cost Sheet of Rockstar Ltd as on 31st March'2019
Direct Costs:
Prime Cost 3,30,000
Add : Factory Overheads 90000
Factory Cost 4,20,000
Add: Admin Overheads 84000
Cost of Production 5,04,000
Add: Selling and Distribution overheads 105000
Cost of Sales 6,09,000
Add: Profit (Given) 121800
Sales 7,30,800
Solution:
Job Cost Sheet of Rockstar Ltd as on 31st March'2019
Direct Costs:
Prime Cost 3,30,000
Add : Factory Overheads 90000
Add: Admin Overheads 84000
Add: Selling and Distribution overheads 105000
Add: Profit (Given) 121800
Sales 7,30,800
Note : Profit is 20% of Cost of Sales = (121800/609000)*100

Solution:
For preparation of the quotation for the Job order received, we need to arrive
at the percentage of Overheads to be charged based on current year numbers
Factory Overheads to Direct wages (90000/150000)

(as a % of Direct Wages) *100 60%
Admin Overheads ( as a % of (84000/420000)

Factory Cost) *100 20%
Selling and Distribution overheads (105000/42000

(as a % of Factory cost) 0)*100 25%
Computation of price Quotation for the job
Direct Costs:
Direct Materials cost (Given) 2,40,000
Direct Labour Cost (Given) 1,50,000
Prime Cost 3,90,000
Add : Factory Overheads (60% of Direct
Labour cost 90,000
Add: Admin Overheads (20% of Works /
Factory cost) 96,000
Add: Selling and Distribution overheads

(25% of Works / Factory cost)+15%
increase (480000*25%)*115% 138000
Add: Profit (20% on Cost) 1,42,800
Sales 8,56,800
2. Batch Costing
Batch Costing - Overview
When certain quantities of similar products are produced at one
time, it is known as Batch Production.
The concept of Batch costing is applied when certain quantities of

similar and identical products are manufactured together as one job.
Generally, the concept of Batch costing is applied in :

• Printing
• Packaging
• Manufacture of automobile and engineering components
i.e when there is mass production and the units are
homogeneous
The cost unit is a particular batch
Cost is ascertained for the entire batch

Batch Costing
Economic Batch Quantity
A = Annual Production
B= Cost of each Set up
C= Cost of production per component
S = Holding and other Inventory carrying costs
Total Annual Cost of production = Annual cost of + Annual Holding

Setup Cost
Question:
• A firm accepted an offer to supply 48,000 pistons per
annum to another firm.
• The inventory holding cost per piston per month is 20

paise.
• The set up cost per run of piston manufacturing is Rs 648/-
• Compute:
1. Optimum run size for piston manufacturing.
2. Interval between two consecutive optimum runs.
3. Minimum inventory cost per annum.
Solution - 1:
1. Calculation of Optimum Run size for Piston Manufacturing :
Optimum Run size
A= Annual supply of pistons = 48,000

B= Set up cost per production run = Rs 648/-
C= annual holding cost per piston = 0.20 paise *12 months = Rs 2.40
Optimum Run Size= 2*48,000*648

= 2,59,20,000
2.40
= 5091 pistons per run

Solution - 2:
2. Interval between two consecutive optimum runs:
Number of production = 48,000 pistons

Runs per annum 5,091 pistons
= 9.48 times
= 9 times
Interval between two = 365 days

Consecutive runs 9 times
= 41 days ( approx.)
Solution - 3:
3. Minimum inventory cost per annum :
Amt (Rs)
Production Run Cost ( 9 times production run *
Rs 648/-) 5,832
Carrying Cost (1/2 *5091 pistons *Rs0.20*12

months) 6,109
Minimum Inventory cost p.a 11,941

3. Contract Costing
Contract for constructing
Features of Contract Costing
1. In (contract) job costing, each contract is treated as a separate

unit of cost.
2. Each contract is allotted a specified number and the contract is

generally carried out at the site of customer.
3. Majority of expenses, which are identifiable with a specific Sub contracting the wood work
contract, are directly allocated to that contract. A few overheads
are allocated on the basis of the overhead absorption policy of
the organization.
4. In contract costing, sub-contracts are assigned for specified jobs

like welding work, electrical work and wood work; therefore,
costs are traceable and directly allocated to the contract.
Features of Contract Costing
5. A contract work may run for more than one accounting

year.
6. For completion of a contract, required plants and

equipment can be hired from different sources. Even
services of experts and consultants can be availed of.
7. A contract may have penalty provisions for non-

completion of work in time or for not carrying out work as
per pre-agreed specifications.
8. Another unique feature of contract costing is

measurement of profit on incomplete works. As per the
accepted accounting practices, in contract costing the
profit on an incomplete work should be calculated on
accrual basis.
Material cost
Labour cost
Process of
Expenses
Contract Costing
Plant and
machinery
Sub-contract
The process of Contract Costing passes through the following phases:
1. Material Cost :
• The materials required to complete a particular contract are debited to
the related contract account.
• If the materials remain in stock at the end of the accounting period,
they are shown as closing stock and carried forward to the next
period.
2. Labour Cost:
• Wages paid to the workers engaged on a particular contract should
be charged to that contract irrespective of the work performed by
them.
• If there are common workers on more than one contract or if workers
are transferred from one contract to another one, time sheets must be
maintained and wages may be distributed based on time spent on
each contract
• Wages of workers working in Central stores/ office can be apportioned
to a particular contract on a suitable basis eg: Time spent etc
3. Expenses:
• All expenses incurred for a particular contract should be charged to
that contract
4.Plant and Machinery:

• The depreciation on the P&M used to complete a contract is
charged to the contract account as per the policy of the firm on
charging depreciation
5.Sub-contract:
• Sometimes due to certain situations, a sub-contractor is appointed to
carry out certain special work for the main contract.
• This special work done by the sub-contractor becomes a direct
charge to the main contract and accordingly debited to the contract
account.
• Eg: The job of fitting electrical lines in a Building construction
contract may be sub-contracted to a specialist in Electrical cabling/
fittings etc
Cost Plus Contract
When it is not possible to estimate the cost of a contract in

advance for various reasons, we use the cost plus contract
system to determine the cost in advance.
This system is used when the costs fluctuate over the contract
period as contract work takes longer time to complete
This system may also be used when a contract is totally new and
cost estimation cannot be done with accuracy
In this contract, the contractor will receive a certain percentage of

total cost as profit.
This system of costing is applicable and more suitable to special

type of work contracts such as construction of shipyards, dams,
etc
Advantages and Disadvantages of the Cost Plus
Contracts
1. The contractor has no risk of loss. But the customer

has to pay more if the cost escalates, maybe on
account of inefficiency.
2. The contractor is protected from the increased cost of
inputs. However, the customer is not certain about the
price of the contract till the end.
3. If the price of inputs remains favourable, the contractor
does not get benefit. The benefit goes to the customer.
4. It is a simplified way to prepare tenders for contractors.
Work Certified
It is known that construction works usually take a longer period

of time for work completion.
The customer needs to make payment from time to time

depending on the extent of work already completed.
This amount is paid on the basis of a certificate issued by an

architect or the chartered engineer.
This is called Work Certified
This also helps to monitor the work progress from time to time
and also estimate and monitor the cost.
Quiz Time
Q1 . All of the following would most likely use a job order costing system
except:
a. A dental practice
b. Auto repair shop
c. Appliance maker of small size
d. Architectural Firm
Quiz Time
Q1 . All of the following would most likely use a job order costing system
except:
a. A dental practice
b. Auto repair shop
c. Appliance maker of small size
d. Architectural Firm
Quiz Time
Q2 . The Chartered Institute of Management Accountants (CIMA), UK defines

Contract costing as “ the aggregate costs relative to a single contract
designated as…“
a. Cost Unit
b. Performance measurement
c. Variable Overhead
d. Contract Cost
Quiz Time
Q2 . The Chartered Institute of Management Accountants (CIMA), UK defines

Contract costing as “ the aggregate costs relative to a single contract
designated as…“
a. Cost Unit
b. Performance measurement
c. Variable Overhead
d. Contract Cost
Key Words
Job costing: This costing technique is for a particular job.
Batch costing: The assessment of cost for a particular batch of production.
Contract costing: The cost allocation methodology of a contract work
Economic batch quantity: The optimal size of a batch from costing

point of view.
Set - up cost: The cost involved in changing one set-up of production process to
another set-up.
Sub-contract: A part of the contract work is given to another contractor by

the main contractor.
Cost plus contract: When a contract is tendered based on certain profit margin
over the cost.
LET US SUM UP
Job Costing: A Job is a customer specific order .
Work of each unit/ process on a particular job is identifiable and the

cost associated with it can also be measured.
Batch Costing: Production of multiple quantities of similar products at

one time is known as Batch production.
Batch costing is applied when certain quantities of similar and identical
products are manufactured as one job.
Contract Costing: Contract is like a job but larger in value and

duration. For eg: Ship building, construction of a building etc.
In contract costing, most of the costs associated with that particular
contract can be identified and directly allocated to the same.
Contract Costing is used to measure the cost and profit of a particular
contract assignment Eg : Civil engineering work in a construction
project.
Do you feel you have a good understanding of Job
Costing, Batch Costing and Contract Costing ?
Do you feel you can decide which method is best

suited for which industry / product ?

4 analysis 4
5 Costing 5
6 Absorption costing 5&6
9 8
48
Learning Objectives
1. Concept of absorption and marginal costing.

2. Inventory valuation based on absorption and marginal
costing.
3. Preparation of income statement and analysis of
differences in both the methods.
4. Practical application of absorption and marginal costing.
5. Limitations of absorption and marginal costing.
6. Calculation of under/over absorption.
1. Marginal Costing
Marginal Costing
Marginal cost can be explained as a change in the total cost of

production of one additional unit of output.
Alternatively, per unit change in the cost of increased output is marginal

cost.
Sales = Fixed Cost + Variable Cost + Profit
Contribution = Sales Revenue – Variable Cost
Contribution = Fixed Cost + Profit
Profit = Contribution – Fixed Cost

Marginal Costing
Marginal cost can be explained as a change in the total cost of

production of one additional unit of output. Alternatively, per unit change
in the cost of increased output is marginal cost.
Opening Stock = Production + Closing Stock – Sales
Closing Stock = Opening stock + Production – Sales
Production = Sales – Opening Stock + Closing Stock
Sales = Opening Stock + Production – Closing Stock

Features of Marginal Costing
1. Cost classification: All costs are classified on the

basis of variability, that is, variable costs and fixed
costs. Mixed costs are segregated into variable and
fixed costs.
2. Inventory valuation: Under marginal costing,
inventory or stock are valued at variable cost or
marginal cost for profit measurement.
3. Product and period costs: Under marginal costing,
all variable costs are treated as product cost and
fixed costs are treated as period cost. A product cost
@ Variable Cost
is charged directly to cost unit, whereas a period
cost is written-off against the profit of the period.
5. Contribution: Marginal costing technique makes use of
contribution for making various decisions.
Contribution is the difference between sales and variable
cost. It is on the basis of the contribution of a product that
production and sales policies are designed by a firm.
5. Determination of Price: The price is determined on the
basis of the marginal cost and contribution margin.
6. Department/Product Profitability: The contribution
margin is the basis for deciding profitability of department
or product.
7. Treatment of fixed costs: Fixed costs are treated as
period cost and debited to profit and loss account and,
thus, excluded from the production cost.
Break Even Point
The Break Even point (BEP) is that quantity of output sold at which
total revenues equal total costs
i.e the quantity of output sold that results in Rs 0 of operating income.
At the BEP, operating income by definition is 0 and hence:
Break even number of = Fixed Cost

units Contribution margin per unit
Break Even Point (Example)
Kinder Kids provides day care for children Mondays through Fridays.
The monthly variable costs per child are as follows:
Amt (Rs)
Lunch and Snacks 1,000
Educational supplies 300
Other supplies 200
Total 1,500
Monthly fixed costs consist of the following:

Amt (Rs)
Rent 15,000
Salaries 20,000
Utilities 2,000
Miscellaneous 3,000
Total 40,000
Kinder Kids charges each parent Rs 4000/- per child

Calculate the BEP
Break Even Point (Example)
Kinder Kids provides day care for children Mondays through Fridays.
The monthly variable costs per child are as follows:
Solution :
Amt (Rs)
Revenue per child 4000
Less: Variable cost per child

1500
Contribution Margin per child

2500
BEP = Fixed Cost

Contribution per child
= Rs 40,000/- = 16 children
Rs 2500/-
Limitations of Marginal Costing
1. Segregation of Fixed cost and Variable cost:

At times, it becomes difficult to segregate the fixed cost
and the variable cost.
2. Per unit Variable cost vs Activity levels :
Marginal costing presumes that per unit variable cost will
remain the same at all levels of activity, which is not true.
3. Not an accepted accounting practice:
Marginal costing concept is not an accepted accounting
procedure for external reporting. It is used primarily used
for Internal reporting and decision making.
Advantages of Marginal Costing
1. Marginal costing is simple to understand.

2. By not charging fixed overhead to the cost of production, the effect of
varying charges per unit is avoided.
3. It prevents the illogical carry-forward in stock valuation of some
proportion of current year’s fixed overhead.
4. The effects of alternative sales or production policies can be made
readily available and assessed and decisions taken would yield the
maximum returns to the business.
5. It eliminates large balances left in the overhead control accounts,
which indicates the difficulty of ascertaining an accurate overhead
recovery rate.
6. Practical cost control is greatly facilitated. By avoiding arbitrary
allocation of fixed overhead, efforts can be concentrated on
maintaining a uniform and consistent marginal cost. It is useful at
various levels of management.
• Advantages of Marginal Costing contd…
7. It helps in short-term profit planning by break-even and profitability

analysis, both in terms of quantity and in terms of graphs.
Comparative profitability and performance between two or more
products and divisions can easily be assessed and brought to the
notice of the management for decision making.
8. It helps in cost–volume–profit analysis.
9. It is also helpful in budgeting and production planning forecasting.
10. Profit and loss account is not affected by the level of closing
inventory.
11. The performance evaluation becomes more effective in case of
responsibility accounting system.
2. Absorption Costing
Advantages of Absorption Costing
1. It is a recognized and accepted accounting practice for

external reporting.
2. It uses the accrual accounting concept of matching costs with
revenue for a particular time period.
3. Fixed cost is absorbed in the production cost and the
inventory valuation complies with accounting standards.
4. There is a proper adjustment of under or over absorption of
fixed costs.
5. The fixed production overheads are also allocated to different
units/divisions.
6. It is better for the firms which follow cost plus pricing method.
Limitations of Absorption Costing
1. The advocates of marginal costing are of the view that carrying over
the fixed cost component of the existing year, which has been
debited to profit and loss account to the next year, is not
appropriate.
2. The profit and loss account will be affected to the extent of value of
closing inventory.
3. It is not helpful in taking managerial decisions where management
wants to know the incremental cost on account of increased output.
Adjustment of Under/Over Absorption
Standard Total Fixed Overheads = Standard Fixed OH rate per unit

Normal Output
Revisiting a few Basics (not in textbook)
Not in textbook
Not in textbook
Difference Between Marginal Costing and Absorption
Costing
Component /
Basis Marginal Costing Absorption Costing
Costs are separated into those
Costs are separated into
that can be traced to cost
Separation of costs variable costs and fixed
centre or cost units and those
costs
which cannot be traced
Variable costs are product
Both Fixed and Variable costs
Product costs* costs and fixed costs are
are product costs
period costs
Only Variable costs are
included in stock
Both Fixed and Variable costs
valuation whereas fixed
Stock Valuation are included in stock
costs are charged to next
valuation
income statement for the
period
Difference Between Marginal Costing and Absorption
Costing
Component /
Basis Marginal Costing Absorption Costing
Computed as Contribution Computed as gross profit
Profit
and net profit and net profit
Suitable and more
meaningful for
Unsuitable for decision
Decision Making Management decision
making
making. Eg : Make or Buy
decisions
Only those costs that can All manufacturing costs are
Recovery of costs
be traced to the products recovered
Used for internal

Reporting Used for external reporting
reporting to Management
Analysis of Difference in Income
1. Quantity of sale is lesser than production which results in higher

inventory level (closing stock is more than opening stock). In this
situation, the income will be on the higher side under absorption
costing method as the part of fixed overheads are carried forward to
the next period. It, therefore, reduces the cost of sale. Income under
marginal costing will be lesser as compared to absorption costing.
2. Quantity of sale is higher than the quantity produced. This will result
in lower level of closing inventory (opening stock is more than
closing stock). The income will be on higher side under the marginal
costing system as more fixed overheads are adjusted in the current
period. Or we can say that a part of the fixed cost of the proceeding
period has been adjusted to current period cost of goods sold.
3. If quantity sold is equal to quantity produced, there is no closing
inventory. Income under both the approaches will be the same.
Analysis of profit under marginal and absorption costing
Profit under Profit under

Production Level Marginal Costing Absorption Costing
Production = Sales Equal Equal
Production greater than
Lower Higher
Sales
Production less than Sales Higher Lower

Format of Income statement under Marginal Costing :
Particulars Amt (Rs)
Sales Revenue (A) XXX
Direct Materials cost xxx
Direct Labour Cost xxx
Variable Mftg Overheads (Variable Cost per unit*no of
units) xxx
Cost of Goods produced ( current variable cost): XXX

Add: Opg stock of Finished Goods ( valued at
variable cost of previous period) xxx
Less: Closing stock of finished Goods ( valued at
current variable cost) xxx
Cost of Goods Sold (B): XXX
Gross Contribution (A-B) XXX
Less: Non- Mftg variable OH's
Administrative overheads xxx
Selling and distribution overheads xxx
Contribution (Net) ( Gross Contribution- Non
production variable cost) XXX
Less: Fixed Costs
Production Costs xxx
Admin Costs xxx
Selling and Distribution costs xxx
Net Profit XXX
Format of Income statement under Absorption Costing :
Sales Revenue (A) XXX
Production Costs
Direct Materials cost xxx
Direct Labour Cost xxx
Variable Mftg Overheads (Variable Cost per unit*no of units) xxx
Fixed Mftg Overheads (No of units*Fixed cost per unit) xxx
Cost of Goods produced XXX
Add: Opg stock of Finished Goods (valued at cost of
previous period's production) xxx
Less: Closing stock of finished Goods (valued at production
cost of current period) xxx
Cost of Goods Sold (B): XXX
Gross Margin (A-B) XXX
Add (Or Less): Under ( or over) abosrption of fixed
manufacturing overheads xxx
Net Margin ( Gross Margin +/- adjustments) XXX
Less: Admin Costs (Fixed+ Variable) A

Less: Selling and Distribution costs (Fixed+ Variable) B (A+B)
Profit XXX
73
Q1. M/s Rohan Motors assembles and sells motors. It uses an actual costing
system in which unit costs are calculated on a monthly basis. Data available for
March and April’19 are as follows :
Mar-19 Apr-19
Particulars Units Units
Unit Data
Beginning Inventory - 150
Production 500 400
Sales 350 520
Variable cost data
Manufacturing cost per unit
produced Rs 10,000 Rs 10,000
Distribution costs per unit sold Rs 3,000 Rs 3,000
Fixed Cost Data

Manufacturing costs Rs 20,00,000 Rs 20,00,000
Marketing costs Rs 6,00,000 Rs 6,00,000
The Selling price per motor is Rs 24,000/-. You are required to :
1. Prepare income statements for M/s Rohan Motors in March and April 2019
under a) Variable /Marginal costing and b) Absorption costing
2. Explain the reason for differences between the 2 methods.
Solution:
1. Calculation of Contribution margin per unit:
Mar-19 Apr-19
Selling Price (A) 24,000 24,000
Variable cost data:
Manufacturing cost per unit
produced 10,000 10,000
Distribution costs per unit sold 3,000 3,000
Total Variable cost (B) 13,000 13,000
Contribution (A-B) 11,000 11,000

Solution:
Calculation of Closing inventory in units

Mar-19 Apr-19
Particulars Units Units
Beginning Inventory - 150
Add: Production 500 400
Total units available for Sale 500 550

Less: Units sold -350 -520
Closing Inventory 150 30
Solution:
Income Statement under Variable costing

Mar-19 Apr-19
Sales (Units) 350 520
Contribution Margin @ 11,000/-

per unit 11,000 11,000
Total Contribution 38,50,000 57,20,000
Less : Fixed Cost 26,00,000 26,00,000

Operating Income 12,50,000 31,20,000
Mar-19 Mar-19 Apr-19 Apr-19
Sales (Units) 350 520
March : (350*24000) 84,00,000
April :( 520*24000) 1,24,80,000
Cost of Goods Sold:
a) Opening Stock
March: Nil -
April : 150*14000 21,00,000
b) Cost of Production
March: 500*10000 50,00,000
April : 400*10000 40,00,000
Fixed Cost ( to be added
under Absorption costing) 20,00,000 20,00,000
c) Closing Stock
March: 150*14000 -21,00,000
April : 30*15000 -4,50,000
Cost of Goods Sold (B) 49,00,000 76,50,000
Gross Profit (A-B) 35,00,000 48,30,000

Less: Variable Distribution
costs:
March: 350*3000 -10,50,000
April : 520*3000 -15,60,000
Less: Fixed Marketing Costs -6,00,000 -6,00,000
Operating Income 18,50,000 26,70,000

Key Words
1. Marginal Cost: Change in the total cost on account of change in one

additional unit of production
2. Marginal Costing: A concept of recognizing Income based on variable

production cost
3. Absorption Costing: An approach which considers both fixed and variable

costs while considering production cost.
4. Contribution: Sales Revenue – Variable cost
5. Profit: Contribution – Total Fixed Cost
6. Fixed Overhead absorption rate: Total Fixed cost / Normal capacity of

production
LET US SUM UP
Marginal Costing: It is defined as the technique of

presenting cost data wherein variable costs and fixed
costs are shown separately for Managerial decision
making.
Only variable costs are charged to cost units ( product

or inventory) whereas fixed cost for the period is
written off against the profit of the period.
Hence, Marginal costing is also known as Variable

costing technique
LET US SUM UP
Absorption Costing:
It is a costing technique in which all manufacturing costs (variable
and fixed) are considered as costs of production.
Fixed overhead is treated as a period cost and not a product cost.
All Variable manufacturing costs and fixed production overheads for

manufacturing are charged to the product.
Other costs such as Admin and S&D overheads are written off
against the profit of the period in which they arise.
Therefore full cost of a product or stocks comprises the variable

(direct) and fixed (indirect) cost of production.
Hence Absorption costing is also known as full costing.

Quiz Time
Q1 . Marginal cost is taken as equal to:
a. Prime cost plus all variable overheads
b. Prime cost minus all variable overheads
c. Prime cost plus Variable overheads plus Fixed overheads

Quiz Time
Q1 . Marginal cost is taken as equal to:
a. Prime cost plus all variable overheads
b. Prime cost minus all variable overheads
c. Prime cost plus Variable overheads plus Fixed overheads

Quiz Time
Q2. Which of the following statements are true ?
a. In Absorption Costing, cost is divided into 3 major parts while in

Marginal costing, it is divided in 2 main parts
b. In Absorption Costing, period is important and in Marginal

costing, product is important
c. Both a and b

Quiz Time
Q2. Which of the following statements are true ?
a. In Absorption Costing, cost is divided into 3 major parts while in

Marginal costing, it is divided in 2 main parts
b. In Absorption Costing, period is important and in Marginal

costing, product is important
c. Both a and b

Do you feel you have a good understanding of
Marginal and Absorption costing ?
Do you feel you can advise management on the

correct option for your company

89
Session 6
Chapter No 7- Process costing and Joint Costing

2nd May’20
Before we start …
off at any time !!
2
4 analysis 4
5 Costing 5
9 8
3
Concept of Management and Cost accounting contd….


Management accounting assists Managers in strategic

decision making such as make or buy, enter new markets,
change process flows etc
Learning Objectives
1. Concept, importance and uses of process costing system.

2. Difference between process and job costing systems.
3. Concept of equivalent units in process cost and its computation.
4. Preparation of production cost report for process costing system.
5. Concept and treatment of normal loss, abnormal loss and abnormal
gain.
6. Concept of joint costs and its measurement.
7. Difference between joint product and by-product.
8. Basis of joint cost allocation to individual products.
1. Process Costing
Process Costing - Definition
As per the Chartered Institute of Management Accountants, process costing is
defined as:“ The costing method applicable where goods or services result
from a sequence of continuous or repetitive operations or process”.
Objective : To arrive at the cumulative cost of a unit or product during that

particular period.
Applicability: This method is more suitable where products pass through different
processes such as units engaged in chemical work, textiles, paints, steel, glass,
refineries, food processing, paper, dairy products and all other products involving
different processes for finished products.
Examples: Pepsi cola makes soft drinks, Exxon Mobil produces oil, Kelloggs
makes breakfast cereals on a continuous basis over long periods.
For these kind of products, companies do not have separate jobs. Instead,
production is an ongoing process for them.
Introduction
1. Each process has certain cost in terms of raw materials, labour

and other overheads.
2. The semi-finished product of one process becomes the raw
material for the other process.
3. At the end of each process, the product along with costs is
transferred to the next process.
4. The finished product at the end of the final process has composite
costs, including all the other earlier processes.
5. It becomes important to monitor and control the costs under each
process.
Features of Process Costing
1. Different processes:
The work process is segregated into different processes and each
process becomes the cost center responsible for maintaining the cost
within the pre-determined standards.
2. Continuous and specific processes:
The final product is the result of continuous series of processes. All the
processes are pre-arranged and specific to give a certain shape to the
product.
3. Separate account for each process: The firm is required to
maintain separate account for each process and all the related costs,
direct and indirect, are allocated to that process.
Features of Process Costing
4. Treatment of Scrap:
The treatment of wastage, abnormal loss/gain, scrap value, etc., are
accounted in the concerned process. The adjustments of normal loss,
abnormal loss and abnormal gain are done under different processes
depending on the nature of loss or gain.
5. Single or multiple stages of production:
During the process, different products may be produced at one or
multi-stages simultaneously.
6. WIP at the end of each process: As the work continues under each
process, there is always work-in-progress (WIP) at the end of the
process which is carried over to the next process. The costing is done
on the basis of equalization concept.
6. Output of one dept = Input of next:
The semi-finished output of one process becomes the input for the next
process in sequence
7. Output cost of one dept = Input cost of next dept:

While output of one process is transferred to the next process, the cost
of the process is also transferred. Thus, output cost of one process
becomes the input cost of the next process.
Job Costing Process Costing
System System
Distinct , Identifiable units of a Masses of identical or similar

Product units of a product
Or Service or Service
(Eg: Custom made Machines) (Eg: Food or Chemical)
Audit assignment given to E&Y Apple (Smartphones)

Aircraft built by Boeing Coca Cola ( Soft Drinks)
Custom made Rolls Royce Exxon Mobil (Gasoline)
Difference between job costing and process costing
Component /
Basis Job Costing Process Costing
Costs are compiled for each
Production process Each job has separate process and cumulated for
for Specific jobs cost determination production in a given period
of time
Each job is separate and The product is manufactured
Entity
independent of others on a continuous flow
All individual entity costs of
The cost of a job is
each process are divided by
divided by the number of
Per unit costs the total production for the
units in the job to arrive
process to calculate the per
at unit cost
unit cost
Measurement of Costs are measured Costs are arrived at the end
cost when a job is completed of cost period
Difference between job costing and process costing
Component /
Basis Job Costing Process Costing
Costs are transferred from
Cost is not transferred one process to another as the
Cost transfer
from one job to another product passes from one
process to another
There may or may not be There has to be some WIP at
Work in progress WIP at the beginning or the beginning and end of the
(WIP) end of the accounting accounting period as the
period process is ongoing
Adequate control on cost
is a challenge as each Adequate control on cost is as
Control product is different and the production is standardized
production is not and typically has a stable flow
continuous
Production is in continuous
Focus It is customer specific
flow and homogeneous
Similarities between job costing and process costing
1. The goal of job and process costing systems is the same,

that is, to determine the cost of products.
2. The cost flows under both the costing systems are also
similar. There are separate records in production account
for raw materials inventory, labour and overhead.
Thereafter, the costs are transferred to a work-in-process
inventory account.
3. In both the cases, overheads rates are pre-determined for

absorption of overhead expenditures.
Hybrid Costing Not in textbook
• Costing systems do not always fall neatly into Job costing or
Process costing categories
• Many production systems are hybrid systems in which both

mass production and customization occur
• For eg: Ford Motor Company

• Automobiles may be manufactured in a continuous flow
(suited to process costing) but individual units may be
customized with different engine sizes, transmission, music
systems and so on (which requires Job costing)
• Firms that manufacture closely related standardized product

(for eg: various types of televisions, dish-washers, washing
machines and shoes) tend to use Hybrid costing systems.
• They use process costing to account for the conversion costs

and job costing for the material and customizable components
Hybrid Costing Not in textbook
2. Normal Loss, Abnormal Loss and
Abnormal Gain
Normal Loss
Normal loss occurs under normal circumstances, and it is an inbuilt loss. It

cannot be avoided by management decisions. It happens in natural course of
production and is also known as a non-controllable loss; for example, loss due
to evaporation or shrinkage, etc.
The following entries are passed in respect of normal loss:

1. For the Scrap value of Normal Loss:
Debit Normal Loss A/c
Credit Process A/c
2. For Adjustment of abnormal gain, which is a situation when normal loss is

lesser than expected normal loss:
Debit Abnormal Gain A/c
Credit Normal Loss A/c
3. For realization of the scrap value of normal loss:

Debit Cash A/c
Abnormal Loss
The loss that occurs due to abnormal circumstances such as

labour strike, delay tactics of workers, breakdown of
machinery, power failure and accidents is abnormal loss.
Abnormal loss can be controlled and avoided by establishing

proper precautionary measures.
Abnormal loss occurs in addition to normal loss, when actual

output is lesser than the expected normal output.
Abnormal Gain
Abnormal gain occurs when actual output is more than the expected normal output.
Abnormal Gain = (Total Cost of Process – Scrap value of normal

loss/ normal output) * No of abnormal gain units
The following entries are passed in the books of accounts:
1. Debiting value of Abnormal gain to process account:

Debit Process A/c
Credit Abnormal Gain A/c
2. For Adjustment of scrap value to abnormal gain account:

3. For transferring balance to P&L account:

Credit Profit and Loss A/c
Difference Between Joint Product and By-Product
1. Joint products are identified at the end of the process,

whereas by-products are obtained during the process of main
product. By-products of Milk
2. Joint products are well designed, whereas by-products are

inbuilt in the process.
3. Joint products have almost same value, whereas by-products

have much lesser value.
4. The cost of by-products is borne by the main product, whereas

cost of joint products is allocated among all products.
Difference Between Joint Product and By-Product
5. There is very little scope for further process in case of by-

products. Joint products are further processed.
6. No additional inputs in case of by-products but additional

inputs are required for further processing of joint products.
7. Final products are sold as independent products in case of

joint products, whereas by-products do not have their own
identity.
8. By-products if further processed will have economies of

scope which is not the case with joint products.
By Products
Products made from by-

products of Sugar
Joint Products
Only 1st 4 are covered in text book
Average Cost Method
Physical Quantity
Method
Survey Method
Methods of
Market value at
Costing of Joint
separation point
Products Sales Revenue
Method Market value
after further
Net Realizable Value processing
(NRV) at Split-Off
Point
Constant Gross Profit

Margin Method
Methods of costing of Joint Products
Average Cost method :
Total costs are assessed and distributed in total number of units.
This gives an average unit cost with particular profit for the total operations
This method can be used where processes are common and inseparable for
the joint Products.
Also, the products so received can be expressed in a common unit, say

kilograms, numbers etc
Limitations of this method:

1. Products may be of different variety, grades or quality and hence fixing
price based on cost may be difficult . Since the costing system is
common, unit price will be uniform having practical implications.
2. If the final products cannot be expressed in common terms, this method

becomes inapplicable
Methods of costing of joint products… contd
Physical Quantity method :
• This is also known as physical unit method.

• A physical base such as raw material, weight or volume is applied in
allocating cost incurred before split off point to joint production.
Eg : Consider Crude oil has 3 components A,B and C where proportion in
production is 30%, 40% and 30% respectively.
The total joint costs will be allocated in the same proportion.
After split off points, each product may have separate costs.

1. In practice, there may be products with different measurements of units
and in that case, it will not be possible to allocate joint costs under this
method.
2. This method assumes that each joint product is equally valuable in terms
of price and identity. This may not be true in all situations.
Survey method :
• This method is based on market survey of various factors.

• All relative and important factors like quantity, prevailing selling price,
technical aspects, marketing process and other factors that affect the
costing of a product are considered after an extensive market survey.
• A percentage weight is given to different products according to their
utility and importance.
• The common costs are allocated based on these pre-decided
weights.
• If a firm feels that a particular product has more utility in generating
revenue, a higher % of weight could be considered. These weights
are arbitrary and may have bias.

This is not a rational method as it has a lot of bias and the firm may
take arbitrary decisions depending on its convenience.
Sales Revenue method :
This is one of the simplest methods where joint

costs are allocated to different products based on
the proportion of sales revenue of each product
on total sales revenue.
This is also known as the Market value method as

this is a convenient approach.
Question 1
Product R is obtained after passing through three different processes. The following data
is obtained from the records for the month ending March 2020
Process (Amount in Rs)

Total I II III
Direct Material 7541 2600 1980 2,962
Direct Wages 9,000 2,000 3,000 4,000
Production Overhead 9,000
A total of 1000 units @ Rs 3/- each were introduced to Process 1. There was no stock of
materials or WIP at the beginning or end of the period.
The output of each process passes direct to the next process and at the end of process III
to finished stock value.
Production OH is recovered @ 100% on Direct wages
Question 1 contd
The following additional data is obtained :
Output during Normal Loss to Scrap Per

Process the month Input% unit (Rs)
I 950 5 2
II 840 10 4
III 750 15 5
Prepare the following:

i. Process Accounts
ii. Abnormal Loss account and
iii. Abnormal Gain account
Solution 1
Process I account
Debit Amt Credit Amt
Particulars Unit Rate (Rs) Particulars Unit Rate (Rs)
To Direct By normal loss
Material xx (scrap value) xx
By abnormal loss
To Direct Wages xx (if any) xx
To Production
OH xx
By Output
To abnormal transfer to
gains ( if any) xx Process II xx
Total XX Total XX
Solution 1
Process II account
To units B/fwd By normal loss
from Process 1 xx (Scrap value) xx
To Direct By Abnormal loss
Material xx (if any) xx
By sale of by-
To Direct Wages xx product if any xx
To Production
overheads xx
By Output
To abnormal transfer to
gain (if any) xx Process III xx
Total 0 XX Total 0 0 XX
Solution 1
Process III account

To units B/fwd By normal loss

from Process 2 xx (Scrap value) xx
To Direct
Material xx xx
To Direct By Abnormal
Wages xx loss (if any) xx
To Production By transfer to
OH xx Finished stock xx
To abnormal
gain (if any) xx xx
XX XX
Solution 1
Process I account
To units By normal loss
introduced 1000 3 3,000 5% of 1000 50 2 100
To Direct
Material 2,600
To Direct
Wages 2,000
To Production By Output
OH (100% of transfer to
wages) 2,000 Process II 950 **10 9,500
Total 9,600 Total 1000 10 9,600

Solution 1
Cost per unit = Total Cost – Value of Normal loss

Input quantity – Normal loss quantity
= 9600 - 100 = 9,500 = Rs 10

1,000 – 50 950
Solution 1
Process II account
introduced 950 10 9,500 10% of 850 95 4 380
To Direct Material 1,980

By Abnormal loss
To Direct Wages 3,000 (balancing figure) 15 20 300
By Output
To Production OH transfer to
(100% of wages) 3,000 Process III 840 **20 16,800
Total 950 17,480 Total 950 10 17,480

** This rate will be applied to the output
= (17,480 – 380) = 17,100 = **Rs 20/- Transferred from Process II to Process III
(950 – 95) 855
Solution 1
Process III account
introduced 840 20 16,800 15% of 840 126 5 630
To Direct
Material 2,962
To Direct Wages 4,000

To Production By Output
OH (100% of transfer to
wages) 4,000 Process III 750 38 28,500
840 27,762 876 29,130
To abnormal
gain (balancing
figure) 36 38 1368
Total 876 29,130 Total 876 29,130

Solution 1

= 27,762 - 630 = 27,132 = Rs 38

840 – 126 714
The value of finished stock and abnormal gain should be calculated at this rate
Solution 1
Abnormal Loss account

By Cash or
Debtors (Sale
To Process II 15 20 300 of scrap) 15 4 60
By Costing
P&L A/c
(Abnormal
loss) 240
Total 15 300Total 15 300

Solution 1
Abnormal Gain account

To Normal
Loss 36 5 180 By Process III 36 38 1,368
To Costing
P&L A/c
(Abnormal
Gain ) 1,188
Total 36 1,368 Total 36 1,368

Solution 1
Normal Loss account

By Cash or
Debtors (Sale of
To Process I 50 2 100 scrap) 50 2 100
By Cash or
Debtors (Sale of
To Process II 95 4 380 scrap) 95 4 380
By Abnormal
To Process III 126 5 630 Gain A/c 36 5 180
By Cash or
Debtors (Sale of
scrap) 90 5 450
Total 271 1,110 Total 271 1,110

Key Words
1. Process Costing: Cost measurement for the particular process
2. Normal Loss: Wastage occurring in the normal course of

manufacture
3. Abnormal Loss: Wastage occurring due to controllable reasons but

not in normal circumstances
4. Abnormal Gain: When loss of the process is lesser than the expected
loss/ standard
5. Cumulative cost: Average cost of all processes

Key Words
6. Scrap Value: Revenue received from sale proceeds of wastage

occurred in the manufacturing process
7. Finished goods: The final output or product
8. Joint Cost: Common costs of products segregated after a particular

point.
9. Split off point: The point at which the products are segregated as
individual products.
10. By-product: A secondary product obtained from the main product

LET US SUM UP
1. Process Costing :
Each division is a stage of production
Production is carried out continuously
The production may result in Joint products and By products
Normal and abnormal losses occurred at different stages are

accounted for, in the unit cost
LET US SUM UP
2. Joint Products:
When two or more products are obtained from a single and common
Process involving common raw materials, labour, overheads, they are
called joint products.
All such products have their own identity and relative sales value
Eg : Petrol, diesel, spirit, kerosene, fuel oil and lubricant oil are all
joint products of crude oil.
The joint products derived from a common process essentially differ

from each other in their physical appearance.
LET US SUM UP
3. Joint Costs: The common costs associated with the combined

process of production are called joint costs. The common costs are
incurred up to the split off point.
The point where joint products are split off into individual
products is called split off point.
The common costs need to be allocated to individual products to have

a fair estimate of the cost of an individual product.
While an organisation can adopt any suitable cost allocation policy, it

is important to understand various joint cost allocation methods and
their significance on overall profits.
Quiz Time
Q1 . Joint cost allocation is useful for:
a. Decision making
b. Product costing
c. Cost control
d. Performance evaluation
Quiz Time
Q1 . Joint cost allocation is useful for:
a. Decision making
b. Product costing
c. Cost control
d. Performance evaluation
Quiz Time
Q2 . Joint costs are most frequently allocated based upon relative
a. Conversion cost
b. Profitability
c. Sales Value
d. Prime Cost
Quiz Time
Q2 . Joint costs are most frequently allocated based upon relative
a. Conversion cost
b. Profitability
c. Sales Value
d. Prime Cost
Do you feel you have a good understanding of Job
costing and Process costing ?
Do you feel you can decide which method should be

followed for which product ?

58
Session 7
Chapter No 8- Standard Costing and Variance

analysis
Before we start …
off at any time !!
2
4 analysis 4
5 Costing 5
8 Standard Costing and Variance Analysis 7&8
9 8
3
Learning Objectives
1. Concept and important uses of standard costing.

2. Need for standard costing and its limitations.
3. Types of standards and its determinants.
4. Measurement of material cost, labour cost and overhead
cost variances.
5. Factors affecting variances.
6. Interpretation of variances.
7. Analysis of sales and profit variances.
8. Uses and significance of control ratio in business
decisions.
1. Standard Costing
Standard Costing and Variances.. An introduction:
• Every Organisation, regardless of it profitability or growth, has to

step back and take a hard look at its spending decisions
• And when customers are affected by a recession, the need for

managers to use Budgeting and variance analysis tools for cost
control becomes especially critical
• By studying variances, managers can focus on where specific

performances have fallen short and use the information they learn
to make corrective adjustments and achieve significant savings
for their companies
• Management by exception is a practice whereby Managers focus

more closely on areas that are not operating as expected and
less closely on areas that are.
Objectives of Standard Costing
1. To exercise control on costs by determining standards in advance.

2. To set standards for quantity and price of various components of cost, such
as raw materials, labour and overheads. The standard so fixed becomes a
goal for future to be achieved.
3. To compare standard costing of one firm with other firms in the industry.
4. To monitor and control the costs by comparing standard costs with actual
costs.
5. To fix the responsibility of the concerned department based on variance
analysis.
6. To take suitable measures to reduce cost and bring efficiency under
different cost components.
7. Once the standards of cost for various cost components are fixed, the cost
control authority is given the responsibility for monitoring and control of
costs at different levels. Thus, control system becomes easy through
standard costing.
Firm’s past trends
Industry trend
Process of
Nearest competitors’
Standard
approach
Costing
Engineering approach
Management
perception
Factors Determining
Standards Under each
Cost Component
Direct raw
Direct labour cost Overhead cost
material cost
Uses of Standard Costing
1. Processing units where the process of output and the

nature of product are the same, such as chemical
engineering, paper making and metal processing.
2. In all those works where methods of manufacturing

process are repetitive and products are
homogeneous, such as food products and electricity.
3. In service units where operating costing system is

implemented, such as transport and gas.
Uses of Standard Costing
5. In industries where varieties of products are

manufactured, such as textile and engineering works
6. Industries where extraction work is done, such as

coal, oil and timber
7. All other manufacturing and services units where unit

cost component is prevailing
8. In construction work, contract work, ship building and

erection work
Benefits of Standard Costing
1. Variance Analysis: It helps in variance analysis.

The actual cost is compared with the standard cost and
variance is found. This is required to initiate corrective
actions and facilitates effective cost monitoring and control
and helps cost reduction.
2. Management Decision making:
Standard costing helps in determination of selling prices,
production planning, valuation of inventories and transfer of
output from one process to another. It is an effective tool for
management for taking various business decisions.
3. Overall Management:
Once the system of standard costing becomes efficient
and operational, the management can focus on other
policies and development issues.
4. Determining Responsibility: Standard costing also

helps in fixing responsibility of the manager responsible
for variations in costing. Once the managers have a sense
of responsibility, they become more cautious towards
monitoring the required standards.
5. Cost Consciousness:
It creates a sense of cost consciousness of all the
concerned because of responsibility and variance
analysis. The responsibility is assessed in both ways, that
is, for favourable or unfavourable performances and
reward/ adversely impact performance of the concerned
accordingly.
6. Budget Preparation:
Standard costing also helps in preparing fairly accurate and
meaningful budget for the future: short-term or long-term. Based on
available data on all the costing aspects, more accurate budget can be
proposed
7. Economies: Standard costing brings economies in terms of
effective utilization of resources, such as manpower, machines and
materials. This results in increased productivity and efficiency in cost
management.
8. MIS Preparation: Standard costing also facilitates preparation of
financial reports for analysis and other uses. Thus, the management
gets an indication of trends of business activity and also the likely
future trends.
9. Flexible Budgets: It also helps in preparation of flexible budget
more conveniently and easily due to standard costing
Limitations of Standard Costing
1. Fixing Standards: Determination of standard for various cost

components requires high degree of technical skills and fair knowledge.
Therefore, small units may find it difficult to establish standard costing
system in view of limited financial resources.
2. Fixing Responsibility: Practically, fixing up of responsibility in case of
wide gaps in variance analysis becomes difficult as there are many
internal and external factors for such variations. Some are controllable
where others are not.
3. Arbitrary process: Fixing standards is an arbitrary process. It may be
either too stiff or too liberal. Different firms may have different
approaches as convenient to them.
4. Not a dynamic approach: It is only a cost control tool. There is a limited
scope for dynamic approach.
Difference between budgetary control and standard
costing
Component /
Basis Budgetary Control Standard Costing
Components included in
Costs components involved
Budgetary control are related to
Cost Component in production process alone
income and expenditure. It is
are included
based on budget of a firm
Different types of budgets are
prepared for all the business Standard Costing is related
Applicability
operations of the firm. It caters to to production process alone
huge activities
Total expenditure and per unit

Cost vs Total Cost of a product is shown
cost of a product are both shown
Expenditure per unit in Standard Costing
in a budget
Difference between budgetary control and standard
costing contd…
Component /
Basis Budgetary Control Standard Costing
Individual activity
Separate Budget is prepared Based on total production units
vs Total
for each activity in a short period
production
There need not be any

Functions only with Budgetary
Inter-dependence standard costing system for
control system
budgetary control
Variance analysis is an
There is no variance analysis
important aspect of Standard
in budgetary control. It is
costing. It is done for all the
Variance Analysis carried out only if actual
cases irrespective of
expenses are more than the
favourable and unfavourable
budgeted expenses
results
Standard Costing and Variance Analysis
The variance can be explained as a gap (deviation) between actual cost

and standard cost.
The variances may be analysed with respect to various elements of costs,

sales and profit.
1. Material cost variances

2. Labour cost variances
3. Overhead variances
4. Sales variances
5. Profit variances
The variances in actual and standard costs can happen on account of
following:
1. Variance on account of functions, such as cost function, profit

function and sales function.
2. Variance in relative terms, for example, difference between actual
and standard cost in unit terms or percentage terms. It can be
absolute term when difference in standard cost and actual cost is
measured in money terms.
3. Variance can be favourable or unfavourable as explained earlier.
4. Variance may be controllable when the decision of management
can affect the cost control. It can also be non-controllable variance if
it cannot be controlled due to external factors.
We will consider the example of Color Plus company, a firm that
manufactures an sells jackets to understand the variances
throughout the chapter.
The jackets manufactured by Color Plus require tailoring and many

hand operations. Color plus swells exclusively to distributors who in
turn sell to independent clothing stores and retail chains.
For simplicity, we assume the following:

1. Color Plus’s only costs are in the manufacturing division. No
costs incurred in other value chain functions such as Marketing
and Distribution etc
2. All units manufactured in Jan 2020 are sold in Jan 2020
3. There is no Direct Materials inventory at the beginning or end
of the period.
4. No work in process or Finished goods inventory at the
beginning or end of the period
The budgeted variable cost per jacket for each category is :
Variable cost per Budgeted fixed costs

Cost Category jacket (Amt ) for production between Rs
Direct Material cost 600
0 and 12000 jackets 2760,000/-
Direct Labour costs 160
Rs 1200 per
Variable Mftg OH 120 Budgeted Selling Price jacket
Total Variable costs 880 Budgeted Production 12,000

and Sales jackets
The number of units manufactured is the cost
Actual Production and 10,000
driver for Direct Materials, direct manufacturing
Sales jackets
labour and variable manufacturing overhead. The
relevant range for the cost driver is from 0 to
12000 jackets.
Particulars Actual Budget Variance Remarks
Units Sold 10000 12000 2000
Revenues 1,25,00,000 14400000 19,00,000 Unfavorable
Variable Costs:
Direct Material 62,16,000 72,00,000 9,84,000 Favorable
Direct Wages 19,80,000 19,20,000 60,000 Unfavorable
Variable Mftg OH 13,05,000 14,40,000 1,35,000 Favorable
Total Variable Costs 95,01,000 1,05,60,000 10,59,000 Favorable
Contribution Margin 29,99,000 38,40,000 8,41,000 Unfavorable
Fixed Costs 28,50,000 27,60,000 -90,000 Unfavorable
Operating Income 1,49,000 10,80,000 9,31,000 Unfavorable

2. Material Cost Variances
Material Cost Variance Analysis
Material Price Variance
Material price variance = Actual Quantity used* (Standard Price-

Actual price)
Material price variance may happen on account of any of the following

reasons:
1. Variations in the market price than the standard price
2. Change in quantity actually purchased in comparison to standard
quantity required
3. Purchase of non-standard materials as per the need
4. Higher or lesser carrying cost than the budgeted one
5. Inefficient purchase policy of the firm
6. Difference in actual purchase discounts than expected
7. Other external reasons, such as inflation and scarcity of raw materials
Material Price Variance
Managers should always consider a broad range of possible causes of
price variance.
Color Plus’ favorable direct Materials price variance could be due to one
or more of the following:
1. Color’s purchasing Manager negotiated the direct materials prices
more skilfully than was planned in the budget
2. The purchasing manager changed to a lower price supplier
3. The purchasing manager ordered larger quantities than budgeted and
obtained quantity discounts
4. Direct materials price reduced unexpectedly o/a oversupply in the
industry.
5. The budgeted purchase price was set too high without careful analysis
of market conditions
Material Usage (Quantity) Variance
Material usage variance = Standard Price* (Standard qty-

Actual qty)
Material usage variance may happen on account of any of the
following reasons:
1. Higher or lower wastage on account of leakages, evaporation,
etc., in storage as compared to expected quantity losses.
2. Difference in the quality of materials actually purchased as

compared to planned quality of materials. It may be either
superior quality or inferior quality.
3. Higher or lesser wastage on account of scrap, normal

wastage, spoilage, etc., than the standard quantity of wastage.
Material Usage (Quantity) Variance contd…
Material usage variance = Standard Price* (Standard qty- Actual

qty)
Material usage variance may happen on account of any of the following
reasons:
4. Improper upkeep of materials resulting pilferage of materials.
5. Theft and leakages of materials due to improper security
arrangements at the storage
6. The standards set might not be correct
7. Technological reasons resulting in higher or lesser consumption of
materials.
8. Inefficient handling of materials in the production process.
Data given by Color plus for Standard and Actual Cost of Material
Particulars Standard Actual Variance Variance
Std Cost per

square yard (Price) 300 280 20*22200 4,44,000
Square yards per -

jacket (Efficiency) 20000 22200 2200*300 -6,60,000
Material cost per

jacket 20,300 22,480 -2,16,000 2 yards per jacket
Material price variance = Actual Quantity used* (Standard Price- Actual price)
Material usage variance = Standard Price* (Standard qty- Actual qty)

Data given by Color plus for Standard and Actual Cost of Material
Budgeted
Actual per Rate per
Particulars unit Actual unit Budget Variance Remarks
Units Sold 10000 10000 2000
Variable Costs:
Direct Material 62,16,000 60,00,000 -2,16,000 Unfavorable
Price Variance
Actual price vs
budgeted price 280 300
Actual Yards used 22,200 62,16,000 22,200 66,60,000 4,44,000 Favorable
Efficiency Variance
Quantity 22,200 20,000
Std price 300 66,60,000 300 60,00,000 -6,60,000 Unfavorable
Material price variance = Actual Quantity used* (Standard Price- Actual price)
Material usage variance = Standard Price* (Standard qty- Actual qty)

Material Mix and Yield variance
Material Usage can be further split into Material Mix and Material Yield
variance :
1. Material Mix Variance : This is the situation when a firm uses more
than one material in producing a product
2. For eg : The standard mix in Product A is as follows:
Cost per
Std Mix Actual Mix unit
X 30% 30% 8.00
Y 30% 35% 20.00
Z 40% 35% 15.00
This will create a variation in the materials cost as all the materials have
a different price.
Hence, when there is a difference in the standard mix and actual mix of
quantity of materials used, it results in material mix variance.
Material Mix Variance
Material Mix Variance = ( Standard Cost of Actual Mix at Standard rate of Mix)
– ( Actual cost of actual Mixture)
= Standard Price * {Actual Quantity in standard mix (known

as RSQ) – Actual Quantity}
Total Actual Qty consumed × Standard portion of particular raw material

RSQ=
Total Standard Mix for all the materials
Material Sub-Usage Variance = ( Std Quantity – Revised Std Quantity) × Standard Price
Material Yield Variance
Material Yield Variance = Standard cost of material per unit of output *

(Standard Output for actual inputs of raw material – Actual output)
Total Cost of actual output at Std price

Standard Cost of material per unit of output =
Standard output for actual inputs
3. Labour Cost Variances
Analysis of Labor Cost Variance
Labour Cost Variance = Labour Rate Variance + Labour Efficiency Variance
Labour Efficiency Variance = Idle Time Variance + Yield Variance + Labour mix
Variance
Labor Rate Variance
Labour rate = Actual Labour time worked* (Standard wage rate-

variance Actual wage rate)
Labour rate variance may occur on account of following reasons:

1. Change in labour mix than the pre-determined standards, may be on account
of shortage of labour in a particular category, labour sitting idle for want of
materials and other equipment.
2. Rise in wage rates due to inflation or wage rate policy of the government such
as minimum wages act.
3. Hike in wage rate due to overtime work where the wage rate is higher or
working in night shifts. In both the cases, the actual wage rate will be higher
than the standard.
4. Improper allocation of job among the workers.
5. Policy changes in the incentive schemes to be provided to the employees.
6. Increased idle labour time due to external factors, such as power failure and
machine breakdown.
Labour Efficiency Variance
Labour efficiency= Standard Wage rate × (Std labour hours–Actual labour
Variance hours)
The labour efficiency variance may arise on account of the following
reasons:
1. More wastage of time due to lack of proper monitoring and supervision
2. Inefficiency of labour productivity may be on account of adverse
working conditions
3. Higher number of labour turnover
4. Power failure or any other unexpected event such as machine
breakdown
5. Frequent interruptions in the production process
6. Lack of trained and skilled workforce
7. Ineffective co-ordination among different units
Labour Efficiency Variance:
Color Plus’ unfavorable efficiency variance for direct manufacturing
labour could be due to one or more of the following:
1. Color Plus’s workers took longer to make each jacket because

they worked slowly or made-poor quality jackets that required
reworking
2. Color’s personnel manager hired unskilled labour
3. Color’s personnel scheduler inefficiently scheduled work resulting
in more manufacturing labour time than budgeted being used per
jacket
4. Color’s maintenance department did not properly maintain
machines
5. Color’s budgeted time standards were too high because the skill
levels of employment and the environment in which they operated
were not accurately evaluated
Idle Time Variance
• The idle time can be defined in terms of non-productive

time spent by workers i.e. time remaining idle without
doing work.
Standard Idle Time:

• There are standard norms for idle time as a firm needs
to give some time for lunch breaks, refreshment breaks
(incl. restroom breaks), etc.
• This is known as standard idle time which is included in
the production process itself.
Idle Time Variance
Abnormal Idle Time:
• However, there maybe occasions where workers spend more time
without work (greater than standard time), this is known as ‘Abnormal
Idle Time’
• This may happen for 2 reasons:
• Either a deliberate attempt to waste time by workers
• Or due to external factors on account of power failure, machine
breakdown, etc.
• It is the Abnormal Idle Time that needs to be calculated for variance
purpose.
• This variance is always unfavorable, calculated as follows:
Idle Time variance = Abnormal Idle time * Total Man hours * Standard
wage rate per hour
Labor Yield Variance
• This happens on account of difference in standard yield in given
number of work hours and actual yield obtained in actual work hours
• Eg: a product requires two hours to produce and in a particular
process, workers worked for 1200 hrs. As per the standards, the output
in given number of hours would have been 600 units. However, the
actual output may differ.
• It may be either higher or lower than the required standard
• This difference between actual and standard causes variance, which
maybe favorable or unfavorable.
• The variance is calculated as follows:
Labor Yield Variance = (Standard yield in units expected from the actual
hours worked less Actual yield) * Standard labour cost per unit
Labor Mix Variance
• The different composition of workers comprising skilled, semi-
skilled and unskilled, men and women, is known as labor mix.
• The firm may have pre-determined standards of labor mix among
various groups. However, the actual mix may differ at the time of
production
• This causes variation due to change in composition of workers as
the wage rate for different groups are different and therefore
impact the costs
• The changes in worker composition may occur on account of :
• Non availability of required number of workers in a particular
category OR
• Change in firm’s policy to change the composition in view of
cost considerations.
Labor Mix Variance
Labor Mix Variance = (Revised Standard hours- Actual

hours)* Standard rate per hour
The revised standard hours can be calculated as follows :
Revised Standard Hours = Standard Hours for the

particular composition / Total Standard Hours * Total Actual hours
The following information is available about a product for the month of December 2019 :
Particulars Units
Material Purchased 24,000 kg ( Rs 105,600/-)
Material Consumed 22,800 kg
Actual wages paid for 5940
hours Rs 29,700/-
Units produced 2160
Standard Rates and prices

are as follows:
Direct Material Rate Rs 4/- per unit
Direct Labour Rate Rs 4/- per hour
Standard Input 10kg for one unit

Based on the data and information, calculate
Standard labour hours per relevant Material and Labour cost variances
unit 2.50 hours per unit
Solution:
Material Variances
Standard Quantity
(SQ) 21,600
Material Cost Variance = (SQ*SP) - (AQ*AP)
Standard Price (SP)
= (2160*4*10) - (22800*4.4) per unit 4.0
=Rs 86,400 - Rs 100,320
Actual Quantity (AQ) 22,800
= Rs 13,920/-
Actual Price (AP) per
unit 105,600/24000 4.4
Material Price Variance = AQ(SP-AP)
=22,800kg ( 4 - 4.40)
=Rs 9,120/-
Material Usage Variance = SP(SQ-AQ)
=4 (21,600-22,800) = 4800
= Rs 4,800/-
Solution:
Labour Variances No of Units

produced 2160
Labour Cost variance = (SH*SR)- (AH*AR) Standard Hours (SH) 2.50 hours per
= (2160*2.50*4) - (29700) per unit unit
= 21600-29700 Total Standard
= Rs 8,100/- Hours (SH) =2160*2.5 5400
Standard Rate (SR) Rs 4/- per hour
Actual Hours (AH) 5940
= Rs 5/-
Labour Rate variance = AH (SR-AR)
Actual Rate (AR) 29,700/5940 per hour
= 5940 (4 - 5) AH*AR ( given) 29,700/-
= Rs 5,940/-
Labour Efficiency variance = SR ( SH-AH)

=4 ( 5400-5940)
=Rs 2,160/-
4. Overhead Cost Variances
Overhead Variances
Variable Overhead Variance
Overhead Variance = AO ( SR- AR)

= (AO*SR) - (AO*AR)
= SVO - AVO
Where
• AO = actual output
• SR = standard rate
• AR = actual rate
• SVO = standard variable overhead and
• AVO = actual variable overhead
Variable Overhead Variance = (Standard Hours x Standard variable

overhead rate per hour) - (Actual Hours x Actual Variable overhead
rate per hour)
Variable Overhead Spending (Expenditure) Variance
This will vary with direct labour hours of input that is budgeted and
actual labour hours.
The actual variable overhead spending may be different from the

budgeted variable OH spending .
This will cause favourable or unfavourable variance which can be

calculated as follows:
Variable overhead spending Variance =
(Actual Hours x Standard Variable Overhead rate per hour) – (Actual Hours x
Actual variable overhead rate per hour)
Variable Overhead Efficiency Variance (VOEV)
Efficiency variance measures the efficiency of labour hours working with

the standard output.
Therefore the variation between the actual hours used to complete the
work and the standard hours required to complete the work may vary.
This indicates efficiency which can be measured in terms of cost

savings or excess cost incurred and calculated as follows:
Fixed Overhead Variance
Fixed OH variance is caused due to over absorption or under absorption
of fixed overheads.
Fixed OH are not affected by the volume of output as it remains the

same irrespective of output.
Fixed OH variance occurs o/a difference between standard fixed OH

and actual fixed OH on actual output
Fixed Overhead Variance = TSC – TAC Fixed Overhead Variance = (AO*SFO)- (AO*AFO)
Where,
TSC = total standard cost for actual output, Where,
TAC = total actual cost AO = actual output,
SFO = standard fixed overhead,
Fixed Overhead Variance = TSO-TAO
AFO = actual fixed overhead
Where
TSO = total standard overhead and
TAO = total actual overhead.
The fixed overhead variance may be further sub-divided into expenditure
variance and volume variance.
1. Expenditure or spending variance:
• These are fixed OH charged as an expense for a specific time period.
• These remain unchanged during a short span of time
• Fixed OH expenditure variance explains the difference between the

amount actually spent during a certain period as fixed overhead and the
amount of fixed OH budgeted for the period.
• It is calculated as follows:
Expenditure Variance = Budgeted Fixed Overhead – Actual Fixed Overhead

2. Volume Variance:
• Volume relates to measurement of output
• This variance maybe caused mainly due to the difference

between budgeted output and actual output
• This variance indicates the over absorbed OH or under

absorbed OH on account of the difference in budgeted level of
output and actual level of output
• The volume variance may occur on account of labour

efficiency or inefficiency resulting in higher or lower output
than budgeted. Also, the number of hours available for
working maybe lesser or higher than the planned hours in the
budget
2. Volume Variance:
• To arrive at this variance we find out the difference between budgeted

output and actual output and then multiply it by the standard fixed OH
absorption rate
• Volume Variance = SC (AQ - BQ)
• Where,
• SC= standard cost per unit of fixed OH
• AQ= actual output in actual hours worked
• BQ= budgeted standard output planned in budgeted standard hours
Fixed Overhead Volume Variance
To further examine, fixed overhead volume variance can be sub-divided
in three categories
1. Efficiency variance : SC ( AQ-SQ)
2. Capacity Variance : SC (SQ-BQ) OR SC (SQ- RBQ)
• Where,
3. Calendar Variance : SC (RBQ-BQ) • SC= standard cost per unit of fixed OH
• AQ= actual output in actual hours worked
• BQ= budgeted standard output planned in
budgeted standard hours
5. Sales Variances
Analysis of Sales Variances
Sales Value Variance:
• Sales value variance is the difference between the planned

value of sales and actual value of sales in a given time
period.
• A firm should make all efforts to measure this gap and

further analyze the rea sons for the variations. We can
calculate the sales value variance through the following
equation:
Sales Value Variance:
Sales value variance can be favorable or unfavorable, and this may
arise on account of following reasons:
1. Standard Selling Price vs Actual Selling price:

There may be a difference in standard selling price and actual selling
price which may be higher or lower than the pre-determined standard
price. This will cause variation in sales total sales value.
2. Actual Quantity sold vs Budgeted Quantity

Further, the actual quantity of goods sold may also vary than the
planned one which could be higher or lesser. This will also cause
variance in sales value.
3. Standard Sales Mix vs Actual Sales Mix:

There may be a difference in actual sales mix and the standard sales
mix.
The sales mix can be explained in terms of combination of different
products/varieties produced by a firm.
Sales Price Variance
Sales price variance is the difference in Actual sales price and Budgeted
sales price.
This will cause difference in actual sales value as compared to planned

sales value. We can calculate the sales price variance through the
following equation:
Sales price variance = Actual quantity sold x (Actual price - Standard

price)
It will be favorable if actual selling price is higher than the standard selling
price and vice versa.
The actual selling price depends on market conditions and other external
factors. Therefore, this variance is common.
Sales Volume Variance
Sales volume variance is the difference in Actual quantity of sales and

Budgeted quantity of sales.
This will cause difference in actual sales value as compared to planned

sales value. We can calculate the sales volume variance through the
following equation:
Quantity of sales will directly impact the sales value and hence higher
quantity sold than budgeted will create a positive variance and vice
versa
It can be calculated with the help of the following equation:
Sales Volume variance = Standard Price (Actual quantity of sales - Standard quantity of sales)
Sales Mix Variance
Sales mix variance can be explained in terms of difference in actual quantity

of sales mix and budgeted quantity of sales mix.
This will cause difference in actual sales volume as compared to planned

sales volume as all the varieties or products have different selling price.
The sales mix is the combination of various products produced by a firm

and sold during a given period of time.
We can calculate the sales mix variance through the following equation:
Sales mix variance= Standard value of actual mix - Standard value of revised standard mix
Sales Sub – Volume Variance
• The difference between the budgeted sales and revised standard sales is
Sales Sub-volume variance.
• The sub-variance is calculated to understand the effect of RSQ as

compared to budgeted sales quantity.
• This is also known as Sales Quantity Variance
• It can be calculated using the following equation:
Sales quantity variance =

(Revised standard sales quantity x Standard selling price)
- (Standard sales quantity x Standard selling price)
6. Variance based on profits
Variances Based on Profits
Total Sales Margin Variance:

• We can also calculate variances based on budgeted profit and actual profit.
• This is a composite variance that is arrived based on other sub-variances.
• It simply represents the difference between the standard margin of profit in
relation to budgeted quantity of sales during a particular time period and the
margin between the standard cost and the actual selling price.
• We can calculate the sales margin variance through the following equation:
❖ Remember: The total sales margin variance may occur on account of variance in selling
price or quantity of goods sold. Let us understand both.
Margin Variance Due to Selling Price:

• Sales margin variance may occur on account of the difference
between the standard price of the quantity of sales offered during the
period and the actual price.
• This can be calculated as follows:
Sales Price Variance = Actual Qty of sales ( Standard Price – Actual Price)
• We can also calculate sales margin variance on account of difference

in selling price as follows:
Sales Price Variance = (Budgeted profit on actual sales at Standard Price

and Standard cost – Actual Price)
Sales Margin Variance Due to Volume of Sales:
• The ‘volume’ represents the quantity. The sales margin variance on account of
quantity of sales may occur due to the difference between the budgeted quantity
of sales and the actual quantity of sales.
• For further analysis, we can calculate two more sub-variances on account of
change in the ratio of quantities of sales of different products known as ‘mix
variance’.
• This may "Occur on account of actual mix of quantities that may be more or lesser
than the budgeted sales mix of different quantities.
• This can be calculated as follows:
Sales Volume Variance = (Budgeted Profit on standard qty of Sales – Standard profit on
actual qty of Sales)
OR
Sales Volume Variance = Budgeted Profit – Profit on actual qty of Sales at Standard price
and standard costs
Sales Margin Variance Due to Sales Mixture
Sales Quantity Variance: Standard Contribution per unit * (Standard

proportion for Actual Sales – Actual proportion)
Sales Margin Variance Due to Quantity of Sale or Sales Quantity Variance:
Sales Quantity Variance:

Standard Average Contribution margin per unit * (Total Budgeted Sales – Total
Actual sales)
The budgeted and actual sales of a Mithai shop during the month of
Diwali, November 2019 is as follows:
Budgeted Rate per Actual Qty

Particulars Qty (Kg) Unit (Kg) Rate per Unit
Laddoo 1,100 50 1,300 55
Kaju Barfi 950 100 1,000 95
Mawa Cake 1,250 80 1,200 78
3,300 3,500
The cost per kg of Laddoo, Kaju Barfi and Mawa cake was
Rs 45, Rs 85, and Rs 70 respectively.
Compute the different Variances to explain the difference between

budgeted and actual profit
Solution:
Standard and Actual Profit per

Unit
Standard (Rs) Actual (Rs)

Particulars SP Cost Profit SP Cost Profit
Laddoo 50 45 5 55 45 10
Kaju Barfi 100 85 15 95 85 10
Mawa Cake 80 70 10 78 70 8
Solution:
Standard (Rs) Actual (Rs)

Profit Total Total
Sales Qty per unit Profit Sales Qty Profit per Profit
Particulars (Kg) (Rs) (Rs) (Kg) unit (Rs) (Rs)
Laddoo 1,100 5 5,500 1,300 10 13,000
Kaju Barfi 950 15 14,250 1,000 10 10,000
Mawa Cake 1,250 10 12,500 1,200 8 9,600
32,250 32,600
Total Profit Variance = Actual Profit – Budgeted Profit

= Rs 32,600 – Rs 32,250= Rs 350 ( F)
Solution:
Profit Variance o/a Selling Price : Actual Quantity ( Actual SP – Standard SP)
Actual
Sales Qty Standard
Particulars (Kg) Actual SP SP
Laddoo 1,300 55 50
Kaju Barfi 1,000 95 100
Mawa Cake 1,200 78 80
Laddoo = 1300 ( 55-50) = Rs 6500 (F)

Kaju barfi = 1000 ( 95-100) = Rs 5000 (A)
Mawa Cake = 1200 (78-80) = Rs 2400 (A)
Total Profit Variance o/a Selling Price = Rs 900 (Adverse)

Solution:
Profit Variance o/a Sales Volume : Standard Profit ( Actual qty – Budgeted qty)
Budgeted
Particulars Std Profit Actual Qty Qty
Laddoo 5 1300 1,100
Kaju Barfi 15 1000 950
Mawa Cake 10 1200 1,250
Laddoo = 5 (1300-1100) = Rs 1000 (F)

Kaju barfi = 15 ( 1000-950) = Rs 750 (F)
Mawa Cake = 10 ( 1200-1250) = Rs 500 (A)
Total Profit Variance o/a Sales Volume = Rs 1,250 (F)

Solution:
Sales Value Variance = Sales Price Variance + Sales Volume Variance
Total Profit Variance = Rs 32,600 – Rs 32,250= Rs 350 ( Favourable)
Total Profit Variance Total Profit Variance

o/a Sales Volume = Rs 1,250 (Favorable) o/a Selling Price = Rs 900 (Adverse)
7. Control Ratios
Control Ratios:
A firm needs to monitor performance from time to time to evaluate and

assess actual performance as against the budgeted and planned
performance.
To achieve this goal, control ratios are very important.
The control ratios measure the extent of variation from the standards as
compared to actual performance.
It also helps to understand if the variance is favourable or non-favourable.
Some of the key Control Ratios are:
1. Standard Hour
2. Activity Ratio
3. Capacity Ratio
4. Efficiency Ratio
5. Calendar Ratio
Control Ratio
1. Standard hour:
• Standard hour (SH) denotes the ideal time to complete a job within
normal circumstances. This is the basic concept to understand and to
further evaluate control ratios.
• SH is a measurement tool to measure the output
• Sometimes, a firm maybe engaged in manufacturing of different types
of products or varieties of products that may differ in size, shape, utility
and value, in that case it becomes difficult to measure the output of
different products. Therefore, the concept of SH becomes more
significant to identify the total output
Control Ratio
2. Activity Ratio
• Through this ratio we can measure actual level of production and find
out the variance.
• It aims to measure whether actual level is higher or lower than the
performance level
• This ratio is also know as ‘Production Volume Ratio’
• It can be calculated as follows:
𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡 𝑖𝑛 𝑆𝐻
× 100
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑂𝑢𝑡𝑝𝑢𝑡 𝑖𝑛 𝑆𝐻
Control Ratio
3. Capacity Ratio
• Through this ratio we can establish the relationship between actual
hours worked and the budgeted hours preplanned for completion of a
job in a particular time period.
• Therefore this ratio measures upto what extent the actual hours
worked are different from the budgeted hours for a particular time
period.
• It assess the difference between ‘ how many hours should have been
worked’ and ‘how many hours have actually been worked to complete
a particular job’.
𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠 𝑤𝑜𝑟𝑘𝑒𝑑

× 100
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 ℎ𝑜𝑢𝑟𝑠
Control Ratio
4. Efficiency Ratio
• This ratio establishes the relationship between the actual output in terms of
SH and the actual hours worked for actual production.
𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡 𝑖𝑛 𝑆𝐻
× 100
𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠 𝑓𝑜𝑟 𝑎𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
5. Calendar Ratio:
• This ratio indicates the relationship between actual number of days worked
during the budget period and the budgeted working days planned during the
budget period
𝐴𝑐𝑡𝑢𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑏𝑢𝑑𝑔𝑒𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
× 100
𝑁𝑜. 𝑜𝑓 𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑏𝑢𝑑𝑔𝑒𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
Key Words
• Standard Cost: A pre-determined cost for various cost

components to set standards to be followed
• Actual Cost: Costs actually incurred on different cost components
• Variance: The difference between the standard cost and the

actual cost
• Material Cost Variance: The difference between standard cost of

raw materials and actual cost of raw materials
• Labour Cost Variance: The difference between standard labour

cost and actual labour cost
Key Words
• Overhead Cost Variance: The difference between standard

and budgeted overheads of a production process and actual
overheads
• Sales Variance: The difference between budgeted value of

sale and actual value of sale
• Profit Margin: The difference between budgeted profit per

unit and the actual profit per unit.
• Yield Variance: The difference between standard output

expected from actual inputs and actual output obtained.
88
Session 8
Chapter No 9- Management accounting in global

perspective
Before we start …
• This Session is for you!

• So participate, ask questions, be involved !
• I shall allocate time towards the end of the session
to respond to your queries
• Please point out in chat in case the “recording” is off
at any time !!
2
4 analysis 4
5 Costing 5
8 Standard Costing and Variance Analysis 7&8
9 8
3
Learning Objectives
1. Global practices of management accounting

2. Technicalities of global business
3. Survival and growth factors of global business
4. Management accounting in competitive world
5. Global environment and changed management accounting
practices
6. Global management accounting principles
7. Recent developments in costing techniques across the globe
Introduction
Organisations across the globe have a common goals in terms of profitability, quality
of products and customer service. The focus is on cost optimization.
The market features have changed in terms of global competition, advanced

technology and faster pace of communication.
It is a global market with much faster accessibility through internet, a 24*7 market
where one can have trade and transactions round the clock.
The transactions, transfer of goods, settlement etc have no boundary lines. The
development and effective functioning of international organisations have changed the
way of international Business, such as :
WTO: World Trade Organisation
EU: European Union
ASEAN: Association of South East Asian Nations
SAARC: South Asian Association for Regional Cooperation
BRICS: Brazil, Russia, India, China and South Africa
Introduction contd…
The management accounting problems are no longer simple, but they have
become more complex. The differences have emerged in terms of the following
factors:
1. Enhanced Competition: The new and much developed information and
communication technology enabled customers to find and get access to
what they wanted wherever it was available. This has resulted in greater
supplier competition. The global market is no longer across the globe, but a
small market on customers table.
2. Advanced Technology: The advanced production techniques and much
faster production operation system allowed suppliers to profitably sell their
goods of distinct not only at low but also at competitive prices. The new
techniques and continued product innovations have mainly focused on
satisfying customer demands.
Both the above developments have successfully created competitive
environment at a faster pace. The traditional management accounting
systems are no longer relevant and they cannot cope up with the new
challenges as the spirit of competitiveness has been defined as defeating
your competitors not only on costs but also on the quality.
3. Positive Contribution: This kind of philosophy greatly emphasizes that
the firm needs to control unit costs and achieve profitability by producing all
it can sell at a price that exceeds variable costs, or in other words the
positive contribution.
4. It is all about the Customer: The new business environment calls for
two major steps to come over the competitiveness, which traditional
management accounting system did not even feel. The present mantra
for a business success depends on two crucial factors:
a. Listen to the customer needs and preferences and
b. Increased focus on eliminating the waste.
5. It is a new world !: The whole management accounting strategies have
undergone sea changes. The new concepts of inventory management,
classification of cost, new cost allocation strategies, workers
participation for continuous product improvements, etc., have brought
significant changes in the planning, practices and strategies of modern
managerial accounting practitioners.
Activity as a Focus
The focus of globally competitive firms is to identify non-value-added

activities and eliminate to avoid wastage and, on the other hand, focus
on the continuous flow of value-adding activities to a greater extent.
To further strengthen the activity audit, the following approaches have

been found useful in an efficient activity management practices:
Efficient Activity
Management
Practices
Activity Activity cost Activity-based

management accounting product costing
Activity as a Focus
Activity management:
An efficient activity management system a process to identify all the activities, measure its
relevance and utility to the product, extent of particular activity in value addition to the product, etc.
In fact, it is the exercise to eliminate the non-financial outcomes of activities.
The major focus of this approach is practically to ignore the costs and pay more attention to
eliminate the waste since waste causes the increased costs.
Activity cost accounting:

Another concept is activity cost accounting which measures the costs of activities and focuses on
eliminating waste.
In practice, it is observed that many activities are inherently wasteful.
This aspect requires prompt attention of the management to identify different cost drivers.
Activity-based product costing:

The activity-based product costing mainly stresses on activities to put them at logical place and
assign them appropriate costs.
Identifying appropriate cost driver is also an important exercise in this area as it relates to product
cost.
Change in Focus
Following are the areas which need focus as per the modern management
practitioners:
1. Eliminate Waste: The modern managerial accounting system needs to

be developed which pays more attention to eliminate most of the
material on financial control systems, especially the use of variances
from standard cost budgets to measure the performance of operating
managers. The budgets are needed for planning, but should not be
strictly used for cost control.
2. Move away from traditional view of costs: The modern managerial
practitioners are also of the view that there is a need to eliminate
breakeven analysis and cost behaviour. There is not much significance
for separating the costs on traditional basis, such as fixed and variable
costs.
3. Constrained Optimization: According to the modern managerial
accounting practitioners, the concept of constrained optimization should
also be eliminated.
Constrained Optimization
In mathematical optimization, constrained optimization (in some contexts
called constraint optimization) is the process of optimizing an objective
function with respect to some variables in the presence of constraints on
those variables.
The objective function is either a cost function or energy function,

which is to be minimized, or a reward function or utility function, which is
to be maximized.
Constraints can be either hard constraints, which set conditions for the
variables that are required to be satisfied, or soft constraints, which have
some variable values that are penalized in the objective function if, and
based on the extent that, the conditions on the variables are not satisfied
Management Accounting in
a competitive world
Management Accounting in a Competitive World
1. Financial and Non financial data:

The management accounting deals with both financial and non-financial
data to support a wide range of managerial decisions, whereas financial
accounting focuses only on financial data to support investors’ and
creditors’ capital allocation decisions. However, it is observed that real
value-add is the integration of financial reporting with operational
information.
2. Forward looking:
Management accounting looks forward as well as backward, whereas
financial accounting is oriented solely toward history.
Management accounting involves future forecasting and anticipations
as what will, could or should happen, as well as indicating the past
happenings and results.
Management Accounting in a Competitive World contd…
3. Tools and Techniques:

Management accounting uses forecasting. Planning and budgeting
for managerial decision making.
Financial accounting focuses on financial statements, financial ratios
and financial reporting. Important instruments are balance sheets and
annual reports.
4. Inward vs Outward looking: In practice, management accounting
looks outward as well as inward, whereas financial accounting is
solely focused on what happens internally within an enterprise.
5. Identifying threats and opportunities: Management accounting
involves proactively seeking and identifying opportunities and
threats that an enterprise faces from customers, competitors,
suppliers, regulatory agencies and other external parties. However,
financial accounting has hardly any role in this.
Management Accounting in a Competitive World contd…
6. Enhancing Business performance:

Management accounting is focused on enhancing business
performance in a competitive environment, not simply on
ensuring compliance with standards and regulations.
7. Value Creation:
Management accountants contribute directly to the creation
of value, not merely to protect and preserve it. The role of
management accountants has increased considerably in the
present global competitive environment as their managerial
decisions have direct impact on cost optimization and
revenue increase, thereby contributing more to the profit
growth of a firm.
Management accounting and Global
environment
Management Accounting and Global Environment
1. The major responsibility is to design internal accounting systems to

achieve the goals of the firm and at the same time have perfect
monitoring of the operations.
2. There is a need to redefine the parameters of performance
evaluation which are basically based on budgets and variance
analysis.
3. Understand the implications of conducting business across the globe.
In this case, interactions with individuals, firms and others assume
significance. Therefore, a managerial professional have to acquire a
global vision to analyze and understand business intricacies across
the globe.
4. Management accountants need to thoroughly understand the
applications of new costing techniques to effectively use them. An in-
depth analysis is required to assess the impact of these strategies on
costing and pricing of a product in comparison to global prices.
5. They also need to understand the various ethical issues of business
which affect the very brand of the product and firm both. The overall
impact of business ethics should be evaluated and a
communication passed across the work force to make them more
cautious toward this important issue.
6. Of course, the prime responsibility is to establish a perfect
management costing system where more focus is required on
activity management in the changing context.
7. Identification of proper cost drivers has been quite useful in
eliminating the non-value activities and thereby reducing the costs.
This exercise has been found quite useful and advantageous. This
should be made for systematic approach.
8. Management accounting professionals have a key role in optimizing
the performance of the firm. They have a close track not only on
costing and revenue aspects but also on other important factors
related to the decision-making process.
Global Management accounting
principles
Global Management Accounting Principles
1. Effective Communication systems: An effective communication system which

provides insight that is influential helps in strategy development and execution. It
also helps in better conversation among the groups.
2. MIS: Availability of information which is relevant, reliable and easily accessible.
3. Impact of Communication and Information: The further requirement is to
analyse impact of communication and information on value of the firm. This
analysis also provides insight into various alternatives and options to prioritize
actions by their impact on different outcomes.
4. Then the next important pillar of the management accounting principle is
stewardship, which builds trust and suggests accountability and credibility for
long-term sustainability.
5. Integrity and ethics are also more important for an effective management
accounting system. This, of course, is developed among the skilled and
competent people who are closely associated in implementing the management
accounting principles.
Changing Global Management
practices perspective
Cost transformation and
management
External reporting
Financial strategy
Changing Global
Management Practices Internal control
Perspective
Investment appraisal
Management and
budgetary control
Price, discount and product

decisions
Changing Global Management Practices – a Perspective
1. Cost Transformations and Management:

The exercise of reducing waste but at the same time preserving or
enhancing value. It involves the continuous exercise to identify activities
and eliminate waste. The resources saved through this exercise can be
invested in customer focused innovations.
2. External Reporting: The management accounting professionals are

also required to integrate a comprehensive assessment of financial and
non-financial performance, business model per se, risks associated and
strategies for effective assessment of future performance.
3. Financial Strategy :
This requires identification of the future strategies which will be helpful for
maximizing the firm’s net present value. This also involves appropriate
allocation of available capital resources among the competing
opportunities and an effective implementation and monitoring system to
evaluate the selected strategies to achieve pre-decided goals and
objectives of the firm
4. Internal Control:
The strengthening of internal control systems and procedures is also
a prime responsibility of management accounting professionals.
They need to prepare a framework of policies, systems, processes and
procedures for effective management of risks. There has to be a well-
defined system to ensure efficient and effective implementation of the
framework.
5. Investment Appraisal:
A decision to evaluate an investment proposal keeping in view the
financial viability and technical feasibility is an important decision area
where management accounting professional can play a crucial role.
They can prioritize the investment option based on affordability and
expected returns and different kinds of risk associated with the
investments
6. Management and budgetary control: This is of

course, a traditional role of managerial accounting
professionals to control performance again budgeted
targets.
The controlling areas may include projects, people,
activities, processes, sales volumes and revenues,
resource quantities, operating costs and expenses, asset,
liabilities and cash flows, etc.
7. Price, discount and product decisions: The most

crucial decision in a firm's operations is to decide what to
produce, how much to produce and at what Selling price
and discount the product is to be sold.
Management accounting and Developed
Costing systems
e-Business
Increased Role of Service Sector
Increased Global Competition
Management Accounting
and Developed Costing Stress on Cross-Functional Groups
Systems
Product Life Cycles and Diversity
Focus on Inventory Management
Total Quality Management

Concept
Management Accounting and Developed Accounting
Systems:
1. E-Commerce
The rapid growth of E-commerce and E-business witnessed the rapid
electronic transformation of the business environment and the way
business is done.
e-commerce may be defined as buying and selling of products or services
online or over the internet and e-business is a much broader concept.
Managerial professionals have also quickly embraced e-accounting by

harnessing the power of online communications to streamline the
procedures of management accounting
For Eg: e-budgeting is adopted by several companies to quickly and
effectively transmit the information needed to construct a budget from far
flung business units around the globe.
E-business is here to stay and as per a market report, this is just the
beginning of significant growth of the e-commerce sector in India
Systems
1. E-Commerce contd…Some facts about e-tailing:
➢ Despite strong growth of E-commerce in India , E-tailing is only 4 to

5% of total Retail sales
➢ In the festive sale (September 29-October 4, 2019), the e-tailers in

India achieved US$ 3 billion of Gross Merchandise Value (GMV).
➢ Online Travel accounts for ~ 70% of E-commerce business in India.

This business has grown at a compounded annual growth rate
(CAGR) of 32% over 2009-2013
➢ E-retail market is expected to continue its strong growth, by

registering a CAGR of over 35 per cent and to reach Rs 1.8 trillion
(US$ 25.75 billion) by FY20.
Systems
1. E-Commerce contd…Some facts about e-tailing:
For every Rs 100 spent on E-tailing , Rs 35 is spent on supporting

services like warehousing, payment gateways and logistics among
others
Demand in India exists in almost 4000 to 5000 cities and towns but
physical retail is not present in almost 95% of them because of
prohibitive real estate costs.
Management Accounting and Developed Accounting Systems
2. Increased Role of service sector :
The market share of service sector has been growing across the globe.
Several governments have made engagements and provided incentives to
boost this sector. The telecommunications, financial services and airline
industries are among them.
As more and more firms provide financial, medical, communication,

transportation, consulting and hospitality services, managerial accounting
techniques must be adapted to meet the needs of managers in those
industries.
As we are aware that the main difference between service and manufacturing
firms is that most Services are consumed as they are produced, the services
cannot be inventoried as manufactured goods.
It has been observed that many of the techniques developed for measuring
costs and performance in manufacturing firms have been adapted
successfully to service industry firms.
Management Accounting and Developed
Accounting Systems
3. Increased Global Competition :
The extensive global competition is forcing firms to strive for

excellence in product quality and service which was not the
case earlier. MNC’s face several challenges that do not
confront domestic companies. Political systems, accounting
rules for external reporting, legal systems and cultural norms
vary widely across countries.
Therefore, Management professionals must be aware of

various policies and practices to successfully carry out
operations across countries.
4. Stress on Cross Functional Groups:
In past, managers used to stick to their own work area:

- Production managers focused on how best to manufacture a
product or produce a service
- Design engineers often emphasized engineering elegance rather
than designing product for manufacturability
- Managerial accountants provided information for decision
making, planning, control and performance evaluation.
Today, the things have changed drastically.
The cross-functional approach has replaced this narrow

managerial perspective.
4. Stress on Cross Functional Groups contd….
The functional groups bring together operations managers,

marketing managers, purchasing and material handling experts,
design engineers, quality management personnel and managerial
accountants to focus their varied expertise and experience on
virtually all management issues.
The managerial accounting professionals develop information

system and provide data ranging across all aspects of the
organizations internal operations and external environment.
They also work as an integral member of the cross-functional

team, interpreting information and analyzing the implications of
decision alternatives.
The cross-functional groups create value for the firm by under-

standing customer's needs in the most effective manner possible.
Management Accounting and Developed
Accounting Systems
5. Product Life cycles and Diversity:
In view of changes in technology at faster pace, the lifespan

of most products is becoming shorter.
In the computer industry, for example, product models are

used only a few years before they are replaced by more
powerful versions.
To be competitive, manufacturers must keep up with the

rapidly changing market place.
The challenge before management accounting

professionals is to have timely information about production
costs and other product features in order to meet effectively
to the competition.
Systems
6. Focus on Inventory Management
In traditional Manufacturing system , inventories of raw materials and

parts, WIP and finished goods were kept as a buffer against the
possibility of running out of an item that may be required.
Large buffer inventories consume valuable resources and cost heavily

to a firm
Hence, many manufacturers have changed their approach to

production and inventory management. These manufacturers have
adopted a strategy for controlling the flow of manufacturing in a multi-
stage production process.
In a Just-in-time (JIT) production system, raw materials and parts are

purchased or produced just in time to be used at each stage of the
production process.
Systems
7. Total Quality Management Concept (TQM):
The concept of TQM has emerged very strongly in the recent past.
If a component has to be produced “Just in Time” for the next

production stage, it must be “ just right” for its intended purpose.
A light delay in the inventory process may shut down the entire
production line, entailing considerable cost.
Therefore Management accountants have become increasingly

involved in monitoring product quality and measuring the costs of
maintaining quality. This information helps companies maintain
programs of TQM
Modern Cost Management System
1. Assessment of cost of the resources consumed in

performing significant activities.
2. Continued focus to identify and eliminate non-value-
added costs. The costs incurred on activities which do
not increase the value of a product can be eliminated
with no deterioration of product quality, performance or
perceived value.
3. More stress on measuring efficiency and effectiveness of
all major activities performed in the firm.
4. On going efforts to identify and evaluate new activities
that can improve the future performance of the firm.
Do you feel you have a good understanding of
Management Accounting in a Global perspective ?
Do you feel modern concepts of TQM, Cross

functional coordination, process optimization are
useful concepts ?
Key Words
1. Global Business : Business transactions conducted across the

world
2. WTO : World trade organisation
3. Global Competitive Firm: A firm having competitive advantage in

global business
4. Activity Management : The focus of a firm to manage relevant and

value added activities
rather than cost
5. Activity Cost accounting: Measurement of cost based on cost

drivers
Key Words
6. Management Ethics: Managerial practices with value and ethics
7. Cost optimization: Optimum utilization of resources at a

minimum cost
8. External Reporting: Financial reports meant for external

stakeholders
9. Investment Appraisal: Assessment of viability of a new

investment opportunity
10.E-Business: Business transactions through internet

LET US SUM UP
Today is the last session for Costing !
Hope you are clear about all the concepts of :

• Various types of Costs and their classification
• Material, Labour and Overhead costs and their efficient
management
• Job and Batch Costing
• Contract costing
• Process Costing
• Marginal Costing and Break even analysis
• Absorption Costing
• Standard Costing and understanding Variances
• Management Costing is increasingly important in an ever
increasing competitive world !
44

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Cost and Management Accounting

1. Management Accounting Fundamentals & Materials Cost Control

5. Process Costing and Joint costing

1.1 Management Accounting Fundamentals

1.2 Materials Cost Controls

All businesses are concerned about revenues and costs

o Managers at companies, small and large must understand

o Managers use cost accounting information to make decisions

Management accounting assists Managers in taking such

Cost accounting: This is the process of measuring, analysing and

Management accounting : Management Accounting is the process of

Financial Accounting Management Accounting

It has a narrow scope in Business It has a broader scope in analyzing

It is concerned with both, short term

It assists only in Management It also helps in performance evaluation

Approach It is a historical approach It is a futuristic approach

It can be installed without the It cannot be implemented without the

1. The concept of “separate entity” implies that the owner (person) is

Cost accounting is a technique to optimize cost of production/services by using

The essential functions of cost accounting are as follows:

1. Ascertaining the cost of production on per unit basis.

Select the right methodologies

Determine how efficient and effective the organization is

Drive implementation of the changes

Make the change sustainable

There are four broad objectives that Management accounting

1. Planning: Preparing a Plan and ensuring its execution to achieve

2. Allocation of resources: The resources in terms of raw materials,

4. Monitoring and Control : Proper monitoring at different intervals is

Cost accounting: It helps in preparing product wise statement of cost,

Management accounting: It analyses different cost elements by

Financial Accounting is Reporting

According to the Chartered Institute of Management Accountants , the

1. MA is a decision making process based on various financial and accounting

2. It ensures adequate resources for operational units

3. It involves perfect monitoring and control through responsibility management

4. It primarily focuses on achieving future strategies and goals of the

Monitoring and Facilitates decision-

The measurement of full costs serves different purposes and is used in

2. Monitoring and Control: Another important use of management accounting

3. Facilitates Decision Making: It generates appropriate and required information

The flow of goods, services and information enhances the

Techniques such as Marginal costing help generate

• Directing:- It is the process of directing the operations for effective use of

• Controlling:- The process of controlling can be defined as a process of

• The management accounting policies and practices have changed

Some of the new innovations in the field of management accounting

a. Internal Cost Analysis

b. Internal Differentiation Analysis

c. Vertical Linkage Analysis

1. Research and Development ( R&D) : Generating and experimenting with ideas

2. Design of products and Services : Detailed planning, engineering and testing

3. Production: Procuring, transporting and storing (“inbound logistics”) and

4. Marketing ( including Sales) : Promoting and Selling products or services

5. Distribution : Processing orders and shipping products or services to

6. Customer Service: Providing after sales service to customers. Sony

Different companies create value for customers in different ways :

1. Gucci: It creates value for its customers by creating a prestigious

2. Toyota: Focuses on Quality to create value for its customers

3. Ebay: Fast response times create quality of the online auction