COST ACCOUNTING

(BCM4B05)

STUDY MATERIAL

CORE COURSE
IV SEMESTER B.Com.
(2019 Admission onwards)

UNIVERSITY OF CALICUT
SCHOOL OF DISTANCE EDUCATION
CALICUT UNIVERSITY P.O.
MALAPPURAM - 673 635, KERALA

19610
School of Distance Education
University of Calicut
STUDY MATERIAL
CORE COURSE
IV SEMESTER B.Com.

BCM4B05 : COST ACCOUNTING

Prepared by:
1. Sri. VINESH OTTUPARAMMAL
Assistant Professor,
Govt. College, Malappuram
2. Smt. T. SHAMEERA KUNHU. T,
Assistant Professor,
Govt. College, Malappuram
3. Sri. T.H. JAHFARALI
Assistant Professor,
Govt. College, Malappuram.
Scrutinised by:
Dr. K. VENUGOPALAN,
Associate Professor,Dept. of Commerce,
Govt. College, Madappally.

DISCLAIMER
"The author(s) shall be solely responsible for the
content and views expressed in this book''.
CONTENT PAGE

Module I 1 - 30

Module II 31 - 56

Module III 57 - 102

Module IV 103 - 168

Module V 169 - 203

 BCM4B05 : Cost Accounting

MODULE I
Introduction
Cost Accounting is a branch of accounting and has
been developed due to limitations of financial accounting.
Financial accounting is primarily concerned with record
keeping directed towards the preparation of Profit and Loss
Account and Balance Sheet. It provides information regarding
the profit and loss that the business enterprise is making and
also its financial position on a particular date. The financial
accounting reports help the management to control in a general
way the various functions of the business but it fails to give
detailed reports on the efficiency of various divisions. The
limitations of Financial Accounting which led to the
development of cost accounting are as follows.
Limitations of Financial Accounting
1. No clear idea of operating efficiency: Sometimes profits
in an organization may be less or more because of
inflation or trade depression and not due to efficiency or
inefficiency. But financial accounting does not give a clear
reason for profit or loss.
2. Weakness not spotted out by collective results:
Financial Accounting shows the net result of an
organization. When the profit and loss account of an
organization, shows less profit or a loss, it does not give
the reason for it or it does not show where the weakness
lies.
3. Does not help in fixing the price: In Financial

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Accounting, we get the total cost of production but it does

not aid in determining prices of the products, services,
production orderand lines of products.
4. No classification of expenses and accounts: In Financial
Accounting, we don’t get data relating to costs incurred by
departments, processes separately or per unit cost of
product lines, or cost incurred in various sales territories.
Further expenses are not classified as direct or indirect,
controllable and uncontrollable overheads and the value
added in each process is not reported.
5. No data for comparison and decision making: It does
not supply useful data to management for comparison with
previous period and for taking various financial decisions
as introduction of new products, replacement of labour by
machines, price in normal or special circumstances,
producing a part in the factory or buying it from outside
market, production of a product to be continued or given
up, priority accorded to different products, investment to
be made in new products or not etc.
6. No control on cost: Financial Accounting does not help
to control materials, supplies, wages, labour and overhead
costs.
7. Does not provide standards to assess the performance:
Financial Accounting does not help in developing
standards to assess the performance of various persons or
departments. It also does not help in checking that costs
do not exceed a reasonable limit for a given quantum of

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work of the requisite quality.

8. Provides only historical information: Financial
Accounting records only the historical costs incurred. It
does not provide day-to-day cost information to the
management for making effective plans for the future.
9. No analysis of losses: It does not provide complete
analysis of losses due to defective material, idle time, idle
plant and equipment etc.. In other words, no distinction is
made between avoidable and unavoidable wastage.
10. Inadequate information for reports: It does not provide
adequate information for reports to outside agencies such
as banks, government, insurance companies and trade
associations.
11. No answer for certain questions: Financial Accounting
will not help to answer questions like:-
(a) should an attempt be made to sell more products or is
the factory operating to capacity?
(b) if an order or contract is accepted, is the price
obtainable sufficient to show a profit?
(c) if the manufacture or sale of product A were
discontinued and efforts make to increase the sale of
B, what would be the effect on the net profit? (d)
Why the profit of last year is of such a small amount
despite the fact that output was increased
substantially? Etc.

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Costing and Cost Accounting

The costing terminology of C.I.M.A ., London defines
costing as the “the techniques and processes of ascertaining
costs”. These techniques consist of principles and rules which
govern the procedure of ascertaining cost of products or
services. The techniques to be followed for the analysis of
expenses and the processes by which such an analysis should
be related to different products or services differ from industry
to industry. These techniques are also dynamic and they
change with time.
The main object of traditional cost accounts is the
analysis of financial records, so as to subdivide expenditure
and to allocate it carefully to selected cost centers, and hence
to build up a total cost for the departments, processes or jobs or
contracts of the undertaking. The extent to which the analysis
of expenditure should be carried will depend upon the nature
of business and degree of accuracy desired. The other
important objective of costing are cost control and cost
reduction.
Cost Accounting may be regarded as “a specialized
branch of accounting which involves classification,
accumulation, assignment and control of costs.” The costing
terminology of C.I.M.A, London defines cost accounting as
“the process of accounting for costs from the point at which
expenditure is incurred or committed to the establishment of its
ultimate relationship with cost centers and cost units. In its
widest usage, it embraces the preparation of statistical data, the
application of cost control methods and the ascertainment of

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profitability of activities carried out or planned”.

Wheldon defines cost accounting as “classifying,
recording and appropriate allocation of expenditure for
determination of costs of products or services and for the
presentation of suitably arranged data purposes of control and
guidance of management”. It is thus a formal mechanism by
means of which costs of products or services are ascertained
and controlled.
General Principles of Cost Accounting
The following may be considered as the General
Principles of Cost Accounting:
1. A cost should be related to its causes: Cost should be
related as closely as possible to their causes so that cost
will be shared only among the cost units that pass
thorough the department of which the expenses are
related.
2. A cost should be charged only after it has been incurred:
While determining the cost of individual units those costs
which have actually been incurred should be considered.
For example, a cost unit should not be charged to the
selling costs, while it is still in the factory. Selling costs
can be charged with the products which are sold.
3. The convention of prudence should be ignored: Usually
accountants believe in historical costs and while
determining cost, they always attach importance to
historical cost. In Cost Accounting this convention must
be ignored, otherwise, the management appraisal of the

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profitability of the projects may be vitiated. According to

W.M. Harper, “a cost statement should, as far as possible,
give facts with no known bias. If a contingency needs to
be taken into consideration it should be shown separately
and distinctly”.
4. Abnormal costs should be excluded from cost accounts:
Costs which are of abnormal nature (eg. Accident,
negligence etc.) should be ignored while computing the
cost, otherwise, it will distort costs figures and mislead
management as to working results of their undertaking
under normal conditions.
5. Past costs not to be charged to future period: Costs which
could not be recovered or charged in full during the
concerned period should not be taken to a future period,
for recovery. If past costs are included in the future period,
they are likely to influence the future period and future
results are likely to be distorted.
6. Principles of double entry should be applied wherever
necessary: Costing requires a greater use of cost sheets and
cost statements for the purpose of cost ascertainment and
cost control, but cost ledger and cost control accounts
should be kept on double entry principle as far as possible.
Objectives of Cost Accounting
Cost accounting aims at systematic recording of
expenses and analysis of the same so as to ascertain the cost of
each product manufactured or service rendered by an
organization. Information regarding cost of each product or

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service would enable the management to know where to

economize on costs, how to fix prices, how to maximize
profits and so on. Thus, the main objectives of cost accounting
are the following.
1. To analyse and classify all expenditure with reference to
the cost of products and operations.
2. To arrive at the cost of production of every unit, job,
operation, process, department or service and to develop
cost standard.
3. To indicate to the management any inefficiencies and the
extent of various forms of waste, whether of materials,
time, expenses or in the use of machinery, equipment and
tools. Analysis of the causes of unsatisfactory results may
indicate remedial measures.
4. To provide data for periodical profit and loss accounts
and balance sheets at such intervals,
e.g. weekly, monthly or quarterly as may be desired by the
management during the financial year, not only for the
whole business but also by departments or individual
products. Also, to explain in detail the exact reasons for
profit or loss revealed in total in the profit and loss
accounts.
5. To reveal sources of economies in production having
regard to methods, types of equipment, design, output
and layout. Daily, Weekly, Monthly or Quarterly
information may be necessary to ensure prompt
constructive action.

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6. To provide actual figures of costs for comparison with

estimates and to serve as a guide for future estimates or
quotations and to assist the management in their price
fixing policy.
7. To show, where Standard Costs are prepared, what the
cost of production ought to be and with which the actual
costs which are eventually recorded may be compared.
8. To present comparative cost data for different periods and
various volume of output and to provide guidance in the
development of business. This is also helpful in budgetary
control.
9. To record the relative production results of each unit of
plant and machinery in use as a basis for examining its
efficiency. A comparison with the performance of other
types of machines may suggest the necessity for
replacement.
10. To provide a perpetual inventory of stores and other
materials so that interim Profit and Loss Account and
Balance Sheet can be prepared without stock taking and
checks on stores and adjustments are made at frequent
intervals. Also to provide the basis for production
planning and for avoiding unnecessary wastages or losses
of materials and stores.
Last but not the least, to provide information to enable
management to make short term decisions of various types,
such as quotation of price to special customers or during a
slump, make or buy decision, assigning priorities to various

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products, etc.
Cost Accounting and Financial Accounting-
Both financial accounting and cost accounting are
concerned with systematic recording and presentation of
financial data. Financial accounting reveals profits and losses
of the business as a whole during a particular period, while
cost accounting shows, by analysis and localization, the unit
costs and profits and losses of different product lines. The
main difference between financial accounting and cost
accounting are summarized below.
1. Financial accounting aims at safeguarding the interests of
the business and its proprietors and others connected with
it. This is done by providing suitable information to
various parties, such as shareholders or partners, present
or prospective creditors etc. Cost accounting on the other
hand, renders information for the guidance of the
management for proper planning, operation, control and
decision making.
2. Financial accounts are kept in such a way as to meet the
requirements of the Companies Act, Income Tax Act and
other statues. On the other hand cost accounts are
generally kept voluntarily to meet the requirements of the
management. But now the Companies Act has made it
obligatory to keep cost records in some manufacturing
industries.
3. Financial accounting emphasizes the measurement of
profitability, while cost accounting aims at ascertainment

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of costs and accumulates data for this very purpose.

4. Financial accounts disclose the net profit and loss of the
business as a whole, whereas cost accounts disclose profit
or loss of each product, job or service. This enables the
management to eliminate less profitable product lines and
maximize the profits by concentrating on more profitable
ones.
5. Financial accounting provides operating results and
financial position usually gives information through cost
reports to the management as and when desired.
6. Financial accounts deal mainly with actual facts and
figures, but cost accounts deal partly with facts and
figures, but cost accounts deal with facts and figures and
partly with estimates.
7. In case of financial accounts stress is on the
ascertainment and exhibition of profits earned or losses
incurred in the business. On account of this reason in
financial accounts, the transactions are recorded,
classified and analyzed in a subjective manner i.e.
according tothe nature of expenditure. In cost accounts the
emphasis is more on aspects of planning and control and
therefore transactions are recorded in an objective manner.
8. Financial accounts are concerned with external
transactions i.e. transactions between the business concern
on one side and third parties on the other. These
transactions form the basis for payment or receipt of cash.
While cost accounts are concerned with internal

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transactions which do not form the basis of payment or

receipt of cash.
9. The costs are reported in aggregate in financial accounts
but costs are broken into unit basis in cost accounts.
10. Financial accounts do not provide information on the
relative efficiencies of various workers, plants and
machinery while cost accounts provide valuable
information on the relative efficiencies of various plants
and machinery.
11. In financial accounts stocks are valued at cost or market
price whichever is less, whereas stocks are valued at cost
price in cost accounts.
Importance of Cost Accounting
The limitations of financial accounting have made the
management to realize the importance of cost accounting.
Whatever may be the type of business, it involves expenditure
on labour, materials and other items required for
manufacturing and disposing of the product. The management
has to avoid the possibility of waste at each stage. It has to
ensure that no machine remains idle, efficient labour gets due
incentive, by-products are properly utilized and costs are
properly ascertained. Besides the management, the creditors
and employees are also benefited in numerous ways by
installation of a good costing system. Cost accounting
increases the overall productivity of an organization and serves
as an important tool, in bringing prosperity to the nation, thus,
the importance of cost accounting can be discussed under the

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following headings:
a) Costing as an aid to management:- Cost accounting
provides invaluable aid to management. It provides
detailed costing information to the management to enable
them to maintain effective control over stores and
inventory, to increase efficiency of the organization and to
check wastage and losses. It facilitates delegation of
responsibility for important tasks and rating of employees.
For all these the management should be capable of using
the information provided by cost accounts in a proper
way. The various advantages derived by the management
from a good system of costing are as follows:
1. Cost accounting helps in periods of trade depression
and trade competition. In periods of trade depression, the
organization cannot afford to have wastages which pass
unchecked. The management must know areas where
economies may be sought, waste eliminated and
efficiency increased. The organization must wage a war
not only for its survival but also continued growth. The
management should know the actual cost of their products
before embarking on any scheme of price reduction.
Adequate system of costing facilitates this.
2. Cost accounting aids price fixation. Although the law of
supply and demand determines the price of the product,
cost to the producer does play an important role. The
producer can take necessary guidance from his costing
records in case he is in a position to fix or change the price
charged.

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3. Cost accounting helps in making estimates. Adequate

costing records provide a reliable basis for making
estimates and quoting tenders.
4. Cost accounting helps in channelizing production on
right lines. Proper costing information makes it possible
for the management to distinguish between profitable and
non-profitable activities; profits can be maximized by
concentrating on profitable operations and eliminating
non-profitable ones.
5. Cost accounting eliminates wastages. As cost
accounting is concerned with detailed breakup of costs, it
is possible to check various forms of wastages or losses.
6. Cost accounting makes comparisons possible.
Proper maintenance of costing records provides
various costing data for comparisons which in turn helps
the management in formulating future lines of action.
7. Cost accounting provides data for periodical Profit
and Loss Account. Adequate costing records provide the
management with such data as may be necessary for
preparation of Profit and Loss Account and Balance Sheet
at such intervals as may be desired by the management.
8. Cost accounting helps in determining and enhancing
efficiency. Losses due to wastage of materials, idle time
of workers, poor supervision etc will be disclosed if the
various operations involved in the production are studied
carefully. Efficiency can be measured, cost controlled and
various steps can be taken to increase the efficiency.

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9. Cost accounting helps in inventory control. Cost

accounting furnishes control which management requires,
in respect of stock of materials, work in progress and
finished goods.
b) Costing as an aid to Creditors.
Investors, banks and other money lending institutions
have a stake in the success of the business concern are
therefore benefitted immensely by the installation of an
efficient system of costing. They can base their judgment
about the profitability and future prospects of the enterprise on
the costing records.
c) Costing as an aid to employees
Employees have a vital interest in their employer’s
enterprise in which they are employed. They are benefited by a
number of ways by the installation of an efficient system of
costing. They are benefited, through continuous employment
and higher remuneration by way of incentives, bonus plans,
etc.
d) Costing as an aid to National Economy
An efficient system of costing brings prosperity to the
business enterprise which in turn brings prosperity to the
business enterprise which in turn results in stepping up of the
government revenue. The overall economic development o f a
country takes place as a consequence of increase in efficiency
of production. Control of costs, elimination of wastages and
inefficiencies led to the progress of the industry and, in
consequence of the nation as a whole.

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Cost units- The Chartered Institute of Management

Accountants, London, defines a unit of cost as “a unit of
quantity of product, service or time in relation to which costs
may be ascertained or expressed”.
The forms of measurement used as cost units are
usually the units of physical measurements like number,
weight, area, length, value, time etc.
Following are some examples of cost unit.
Industry/product Cost unit basis
Automobile Numbers
Brick works per 1000 bricks
Cement per Tonne
Chemicals Litre, gallon, kilogram, ton
Steel Tonne
Sugar Tonne
Transport Passenger-kilometre, tonne kilometer
Cost centre – According to Chartered Institute of
Management Accountants, London, cost centre means “a
location, person or item of equipment (or group of these) for
which costs may be ascertained and used for the purpose of
cost control”. Cost centre is the smallest organizational sub-
unit for which separate cost collection is attempted. Thus cost
centre refers to one of the convenient unit into which the whole
factory organization has been appropriately divided for costing
purposes. Each such unit consists of a department or a sub-

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department or item of equipment or , machinery or a person or

a group of persons.
For example, although an assembly department may be
supervised by one foreman, it may contain several assembly
lines. Some times each assembly line is regarded as a separate
cost centre with its own assistant foreman.
The selection of suitable cost centres or cost units for
which costs are to be ascertained in an undertaking depends
upon a number of factors which are listed as follows.
1. Organization of the factory
2. Conditions of incidence of cost
3. Requirements of the costing system ie. Suitability of the
units or centres for cost purposes.
4. Availability of information
5. Management policy regarding making a particular choice
from several alternatives.
Profit centre – A profit centre is that segment of activity of a
business which is responsible for both revenue and expenses
and discloses the profit of a particular segment of activity.
Profit centres are created to delegate responsibility to
individuals and measure their performance.
Difference between Profit centre and Cost centre
The various points of difference between Profit centre
and cost centre are as follows. Cost centre is the smallest unit
of activity or area of responsibility for which costs are
collected whereas a profit centre is that segment of activity of a

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business which is responsible for both revenue and expenses.

(i) Cost centres are created for accounting conveniences of
costs and their control whereas as a profit centre is created
because of decentralization of operations i.e., to delegate
responsibility to individuals who have greater knowledge
of local conditions etc.
(ii) Cost centers are not autonomous whereas profit centres are
autonomous.
(iii) A cost centre does not have target cost but efforts are
made to minimize costs, but each profit centre has a profit
target and enjoys authority to adopt such policies as are
necessary to achieve its targets.
(iv) There may be a number of cost centres in a profit centre in
a profit centre as production or service cost centres or
personal or impersonal but a profit centre may be a
subsidiary company within a group or division in a
company.
Cost classification
Costs can be classified or grouped according to their
common characteristics. Proper classification of costs is very
important for identifying the costs with the cost centers or cost
units. The same costs are classified according to different ways
of costing depending upon the purpose to be achieved and
requirements of a particular concern. The important ways of
classification are:
1. By Nature or Elements. According to this classification
the costs are classified into three categories i.e., Materials,

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Labour and Expenses. Materials can further be sub-

classified as raw materials components, spare parts,
consumable stores, packing materials etc. This helps in
finding the total cost of production and the percentage of
materials (labour or other expenses) constituted in the total
cost. It also helps in valuation of work-in-progress.
2. By Functions: This classification is on the basis of costs
incurred in various functions of an organization ie.
Production, administration, selling and distribution.
According to this classification, costs are divided into
Manufacturing and Production Costs and Commercial
costs.
Manufacturing and Production Costs are costs involved
in manufacture, construction and fabrication of products.
Commercial Costs are (a) administration costs (b) selling
and distribution costs.
3. By Degree of Traceability to the Product : According to
this, costs are divided indirect costs and indirect costs.
Direct Costs are those costs which are incurred for a
particular product and can be identified with a particular
cost centre or cost unit. Eg:- Materials, Labour. Indirect
Costs are those costs which are incurred for the benefit of
a number of cost centre or cost units and cannot be
conveniently identified with a particular cost centre or cost
unit. Eg:- Rent of Building, electricity charges, salary of
staff etc.
4. By Changes in Activity or Volume: According to this

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costs are classified according to their behavior in relation

to changes in the level of activity or volume of production.
They are fixed, variable and semi-variable. Fixed Costs
are those costs which remain fixed in total amount with
increase or decrease in the volume of the output or
productive activity for a given period of time. Fixed
Costs per unit decreases as production increases and vice
versa. Eg:- rent, insurance of factory building, factory
manager’s salary etc. Variable Costs are those costs
which vary in direct proportion to the volume of output.
These costs fluctuate in total but remain constant per unit
as production activity changes. Eg:- direct material costs,
direct labour costs, power, repairs etc. Semi-variable
Costs are those which are partly fixed and partly variable.
For example; Depreciation, for two shifts working the
total depreciation may be only 50% more than that for
single shift working. They may change with
comparatively small changes in output but not in the same
proportion.
5. Association with the Product: Cost can be classified as
product costs and period costs. Product costs are those
which are traceable to the product and included in
inventory cost, thus product cost is full factory cost.
Period costs are incurred on the basis of time such as rent,
salaries etc. thus it includes all selling and administration
costs. These costs are incurred for a period and are treated
as expenses.
6. By Controllability: The CIMA defines controllable cost

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as “a cost which can be influenced by the action of a

specified member of an undertaking” and a non-
controllable cost as “a cost which cannot be influenced by
the action of a specified member of an undertaking”.
7. By Normality: There are normal costs and abnormal
costs. Normal costs are the costs which are normally
incurred at a given level of output under normal
conditions. Abnormal costs are costs incurred under
abnormal conditions which are not normally incurred in
the normal course of production.Eg:- damaged goods due
to machine break down, extra expenses due to disruption
of electricity, inefficiency of workers etc.
8. By Relationship with Accounting Period: There are
capital and revenue expenses depending on the length of
the period for which it is incurred. The cost which is
incurred in purchasing an asset either to earn income or
increasing the earning capacity of the business is called
capital cost, for example, the cost of a machine in a
factory. Such cost is incurred at one point of time but the
benefits accruing from it are spread over a number of
accounting years. The cost which is incurred for
maintaining an asset or running a business is revenue
expenditure. Eg:- cost of materials, salary and wages paid,
depreciation, repairs and maintenance, selling and
distribution.
9. By Time..Costs can be classified as 1) Historical cost and
2) Predetermined Costs.

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The costs which are ascertained and recorded after it

has been incurred is called historical costs. They are based on
recorded facts hence they can be verified and are always
supported by evidences. Predetermined costs are also known as
estimated costs as they are computed in advance of production
taking into consideration the previous periods’ costs and the
factors affecting such costs. Predetermined costs when
calculated scientifically become standard costs. Standard costs
are used to prepare budgets and then the actual cost incurred is
later-on compared with such predetermined cost and the
variance is studied for future correction.
Types, Methods and Techniques of Costing
The general fundamental principles of ascertaining
costs are the same in every system of cost accounting, but the
methods of analysis and presenting the costs vary from
industry to industry. Different methods are used because
business enterprises vary in their nature and in the type of
products or services they produce or render. Basically, there
are two principal methods of costing, namely (i) Job Costing,
and (ii) Process costing.
1. Job costing: It refers to a system of costing in which costs
are ascertained in terms of specific jobs or orders which
are not comparable with each other. Industries where this
method of costing is generally applied are Printing
Process, Automobile Garages, Repair Shops, Ship-
building, House building, Engine and Machine
construction, etc. Job Costing includes the following
methods of costing:

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(a) Contract Costing: Although contract costing does not

differ in principle from job costing, it is convenient to
treat contract cost accounts separately. The term is usually
applied to the costing method adopted where large scale
contracts at different sites are carried out, as in the case of
building construction.
(b) Bach Costing: This method is also a type of job costing. A
batch of similar products is regarded as one job and the
cost of this complete batch is ascertained. It is then used to
determine the unit cost of the articles produced. It should,
however, be noted that the articles produced should not
lose their identity in manufacturing operations.
(c) Terminal Costing: This method is also a type of job
costing. This method emphasizes the essential nature of
job costing, ie, the cost can be properly terminated at some
point and related to a particular job.
(d) Operation Costing: This method is adopted when it is
desired to ascertain the cost of carrying out an operation in
a department, for example, welding. For large
undertaking, it is frequently necessary to ascertain the cost
of various operations.
2. Process Costing: Where a product passes through distinct
stages or processes, the output of one process being the
input of the subsequent process, it is frequently desired to
ascertain the cost of each stage or process of production.
This is known as process costing. This method is used
where it is difficult to trace the item of prime cost to a

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particular order because its identity is lost in volume of

continuous production. Process costing is generally
adopted in textile industries, chemical industries, oil
refineries, soap manufacturing, paper manufacturing,
tanneries, etc.
3. Unit or single or output or single output costing: This
method is used where a single article is produced or
service is rendered by continuous manufacturing activity.
The cost of the whole production cycle is ascertained as a
process or series of processes and the cost per unit is
arrived at by dividing the total cost by the number of units
produced. The unit of costing is chosen according to the
nature of the product. Cost statements or cost sheets are
prepared under which various items of expenses are
classified and the total expenditure is divided by total
quantity produced in order to arrive at unit cost of
production. This method is suitable in industries like
brick-making, collieries, flour mills, cement
manufacturing, etc. this method is useful for the assembly
department in a factory producing a mechanical article eg.
Bicycle.
4. Operating Costing: This method is applicable where
services are rendered rather than goods produced. The
procedure is same as in the case of single output costing.
The total expenses of the operation are divided by the
units and cost per unit of services is arrived at. This
method is employed in Railways, Road Transport, Water
supply undertakings, Telephone services, Electricity

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companies, Hospital services, Municipal services, etc.

5. Multiple or Complete Costing: Some products are so
complex that no single system of costingis applicable. It is
used where there are a variety of components separately
produced and subsequently assembled in a complex
production. Total cost is ascertained by computing
component costs which are collected by job or process
costing and then aggregating the costs through use of the
single or output costing system. This method is applicable
to manufacturing concerns producing Motor Cars,
Aeroplanes, Machine tools, Type-writers, Radios, Cycles,
Sewing Machines, etc.
6. Uniform Costing: It is not a distinct method of costing by
itself. It is the name given to a common system of costing
followed by a number of firms in the same industry. This
helps in comparing performance of one firm with that of
another.
7. Departmental Costing: When costs are ascertained
department by department, the method is called
“Departmental Costing”. Usually, for ascertaining the cost
of various goods or services produced by the department,
the total costs will have to be analysed, say, by the use of
job costing or unit costing.
In addition to the above methods of costing, mention can be
made of the following techniques
of costing which can be applied to any one of the above
method of costing for special purposes of cost control and

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policy making:
a) Standard or Predetermined Costs.
b) Marginal Costs
Elements of Cost- The management of an organization needs
necessary data to analyze and classify costs for proper control
and for taking decisions for future course of action. Hence the
total cost is analyzed by elements of costs ie by the nature of
expenses. The elements of costs are three and they are
materials, labour and other expenses. These can be further
analyzed as follows.

By grouping the above elements of cost, the following

divisions of cost are obtained.
1. Prime cost = Direct Materials + Direct
Labour+ Direct Expenses
2. Works or Factory Cost = Prime Cost + Works or

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Factory Overheads
3. Cost of Production = Works Cost +
Administration Overheads
4. Total Cost or Cost of Sales = Cost of Production +
Selling and Distribution
Overheads The difference
between the cost of sales
and selling price represents
profit or loss.
Illustration 1. Find the Prime Cost, Works Cost, Cost of
production, total Cost and profit from the following:- Direct
Materials Rs.20000; Direct Labour Rs. 10000; Factory
Expenses Rs. 7000; Administration Expenses Rs. 5000; Selling
Expenses Rs. 7000 and Sales Rs.60,000.
Solution:
Prime Cost = Direct Materials + Direct Labour = Rs.20,000 +
Rs.10,000 = Rs.30,000. Works Cost = Prime Cost + Factory
Expenses = Rs.30,000 + Rs.7,000 = Rs.37,000.
Cost of Production = Works Cost + Administration
Expenses=Rs.37000+ Rs.5, 000 = Rs.42, 000.
Total Cost or Cost of sales= Cost of Production + Selling
Expenses = Rs.42, 000+ Rs.7, 000 = Rs.49, 000. Profit = Sales
- Total Cost = Rs.60,000 - Rs.49,000=Rs.11, 000.
These terms can be explained as follows
1. Direct Materials are those materials which can be
identified in the product and can be conveniently

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measured and directly charged to the product. For

example, bricks in houses, wood in furniture etc. Hence all
raw materials, materials purchased specifically for a job or
process like glue for book making, parts or components
purchased or produced like batteries for radios and tyres
for cycles, and primary packing materials are direct
materials.
2. Indirect Materials are those materials which cannot be
classified as direct materials. Examples are consumables
like cotton waste, lubricants, brooms, rags, cleaning
materials, materials for repairs and maintenance of fixed
assets, high speed diesel used in power generators etc.
3. Direct Labour is all labour expended in altering the
construction, composition, confirmation orcondition of the
product. Thus direct wages means the wages of labour
which can be conveniently identified or attributed wholly
to a particular job, product or process or expended in
converting raw materials into finished goods. Thus
payment made to groups of labourers engaged in actual
production, or carrying out of an operation or process, or
supervision, maintenance, tools setting, transportation of
materials, inspection, analysis etc is direct labour.
4. Direct Expenses are expenses directly identified to a
particular cost centre. Hence expenses incurred for a
particular product, job, department etc are direct expenses.
Example royalty, excise duty, hire charges of a specific
plant and equipment, cost of any experimental work
carried out especially for a particular job, travelling

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expenses incurred in connection with a particular contract

or job etc.
5. Overheads may be defined as the aggregate of the cost of
indirect materials, indirect labour and such other expenses
including services as cannot conveniently be charged
direct ot specific cost units. Overheads may be sub-divided
into (i) Manufacturing Overheads; (ii) Administration
Overheads; (iii) Selling Overheads; (iv) Distribution
Overheads; (v) Research and DevelopmentOverheads.
Cost sheet or Statement of Cost: When costing information is
set out in the form of a statement, it is called “Cost Sheet”. It is
usually adopted when there is only one main product and all
costs almost are incurred for that product only. The
information incorporated in a cost sheet would depend upon
the requirement of management for the purpose of control.
Specimen of Cost Sheet or Statement of Cost

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Illustration 2: Calculate Prime Cost, Factory Cost, Cost of

Production, Cost of Sales and profit from the following
particulars:
Rs. Rs.
Direct Materials 1,00,000 Consumable stores 2,500
Direct Wages 30,000 Manager’s Salary 5,000
Wages of Foreman 2,500 Directors’ fees 1,250
Electric power 500 Office Stationery 500
Lighting: Factory 1,500 Telephone Charges 125
Office Postage and
500 Telegrams 250
Storekeeper’s wages 1,000 Salesmen’s salary 1,250
Oil and water 500 Travelling expenses 500
Rent: Factory 5,000 Advertising 1,250
Office 2,500 Warehouse charges 500
Repairs and Renewals: Sales 1,89,500
Factory plant 3,500 Carriage outward 375
Transfer to Reserves 1,000 Dividend 2,000
Discount on shares written
off 500
Depreciation: Factory Plant 500
Office Premises 1,250

Solution
STATEMENT OF COST AND PROFIT
Rs. Rs.
Direct Materials 1,00,000
Direct Wages 30,000
Prime Cost 1,30,000
Add: Factory Overheads:
Wages of foreman 2,500
Electric power 500
Storekeeper’s Wages 1,000

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Oil and Water 500

Factory rent 5,000
Repairs and renewals-Factory Plant 3,500
Factory lighting 1,500
Depreciation-Factory Plant 500
Consumable stores 2,500
17,500
Factory Cost 1,47,500

Add: Administration Overheads:

Office rent 2,500
Repairs and Renewals-Office Premises 500
Office lighting 500
Depreciation : Office Premises 1,250
Manager’s Salary 5,000
Director’s fees 1,250
Office Stationery 500
Telephone charges 125
Postage and telegrams 250
11,875
Cost of Production 1,59,375

Add: Selling and Distribution

Overheads:Carriage 375
Outward
Salesmen’s Salaries 1,250
Travelling Expenses 500
Advertising 1,250
Warehouse charges 500
3,875
Cost of Sales 1,63,250
Profit 26,250
Sales 1,89,500

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MODULE II
MATERIALS
Materials: - The materials are a major part of the total cost of
producing a product and are one of the most important assets
in majority of the business enterprises. Hence the total cost of
a product can be controlled and reduced by efficiently using
materials.
The materials are of two types, namely:
(i) Direct materials: The materials which can be easily
identified and attributable to the individual units being
manufactured are known as direct materials. These
materials also form part of finished products. All costs
which are incurred to obtain direct materials are known as
direct material costs.
(ii) Indirect materials: Indirect materials, on the other hand,
are those materials which are of small value such as nuts,
pins, screws, etc. and do not physically form part of the
finished product. Costs associated with indirect materials
are known as indirect material costs.
Factory supplies, office supplies and selling supplies
are generally termed as stores.
Purchasing Control and Procedure: Purchasing is an art.
Wrong purchases increase the cost of materials, store
equipments and the finished goods. Hence it is imperative that
purchases should be effectively, efficiently and economically
performed.
Dr. Walters defines scientific purchasing as the
“Procurement by purchase of the proper materials, machinery,

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equipment and supplies of stores used in the manufacture of a

product, adapted to marketing in the proper quantity and
quality at the proper time and the lowest price consistent with
the quality desired”.
According to Alford and Beatty, “Purchasing is the
procuring of materials, supplies, machines tools and services
required for the equipment, maintenance and operation of a
manufacturing plant”.
The major objectives of scientific purchasing it to
purchase the right quantity at the best price, materials
purchased should suit the objective, production should not be
held up, unnecessarily capital should not be locked up in
stores, best quality of materials should be purchased and
company’s competitive position and its reputation for fairness
and integrity should be safeguarded.
Only scientific purchasing will help in achieving the
above objectives. With proper plans, materials can be
purchased at a lower price than competitors, turnover of
investment in inventories can be high, purchasing department
can advise regarding substitute materials, new products,
changein trends, creating goodwill etc.
Methods of Purchasing
Purchasing can be broadly classified as centralized and
localized purchasing.
(a) Centralized Purchasing: In a large organization,
manufacturing units are many. In such cases centralized
purchasing is beneficial. The advantages of centralized
purchasing are:
1. Specialized and expert knowledge is available.

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2. Advantages arise due to bulk purchases.

3. The cost of purchasing can be reduced and selling price
can be lowered.
4. As there is good knowledge of market conditions, greater
control can be exercised.
5. When materials have to be imported, it is advantageous to
centralize the buying.
6. Economy and ease in compilation and consultation of
results.
7. It can take advantage of market changes.
8. Investment in inventories can be reduced.
9. Other advantages include undivided responsibility,
consistent buying policies.
Factors to be considered when decision regarding
centralization has to be taken are geographical separation of
plants, homogeneity of products, type of material bought,
location of supplies etc.
(b) Decentralization of Purchases: The advantages of
localized purchasing or decentralizationof purchases are:-
1. Each plant may have its own particular need. This can be
given special attention.
2. Direct contact can be established with suppliers.
3. The time lag between indenting and receiving materials
can be reduced.
4. Technical requirements of each plant can be ascertained.
Purchase Procedure: The steps usually followed for purchase
of materials may be enumerated as follows:-
1. Indenting for materials : The stores department prepares

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indents for the purchase of materials for replenishment of

stocks (regular indents) or for a special job(special
indents) and sends it to the purchase department. Regular
indents are prepared periodically and placed when the
ordering level for different items of stocks are reached.
The quantity indented is equal to the ordering quantity
fixed for each item. The special indents are based on the
demands received either from the planning or production
department.

2. Issue of tenders to suppliers: The purchase department

issue tenders to suppliers or publish them in papers. The
suppliers quote their terms of price and
delivery/payment. After the last date for receipt of
quotations is over, the tenders are opened and a
comparative statement is prepared. Tenders are prepared
in triplicate. Of them, two are sent to the suppliers and one
is retained with the purchase department. The supplier

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mentions his terms in the original.

While considering the tenders, the reliability of the
supplier has to be taken into account. The quality of goods and
time taken to deliver the goods on previous occasions should
be checked. The financial stability and capacity to deliver
goods should be ensured.
Sometimes purchases may be made without inviting
quotations. The circumstances are when prices are controlled,
or purchases are made under long term contracts, or catalogue
prices are available or when there is a cost plus contract. If
purchase is made under cost plus profit basis, the cost
composition and reasonableness of price should be checked.

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3. Placing of purchase orders: Normally six copies of

purchase order are made. The supplier, stores, inspection
department, store accounting section, purchase department
and progress department are sent one copy each.
The purchase order has legal and accounting
significance. From legal point of view, it binds both the parties
to the terms of the contract. Form the accounting point of
view; it signifies the amount which has to be spent. It
signifies the stores department to accept the goods and the
accounts department to accept the bill.

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4. Inspection: The supplier delivers goods at the place

specified. Two delivery challans are prepared by the
supplier one of which is returned. It is a proof of delivery.
After receiving the goods, the inspection department or
production department or maintenance department (as the
case may be) is intimated.

The inspector checks that the materials are in

accordance with the quality required, standard expected,
tolerances allowed etc. After inspection an inspection note is
prepared in triplicate, one copy is sent to the supplier, one to
the stores, and one to the inspection department.

5. Receiving Stores: The stores department prepares a Stores

Receipt Note for the quantity of stock accepted in
inspection. After issuing of the Stores Receipt, the
Storekeeper is responsible for the stocks. The stores receipt is
the document for the posting of receipts in Bin Card and the
Stores Ledger. It is prepared in quadruplicate and sent to the
supplier; stores accounting section and purchase department
and one copy are retained with thestores. The supplier encloses
this copy along with his bill. The stores accounting section
compares the note with the purchase order.

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6. Checking and passing of bills for payment: Bills

received by the purchase department are forwarded to the
stores accounting section to check the authenticity
regarding quantity and price and the arithmetical accuracy.
Special items included in the bills eg:- freight, packing
charges are verified with the purchase order. The bill is
later passed for payment.
Storekeeping: Store keeping is a service function. The
storekeeper is a custodian of all the items kept in the store.
The stores should be maintained properly and cost minimized.
The main objectives of store keeping are:-
i) To protect stores against losses
ii) To keep goods ready for delivery/issue

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iii) To provide maximum service at minimum cost.

The duties and functions of Store-keeper can be
summarized as follows:
i) Materials should be received, unloaded, inspected and
then moved to stores. The materials have to be stored in
appropriate places and records the receipts in proper
books.
ii) The stores records should be maintained in an efficient
and orderly manner so that materials can be easily located
and information can be obtained for various departments.
iii) The stores should provide maximum protection and
safety and accessibility and utilize minimum space.
Suitable storage devices should be installed.
iv) The materials should be given special covering to
prevent damage due to atmosphericconditions.
v) All issues should be properly recorded, efficiently,
promptly and accurately. All issues should be duly
authorized and procedures laid down should be duly
followed.
vi) The storekeeper is responsible for co-ordination with
materials control according to thetype of production, size
of the company, the organization structure etc.
vii) Ensure that all transactions are posted in the Bin Card
see that the Bin Card is up-to-date.
viii) All items should be in its proper place.
ix) Maintenance of stores at required levels.

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x) Neatness in stores to facilitate physical verification.

xi) Co-ordination and supervision of staff in the stores
department.
xii) Periodical review of various scales, measuring
instruments, conversion ratios etc.
xiii) Protect stores from fires, rust, erosion, dust, theft, weather,
heat, cold, moisture and deterioration etc.
Requisitioning for Stores
One of the duties of the storekeeper is to send
requisitions for materials for replenishment in time so that the
production is not held up due to shortage of materials. The
storekeeper should also see that there is no unnecessary
blocking of capital due to overstocking of materials. For this
he keeps a check on the re-order level, economic ordering
quantity, and the maximum and minimum quantity which he is
authorized to store in respect of each kind of material.
(a) Re-ordering Level
Re-ordering level is that point of level of stock of a
material where the storekeeper starts the process of initiating
purchase requisition for fresh supplies of that materials. This
level is fixed somewhere between the maximum and minimum
levels in such a way that the difference of quantity of the
material between the re-ordering level and minimum level will
be sufficient to meet the requirements of production until the
fresh supply of the materials isreceived.
Re-ordering Level= Minimum Level + Consumption during

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the time required to get the fresh delivery

According to Wheldon,
Re-ordering Level= Maximum Level x Minimum re-order
period.
Here, maximum re-order period means the maximum
period taken to get the material once the order for new material
is placed. Wheldon has taken the maximum period and
maximum consumption during that period so that factory may
not stop production due to shortage of materials.
Illustration: 3. Calculate the ordering level of material A from
the following particulars:
Minimum Limit 1,000 units. Maximum Limit 5,000 units.
Daily requirement of material 200 units. Time required for
fresh delivery 10 days. Solution
Ordering Level=Minimum limit + Consumption during the
time required for fresh delivery = 1000 units+ 200 units x
10 days = 3000 units
Order for the purchase of material should be placed
when the material in stock reaches 3,000 units. Illustration: 4.
Calculate the re-ordering level from the following information:
Maximum consumption = 500 units per day Minimum
consumption = 400 units per dayRe-order period = 10 to 12
days Solution
Re-order Level = Maximum consumption x maximum re-order
period = 500 units x 12 days = 6000 units.

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(b) Economic Ordering Quantity

The quantity of material to be ordered at one time is
known as economic ordering quantity. This quantity is fixed in
such a manner as to minimize the cost of ordering and carrying
the stock.
The total costs of a material usually consist of:
Total acquisition cost + total ordering cost + total carrying
cost.
Since the acquisition cost per unit of material is same
whatever is the quantity purchased, it is usually excluded when
deciding the quantity of a material to be ordered at one time.
The only costs to be taken care of are the ordering costs and
carrying costs which vary with the quantity ordered.
Carrying Cost: It is the cost of holding the materials in the
store and includes:
1. Cost of storage space which could have been utilized for
some other purpose.
2. Cost of bins and racks
3. Cost of maintaining the materials to avoid deterioration.
4. Amount of interest payable on the amount of money
locked up in the materials.
5. Cost of spoilage in stores and handling.
6. Transportation cost in relation to stock.
7. Cost of obsolescence of materials due to change in the
process or product.

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8. Insurance cost
9. Clerical cost etc.
In India all these costs amount to 20 to 25 % of the
cost of materials per year. Hence it becomes necessary to
reduce such carrying cost for efficient operations.
Ordering Cost: It is the cost of placing orders for the purchase
of materials and includes:
1. Cost of staff posted in the purchasing department,
inspection section and stores accountsdepartment.
2. Cost of stationary postage and telephone charges.
Thus, this type of costs includes cost of floating
tenders, cost of comparative evaluation of quotations, cost of
paper work, and postage involved in placing the order, cost of
inspection and cost of accounting and making payments. In
other words, the cost varies with the number of orders.
When the quantity of materials ordered is less, the cost
of carrying will decrease but ordering cost will increase and
vice versa.

2CO
Q=
−I
Q = Quantity to be ordered
C = Consumption of the material concerned in units during a
year.
O = Cost of placing one order including the cost of
receiving the goods i.e. the cost of getting an item into

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the firms inventory

I = Interest payment including variable cost of storing per
unit per year i.e holding costs of inventory.
Illustration 4: Find out the economic ordering quantity (EOQ)
from the following particulars.
Annual usage: 6000 units
Cost of material per unit: Rs. 20
Cost of Placing and receiving one order: Rs.60
Annual carrying cost of one unit: 10% of inventory value.
Solution

2CO
EOQ =
I
Where,
C = Annual usage of material ie6,000 units
O = Cost of placing one order ie Rs.60
20× 10
I = Annual carrying cost of one unit ie Rs. = Rs. 2
100

2 × 6000 units × 60
EOQ = = 360000 = 600
Rs. 2

2CO
The formula of economic ordering quantity is
I
applicable only if annual consumption of raw material in units
is given. But if the consumption of material is given in value,

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2CO
the formula of economic ordering quantity will remain
I
the same; however, the meaning of signs will differ as given:
C = Annual requirement of material in rupees
O = Cost of placing one order
I = % carrying Cost.
c) Minimum Level or Safety Stock level
The minimum level is the minimum quantity of the
material which must be maintained in hand at all times. The
quantity is fixed so that the production is not held up due to
shortage of the materials. In fixing this level, the following
factors should be considered:
1. Lead time i.e. time lag between indenting and
receiving of the material. It is the time required to
replenish the supply.
2. Rate of consumption of the material during the lead time.
3. Nature of the material. Minimum level is not required in
case of a special material which is required against
customer’s specific order.
Formula for calculating minimum level or safety stock
level given by Wheldon is as follows: Minimum Stock Level =
Re-ordering level – (Normal consumption x Normal Re-order
period)
d) Maximum Level
It is the maximum of stock which should be held in

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stock at any time during the year. The quantityis fixed so as to

avoid overstocking as it leads to the following disadvantages.
1. Overstocking leads to increase in working capital
requirement which could be profitable used somewhere
else.
2. Overstocking will need more godown space, so more rent
will have to be paid.
3. It may also lead to obsolescence on account of
overstocking.
4. There are chances that the quality of materials will
deteriorate because large stock will require more time
before they are consumed.
5. There may be fear of depreciation in market values of the
overstocked materials.According to Wheldon,
Maximum Stock level = Reordering level + Re-ordering
Quantity – (Minimum consumption x Minimum re-ordering
period)
e) Danger Level
This level means that level of stock at which normal
issues of the material are stopped and issues are made only
under specific instructions. The purchase officer will make
special arrangements to get the materials which reach at their
danger levels so that the production may not stop due to
shortage of materials.
Danger Level = Average consumption x Max.re-order period
for emergency purchases.

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f) Average Stock Level

The average stock level is calculated by the following formula:
Average Stock Level = Minimum Stock Level + ½ of Re-order
Quantity. Or ½ (Minimum Stock Level + Maximum Stock
Level)
Illustration 5: Calculate the minimum stock level,
maximum stock level, re-ordering level and average stock
level from the following information:
(i) Minimum consumption = 100 units per day
(ii) Maximum consumption = 150 units per day
(iii) Normal consumption = 120 units per day
(iv) Re-order period = 10-15 days
(v) Re-order quantity = 1,500 units
(vi) Normal re-order period = 12 days
Solution
Re-ordering Level = Maximum Consumption x Maximum re-order period
= 150 units x 15 days = 2,250 units
Minimum Stock Level = Re-ordering Level-(Normal consumption x
Normal re-order period)
= 2,250 – (120 x12) = 810 units
Maximum Stock Level = Re-ordering Level + Re-order Quantity –
(Minimum Consumption x MinimumRe-Order Period)
= 2,250 + 1500 – (100 x 10)= 2,750 units
Average stock Level = Minimum Stock Level + ½ Re-order Quantity
= 810 units + ½ x 1500 units = 1,560 units

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Stores (or Materials) records

In the stores the most important two records kept are
bin cards and stores ledger.
(a) Bin Card. A bin card is a record of the receipt and issue of
material and is prepared by the store keeper for each item
of stores. A bin card is also known as bin tag or stock card
and is usually kept in the rack where the material is kept.
In a bin card not only the receipt and issue of material is
recorded, minimum quantity, maximum quantity and
ordering quantity are stated on the card. This helps the
store keeper to send the material requisition for the
purchase of material in time.
(b) Stores Ledger: This ledger is kept in the costing
department and is identical with the bin card except that
receipts, issues and balances are shown along with their
money values. This provides the information for the
pricing of materials issued and the money value at any
timeof each item of stores.
Perpetual Inventory System
The Chartered Institute of Management Accountants,
London, defines the perpetual inventory as “asystem of records
maintained by the controlling department, which reflects the
physical movements of stocks and their current balance”. Thus
this is a system in which, with the help of Bin Cards and Stores
Ledger, the balance of stock is ascertained after every receipt
and issue of materials. This is helps in avoiding closing down
of firm for physical verification.

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Advantages of the Perpetual Inventory System

The following are the advantages of the perpetual
inventory system:
1. It avoids the disruption of production for physical
checking of all items of stores at the endof the year.
2. The preparation of Profit and Loss Account and Balance
Sheet is possible without physicalverification of stock.
3. A detailed and more reliable control on the materials in
store is obtained.
4. As the work of recording and continuous stocktaking
is carried out systematically andwithout undue haste, the
figures are more reliable.
5. Continuous stocktaking will make the storekeeper and the
stores accountant more vigilant in their work and they will
try to keep the records accurate and up-to-date.
6. Planning of production can be done without any fear
of shortage as the management is constantly informed of
the stores position.
7. An inbuilt system of internal check will be in operation
as bin cards and the stores ledger keep a check on each
other.
8. Errors and shortage of stock are readily discovered and
efforts are made to avoid theshortage of stock in future.
9. The capital invested in the stores can be kept under
control and efficiently used as stock can be compared with
the minimum and maximum levels.

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10. It makes available correct stock figures for claim to be

lodged with the insurance company for loss on account of
stock destroyed by fire.
ABC Analysis
Under ABC Analysis, the materials in stock are divided
into three categories for the purpose of control. Generally it is
seen that the materials which constitute the least percentage of
items in stockmay contribute to a large percentage of value and
a large percentage of items may represent a smaller percentage
of value of items consumed. Between these two items are those
items, the percentage of which is more or less equal to their
value in consumption. Items falling in the first category are
treated as ‘A’ items, of the second category as ‘B’ items
and items of the third category are taken as ‘C’ items. Such
an analysis of material is known as ABC analysis. This
technique of stock control is also known as stock control
according to value method or Always Better Control method or
Proportional Parts Value Analysis method. Thus, under this
technique of material control, materials are listed in ‘A’, ‘B’
and ‘C’ categories in descending order based on money value
of consumption.
ABC analysis measures the cost significance of each
item of material. It concentrates on important items, so it is
also known as ‘Control by Importance and Exception” (CIE).
The report of the Indian Productivity Team on “Stores
and Inventory Control in U.S.A., Japan and West Germany”
gives the following example of ABC Analysis:

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Group Percentage of Items Percentage of Costs

A 8% 75%
B 25% 20%
C 67% 5%

The significance of this analysis is that a very close

control is exercised over the items of ‘A’ group which account
for a high percentage of costs while less stringent control is
adequate for category ‘B’ and very little control would suffice
for category ’C’ items.
Issue of materials
Materials issued from stores are debited to the jobs or
work orders which received them and credited to the materials
account. These jobs are debited with the value of materials
issued to them.
But what is the value of materials? Theoretically the
value includes the invoice price less trade discount, the freight,
cartage, octroi and insurance on incoming materials, expenses
of purchase, receiving, storing and record keeping and carriage
from the stores up to the process plant. However, in practice, it
involves minute calculations for including all these expenses
and is a big task compared to the benefit derived from it.
Moreover the price changes according to the market
conditions and at any given time there will be stock of
materials purchased at different times at different prices.

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Hence the problem as to at what price the materials should be

issued?
There are many methods of pricing material issues. The
most important being: FIFO, LIFO, simple and weighed
average methods.
1) First in First Out (FIFO)
Under this method material is first issued from the
earliest consignment on hand and priced at the cost at which
that consignment was placed in the stores. In other words,
materials received first are issued first. The units in the
opening stock of materials are treated as if they are issued first,
the units from the first purchase issued next, and so on until the
units left in the closing stock of materials are valued at the
latest cost of purchases.
This method is most suitable in times of falling prices
because the issue price of materials to jobs or work order will
be high while the cost of replacement of materials will be
low. But in case of rising prices this method is not suitable
because the issue price of materials to production will be low
while the cost of replacement of materials will be high. The
following example will illustrate how issues of materials are
valued under this method.
Illustration 6: The received side of the Stores Ledger Account
shows the following particulars:
Jan. 1 Opening Balance: 500 units @ Rs.4
Jan. 5 Received from vendor: 200 units @ Rs.4.25
Jan.12 Received from vendor: 150 units @ Rs.4.10

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Jan. 20 Received from vendor: 300 units @ Rs.4.50

Jan. 25 Received from vendor: 400 units @ Rs.4
Issues of material were as follows:
Jan. 4- 200 units; Jan.10- 400 units; Jan. 15- 100 units; Jan 19- 100 units;
Jan.26- 200 units; Jan.30- 250 units.

Issues are to be priced on the principle of “first in first

out”. Write the Stores Ledger Account in respect of the
materials for the month of January.
Solution:
2) Last in Last Out (LILO)
Under this method, issues are priced in the reverse
order of purchase i.e., the prices of the latest available
consignment is taken. This method is suitable in times of rising
prices because material will be issued from the latest
consignment at a price which is closely related to the current
price levels. Valuing material issues at the price of the latest
available consignment will help the management in fixing the
competitive selling prices of theproducts.

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SOLUTION (Illustration 6)
STORES LEDGER ACCOUNT
Receipts Issues Balance
Date Particulars Quantity Total Unit Quantity Total Unit Quantity Amount Per
(Units) Cost(Rs) cost(Rs) (units) Cost(Rs) cost(Rs) (units) (Rs) unit(Rs)
Jan 1 Balance b/d - - - - - - 500 2000 4
Jan 4 Requisition slip no. …….. - - - 200 800 4 300 1200 4
Jan 5 Goods received note no. …… 200 850 4.25 - - - 300 1200 4
200 850 4.25
Jan 10 Requisition slip no. …….. - - - 300 1200 4
100 425 4.25 100 425 4.25
Jan 12 Goods received note no. …… 150 615 4.10 - - - 100 425 4.25
150 615 4.10
Jan 15 Requisition slip no. …….. - - - 100 425 4.25 150 615 4.10
Jan 19 Requisition slip no. …….. - - - 100 410 4.10 50 205 4.10
Jan 20 Goods received note no. …… 300 1350 4.50 - - - 50 205 4.10
300 1350 4.50
Jan 25 Goods received note no. …… 400 1600 4.00 - - - 50 205 4.10
300 1350 4.50
400 1600 4.00
Jan 26 Requisition slip no. …….. - - - 50 205 4.10 150 675 4.50
150 675 4.50 400 1600 4.00
Jan 30 Requisition slip no. …….. - - - 150 675 4.50 300 1200 4.00
100 400 4.00

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Illustration 7: Prepare Stores Account on Last in First Out

method assuming the same particularsas in Illustration 6:
3) Simple Average Method
In this method, price is calculated by dividing the total
of the prices of the materials in the stock from which the
material to be priced could be drawn by the number of the
prices used in that total. This method may lead to over-
recovery or under-recovery of cost of materials from
production because quantity purchased in each lot is ignored.
Eg:- 1000 units purchased @ Rs.10
2000 units purchased @ Rs.11
3000 units purchased @ Rs.12
In this example, simple average price will be Rs.11 calculated
as below:
Rs. 10 + Rs. 11 + Rs.12
= Rs.11
3
4) Weighted Average Methods
In this method, price is calculated by dividing the total
cost of materials in the stock from which the materials to be
priced could be drawn by the total quantity of materials in that
stock.
In the above example, the weighted average price is Rs.11.33
per unit calculated as follows:
100 × Rs.10 + 2000 × Rs.11 + 3000 × Rs.12
= Rs. 11.33
1000 + 2000 + 3000
In the periods of heavy fluctuations in the prices of
materials, the average cost method gives better results because
it tends to smooth out the fluctuations in prices by taking the
average of prices of various lots in stock.

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SOLUTION (Illustration 7) LIFO Method

STORES LEDGER ACCOUNT
Receipts Issues Balance
Date Particulars Quantity Total Unit Quantity Total Unit Quantity Amount Per
(Units) Cost(Rs) cost(Rs) (units) Cost(Rs) cost(Rs) (units) (Rs) unit(Rs)
Jan 1 Balance b/d - - - - - - 500 2000 4
Jan 4 Requisition slip no. …….. - - - 200 800 4 300 1200 4
Jan 5 Goods received note no. …… 200 850 4.25 - - - 300 1200 4
200 850 4.25
Jan 10 Requisition slip no. …….. - - - 200 850 4.25
200 850 4.00 100 400 4.00
Jan 12 Goods received note no. …… 150 615 4.10 - - - 100 400 4.00
150 615 4.10
Jan 15 Requisition slip no. …….. - - - 100 410 4.10 100 400 4.00
50 205 4.10
Jan 19 Requisition slip no. …….. - - - 50 205 4.10
50 200 4.00 50 200 4.00
Jan 20 Goods received note no. …… 300 1350 4.50 - - - 50 200 4.00
300 1350 4.50
Jan 25 Goods received note no. …… 400 1600 4.00 - - - 50 200 4.00
300 1350 4.50
400 1600 4.00
Jan 26 Requisition slip no. …….. - - - 200 800 4.00 50 200 4.00
300 1350 4.50
200 800 4.00
Jan 30 Requisition slip no. …….. - - - 200 800 4.00 50 200 4.00
50 225 4.50 250 1125 4.50

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MODULE III
LABOUR
Labour cost is a second major element of cost. The
control of labour cost and its accounting is very difficult as it
deals with human element. Labour is the most perishable
commodity and as such should be effectively utilized
immediately.
Importance of Labour Cost Control
Labour is of two types (a) direct labour, (b) indirect
labour. Direct Labour is that labour which is directly engaged
in the production of goods or services and which can be
conveniently allocated to the job, process or commodity or
process. For example labour engaged in spinning department
can be conveniently allocated to the spinning process.
Indirect Labour is that labour which is not directly
engaged in the production of goods and services but which
indirectly helps the direct labour engaged in production. The
examples of indirect labour are supervisors, sweepers,
cleaners, time-keepers, watchmen etc. The cost of indirect
labour cannot be conveniently allocated to a particular job,
order, process or article.
The distinction between direct and indirect labour must
be observed carefully because payment of direct labour is a
direct expenditure and is a part of prime cost whereas
payment of indirect labour is an item of indirect expenditure
and is shown as works, office, selling and distribution
expenditure according to the nature of the time spent by the

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indirect worker.
Management is interested in the labour costs due to the
following reasons.
• To use direct labour cost as a basis for increasing the
efficiency of workers.
• To identify direct labour cost with products, orders, jobs
or processes for ascertaining the cost of every product,
order, or process.
• To use direct labour cost as a basis for absorption of
overhead, if percentage of direct labour cost to overhead is
to be used as a method of absorption of overhead.
• To determine indirect labour cost to be treated as overhead
and
• To reduce the labour turnover.
Hence control of labour cost is an important objective
of management and the realization of this objective depends
upon the co-operation of every member of the supervisory
force fromthe top executive to foremen.
Time keeping
Time-keeping will serve the following purposes:
1. Preparation of Pay Rolls in case of time-paid workers.
2. Meeting the statutory requirements.
3. Ensuring discipline in attendance.
4. Recording of each worker’s time ‘in’ and ‘out’ of the

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factory making distinction between normal time,

overtime, late attendance, early leaving.
5. For overhead distribution when overheads are absorbed on
the basis of labour hours.
Methods of Time-keeping
There are two methods of time-keeping. They are the
manual methods and the mechanical methods. Whichever
method is used it should make a correct record of the time and
the method should be cost effective and minimize the risk of
fraud.
The manual methods of time keeping are as follows:
a) Attendance Register Method, and
b) Metal Disc Method
Attendance Register Method
This is the traditional method where an attendance
register or muster roll is kept at the time office near the factory
gate or in each department. The timekeeper records the name
of the worker, the worker’s number, the department in which
he is working, the rate of wages, the time of arrival and
departure, normal time and overtime. If the workers are
literate, they may make a record of time themselves in the
presence of a time-keeper or foreman.
This method is simple and inexpensive and can be used
in small firms where the number of workers is not large.
However recording the time of workers who work at
customers’ premises and places which are situated at a distance

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from the factory is not practical in this method.

Metal Disc Method
Under this method, each worker is allotted a metal disc
or a token with a hole bearing his identification number. A
board is kept at the gate with pegs on it and all tokens are hung
on this board. These boards can be maintained separately for
each department so that the workers can remove the token
without delay and put it in a tray or box kept near the board.
Immediately after the scheduled time for entering the factory,
the box is removed and the latecomers will have to give their
tokens to the timekeeper and their exact time of arrival is
recorded. The tokens or disc left on the board will represent
the absentee workers. Later the timekeeper records the
attendance in the attendance register and subsequently it is
passed on to the Pay Roll Department.
Mechanical Methods
The mechanical methods that are generally used for the
recording of time of workers may be as follows:
(a) Time Recording Clocks
(b) Dial Time Records
Time Recording Clocks
The time recording clock is a mechanical device which
automatically records the time of the workers. Under this
method, each worker is given a Time Card which is kept in a
tray near the factory gate and as the worker enters the gate, he
picks up his card from the tray, puts it in the time recording

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clock which prints the exact time of arrival in the proper space
against the particular day. This procedure is repeated for
recording time of departure for lunch, return from lunch and
time of leaving the factory in the evening. Late arrivals and
overtime are recorded in red to attract the attention of the
management.
Dial Time Records
Under this method, a dial time recorder machine us
used. It has a dial with number of holes (usuallyabout 150) and
each hole bears a number corresponding to the identification
number of the worker concerned. There is one radial arm at
the centre of the dial. As a worker enters the factory gate, heis
to press the radial arm after placing it at the hole of his number
and his time will automatically be recorded on roll of a paper
inside the dial time recorder against the number. The sheet on
which the time is recorded provides a running account of the
worker’s time and it can calculate the number of hours and
prepare the wage sheets. However, the high installation cost of
the dial time recorder and its use for only a limited number of
worker are the drawbacks of this method.
Time Booking
Time booking is the recording of time spent by the
worker on different jobs or work orders carried out by him
during his period of attendance in the factory. The objects of
time booking are:
1. To ensure that time spent by a worker in a factory is
properly utilized on different jobs or work orders.

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2. To ascertain the labour cost of each individual job or work

order.
3. To provide a basis for the apportionment of overhead
expenses over various jobs or work orders when the
method for the allocation of overheads depends upon time
spent on different jobs.
4. To ascertain unproductive time or idle time so as to make
efforts to keep it in limit.
5. To know the time taken to complete a particular job so
that bonus can be paid as per the incentive schemes.
6. To know the efficiency of workers, it is necessary to make
the comparison of actual time taken with time allowed for
completing a particular task.
Following documents are generally used for time
booking:
1. Daily Time Sheets
2. Weekly Time Sheets
3. Job Tickets or Job Cards.
Daily time sheets are given to each worker where he
records the time spent by him on each job or work order.
Weekly time sheets record the same particulars for a week and
hence one card is required for a week. Job cards are used to
keep a close watch on the time spent by a worker on each job
so that the labour cost of a job may be conveniently
ascertained.

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Idle Time
There is always a difference between the time booked
to different jobs or work orders and the time recorded at the
factory gate. This difference is known as idle time. Idle time is
of two types.
(a) Normal Idle Time
(b) Abnormal Idle Time
Normal Idle Time: This represents the time, the wastage of
which cannot be avoided and, therefore, the employer must
bear the labour cost of this time. But every effort should be
made to reduce it to the lowest possible level. Examples of
normal idle time are: time taken in going from the factory gate
to the department in which the worker is to work and back at
the end of the day, time taken in picking up the work for the
day, time between the completion of one work and the start of
another work, time taken for personal needs like tea or toilet,
time taken for machine maintenance, time taken for waiting for
instructions, printouts, machine set-up time etc.
Normal Idle Time is unavoidable cost as such should
be included in cost of production. The cost of normal idle time
can be treated as an item of factory expenses and recovered as
an indirect chargeor added to labour cost.
Abnormal Idle Time: It is that time the wastage of which can
be avoided if proper precautions are taken. Example: time
wasted due:- to breakdown of machinery on account of
inefficiency of the works engineer, failure of the power supply,
shortage of materials, waiting for instructions, waiting for tools

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and raw materials, strikes or lock-outs in the factory.

It is a principle of costing that all abnormal expenses
and losses should not be included in costs and as such wages
paid for abnormal idle time should not form part of the cost of
production. Hence it is debited to Costing Profit and Loss
Account.
Over Time: - It is the work done beyond the normal working
period in a day or week. For overtime done, the workers are
given double the wages for the overtime done. The additional
amount paid on account of overtime is known as overtime
premium.
Overtime increases the cost of production and should
not be encouraged as it has the following disadvantages.
1. Overtime is paid at higher rate.
2. Overtime is done at late hours when workers have become
tired and efficiency will it be as much as during the
normal working hours.
3. Workers will develop the habit of working slowly during
normal hours and complete the work using overtime to
earn more wages.
4. Expenses like lighting, cost of supervision, and wear and
tear of machines will increase disproportionately.
Overtime should be recorded separately and thoroughly
investigated to see that it is incurred only when genuinely
required.
The treatment of overtime depends on the situation. If

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overtime is incurred for because of the sequence of jobs, then

normal wages is charged to labour cost for the overtime also
but if it is a rush job, then the overtime wages is added to the
cost of labour. On the other hand if overtime arises due to any
abnormal reason like breakdown of machinery or power
failure, overtime premium is excluded from the cost of
production and is debited to the Costing Profit and Loss
Account.
Illustration 8: Calculate the normal and overtime wages
payable to a workman from thefollowing data:
Days Hours Worked
Monday 8 hrs.
Tuesday 10 hrs.
Wednesday 9 hrs.
Thursday 11 hrs.
Friday 9 hrs.
Saturday 4 hrs.
Total 51 hrs.
Normal Working Hours 8 hours per day
Normal rate Re.1 per hour
Overtime rate up to 9 hours in a day at
single rate and over 9
hours in a day at double
rate; or up to 48 hours in a
week at single rate and
over 48 hours at double rate
whichever is more
beneficial to the workman.

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Solution:
Overtime Hours
Total Normal
Days At Single At Double
Hours Working Hours
rate rate
Monday 8 8 - -
Tuesday 10 8 1 1
Wednesday 9 8 1 -
Thursday 11 8 1 2
Friday 9 8 1 -
Saturday 4 4
Total 51 44 4 3

Normal Wages for 44 hours @ Re.1 Rs.44

Overtime Wages:
At single rate for 4 hours @ Re.1 = Rs.4
At double rate for 3 hours @ Rs.2 = Rs.6 Rs.10
Total Wages Rs.54
Or
Normal Wages for 48 hours @ Re.1 per hour = Rs.48
Overtime Wages for 3 hours @ Rs.2 per hour= Rs. 6
Rs.54

Therefore, whichever method is followed, the amount

of the wages payable to the worker is Rs.54.
System of Wage Payment
There is no single method of wage payment which is

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acceptable both to the employers and the workers. The system

of wages should result into higher production, improved
quality of output anda contented labour force.
There are two principal wage systems: (i) Payment on
the basis of time spent in the factory irrespective of the amount
of work done. This method is known as time wage system. (ii)
Payment on the basis of the work done irrespective of the time
taken by the worker. This method is called piece rate system.
Other methods called premium plans or bonus and
profit sharing schemes are used with either of the two
principal methods of wage payment.
Time Wage System
Under this method of wage payment, the worker is paid
at an hourly, daily, weekly or monthly rate. This payment is
made according to the time worked irrespective of the work
done.
This method is highly suitable for following types of
work:
1. Where highly skilled and apprentices are working.
2. Where quality of goods produced is of extreme importance
eg., artistic goods
3. Where the speed of work is beyond the control of the
workers.
4. Where close supervision of work is possible.
5. Where output cannot be measured. The disadvantages of
this method are:

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1. Workers are not motivated.

2. Workers will get payment for idle time.
3. Efficient workers will become inefficient in the long run
as all of them get same wages.
4. Employer finds it difficult to calculate labour cost per
unit as it varies as productionincreases and decreases.
5. Strict supervision is necessary to get the work done.
6. Inefficiency results in upsetting the production schedule
and increases the cost per unit.
7. It will encourage a tendency among workers to go slow so
as to earn overtime wages.
Thus this method does not establish a proportionate
relationship between effort and reward and the result is that it
is not helpful in increasing production and lowering labour
cost per unit.
Piece Rate System (payment by result)
Under this system of wage payment, a fixed rate is paid
for each unit produced, job completed or an operation
performed. Thus, payment is made according to the quantity of
work done no consideration is given to the time taken by the
workers to perform the work.
There are four variants of this system.
a) Straight piece rate system
b) Taylor’s differential piece rate system
c) Merrick’s multiple piece rate system
d) Gant’s task and bonus plan

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(a) Straight piece rate system

Payment is made as per the number of units produced
at a fixed rate per unit. Another method is piece rate with
guaranteed time rate in which the worker is given time rate
wages if his piece rate wages is less than the time rate.
Advantages
1. Wages are linked to output so workers are paid according
to their merits.
2. Workers are motivated to increase production to earn more
wages.
3. Increased production leads to decreased cost per unit
of production and hence profit per unitincreases.
4. Idle time is not paid for and is minimized.
5. The employer knows his exact labour cost and hence can
make quotations confidently.
6. Workers use their tools and machinery with a greater
care so that the production may not be held up on
account of their defective tools and machinery.
7. Less supervision is required because workers get wages
for only the units produced.
8. Inefficient workers are motivated to become efficient and
earn more wages by producing more.
Disadvantages
1. Fixing of piece work rate is difficult as low piece rate will
not induce workers to increase production.

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2. Quality of output will suffer because workers will try to

produce more quickly to earn more wages.
3. There may not be an effective use of material, because of
the efforts of workers to increase the production. Haste
makes waste. Thus there will be more wastage of material.
4. When there is increased production, there may be
increased wastage of materials, high cost of supervision
and inspection and high tools cost and hence cost of
production might increase.
5. Increased production will not reduce the labour cost per
unit because the same rate will be paid for all units. On the
other hand, increased production will reduce the labour
cost per unit under the time wage system.
6. Workers have the fear of losing wages if they are not able
to work due to some reason.
7. Workers may work for long hours to earn more wages,
and thus, may spoil their health.
8. Workers may work at a very high speed for a few
days, earn good wages and then absent themselves for a
few days, upsetting the uniform flow of production.
9. Workers in the habit of producing quality goods will
suffer because they will not get any extraremuneration for
good quality.
10. The system will cause discontentment among the slower
workers because they are not able toearn more wages.

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This method can be successfully applied when:

1. The work is of a repetitive type.
2. Quantity of output can be measured.
3. Quality of goods can be controlled.
4. It is possible to fix an equitable and acceptable piece rate
5. The system is flexible and rates can be adjusted to changes
in price level.
6. Materials, tools and machines are sufficiently available to
cope with the possible increase inproduction.
7. Time cards are maintained so that workers are punctual
and regular so that production maynot slow down.
(b) Taylor’s Differential Piece Rate system
This system was introduced by Taylor, the father of
scientific management to encourage the workers to complete
the work within or less than the standard time. Taylor
advocated two piece rates, so that if a worker performs the
work within or less than the standard time, he is paid a higher
piece rate and if he does not complete the work within the
standard time, he is given a lower piece rate.
Illustration 9: Calculate the earnings of workers A and B
under Straight Piece-rate System and Taylor’s Differential
Piece-rate System form the following particulars.
Normal rate per hour = Rs.1.80
Standard time per unit = 20 seconds
Differentials to be applied:
80 % of piece rate below standard

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120% of piece rate at or above standard.

Worker A produces 1,300 units per day and worker B produces
1,500 units per day.
SOLUTION
Standard production per 20 seconds = 1 unit
Standard production per minute = 60/20= 3 units
Standard production per hour = 3 x 60 = 180 units
Standard production per day of 8 hrs(assumed) = 180x8 = 1440 units
Normal rate per hour = Rs.1.80
Normal piece rate = Rs.1.80/ 180 units = 1 paisa
1P × 80
Low piece rate below standard production = 0.8 paise
100
1P × 120
High piece rate at or above standard = 1.2 paise
100
Earning of worker A

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High piece-rate has been applied because worker B’s

daily production of 1500 units is more than the standard daily
production of 1440 units.
c) Merrick’s Multiple Piece Rate System
This method seeks to make an improvement in the
Taylor’s differential piece rate system. Under this method,
three piece rates are applied for workers with different levels
of performance. Wages are paid at ordinary piece rate to those
workers whose performance is less than 83% of the standard
output, 110% of the ordinary piece rate is given to workers
whose level of performance is between 83% and 100% of the
standard and 120% of the ordinary piece rate is given to
workers who produce more than 100% of the standard output.
This method is not as harsh as Taylor’s piece rate
because penalty for slow workers is relatively lower.
Illustration 10: Calculate the earnings of workers A, B and C
under straight piece rate system and Merrick’s multiple piece
rate system from the following particulars:
Normal rate per hour Rs.1.8 Standard time per unit 1 minute
Output per day is as follows:
Worker A : 384 units
Worker B : 450 units
Worker C : 552 units
Wording hours per day are 8

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SOLUTION

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Worker C’s level of performance is 115% which is

more than 100% of standard output; so he is entitled to get
120% of normal piece rate (ie. 120% of 3 paise or 3.6 paise per
unit)
Premium and Bonus Plan
The object of a premium plan is to increase the
production by giving an inducement to the workers in the form
of higher wages for less time worked.
Under a premium plan, a standard time is fixed for the
completion of a specific job or operation at an hourly rate plus
wages for a certain fraction of the time saved by way of a
bonus. The plan is also known as incentive plan because a
worker has the incentive to earn more wages by completingthe
work in less time.
This system of wage payment is in between the time
wage system and piece work system. In time wage system,
worker does not get any reward for the time saved and in piece
work system, the worker gets full payment for time saved
whereas in a premium plan both the worker and the employer
share the labour cost of the time saved.
The following are some of the important premium
plans.

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(i) Halsey Premium Plan: Under this method, the worker is

given wages for the actual time taken and a bonus equal to
half of wages for time saved. The standard time for doing
each job or operation is fixed. In practice the bonus may
vary from 33⅓ % to 66⅔ % of the wages of the time
saved.
Thus if S is the standard time, T the time taken, R the
labour rate per hour, and % the percentage of the wages of
time saved to be given as bonus, total earnings of the worker
will be:
T x R + % (S-T) R
Under Halsey-Weir plan, the premium is set at 30% of the time
saved.
Illustration 11:

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The advantages of the Halsey Premium Plan are:

It is simple to understand and relatively simple to
calculate.
1. It guarantees time wages to workers.
2. The wages of time saved are shared by both employers
and workers, so it is helpful in reducing labour cost per
unit.
3. It motivates efficient workers to work more as there is
increasing incentive to efficient workers.
4. Fixed overhead cost per unit is reduced with increase in
production.
5. The employer is able to reduce cost of production by
having reduction in labour cost and fixed overhead cost
per unit. So, he is induced to provide the best possible
equipment and working conditions.
Disadvantages
1. Quality of work suffers because workers are in a hurry to
save more and more time to getmore and more bonus.
2. Workers criticize this method on the ground that the
employer gets a share of wages of thetime saved.
(ii) Rowan Plan: The difference between Halsey plan and
Rowan Plan is the calculation of the bonus. Under this
method also the workers are guaranteed the time wages
but the bonus is that proportion of the wages of the time
taken which the time saved bears to the standard time
allowed.

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Illustration 12:
A worker completes a job in a certain number of hours.
The standard time allowed for the job is 10 hours, and the
hourly rate of wages is Rs.1. The worker earns a 50% rate of
bonus of Rs. 2 under Halsey Plan. Ascertain his total wages
under the Rowan Premium Plan.
Solution: The worker earns Rs.2 as bonus at 50%; so
total bonus at 100% should be Rs.4. The hourly rate of wages
being Re.1, the time saved should be 4 hours.
Standard time allowed 10 hours
Less: Time Saved 4 hours
Time Taken 6 hours
Earnings under the Rowan Premium Plan
Earnings =T x R + S-T x T x R
S
Where, T = 6 hours
S = 10 hours
R = Re.1 per hour
Earnings = 6 x 1 + 10-6 x 6 x 1
10
= 6 + Rs.2.40 = Rs.8.40

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Advantages
1. It guarantees time wages to workers
2. The quality of work does not suffer as they are not
induced to rush through production asbonus increases at a
decreasing rate at higher levels of efficiency.
3. Labour cost per unit is reduced because wages of time
saved are shared by employer andemployee.
4. Fixed overhead cost is reduced with increase in
production.
Disadvantages
1. The Rowan plan is criticized by workers on the ground
that they do not get the full benefit of the time saved by
them as they are paid bonus for a portion of the time
saved.
2. The Rowan plan suffers from another drawback that two
workers, one very efficient and the other not so efficient,
may get the same bonus.
Overheads: -
Cost related to a cost center or cost unit may be divided
into two ie. Direct and Indirect cost. The Indirect cost is the
overhead cost and is the total of indirect material cost, indirect
labour cost, indirect expenses. CIMA defines indirect cost as
“expenditure on labour, materials or services which cannot
be economically identified with a specific salable cost per
unit”. Indirect costs are those costs which are incurred for the
benefit of a number of cost centers or cost units. So any

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expenditure over and above prime cost is known as overhead.

It is also called ‘burden’, ‘supplementary costs’, ‘on costs’,
‘indirect expenses’.
Classification of Overheads
Overheads can be classified on the following basis:
i) Function-wise classification: Overheads can be divided
into the following categories on functional basis.
(a) Manufacturing or production overheads eg:- indirect
materials like lubricants, cotton wastes, indirect labour like
salaries and wages of supervisors, inspectors,
storekeepers, indirect expenses like rent, rates and
insurance of factory, power, lighting of factory, welfare
expenses like canteen, medical etc.
(b) Administration overheads eg:- indirect materials like
office stationery and printing, indirect labour salaries of
office clerks, secretaries, accountants, indirect expenses
rent, rates and insurance of office, lighting heating and
cleaning of office, etc.
(c) Selling and Distribution overheads eg:- indirect materials
like catalogues, printing, stationery, price list, indirect
salary of salesmen, agents, travellers, sales managers,
indirect expenses like rent, rates and insurance of
showroom, finished goods, godown etc., advertising
expenses, after sales service, discounts, bad debts etc.
ii) Behavior-wise classification: Overheads can be classified
into the following categories as per behavior pattern.

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(a) Fixed overheads like managerial remuneration, rent of

building, insurance of building, plant etc.
(b) Variable overheads like direct material and direct
labour.
(c) Semi-variable overheads like depreciation, telephone
charges, repair and maintenance of buildings,
machines and equipment etc.
iii) Element-wise classification: Overheads can be classified
into the following categories as per element.
(a) Indirect materials
(b) Indirect labour
(c) Indirect expenses
Allocation and Apportionment of Overhead to Cost
Centres (Depart-mentalisation of Overhead)
When all the items are collected properly under
suitable account headings, the next step is allocation and
apportionment of such expenses to cost centres. This is also
known as departmentalization or primary distribution of
overhead.
A factory is administratively divided into different
departments like Manufacturing or Producing department,
Service department, partly producing departments.
Allocation of Overhead Expenses
Allocation is the process of identification of overheads
with cost centres. An expense which is directly identifiable
with a specific cost centre is allocated to that centre. Thus it is

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allotment of a whole item of cost to a cost centre or cost unit.

For example the total overtime wages of workers of a
department should be charged to that department. The
electricity charges of a department if separate meters are there
should be charged to that particular department only.
Apportionment of Overhead Expenses
Cost apportionment is the allotment of proportions of
cost to cost centres or cost units. If a cost is incurred for two or
more divisions or departments then it is to be apportioned to
the different departments on the basis of benefit received by
them. Common items of overheads are rent and rates,
depreciation, repairs and maintenance, lighting, works
manager’s salary etc.
Basis of Apportionment
Suitable bases have to be found out for apportioning
the items of overhead cost to production and service
departments and then for reapportionment of service
departments costs to other service and production departments.
The basis selected should be correlated to the expenses and the
expense should be measurable by the basis. This process of
distribution of common expenses over the departments on
some equitable basis is known as ‘Primary Distribution’.
The following are the main bases of overhead
apportionment utilized in manufacturing concerns:
Direct Allocation. Under direct allocation, overheads are
directly allocated to the department for which it is incurred.
Example overtime premium of workers engaged in a particular
department, power, repairs of a particular department etc.

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(i) Direct Labour/Machine Hours. Under this basis,

overhead expenses are distributed to various departments
in the ratio of total number of labour or machine hours
worked in each department. Majority of general overhead
items are apportioned on this basis.
(ii) Value of materials passing through cost centres. This
basis is adopted for expenses associated with material
such as material handling expenses.
(iii) Direct wages. Expenses which are booked with the
amounts of wages eg:- worker’s insurance, their
contribution to provident fund, worker’s compensation
etc. are distributed amongst the departments in the ratio of
wages.
Illustration 13: The Modern Company is divided into four
departments: A, B and C are producing departments, and D is a
service departments. The actual costs for a period are as
follows:
Rent Rs.1000 Repairs to Plant Rs.600
Supervision Rs.1500 Fire Insurance in respect of Stock Rs.500
Depreciation of Plant Rs.450 Power Rs.900
Light Rs.120 Employers’ liability for insurance Rs.150
The following information is available in respect of the four departments;
Dept.A Dept.B Dept.C Dept.D
Area (sq.mtrs) 1,500 1,100 900 500
Number of Employees 20 15 10 5
Total Wages (Rs.) 6,000 4,000 3,000 2,000
Value of Plant (Rs.) 24,000 18,000 12,000 6,000
Value of stock (Rs.) 15,000 9,000 6,000 -
H.P. of Plant 24 18 12 6
Apportion the costs to the various departments on the most equitable basis.

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SOLUTION
OVERHEADS DISTRIBUTION SUMMARY

Re-apportionment of Service Department Costs to

Production Departments
Service department costs are to be reapportioned to the
production departments or the cost centres where production is
going on. This process of re-apportionment of overhead
expenses is known as ‘Service Distribution’. The following is
a list of the bases of apportionment which may be accepted for
the service departments noted against

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The following are the various methods of re-

distribution of service department costs to production
departments.
1. Direct re-distribution method
2. Step distribution method
3. Reciprocal Services method
a. Simultaneous Equation Method
b. Repeated Distribution Method
c. Trial and Error Method
Direct re-distribution method
Under this method, the costs of service departments are
directly apportioned to production departments without taking
into consideration any service from one service department to

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another service department. Thus, proper apportionment

cannot be done on the assumption that service departments do
not serve each other and as a result the production departments
may either be overcharged or undercharged. The share of each
service department cannot be ascertained accurately for control
purposes. Budget for each department cannot be prepared
thoroughly. Therefore, Department Overhead rates cannot be
ascertained correctly.
Illustration 14:In an Engineering factory, the following
particulars have been collected for the three months’ period
ended on 31st March, 2007. You are required to prepare
Production Overheads Distribution Summary showing clearly
the basis of apportionment where necessary.

The expenses for the period were:

Motive power Rs.550; Lighting Power Rs.100; Stores
Overheads Rs.400; Amenities to Staff Rs.1500; Depreciation

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Rs.15,000; Repairs and Maintenance Rs.3,000; General

Overheads Rs.6000;and Rent and Taxes Rs. 275.
Apportion the expenses of service department E in
proportion of 3:3:4 and those of service department D in the
ratio of 3:1:1 to departments A, B and C respectively.
SOLUTION
PRODUCTION OVERHADS DISTRIBUTION SUMMARY
For the quarter ending 31st March, 2007

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Step Distribution Method

Under this method, the cost of most serviceable
department is first apportioned to other service departments
and production departments. The next service department is
taken up and its cost is apportioned and this process goes on
till the cost of the last service department is apportioned.
Thus, the cost of last service department is apportioned only to
production departments.
Illustration 15: A manufacturing company has two Production
Departments, P1 and P2 and three Service Departments, Time-
keeping, Stores and Maintenance. The Departmental Summary
showed the following expenses for July, 2007 .

The other information relating to departments were:

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SOLUTION:

Note: basis of apportionment

(a) Time-keeping – No. of employees (ie. 2:1:4:3)
(b) Stores – No. of stores requisitions ( ie. 3:12:10)
(c) Maintenance- Machine Hours (ie. 3:2)
The most important limitation of this method is that the
cost of one service centre to other service cost centres is
ignored and thus the cost of individual cost centres are not
truly reflected.
Reciprocal Services Method
In order to avoid the limitation of Step Method, this
method is adopted. This method recognizes the fact that if a
given department receives service from another department,
the department receiving such service should be charged. If

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two departments provide service to each other, each

department should be charged for the cost of services rendered
by the other. There are three methods available for dealing
with inter-service departmental transfer:
a. Simultaneous Equation Method
b. Repeated Distribution Method
c. Trial and Error Method
(a) Simultaneous Equation method
Under this method, the true cost of the service
departments are ascertained first with the help of simultaneous
equations; these are then redistributed to production
departments on the basis of given percentage. The following
illustration may be taken to discuss the application of this
method.
Illustration 16:
A company has three production departments and two
service departments, and for a period the departmental
distribution summary has the following totals.
Rs.
Production Departments
P1- Rs. 800; P2- Rs. 700; P3- Rs.500 2000
Service Departments:
S1 – Rs. 234; S2- Rs.300 534
2534
The expenses of the service departments are charged
out on a percentage basis as follows;

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P1 P2 P3 S1 S2
Service Department S1 20% 40% 30% - 10%
Service Department S2 40% 20% 20% 20% -
Prepare a statement showing the apportionment of two
service departments expenses to production departments by
Simultaneous Equation Method.
SOLUTION:
By Simultaneous Equation Method
Let x = total overheads of department S1
y = total overheads of department S2
Then,
x=Rs.234+. 2y
y=Rs.300+. 1x
Rearranging and multiplying to eliminate decimals;
10x-2y=Rs.2,340…………………(1)
-x+10y=Rs.3,000…………………(2)
Multiplying equation (1) by 5 and add result to (2), we get
49x=Rs.14,700
x=Rs.300
Substituting this value in equation (1), we get
y=Rs.330

All that now remains to be done is to take these values

x=Rs.300 and y=Rs.330 and apportion them on the basis of the
agreed percentage to the three production departments; thus:

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Total P1 P2 P3
Per distribution summary 2,000 800 700 500
Service department S1 270 60 120 90
Service department S2 264 132 66 66
2,534 992 886 656

This method is recommended in more than two

service departments if the data is processed with computers
and in two service departments only where the data is
processed manually.
(b) Repeated Distribution Method
Under this method, the totals are shown in the
departmental distribution summary, are put out in a line, and
then the service department totals are exhausted in turn
repeatedly according to the agreed percentages until the figures
become too small to matter.
By solving illustration 16 by Repeated Distribution
Method, we get the Secondary Distribution Summary which is
given as follows:
SECONDARY DISTRIBUTION SUMMARY
P1 P2 P3 S1 S2
Rs. Rs. Rs. Rs. Rs.
As per summary 800 700 500 234 300
Service Department S1 47 94 70 (234) 23
Service Department S2 129 65 65 64 (323)
Service Department S1 14 25 19 (64) 6
Service Department S2 2 2 2 (6)
992 886 656 - -

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(c) Trial and Error Method

Under this method, the cost of one service department
is apportioned to another centre. The costof another centre plus
the share received from the first centre is again apportioned to
the first cost centre and this process is repeated till the
balancing figure becomes negligible.
By solving illustration 16 by Trial and Error Method,
we get the following:
Service Departments
S1 S2
Rs. Rs.
Original apportionment 234 300
(23) 23 (10% of 234)
65(20% of 323) (323)
(65) 7 (10% of 65)
1(20% of 7) (7)
Total of positive figures 300 330

ABSORPTION OF OVERHEAD
Absorption means the distribution of the overhead
expenses allotted to a particular department over the units
produced in that department. Overhead absorption is
accomplished by overhead rates.
Methods of Absorption of Manufacturing Overhead
The following are the main methods of absorption of
manufacturing or factory overheads.
(a) Direct Material Cost Method. Under this method

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percentage of factory expenses to value of direct materials

consumed in production is calculated to absorb
manufacturing overheads.
Production Overhead Expenses (Budgeted)
The formula is Overhead Rate =
Anticipated Direct Material Cost

If in a factory the anticipated cost of direct material is

Rs. 4,00,000 and the over head budgeted expenses are Rs.
1,00,000, then the overhead rate will be 25% ie.( Rs.1,00,000 ÷
Rs.4,00,000) of the materials used. It is assumed that
relationship between materials and factory expenses will not
change. This method is simple and can be adopted under the
following circumstances:
(i) Where the proportion of overheads to the total cost is
significant.
(ii) Where the prices of materials are stable.
(iii) Where the output is uniform ie. Only one kind of article is
produced.
(b) Direct Labour Cost (or Direct Wages) Method. This is
a simple and easy method and widely used in most of the
concerns. The overhead rate is calculated as under:
Production Overhead Expenses
Overhead Rate =
Direct Labour Cost

If from past experience, the percentage of factory

expenses to direct wages is 50%, then the factory expenses in
the next year is taken as 50% of the direct wages.
This method is suitable under the following situations:

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(i) Where direct labour constitutes a major proportion of the

total cost of production.
(ii) Where production is uniform.
(iii) Where labour employed and types of work performed are
uniform.
(iv) Where the ratio of skilled and unskilled labour is constant.
(v) Where there are no variations in the rates of pay ie., the
rates of pay and the methods are the same for the majority
of the workers in the concern.
In some concerns a separate rate is calculated for the
fringe benefits and applied on the basis ofdirect labour cost.
(c) Prime Cost Method. Under this method the recovery rate
is calculated dividing the budgeted overhead expenses by
the aggregate of direct materials and direct labour cost of
all the products of a cost centre. The formula is
Production Budgeted Overhead Expenses
Overhead Recovery Rate =
Anticipated Direct Materials and
Direct Labour Cost

Suppose if the budgeted overheads are Rs.50,000 and

the estimated values of direct materials and direct labour are
Rs.30,000 and Rs.20,000, then overhead recovery rate will be
100%
50000
i.e., × 100
30000 + 20000

(d) Direct Labour (or Production) Hour Method. This rate

is obtained by dividing the overhead expenses by the

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aggregate of the productive hours of direct workers. The

formula is
Production Overhead Expenses
Overhead rate =
Direct Labour Hours

If in a particular period the overhead expenses are

Rs.50,000 and direct labour hours are1,00,000, then overhead
labour rate will be Re.0.50 (i.e., Rs.50,000 ÷1,00,000).
This rate is suitable where:
(i) The production is done using more of labour and less
technology is used.
(ii) It is desired to taken into consideration the time factor.
(iii) The rate may not be affected by the method of wage
payment or the grade or the rateof workers.
Illustration17: From the following particulars find out
“Direct Labour Rate”.
(a) Total number of labourers working in the department. 400
(b) Total working days in a year 300
(c) Number of working hours per day 8
(d) Total departmental overheads per year Rs.1,82,400
(e) Normal idle time allowed. 5%

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SOLUTION:
CALCULATION OF DIRECT LABOUR RATE FOR
DEPARTMENTAL OVERHEADS
Total working days in a year 300
Number of working hours per day 8
Total working hours available per worker per year 2,400(300 x 8)
Less: normal idle time allowed (5% of 2,400hrs) 120
Effective working hours per worker per year (2400-120) 2,280
Number of workers working in the department 400
Total effective working hours in the department(2280 x 400) 9,12,000
Total departmental overheads per year Rs.1,82,000
Direct Labour Rate for absorption of overheads per hour Re.0.20
(Rs.182,400÷9,12,000hrs=Rs.0.20)

(e) Machine Hour Rate. Machine hour rate is the cost of

running a machine per hour. It is one of the methods of
absorbing factory expenses to production. There is a basic
similarity between the machine hour and the direct labour
hour rate methods, in so far as both are based on the time
factor. The choice of one or the other method depends on
the actual circumstances of the individual case. In
respect of departments or operations, in which
machines predominate and the operators perform a
relatively a passive part, the machine hour rate is more
appropriate. This is generally the case for operations or
processes performed by costly machines which are
automatic or semi-automatic and where operators are
needed merely for feeding and tending them rather than

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for regulating the quality or quantity of their output. In

such cases, the machine hour rate method alone can be
depended on to correctly apportion the manufacturing
overhead expenses to different items of production. What
is needed for computing the machine hour rate is to divide
overhead expenses for a specific machine or group of
machines for a period by the operating hours of the
machine or the group of machines for the period. It is
calculated as follows:
Amount of overheads
Machine hour rate =
Machine hours during a given period

The following steps are required to be taken for the

calculation of machine hour rate:
1) Each machine or group of machine should be treated as a
cost centre.
2) The estimated overhead expenses for the period should be
determined for each machine or group of machines.
3) Overheads relating to a machine are divided into two parts
i.e., fixed or standing charges and variable or machine
expenses.
4) Standing charges are estimated for a period for every
machine and the amount so estimated is divided by the
total number of normal working hours of the machine
during that period in order to calculate an hourly rate for
fixed charges. For machine expenses, an hourly rate is
calculated for each item of expenses separately by
dividing the expenses by the normal working hours.

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5) Total of standing charges and machines expenses rates

will give the ordinary machine hour rate.
Some of the bases which may be adopted for
apportioning the different expenses for the purpose of
calculation of machine hour rate are given below.
Some of the expenses and the basis of apportionment
are given below.
1. Rent and Rates - Floor area occupied by
each machine including the surrounding space.
2. Heating and Lighting - The number of points used plus
cost of special lighting or heating for any individual
machine, alternatively according to floor area occupied by
each machine.
3. Supervision – estimated time devoted by the supervisory
staff to each machine.
4. Lubricating Oil and Consumable Stores – On the basis of
past experience.
5. Insurance – Insurable value of each machine
6. Miscellaneous Expenses – Equitable basis depending upon
facts.
Machine Expenses
1. Depreciation – cost of machine including cost of
stand-by equipment such as spare motors, switchgears
etc., less residual value spread over its working life.
2. Power – Actual consumption as shown by meter

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readings or estimated consumption ascertained from past

experience.
3. Repairs – Cost of repairs spread over its working life.
Illustration 18: A machine is purchased for cash at Rs.9,200.
Its working life is estimated to be 18,000 hours after which its
scrap value is estimated at Rs.200. it is assumed from past
experience that:
(i) The machine will work for 1,800 hours annually.
(ii) The repair charges will be Rs.1,800 during the whole
period of life of the machine.
(iii) The power consumption will be 5 units per hour at 6 paisa
per unit.
(iv) Other annual standing charges are estimated to be:.
Rs.
th
(a) Rent of department (machine occupies 1/5 of total space) 780
(b) Light (12 points in the department-2 points engage d in the 288
machine)
(c) Foreman’s salary (1/4th of his time is occupied in the machine) 6000
(d) Insurance premium (fire) for machinery 36
(e) Cotton waste 60

Find out the machine hour rate on the basis of above

data for allocation of the works expenses to all jobs for which
the machine is used.

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SOLUTION:
CALCULATION OF MACHINE HOUR RATE

(f) Rate Per Unit of Production. This method is simple,

direct and easy. It is suitable for mining and other
extractive industries, foundries and brick laying industries,
where the output is measured in convenient physical units
like number, weight, volume etc. the rate is calculated as
under:
Overhead expenses (budgeted)
Overhead Rate =
Budgeted Production

For example, if the overhead expenses (budgeted) are

Rs. 30,000 and the budgeted production is 10,000 tonnes, then
overhead rate according to this method will be Rs. 3 per tonne.
The main limitation of this method is that it is restricted to
those concerns which produce only one item of product or a
few sizes, qualities or grades of the same product. If more

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than one item are produced, then it is essential to express

dissimilar units against a common denominator on weightage
or point basis.
(g) Sale Price Method: Under this method, budgeted
overhead expenses are divided by the sale price of units of
production in order to calculate the overhead recovery
rate. The formula is sale price of units of production in
order to calculate the overhead recovery rate, the formula
is
Budged overhead expenses
Overhead Recovery Rate =
Sale value of units production

The method is more suitable for apportioning of

administration, selling and distribution, research, development
and design costs of products. It can also be used with
advantage for the appropriation of joint products costs.

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MODULE IV
METHODS OF COSTING

1. UNIT COSTING
It is an important method of costing. It is also known as
output costing or single costing. It is used to ascertain the cost
of producing a unit of output. This method is called ‘unit’
costing since every unit of production is identical in all
respects and the cost unit is a standard product.
According to J.R Batliboi, “Single or output cost
system is used in business where a standard product is
turned out and it is desired to find out the cost of a basic unit of
production.”
Features:
1. It is used where output can be measured in convenient
physical unit
2. It is followed in concern s engaged in the production of a
single product
3. It is followed in industries where manufacturing process is
continuous
4. It is followed where all units of production are identical
Cost sheet:
Cost sheet is a device used to determine and present the
cost under unit costing. It is a statement of costs incurred at
each level of manufacturing a product or service. In a Cost
sheet all the elements of cost is taken into consideration. It

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includes Prime cost, Factory/manufacturing cost, cost of

production, cost of sale Profit/loss etc.
Items excluded from Cost Sheet:
1. Pure financial expenses like interest on capital, interest on
loan, discount on debentures, loss on sale of fixed asset
provision for bad debts and doubtful debts, writing off
goodwill, copyright, preliminary expenses etc.
2. Pure financial incomes like interest received, profit on sale
of investment, dividend received, rent received,
commission received, discount received etc.
In addition to the above, no appropriation items will
include in cost sheet
Form of a Cost Sheet: Cost sheet for the period ending -------

Treatment of Stock:
While preparing a cost sheet we have to consider the
opening and closing stocks of the following three items
1. Stock of Raw materials
2. Stock of finished goods
3. Stock of work in progress

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Stock of Raw materials: In order to get the cost of material

consumed, opening stock of material is added to the cost of
raw materials purchased and closing stock of raw materials is
deducted from it.
Opening stock of raw materials xxx
Add Purchase of RM xxx
xxx
Less closing stock of RM xx
Cost of materials consumed xxx
=====
Stock of Work – in – progress: The Cost of work in progress
are adjusted at the work cost stage
Prime cost xxx
Add works OH xxx
Xxx
Add opening stock of WIP xx
xxx
Less closing stock of WIP xx
Works cost xxxx
=====
Stock of finished goods: It is adjusted immediately after
ascertaining the cost of production.
Cost of production xxx
Add opening stock of FG xx
Xxxx
Less closing stock of FG xxx
Cost of Goods sold xxxx
====

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Illustration 1
From the following particulars prepare a cost sheet for the
month of March 2008.
Rs.
st
Stock in hand 1 March
Raw materials 26,000
Finished goods 18,300
Work in Progress 9,200
Stock on hand – 31st MarchRaw materials 27,200
Finished goods 16,700
Work in Progress 10,100
Purchase of Raw materials 23,000
Carriage on purchases 1,500
Direct wages 18,500
Indirect wages 1,000
Sale of finished goods 76,000
Chargeable expenses 2,200
Factory overheads 9,500
Administration OH 4,000
Selling and Distribution OH 5,200

Solution
Cost sheet for the month of March 2008

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Tenders or Quotations: A tender or quotation is an offer

made by a person to supply certain goods at a specified price. It
is an estimated price which is determined in advance of
production. A reasonable margin of profit is added to the
estimated cost to get the tender price. A tender has to be
prepared very carefully as the receipts of orders depend upon
the acceptance of quotations or tenders supplied by the
manufacturers. It requires information regarding Prime cost,
works cost, administration and selling overhead cost and profit
of the preceding period.

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Computation of Tender price

I. Calculation of Tender price on the basis of Percentages
of Overheads
In this case a cost sheet is prepared for the past period
with the total amount of different elements of cost. Here
Indirect or overhead costs are charged on a percentage basis.
The percentage is calculated on the basis of the past year’s cost
sheet. These are calculated as follows:
a. Factory OH is charged as a percentage if direct wages.
= Factory OH x 100
Direct wages
b. Administration OH is charged as a percentage of
Factory cost
= Administration OH x 100
Factory Cost
c. Selling and Distribution OH is charged as percentage of
Factory cost
= Selling and Distribution x 100
Factory cost
Profit may be calculated either as a percentage of cost or
selling price. If the given percentage of profit is on selling
price, the percentage of profit on selling price should be
convertedinto percentage of profit on cost.
Illustration 1. Following particulars relates to the manufacture
of machines by ABC Co Ltd for the year ending 31st March
2011

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Materials used 2,50,000

Direct wages 1,90,000
Factory OH 38,000
Establishment charges 35900
Prepare a cost sheet showing the cost of Production of the
Machines. What price the company should quote to
manufacture a machine which, it is estimated will require an
expenditure of Rs. 12,000 in material and Rs. 10,000 in wages
so that it will yield a profit of 20% on selling price.
Solution:
Cost sheet for the year ending 31st March 2011

Rs.
Materials used 2,50,000
Direct wages 1,90,000
Prime cost 4,40,000
Factory Over head 38,000
Factory Cost 4,78,000
Establishment charge 35,900
Cost of Prodction 5,13900

a. Percentage of factory overhead on direct wages =

38,000 x 100
1,90,000
= 20%

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b. Percentages of establishment charges on factory OH

= 35900 x100
4,78,000
= 7.5%
Estimated Cost Sheet

II. Computation of Tender price on the basis of

Previous year’s per unit cost:
Under this situation , previous periods cost and output figures
are available. Tender price is fixed by multiplying the quantity
with previous periods per unit cost and adding the required
percentage of profit. There are three different situations under
this method.
a. When there is no change in past cost and past
percentage of profit. In this case a detailed probable cost
sheet is prepared by multiplying previous period’s cost of

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each unit with the quantity of tender. Profit is added at the

same percentage of profits of the past period.
b. When there is change in past cost, but no change in
past percentage of profit: - Here the cost of the tender is
calculated by making necessary adjustments in the elements of
cost. Same percentage of cost is added as profit to get tender
price.
c. When there is change in past cost and past
percentage of profit: - Here the total cost tender is calculated
by making necessary adjustments in the cost and the tender
price is then calculated by adding the required percentage of
profit.
Illustration II. The following is the Trading and Profit and
loss account of XYZ Co. for the year ending 31st March 2011
in which half year 1000 refrigerators manufactured and sold.
Trading and Profit & Loss Account

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For the year ending 31st March 2012, it is estimated that:

1. The price of raw materials will increase by 20% on the
previous year’s level.
2. Rate of wages will rise by 5%
3. The output and sale will be 1,200 Refrigerators
4. Selling exp. Per unit will remain constant.
5. Manufacturing OH will rise in proportion to combined
cost of material and wages
6. Other expenses remain unaffected by the rise in output.
You are required to prepare an estimated cost sheet for
the year 2012, showing the prices at which a refrigerator
should be sold keeping a net profit of 10% on the selling price.
Solution: Cost sheet for the year ended 31st March 2011

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Estimated cost sheet for the year ended 31st March 2012

III Calculation of Tender price based on fixed and variable

costs: Here, costs are classified according to variability into
three types,, fixed, variable and semi variable. Tender price is
calculated on the basis of degree of variability
Illustration III The Cost of manufacturing 5000 units of a
commodity comprises Material cost Rs. 40,000, wages Rs.
50,000 Direct expenses Rs. 800, Variable OH Rs. 8000
and fixed OH Rs. 32,000. For the manufacturing of every
1000 extra units of the commodity, the cost of production
increases as follows:
a. Fixed OH Rs. 400 extra
b. Direct expenses proportionately

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c. Wages 10% less than proportionately

d. Materials proportionately
e. Variable OH 25% less than proportionately.
Calculate the estimated cost of producing 8,000 units of the
commodity.
Solution:
Statement of Cost

Notes:
Increase in the Value of Materials = 40,000/5000 x 3000
= Rs.24,000
“ Wages = 50000/5000 x3000 – 10% = Rs. 27,000
“ Direct expenses = 800/5000 x 3000 = Rs. 480“
Fixed Expenses = 400 x3 =Rs. 1200
“ Variable expenses = 8000/5000 x 3000 - 25%
= Rs. 3,600

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JOB COSTING
It means ascertaining costs of an individual job, work
order or project separately. According to ICMA London, “job
costing is that form of specific order costing which applies
where work is undertaken to customer’s specific requirements
and each order is of comparatively of short duration.” Under
this method of costing, each job is considered to be a distinct
cost unit. As such, each job is separately identifiable.
In the case of a job, work is usually carried out within
the factory or workshop. Sometimes, a job is accomplished
even in the customer’s premises. This method of costing is
applicable to ship building, printing, engineering, machine
tools, readymade garments, shoes, hats, furniture, musical
instruments, interior decorations etc.
Features:
1. Each job has its own characteristics, depending up
on the special order placed by thecustomer.
2. Each job is treated as a cost unit.
3. A separate job cost sheet is made out for each job on the
basis of distinguishing numbers.
4. A separate work in progress ledger is maintained for each
job.
5. The duration of the job is normally a short period.
6. Profit or loss is determined for each job independently of
others

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Advantages of Job costing:

1. It helps to distinguish profitable jobs from unprofitable
jobs
2. It helps to identify defective work and spoilage with a
department or person
3. Selling price of special orders can easily be fixed.
4. It helps to prepare estimates of cost for submitting
quotations and tender for similar jobs
5. It helps to control future cost.
Requisites of Job costing system:
1. A sound system of production control
2. An effective time booking system
3. Clearly defined cost centre
4. Appropriate overhead absorption rate, and
5. Proper material issue pricing method.
Procedure for Job order costing system:
The Procedure for job order costing system may be
summarized as follows:-
1. Receiving an enquiry from the customer regarding price,
quality etc
2. Make an estimation of the price of the job after
considering the cost incurred for the execution of
similar job in the previous year
3. Receiving an order, if the customer is satisfied with the

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quotation price and other terms ofexecution.

4. If the job is accepted, a production order is made by the
Planning department.
5. The costs are collected and recorded for each job under
separate production order Number,and a Job Cost Sheet is
maintained for that purpose.
6. On completion of job, a completion report is sent to
costing department.
Illustration I
From the following particulars calculate the cost of Job No.505
and price for the job to give a profitof 25% on the selling price.
Material : Rs. 6820
Wage details:
Department X : 60 hrs @ Rs. 3 per hr
Y : 50 hrs @ Rs. 3 per hr
Z : 30 hrs @ Rs. 5 per hr
The variable Overheads are as follows:
Department X : Rs. 5000 for 5000 hrs
Y : Rs. 4000 for 2000 hrs
Z : Rs. 2000 for 500 hrs
The total fixed expenses amounted to Rs. 20,000 for 10,000
working hours.
Calculate the cost of Job No. 505 and price for the job to give a
profit of 25% on selling price

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Solution:
Job Cost Sheet No. 505

Practical problem 1
The following information is extracted from the Job ledger in
respect of Job No. 205Materials Rs. 8,500
Wages : 80 hours @ Rs. 6 per hour
Variable OH incurred for all jobs is Rs. 10,000 for 4,000
labour hours. Find the profit if the job isbilled for Rs. 8,400.
Practical Problem 2
From the following information, ascertain the work cost of Job
No. 505
The job was commenced on 10th January 2011 and completed

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on 1st Feb.2011. Materials used were Rs. 2,400 and labour

charges were Rs. 1,600. Other details were as follows:
1. Indirect labour cost in the factory amounted to Rs. 1,200
2. Machine X was used for 50 hours @ Rs. 20 per hour
3. Machine Z was used for 40 hours @ Rs. 22 per hour
CONTRACT COSTING
Meaning
It is a special form of job costing and it is the most
appropriate method to be adopted in such industries as
building and construction work, civil engineering, mechanical
fabrication and ship building. In other words, it is a form of
specific order costing which applies where the work is
undertaken to customer’s requirements and each order of long
duration as compared to job costing. It is also known as
terminal costing.
The official CIMA terminology defines contract
costing as “ a form of specific order costing in which costs are
attributed to individual contracts.”
Basic features:
1. Each contract itself a cost unit.
2. Work is executed at customers site
3. The existence of sub contract
4. Most of the expenses incurred upon the contracts are
direct.
5. Cost control is very difficult in contract costing.

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Types of contracts
Generally there are three types of contracts:
1. Fixed price contracts: Under these contracts both parties
agree to a fixed contract price.
2. Fixed price contract with Escalation clause
3. Cost plus contract: Under this contract no fixed price
could be settled for a contract.
Contract Account
A contract account is a nominal account in nature. It is
prepared to find out the cost of contract and to know profit or
loss made on the contract. A contractor may undertake a
number of contracts at a time. For each contract a separate
account is opened. In the contract account all direct cost such
as material, labour and other direct expenses incurred during
an accounting period are debited and the indirect expenses are
apportioned on an equitable basis. The differences between the
two sides are known as Notional profit or notional loss.
SPECIAL TERMS IN CONTRACT ACCOUNT
1. Work in Progress: It is the unfinished contract at the
end of the accounting period and it includes amount of work
certified and amount of work uncertified. Work in progress is
an asset, shown in the balance sheet by deducting there from
any advance received from the contractee.
2. Work certified: The sales value of work completed as
certified by the architect is known as ‘work certified’. In the
case of contracts of long duration, the amount payable by the

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customer to the contractor is based on the sales value of work

done as certified by the architect. At the end of the financial
year, the total sales value of work done and certified by the
architect is credited to the contract account.
3. Work Uncertified: It means work which has been
carried out by the contractor but has not been certified by the
architect. Sometimes, work which is complete remains
uncertified at the end of the financial year. The reasons for the
same may be
a. Work not sufficient enough to be certified
b. Work has not reached the stipulated stage to qualify for
certification It is always valued at cost and credited to the
contract account.
4. Retention money: - Regardless of the amount of work
certified, the contractor is paid a specified percentage of the
same and the balance is held or retained by the contractee.
This is because of the fact that the contractee has to safe guard
himself against any contingency arising from the non
fulfillment of the terms of the contract by the contractor. The
unpaid balance of work certified or the amount held back or
retained by the contractee is known as ‘retention money’.
5. Sub contract: Sometimes the contractor enters into
contracts with another contractor to give a portion of work
undertaken by him. In such cases the work performed by the
subcontractor s forms a direct charge to the contract concerned.
Sub contract cost will be shown on the debit side of the
contract account.

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6. Escalation clause: This is clause which is provided in

the contract to cover up any increasein the price of the contract
due to increase in the prices of raw material or labour or in the
utilization of any other factors of production. If material and
labour utilization exceeds a particular limit, the customer
agrees to bear the additional cost occasioned by excessive
utilization. Here, the contractor has to satisfy the customer that
excessive utilization is not the result of decreased efficiency.
SPECIMEN FORM OF CONTRACT ACCOUNT
(Unfinished contract)
Contract A/C

Treatment of Plant and Machinery:

One of the distinguishing features of a contract is the
use of special plant and machinery. The cost of these is capital
expenditure, but yet, the usage of these should be reflected in
the form of depreciation. There are two distinct methods of
charging depreciation.
1. At the time of issue of plant to contract the contract

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account is debited with the full value of the plant. At the end of
the period contract account is credited with the depreciated
value. This method is used when plant and machinery is used
at the contract site for a long period.
2. In the second method, contract account is debited with
an hourly rate of depreciation for the number of hours the plant
is used on the contract. A cost centre is set up for each
machine. An estimate is made is made of the cost such as
maintenance, depreciation, driver’s wage etc to be incurred.
The total of this cost is divided by the number of hours that the
machine is expected to be used.
Profit on Incomplete Contract:
In the case of a small contract extending over the
financial period, profit or loss on the same may be ascertained
by crediting it with the contract price due by the contractee.
This procedure cannot be adopted in the case of contracts
extending beyond the accounting period, and taking a long
time for completion. If there is any profit upon the incomplete
contract, it cannot be taken as actual profit. The profit upon the
incomplete contract is called notional profit.
For the purpose of determining the amount of profit to
be transferred to profit and loss account and making provision
for future contingencies, the following guidelines may be kept
in mind.
1. When the work has not reasonably advanced (1/4 or
less than ¼) : - No profit should be taken to the credit of p/L
account in the case of contracts which have just commenced

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and asmall portion of the work is complete.

2. Where the work is complete more than ¼ but less
than ½ of contract price: In this case1/3 of the notional profit
as reduced by the percentage of cash received may be credited
to profit and loss account. The usual formula is
Notional profit x1/3 x Cash received
Work certified
The balance of notional profit shall be kept as reserve
till the completion
3. If the contract completed is more than 1/2 but less
than 90%: Here 2/3 rd of the notional profit should be taken to
profit and loss account.
Notional profit x2/3 x Cash received
Work certified
The balance of notional profit shall be transferred to
work in progress as reserve. It is to be noted that in order to
find out how much portion of contract is completed, work
certified should be compared with contract price.
4. If the contract is nearing completion: Here,
estimated profit may be ascertained by deducting the total cost
of contract to date plus estimated additional expenses to
complete the contract , from the contract price. It is calculated
by using the following formula
Estimated profit x Cash received
Contract price

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The loss on incomplete contract should be fully

transferred to profit and loss account.
Example 1
The following was the expenditure on a contract for
Rs.6,00,000

Cash received on account of the contract was

Rs.2,40,000 being 80% of the work certified. The Value of
material in hand was Rs. 10,000. The plant has undergone
20% depreciation.
Solution:
CONTRACT ACCOUNT

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Example 2
XY Ltd undertook a contract, the following was the
expenditure on a contract for Rs. 6,00,000.
Material issued to contract Rs. 1,02,000
Plant issued for contract Rs. 30000
Wages Rs.1,62,000
Other expenses Rs. 10,000
Cash received on account of contract up to 31st march 2011
amounted to Rs. 2,56,000 being 80% of work certified. Of the
plant and material charged to the contract plant costing Rs.
3000 and material costing Rs. 4000/ were lost. On Ist March
2011, Plant which cost Rs. 2,000 was returned to the store, the
cost of work done but not certified was Rs. 3000 and material
costing Rs. 2,500 were in hand on site. Provide 10%
depreciation on plant, reserve 1/3 of profit received and
prepare contract account from the above particulars.
Solution
CONTRACT ACCOUNT

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Note: It is assumed that the contract has begun on 1/4/10.

Example- 3
Mr. A has undertaken several contract works. He maintains a
separate record for each contract. From the records for the year
ending 31-12-98, Prepare contract account for Contract No.50
and find the amount transferred to profit and loss account.

The contract price was Rs. 15,00,000. Cash received

up to 31-12-2008 was Rs. 6,00,000 which is 80% of work

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certified . Material at site Rs. 16,000. Depreciation for

Machine Rs. 16,000.
Solution

PROCESS COSTING
Process costing is the method of costing applied in the
industries engaged in continuous or mass production. Process
costing is a method of costing used to ascertain the cost of a
product at each process or stage of manufacturing.
According to ICMA terminology, “Process Costing is that
form of operation costing which applies where standardized
goods are produced”.
So it is a basic method to ascertain the cost at each stage of
manufacturing. Separate accounts are maintained at each
process to which expenditure incurred. At the end of each
process the cost per unit is determined by dividing the total
cost by the number of units produced at each stage. Hence, this

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costing is also called as “Average Costing” or “Continuous

Costing”. Process Costing is used in the industries like
manufacturing industries, chemical industries, mining works
and public utility undertakings.
Characteristics of Process Costing
1. Production is continuous
2. Products pass through two or more distinct processes of
completion.
3. Products are standardized and homogeneous.
4. Products are not distinguishable in processing stage.
5. The finished product of one process becomes the raw
material of the subsequent process.
6. Cost of material, labour and overheads are collected for
each process and charged accordingly.
Advantages of Process Costing
1. It is easy to compute average cot because the products are
homogeneous in Process Costing.
2. It is possible to ascertain the process costs at short
intervals.
3. Process Costing is simple and less expensive in relation o
job costing.
4. By evaluating the performance of each process effective
managerial control is possible.
Disadvantages of Process Costing
1. Valuation of work in progress is difficult.

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2. It is not easy to value losses, wastes, scraps etc.

3. The apportionment of total cost among joint products and
by-products is difficult.
4. Process cost are not accurate, they are only average costs
5. Process costs are only historical.Principles of Process
Costing
The following points are considered while determining the
cost under Process Costing.
1. Production activity should be divided into different
processes or departments.
2. A separate account is opened for each process.
3. Both direct and indirect costs are collected for each
process.
4. The quantity of output and costs are recorded in the
respective process accounts.
5. The cost per unit is determined by dividing the total cost
at the end of each process by thenumber of output of
each process.
6. Normal loss and abnormal loss are credited in the process
account
7. The accumulated cost of each process is transferred to
subsequent process along with output. The output of the
last process along with cost is transferred to the finished
goods account.
8. In case of by-products and joint products their share in

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joint cost should be estimated and credited to the min

process.
9. When there is work in progress at the end of the period
the computation of inventory is made I terms of complete
units.
Difference between Process Costing and Job Costing

Procedure for Process Costing

1. Each process is separately identified. Separate process
account is opened for each process.
2. Along with ‘Particulars Column’, two columns are
provided on both sides of the process account – units
(quantity) and amount (Rupees).
3. All the expenses are debited in the respective process
account.
4. Wastage, sale of scrap, by-products etc are reordered
on the credit side 0f the processaccount.
5. The difference between debit and credit side shows the
cost of production and output of that particular process

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which is transferred to the next process.

6. The cost per unit in every process is calculated by
dividing the net cost by the output.
7. The output of last process is transferred to the Finished
Stock Account.
8. Incomplete units at the end of the each period ion
every process s converted in terms ofcompleted units.
Specimen of Process Account

Preparation of Process Accounts

The preparation of Process Account depends upon the
following situations
1. Simple Process Account
2. Process costing with normal process loss
3. Process costing with abnormal process loss
4. Process costing with abnormal process gains
5. Inter – process profits.

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Simple Process Account

Under this case it is very easy to prepare process

account. A separate account is opened for each process. All
costs are debited to the process account. The total cost of the
process is transferred to the next process. At the end of each
process the cost per unit is obtained by dividing the total cost
by the number of units.

Illustration 1: Product A requires three distinct processes and

after the third process the product is transferred to finished
stock. Prepare various process accounts from the following
information.

Production overheads to be allocated to different

processes on the basis of 150% of direct wages. Production
during the period was 200 units. Assume 5here is no opening
or closing stock.

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Solution:
Process I Account

Process II Account

Process III Account

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Process losses
The process loss is classified into two- normal process
loss and abnormal process loss.
Normal process loss
This is the loss which is unavoidable on account of
inherent nature of production process. It arises under normal
conditions. It is usually calculated as a certain percentage of
input. Normal process los includes either waste or scrap r both.
Waste is unsalable and has no value. Loss in weight is an
example of waste. Loss in weight should be credited to the
concerned process account. It should be recorded only in terms
of quantity.
Loss in weight = Opening Stock + output from the preceding
process – (output of theConcerned process + closing stock)
Illustration 2: From the following figures, show the cost of
three processes of manufacture. The production of each
process is passed on to the next process immediately on
completion.

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Solution:

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Illustration 3: Bihar Chemicals Ltd produced three chemicals

during the month of July 2012 by three consecutive processes.
In each process 2% of the total weight put in is lost and 10 %
is scrap which from process 1 and 2 realizes Rs.100 a ton and
from process 3Rs.20 a ton.
The product of three processes is dealt with as follows:
Process 1 Process 2 Process 3
Passed on to the next process 75% 50%
Sent to warehouse for sale 25% 50% 100%

Expenses incurred:
Rs Tons Rs Tons Rs Tons
Raw materials 120000 1000 28000 140 107840 1348
Manufacturing wages 20500 18520 15000
General expenses 10300 7240 3100

Prepare Process Cost Accounts showing the cost per

ton of each product.Solution:
Process 1 Account

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Process 2 Account

Process 3 Account

Abnormal Process Loss

Any loss caused by unexpected or abnormal conditions
such as plant break don, substandard materials, carelessness,
accident etc. or loss in exceeds of the margin anticipated for
normal processloss can be called as abnormal process loss. It is
controllable and avoidable. When actual loss in the process is
greater than the estimated normal loss, it is a case of abnormal
loss. It may also be determined by comparing actual output

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with expected or normal output. If actual output is les than the

normal output, the difference is abnormal loss.
Value of Abnormal loss =
Normal cost of normal output x Units of Abnormal loss
Normal output
Normal cost of normal output =
Total expenditure (i.e., total debit of process A/c) – Sale
Proceeds of scrap (i.e. Value of normal loss)
Normal output = Input – Units of normal loss
Illustration 4: In process A 100 units of raw materials were
introduced at a cost of Rs.1000. the other expenditure incurred
by the process was Rs. 602. Of the units introduced 10% are
normally lost in the course of manufacture and them posses a
scrap value of Rs.3 each. The output of process A was only 75
units. Prepare Process A A/c and Abnormal loss A/c.
Solution:
Process A A/c

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Working Note:
Normal cost of normal output =
Total expenditure – Sale Proceeds of scrap
= 1602-30= 1572
Normal output = Input – Units of normal loss
= 100 – 10 = 90
Value of Abnormal loss =
Normal cost of normal output x Units of Abnormal loss
Normal output
= 1572 x 15 = Rs. 262
90
Abnormal Loss A/c

Abnormal Gain (or Abnormal Effective)

Sometimes actual loss or wastage in a process is less
than expected normal loss. In this case the difference between
actual loss and expected loss is known as abnormal gain or
abnormal effective. It is the excess of actual production over
normal output.

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Abnormal gain is valued in the same manner as

abnormal loss. The value of abnormal gain is debited to
process A/c and credited to abnormal gain A/c. the value of
scrap is debited to abnormal gain A/.c and credited to normal
loss A/c. finally abnormal loss A/c is closed bytransferring the
credit balance to Costing P&L A/c.
Value of Abnormal Gain =
Normal cost of normal output x Units of Abnormal gain
Normal output
Normal cost of normal output =
Total expenditure– Sale Proceeds of scrap
Normal output = Input – Units of normal loss
Units of Abnormal gain = Normal loss- Actual loss
Or = Actual output - Normal output
Illustration 5: Product X is obtained after it passes through
three distinct processes. 2000 kg of materials at Rs.5 per kg
were issued to the first process. Direct wages amounted to
Rs.900 and production overhead incurred was Rs.500. Normal
loss is estimated at 10% of input. This wastage is sold at Rs.3
per kg. The actual output is 1850 kg. Prepare process I A/c and
Abnormal Gain/ Abnormal loss A/c as the case may be.

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Solution:
Process I Account

Abnormal Gain A/c

Working note:
1. (200+1850)-2000=50
2. (10000+900+500)-600 = Rs.6
1850-50
1850x6=11100
3. 50x6=30
Illustration 6: The product of a company passes through three
distinct processes to completion – A,B and C. from the past
experience it s ascertained that los s incurred in each process as

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– A-2%, B-5% and C-10%.

In each case the percentage of loss is computed on the
number of units entering the process concerned. The loss of
each process possesses a scrap value. The los of processes A
and B sold at Rs.5 per 100 units and that of C at Rs.20 per 100
units.
The output of each process passes immediately to the
next process and the finished units are passed from process C
into stock.

Process A Process B Process C

Materials consumed 6000 4000 2000
Direct labour 8000 6000 3000
Manufacturing expenses 1000 1000 1500

20000 units have been issued to process A at a cost of

Rs.10000. the output of each processhas been as under:
A-19500, B- 18800 and C - 16000.
There is no work in progress in any process. Prepare
process accounts. Calculations should be made to the nearest
rupee.

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Solution:
Process A Account

Process B Account

Process C Account

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Finished Stock A/c

Abnormal Loss A/c

Normal loss A/c

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Abnormal Gain A/c

Working note:
Process A:
Value of Abnormal loss = Rs.24980/19600 units x 100 units
= Rs. 127.Process B:
Value of Abnormal gain = Rs.35804/18525 units x 275 units
= Rs. 532.Process C:
Value of Abnormal loss = Rs.42460/16920 units x 920 units
= Rs. 2309.
Work-in-Progress
In most of the firms manufacturing is on a continuous
basis and the problem of work-in- progress is quite common.
The work-in-progress consists of direct materials, direct wages
and production overhead.
Equivalent Production
Equivalent production represents the production of a
process in terms of completed units. In other words, it means

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converting the incomplete units into its equivalent of

completed units. It is also known as effective production. For
calculating equivalent production, work-in-progress needs to
be inspected. Then an estimate is made of the degree of
completion, usually on a percentage basis.
Steps and procedure of computation of Equivalent
Production
1. Ascertain Equivalent Production in respect of opening
work-in-progress, if any. In this case the Equivalent
Production is computed by taking into consideration the
percentage of work required to finish now in the process. The
following formula is used.
Opening WIP (Units) x % of work needed to complete.
2. Find the units introduced and completed and add this to
(1). It is calculated as follows: Units completed and transferred
– Opening work-in-progress.
3. Convert the equivalent production of closing work-in-
progress and add to the above. The formula is:
Closing work-in-progress (units) x% of work completed.
4. Obtain the total Equivalent Production terms of
materials, labour and overhead separately (if degree of
completion is different). For this, ‘Statement of Equivalent
Production’ is prepared.
5. Find out the net process costs, element wise- materials,
labour and overheads.

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6. Ascertain the cost per unit of Equivalent Production for

each element of cost separately.
Material cost per unit = Material cost ______
Equivalent Production in respect of materials
Labour cost per unit = Labour cost ______________
Equivalent Production in respect of labour
Overhead cost per unit = Overhead cost ________
Equivalent Production in respect of overhead
For this purpose ‘Statement of Cost is prepared’
7. Find out the value of opening work-in-progress, finished
units and closing work-in-progress. Theformula is:
Equivalent Production in respect of materials x Material cost
per unit Equivalent Production in respect of labour x Labour
cost per unit Equivalent Production in respect of overhead x
Overhead cost per unit
For this purpose ‘Statement of Evaluation or Apportionment’ is
prepared.
In short, the following three statements are to be prepared:
1. Statement of Equivalent Production
2. Statement of Cost
3. Statement of Evaluation.
I. When there is only closing work-in-progress but with no
process losses
Under this case the closing work-in-progress is
converted into equivalent units on the basis of estimate as

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regards degree of completion of materials, labour and

production overhead.
Illustration 7: Input 3800 units, Output 3000 units and closing
work-in-progress 800 units.

Degree of Process costs

completion Rs.
Materials 80% 7280
Labour 70% 10680

Overheads 70% 7120

Find out Equivalent Production, Cost per unit of equivalent

production and prepare the Process A A/c assuming that there
is no opening work-in-progress and process loss.
Solution:
Statement of Equivalent Production

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Statement of Cost

Elements of Equivalent Cost per

Cost (Rs.)
cost Production(units) completedunit
Materials 7280 3640 2.00
Labour 10680 3560 3.00
Overheads 7120 3560 2.00
25080 7.00

Statement of Evaluation

Process A A/c

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II. When there is only closing work-in-progress but with

process losses
In case of normal loss, nothing should be added as
equivalent production. However, abnormal loss should be
considered as production of good units completed during the
period.
Illustration 8: During January 2000 units were introduced into
Process I. the normal loss was estimated at 5% on input. At the
end of the month, 1400 units had been produce and transferred
to the next process, 460 units were uncompleted and 140 units
had been scrapped. It was estimated that uncompleted units
had reached a stage in production as follows:
Material 75% completed
Labour 50% completed
Overheads 50% completed
The cost of 20000 units was Rs.5800
Direct material introduced during the process Rs.1440Direct
wages Rs.3340
Production overheads incurred were Rs. 1670Units scrapped
realized Re.1 each.
Units scrapped passed through the process, so were 100%
completed as regards material, labourand overhead.
Find out Equivalent Production, Cost per unit and prepare the
necessary accounts.

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Solution:
Statement of Equivalent Production

Statement of Cost

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Statement of Evaluation

Process I A/c

Finished Production A/c

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Abnormal Loss A/c

III. When there is opening as well as closing work in

progress but with no process loss.
Sometimes in a continuous process there will be
opening as well as closing work in progress which are to be
converted into equivalent of completed units for apportionment
of process costs. The procedure of conversion of opening work
in progress will vary depending upon whether average cost or
FIFO or LIFO method of apportionment of costs is followed.
Illustration 9: From the following details, prepare statement
of equivalent production, statement of cost, statement of
evaluation and process A/c by following FIFO method.

There are 2000 units in progress and the stage of completion is

estimated to be:
Materials 100%
Labour 50%
Overheads 50%

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8000 units are transferred to the next process:

The process costs for the period are:
Materials Rs.96000
Labour Rs. 54600
Overheads Rs. 31200

Solution:
Statement of Equivalent Production

Statement of Cost

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Statement of Evaluation

Process A/c

IV. When there is opening as well as closing work-in-progress

but with losses.
Under this equivalent production units regarding
opening and closing work in progress are to be calculated with
due adjustment for process losses.

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Illustration 10: Following data are relating Process A for

March 2012.Opening WIP – 1500 units for Rs.15000
Degree of completion:
Materials 100%, Labour and overheads 33 1/3% Input of
materials 18500 units at Rs.52000 Direct labour Rs. 14000
Overheads Rs. 28000 Closing WIP - 5000 units.
Degree of completion: Materials 90% and labour and
overheads 30%. Norma process loss is 10% of total input
(opening WIP units + units put in)Scrap value Rs. 2 per unit.
Unit transferred to the next process 15000 units.
Compute equivalent units of production, cost per
equivalent unit for each cost element and cost of finished
output and closing WIP. Also prepare Process and other
accounts. Assume that FIFO method is used by the company
and the cost of opening WIP is fully transferred to the next
process.

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Solution:
Statement of Equivalent Production and Cost

Statement of Evaluation

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Process I A/c

Normal loss A/c

Abnormal Gain A/c

OPERATING COSTING(SERVICE COSTING)

It is the costing procedure used for determining the cost
of per unit of service rendered. It is a method of costing
applied to undertaking which provides service rather than
production of commodities. The services may be in the form of

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transport, supply service, welfare service, etc. There is a

difference between operating costing and operation costing.
Operating costing is a method of costing designed to find out
the cost of operating or rendering a service. On the other hand,
operation costing is a method of costing applied to determine
the total cost and unit cost of each operation. Though service
undertakings are of different types, but here we discuss only
transport operating costing.
Transport costing:
Transport industries include Air, Water, Rail and Road.
They render services to the community at large. We have to
give utmost care while selecting the cost unit. The cost unit of
other forms operation costing is quite different from that of a
service undertaking. The cost unit of a service organization is a
composite unit. The important factors to be considered
includes the number of passengers, tonnage carried, distance
covered etc.
Classification of Costs:
Operating costs of a transport undertaking comprising
different items, which are classified under the following three
groups.
1. Standing or fixed charges: These charges are incurred in
spite of the kilometers run. It is fixed in nature. Eg. Insurance,
Motor vehicle tax, license fee, rent, salary of operating
manager etc.
2. Maintenance charges: It includes semi variable expenses
Eg. Tyres and tubes, repairs and paintings etc.

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3. Operating and running charges: These charges vary

more or less in direct proportion to kilometers. All the variable
charges of running vehicles are included in this group.
Generally it includes, petrol, oil,, grease etc., wages of driver,
attendant if payment is relatedto time or distance of trip etc.
In the place of the above classification, all expenses
can be divided into two – fixed cost and variable costs. Here,
both maintenance charges and running charges are considered
as variable charges.
Selection of Unit:
In transport costing, a composite unit such as passenger
mile or passenger kilometer or tone kilometer is often selected.
Such unit takes into account both the number of passengers or
weight of goods carried and distance run.
Absolute passenger or commercial passenger/ tone km:
It is calculated by multiplying every part of distance
travelled/covered with either weight carried or passenger
carried.. After getting the product of each journey we add all
the products. The total is absolute ton/quintal km
In the case of goods transport the equation is Distance of each
part of journey x weight carried
In the case of passenger transport, the following formula is
used
Distance of each part of journey x No. of passengers taken for
the same distance

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Commercial method:
The following steps are used to find out the commercial tone
km
a. Find out average trip load
b. Find out total distance of journey
c. Multiply a and b , the resultant figure is commercial tone
km
Example 1
A truck starts with a load of 10 tonnes of goods from
station P. It unloads 4 tonnes at station Q and rest of the goods
at station R. It reaches back directly to station P after getting
reloaded with 8 tonnes of goods at station R. The distance
between P to Q, Q to R and then from R to P are 40 kms, 60
kms, and 80 kms respectively. Compute absolute tone kms
and commercial tone-km .
Absolute ton/ km = Total distance x weight carried
= (40x10) + (60x6) + (80x8) =400+360+640= 1400
Commercial tone/km = Distance x average load
= [40+60+80] x{10+6+8/3}= 180x8=1440
Example 2
A bus with a capacity of 50 passengers makes a return
trip from P to Q via station X every day.The distance between
P and X is 60 kms where as between X and Q is 40 40 km.
During the onward journey, the bus is full to capacity up to
station X but only 60% full between X and Q. On the other

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hand, on return trip it is full from Q to X but only comes 40%

of the capacity between X and P.
Compute the total passenger kms of service the bus renders
every day.
Solution:
Total passenger kms per day:
Onward journey:
P to XX to Q 60kms X 50 40kmsX50X60% =3000
=1200
Total (A) 4200
Return Trip:
Q to X 40 kms X 50 X 100% =2000
X to P 60 kms X 50 X 40 % =1200
Total (B) 3200
Total passenger kms every day = (A) + (B)
= 4200+3200 = 7400 kms
Preparation of Operating Cost sheet:
An operating cost sheet is prepared periodically in
order to ascertain the cost per unit. Here, the total fixed,
maintenance and running costs are collected and allocated
under respective heads and these are then divided by total
units.
The Performa of a operating cost sheet is given below:

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OPERATING COST SHEET

Calculation of Depreciation:
If the rate of depreciation is not given, depreciation is
calculated as follows:
Depreciation =Cost- scrap
Life in years

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Depreciation per mile, or km = Depreciation p.a

Kms/miles run p.a
Example 3
From the following data calculate the cost per mile of a
vehicle:
Value of vehicle Rs. 15,000
Road license for the year 500
Insurance charges per year 100
Garage rent per year 600
Drivers’ wages per month 200
Cost of petrol per litre 0.80
Miles per litre 8
Proportional charge for tyre and maintenance 0.20
per mile
Estimated life 1,50, 000 miles
Ignore interest on capital.

Solution:
Operating cost statement
Particulars Annual cost Cost per unit
Fixed expenses:
Road license fee 500 0.08
Insurance charge 100 0.02
Garage rent 600 0.10
Maintenance charges:
Cost of tyre and maintenance of
0.20 0.20
per mile

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Operating /running charges:

Cost of petrol per mile 80p/8 0.10
Drivers wage per mile
0.40
2400/6000
Depreciation of vehicle
0.10
15000X6000/1,50,000
1.00

Example 4
Mathrubhumi Transport Co. is running four buses
between two towns which are fifty miles apart, seating
capacity of each bus is 40 passengers.
The following particulars were obtained from their
books for the month of November 2010. Salaries of office and
supervisory staff Rs. 3000
Diesel oil and other oils Rs. 4000
Wages of Drivers and conductors Rs. 2400
Repairs and maintenance Rs. 800
Taxation, insurance etc Rs. 1600
Depreciation Rs. 2600
Interest and other charges Rs. 2000
-----------
16,400
Actual passengers carried were 75% of the seating capacity.
All the four buses ran on 30 days in a month, each bus made
one round trip per day.

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Prepare an operating cost statement for the month showing cost

per passenger mile.
Operating cost sheet for the month of November 2010
Particulars Total cost
Salaries of office staff 3000
Wages of driver’s , conductors etc 2400
Diesel oil and other oils 4000
Repairs and maintenance 800
Taxation , insurance etc 1600
Depreciation 2600
Interest and other charges 2000
16400

Cost per passenger mile =16400/3,60,000= 0.04 paise

Working note:-
Passenger miles = No. of Trips per day X No. of days in a
month X percentage of capacity Xmileage per trip
= 4x 1 x 30 x (75% of 40) x (50 x 2)
4 x 1 x 30 x 30 x 100 = 3,60,000 passenger miles.
Practical problem 1
Work out in appropriate cost sheet form the unit cost
per passenger km for the year 2009-10 for a fleet of passenger
buses run by a transport company from the following figures
extracted from its books:-

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5 passenger buses costing Rs.60,000, Rs.1,20,000, Rs.50,000,

Rs. 65,000 and Rs. 45,000 respectively. Yearly depreciation
of vehicles is 20% of cost.
Annual repairs, maintenance and spare parts is 80% of
depreciation. Wages of 10 drivers @Rs. 100 each per month,
wages of 20 cleaners @ Rs. 50 each per month. Yearly rate of
interest @ 4% on capital. Rent of 6 garages @ Rs. 50 each per
month. Directors fees @ Rs.400 per month, office
establishment @ Rs. 1000 per month, license and taxes@
Rs.1000 every six months, realization by sale of old tyres and
tubes @ Rs. 3,200 every six months, 900 passengers were
carried over 1,600 kms during the year.

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MODULE V
COST CONTROL TECHNIQUES

BUDGET AND BUDGETARY CONTROL

Meaning and definition of budget:
A budget is a plan of action for a future period. It
simply means a financial plan expressed in terms of money.
The budget pertaining to any of the activities of business is
always forward looking. The term ‘budget’ has been derived
from the French word, ”bougette”, which means a leather bag
into which funds are appropriated to meet the anticipated
expenses.
The CIMA Official Terminology defines a budget as
“A quantitative statement, for a defined period of time,
which may include planned revenues, expenses, assets,
liabilities and cash flows.”
Budgeting and Budgetary control:
Budgeting simply means preparing budgets. It is a
process of preparation, implementation and the operation of
budget. Being a plan of action, a budget guides every manager
in the decision making process.
In the words of Rowland Harr, “Budgeting is the
process of building budgets”.
Budgetary control is a system of using budgets for
planning and controlling costs. The official terminology of

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CIMA defines the term ‘budgetary control, as “the

establishment of budgets relating to the responsibilities of
executives to the requirement of a policy, and the continuous
comparison of actual with budgetary result, either to secure by
individual action the objectives of that policy or to provide a
basis for its revision.” Thus, when plans are embodied in a
budget and the same is used as the basis for regulating
operations, we have budgetary control. As such budgetary
control starts with budgeting and ends with control.
Objectives of Budget and Budgetary control:
The following points reveal the objectives of Budget
and budgetary control:-
1. To aid the planning of annual operations
2. To co ordinate the activities of the various parts of the
organization
3. To communicate plans to the various responsibility centre
managers
4. To motivate managers to strive to achieve the
organizational goals.
5. To control activities
6. To eliminates the wastes of all kinds
7. To provide a yard stick against which actual results can be
compared
8. To evaluate the performance of managers.
9. To reduce the uncertainties

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Meaning of Estimate, forecast and Budget:

An estimate is predetermination of future events either
on the basis of simple guess work or following scientific
principles.
Forecast is an assessment of probable future events.
Budget is based on the implication of a forecast and related to
planned events. To establish a realistic budget, it is necessary
to forecast a wide range of factors like sales volume, sales
prices, material availability, wage rate, the cost of overheads
etc.
Steps involved in Budgetary Control:
The following steps may be considered necessary for
a comprehensive budgetary controlprogramme:-
1. Laying down organizational goals or objectives
2. Formulating the necessary plans to ensure that the
desired objectives are achieved.
3. Translating plans into budget
4. Relating the responsibilities of executives to the
requirements of a policy.
5. Recording and reporting actual performance
6. Continuous comparison of actual with budgeted results
7. Ascertainment of deviations, if any
8. Focusing attention on significant deviations
9. Investigation into deviations to establish causes
10. Presentation of information to management, relating
the variations to individualresponsibility.

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11. Taking corrective action to prevent recurrence of

variations.
12. Provide a basis for revision of budgets.
Essentials of a Budgetary Control system: Successful
implementation of a budgetary control system depends up on
the following essentials.
1. Support by top management: The wholehearted support
of all managerial persons is very necessary for the success of a
budgetary control system.
2. Formal organization: The existence of a formal and
sound organizational structure is of an absolute necessity for an
effective system of budgetary control.
3. Budget centers: For budgetary control purposes, the
entire organization will be split into a number of departments,
area or functions, known as ‘centres’, and budgets will be
prepared for each such centers
4. Clear cut objectives and reasonably attainable goals:-
If goals are too high to be attained, the purpose of budgeting
is defeated. On the other hand, if the goals are so low that
they can be attained very easily, there will be no incentive to
special effort.
5. Participative budgeting: Every executive responsible for
the implementation of budgets should be given an opportunity
to take part in the preparation of budgets.
6. Budget committee: The work of preparing a budget
manual should be entrusted to a Budget committee. The work
of scrutinizing the budgets as well as approving of the same

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should be the work of this committee.

7. Comprehensive budgeting: Budgeting should not be
partial, it should cover all the functions .
8. Adequate accounting system: There should be an
adequate accounting system for the successful budgetary
control system, because those who are involved in the
preparation of estimates depend heavily on the accounting
department.
9. Periodic reporting: - There should be a prompt and
timely communication and reporting system for the effective
implementation of a budgetary control system.
Budget manual:
CIMA England, defines a budget manual as “a
document , schedule or booklets which sets out; inter alia, the
responsibilities of the persons engaged in the routine of and the
forms and records required for budgetary control”. In other
words, it is a written document which guides the executives in
preparing various budgets.
Budget period: This may be defined as the period for which a
budget is prepared and employed. The budget period will
depend on the type of business and the control aspects. There
is no general rule governing the selection of the budget period.
Classification of Budget
1. Classification according to time factor
2. Classification according to flexibility factor
3. Classification according to function.

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I. Classification according to time factor: - On this basis,

budgets can be of three types:
1. Long term budget – for a period of 5 to 10 years
2. Short term budgets – Usually for a period of one to two
years
3. Current budgets - Usually covers a period of one month
or so,
II. Classification according to flexibility: It includes
1. Flexible budgets and
2. Fixed budgets
Flexible budgets: It is a dynamic budget. It gives different
budgeted cost for different levels ofactivity. It is prepared after
making an intelligent classification of all expenses between
fixed , semi variable and variable because the usefulness of
such a budget depends up on the accuracy with which the
expenses can be classified.
Steps in preparing flexible budgets:
1. Identifying the relevant range of activity
2. Classify cost according to variability
3. Determine variable cost
4. Determine fixed cost
5. Determine semi variable cost
6. Prepare the budget for selected levels of activity

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Example 1
The expenses budgeted for production of 10,000 unit in a
factory are furnished below:
Per unit in Rs
Material cost 70
Labour cost 25
Variable factory over head 20
Fixed over head (Rs. 1,00,000) 10
Variable expenses(Direct) 5
Selling expenses (20% fixed) 15
Distribution overhead (10% fixed) 10
Administration expenses (Rs, 50,000) 5

Prepare a flexible budget for production of 8,000 units.

Solution:

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Fixed Budget
It is a budget which is designed to remain unchanged
irrespective of the level of activity attained. It does not change
with the change in the level of activity. This type of budget are
most suited for fixed expenses. It is a single budget with no
analysis of cost.
III. Classification according to function: It includes:
1. Functional budgets and
2. Master budgets
Functional budgets are those which are prepared by
heads of functional department s for their respective
departments and are subsidiary to the master budget.
Functional budget may be Operating budgets or financial
budget. Operating budgets are those budgets which relate to
the different activities or operations of a firm. These are the
primary budgets. Financial budgets are those which
incorporate financial decisions of an organization. They show
in detail the inflow and outflow of cash and the overall
financial position.

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Master budget is the summary of all functional budgets. It

summarizes sales, production, purchase, labour, finance
budgets etc. It is considered as the overall budget of the
organization.
Different types of functional budgets:
1. Sales budget: It is forecast of total sales expressed in
quantities and money. It is prepared by the sales manager.
While preparing sales budget we have to consider the past
sales data , market conditions, general trade and business
conditions etc
Illustration 1
A manufacturing company submits the following figures of
product ‘Z’ for the first quarter of 2010.
Sales (in units) January 50,000
February 40,000
March 60,000
Selling price per unit Rs. 100
Sales target of 1st quarter 2011:
Sales quantity increase 20%
Sales price increase 10%
Prepare sales budget for the first quarter of 2011.

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Solution:
SALES BUDGET
For the first quarter of 2011

2. Production budget: It is the forecast of the quantity of

production for the budget period. It is usually expressed in
physical quantity.
Illustration 2
A manufacturing company submits the following
figures relating to product X for the first quarterof 2010.
Sales targets: January 60,000 units
February 48,000 units
March 72,000 units
Stock position: 1-1-2010(% of January 2010 sale) - 50%
Stock position: 31-3-2010 40,000 units
Stock position: End January & February 50%
(% of subsequent month’s sales)
You are required to prepare production budget for the
first quarter of 2010.

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Solution
PRODUCTION BUDGET FOR THE FIRST QUARTER
OF 2010

3. Material budget: It shows the estimated quantities as

well as cost of raw material required for the production of
different product during the budget period.
4. Purchase budget: It shows the quantity of different
type of materials to be purchased during the budget period
taking into consideration the level of activity and the inventory
levels.
5. Cash budget: It is prepared only after all the other
functional budgets are prepared. It is also known as financial
budget. It is a statement showing estimated cash inflows and
cash outflows over the budgeted period.
The cash budget is prepared on the basis of the cash
forecast. The cash forecast is an estimate showing the
availability or otherwise of adequate amount of cash in a future
period for meeting the operating expenses and all other
commitments. It summarizes the anticipated cash receipts and

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cash payments for the budget period.

There are three methods for preparing the cash budget.
They are:
a. The receipts and payment method
b. Adjusted Profit and Loss account method
c. Balance sheet method.
Example 2(Receipts and Payment method)
A company is expecting to have Rs. 25000cash in hand
st
on 1 April 2000 and it requires you to prepare an estimate of
cash position during the three month, April to June 2000. The
following information is supplied to you.

Months Sales(Rs)Purchase(Rs)Wages(Rs) Expenses(Rs)

February 70,000 40,000 8,000 6,000
March 92,000 52,000 9,000 7,000
May 1,00,000 60,000 10,000 8,000
June 1,20,000 55,000 12,000 9,000

Other information:
1. Period of credit allowed by suppliers – two months
2. 25% of sale is for cash and the period of credit allowed
to customers for credit sale is onemonth.
3. Delay in payment of wages and expenses – one month.
4. Income tax of Rs.25,000 is to be paid in June 2000.

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Solution:
CASH BUDGET FOR THE PERIOD ENDING JUNE
2000

b. Adjusted Profit and Loss method: Under this method,

profit is adjusted by adding back depreciations, provisions,
stock and work in progress, capital receipts, decrease in
debtors, increase in creditors etc. Similarly, dividends, capital
payments, increase in debtors, increase in stock and decrease
in creditors are deducted. The adjusted profit will be the
estimated cash available. Under this method, the following
information becomes necessary.

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1. Expected opening balance

2. Net profit for the period
3. Changes in current asset and current liabilities
4. Capital receipts and capital expenditure
5. Payment of dividend
c. Balance sheet method: Under this method, a budgeted
balance sheet is prepared for the budgeted period, showing all
assets and liabilities except cash. The two sides of the balance
sheet are then balanced. The balance then represents cash at
bank or overdraft, depending upon whether the assets total is
more than that of the liabilities total or the latter is more than
that of the former.
Advantages of Cash budget:
1. It helps to ascertain the shortage of cash
2. It helps to identify excess of cash, so that the surplus cash
can be invested for a short period
3. It helps to ensure sufficient cash is available when
required.
Recent trends in budgeting:
1. Zero Base Budgeting (ZBB): According to the official
CIMA terminology, zero base budgeting is, “ a method of
budgeting which requires each cost element to be specifically
justified, as though the activities to which the budget relates
were being undertaken for the first time. Without approval, the
budget allowance is zero” . Under ZBB the programmes
and activities get evaluated and ranked from zero base as if
these were launched for first time. In this technique of

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budgeting the unwanted projects and activities get dropped and

wanted and desirable activities and projects get included in the
budget.
Features:
a. It starts from zero
b. All activities are identified in appropriate decision
packages
c. All programmes are considered totally afresh
d. A detailed cost benefit analysis of each programme is
undertaken
e. There is an officer responsible for each decision packages
f. Priorities are established and decision packages are ranked
Advantages of ZBB
1. It considers every time alternative ways of
performing the same job. It helps the management
to get a critical appraisal of its activities.
2. It is helpful to the management in making optimum
allocation of scarce resources
3. ZBB is particularly useful for service departments and
Governments
4. It ensures active participation of managers in the
budgeting process.
5. It promote high level of motivation at the level of unit
managers
6. It focuses on output in relation to value for money.

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7. It makes managers cost conscious and helps them in

identifying priorities in the overall interest of the
organization.
Difference between Traditional budgeting and ZBB
Traditional budgeting ZBB
1. Begins with previous 1. Begins with zero a based
year’s budget 2. Focuses on goals and
2. Focuses on money objectives
3. Produces a single level of 3. Produces alternative level of
expenditure for an activity expenditure and desired
4. Resources are allocated result
not on thebasis of cost 4. Resources are allocated on
benefit analysis the basis ofcost benefit
5. Prepared annually analysis
5. Prepared once in every five
years

2. Activity base budgeting: The CIMA official terminology

defines activity based budgeting as,” a method of budgeting
based on an activity frame work and utilizing cost driver data
in the budget setting and variance feedback processes.” In the
case of traditional budgeting, budgets are established on the
basis of budget centers. In the case of activity based budgeting,
however, the budget centres are activity based cost pools or
cost centres in relation to which budgets are prepared. Separate
cost pools are established for each type of activity.
3. Performance budgeting: - Performance oriented

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budgets are established in such a manner that each item of

expenditure related to a specific responsibility centre is closely
linked with the performance of that centre. The following
matters will be specified very clearly in such budgeting
a. Objectives of the organization and for which funds are
requested
b. Cost of activities proposed for the achievement of these
objectives
c. Quantitative measures to measure the performance
d. Quantum of work to be performed under each activity.
Advantages of performance budgeting:
1. It improves budget formulation process
2. It enhances accountability of the executives
3. It facilitate more effective performance audit
4. It presents clearly the purpose and objectives for which
funds are requiredPractical Problems:
I. ABC Company Ltd .has given the following
particulars. You are required to prepare a Cash budget for the
three months ending 31st Dec. 2010.

Months Sales(Rs) Materials(Rs)Wages(Rs) Overhead(Rs)

August 20,000 10200 3,800 1,900
September 25,000 11000 3,900 2,100
October 23,000 9800 4,000 2,300
November 26,000 9000 4,200 2,400
December 30,000 10800 4,500 2,500

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Credit items are:-

1. Debtors/Sales – 10% sales are on cash basis, 50% of
the credit sales are collected next month and the balance
in the following month.
2. Creditors - - Materials 2 months
--Wages 1/5 month
-- Overhead ½ month
3. Cash balance on 1st October 2010 is expected to be Rs.
8,000
4. A machinery will be installed in August, 2010 at a cost of
Rs. 1,00,000. The monthly Installment of Rs. 5,000 is
payable from October onwards.
5. Dividend at 10% on preference share capital of
Rs.3,00,000 will be paid on 1stDecember ,2010
6. Advance to be received for sale of vehicles Rs. 20,000 in
December
7. Income tax (advance) to be paid in December Rs. 5,000.
STANDARD COSTING
Meaning of ‘standard’ and ‘standard cost’: In the ordinary
language, the term ‘standard’ means a yardstick of
measurement. The CIMA terminology defines this term as, “a
benchmark measurement of resources usage, set in defined
conditions.”
Standard cost is a pre determined operating cost calculated
from management’s standards of

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efficient operation and the relevant necessary expenditure.

Need for Standard Costs: The need for standard cost arises
for the following reasons.
1. Cost control
2. Measurement of efficiency
3. Fixation of selling price
4. Economy in cost of costing
Estimated cost: Pre determined costs may either be estimated
or standard cost. Estimated cost is a pre determined cost for a
future period under normal conditions of operations. It is a
prospective costing. Cost estimation is made for submitting
tenders or quoting price of a product or a unit of services.
Definition of standard costing:
Standard costing is a technique of cost control. The CIMA
official terminology defines it as “ a control technique which
compares standard costs and revenues with actual results to
obtain variances which are used to stimulated improved
performance.”
In standard costing the actual costs incurred are compared with
the standard costs. The difference between the two is called
variance.
Features: The following are the important characteristics of
the standard costing system
1. Standard costs are set for various elements of total cost
2. It makes a comparison of actual cost with standard cost
3. Main objective of standard costing is to control cost

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4. Variances are reported to management for the purpose of

decision making
Standard costing and Budgetary control
Both standard costing and budgetary control are similar in
principle since both are concerned with setting performance
and cost levels for control purposes. Neither of the two
techniques can be operated successfully without the other.
Budgetary control and standard costing are inseparably linked
together.
Distinction between standard costing and budgetary
control:
1. Budget is based on past performance, while standard is
established on the basis of technicalestimates.
2. Budgets consider both income and expenditure whereas
standards are for expenditure only.
3. Budgets projects financial accounts, while standard cost
project cost accounts
4. In standard costing, variances are analyzed in detail, but
such a detailed analysis of variance is not possible in
budgetary control.
5. Budget fix minimum limit while standard fix targets.
6. Budgets are used for the forecasting men, money and
materials, standards cannot be usedfor forecasting.
7. Budgetary control technique is applicable to all types
of businesses. However standard costing is useful only
for manufacturing organizations.

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8. The standards are expressed in per unit of production

whereas budgets are for specific periods and are
expressed in total.
9. Budgetary control does not require standardization of
product. But standard costing requires standardization of
product.
Objectives of standard costing:
1. Performance measurement
2. Cost control
3. Stock valuation
4. Establishing selling prices
5. Profit planning and decision making
6. Basis of estimating
7. Assisting establishment of budgets
Basic requirements of standard costing:
a. Organization structure: The existence of a sound
organization structure with well defined authority relationship
is the basic requirement of a standard costing system.
b. Technical and engineering studies: It is very necessary
to make thorough study of the production methods and the
processes required for production.
c. Preparation of manual: It is also necessary to prepare a
detailed manual for the guidance of staff. The manual should
describe the system to be introduced and the benefits thereof.
d. Type of standards: It is very necessary to determine

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the type of standard to be used, whether current, basic or

normal standard.
e. Co-operation of Executives and staff:- Without the
co-operation of the executives and staff, it is very difficult to
run the standard costing system.
f. Fixation of standards: Standard should be set for each
element of cost and it should bescientific.
Steps involved in Standard Costing:-
The procedure for establishing standard costing is
summarized as follows:-
1. Establishment of cost centres: - A cost centre is a
location, person or item of equipment for which costs may be
ascertained and used for the purpose of cost control. Cost
centres are set up for cost ascertainment and cost control.
2. Classification and codification of accounts: - It
facilitates quick collection and analysis ofcost information.
3. Establishment of standards: The success of the standard
costing system depends up on the reliability and accuracy of
standards. Standards are always established scientifically.
4. Ascertainment of actual cost: Measuring the actual cost
which is incurred in the next step in the standard costing.
5. Comparison of Standard cost and Actual cost.
6. Analysis of Variances
7. Reporting of variance

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Types of standards
1. Basic standards: A standard established for use over a
long period is known as the basic standard. It remains
unaltered over a long period. Its use is to show long term
trends, and it operates in a similar way to index numbers. It is
also known as the ‘bogey, standard. This standard is used for
items or costs which are likely to remain constant over a long
period.
2. Current standard: A standard established for use over a
short period of time and related to current conditions, is known
as the ‘current standard’. This standard shows what the
performance should be under current conditions. Conditions
during which period the standard is used are known as current
conditions.
3. Ideal standards & Expected standards:- Ideal
standard is that which can be attained under the most
favourable conditions, while expected standard is that which is
expected to be attained during a specified budget period. It is a
target which is attainable and can be achieved if the expected
conditions operate during the period for which the standard is
set.
4. Normal standard: This standard is defined as “the average
standard which it is anticipated can be attained over a future
period of time, preferably long enough to cover one trade
cycle.”It is difficult to follow normal standards in practice as it
is not possible to forecast performance with a reasonable
degree of accuracy for a long period of time.

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Analysis of Variances:
Variance is the difference between a standard cost and
the comparable actual cost incurred during a period. It is the
deviation of actual cost from the standard cost. In other words,
the deviation of the actual cost or profit or sales from the
standard cost or profit or sales is known as variance. If the
actual cost is less than the standard, the difference is known as
favourable or positive variance and it is symbol of efficiency.
If the actual cost is more than the standard cost, the difference
is known as unfavorable variance. Analysis of variance means
carrying out the appropriate investigation to identify the
reasons for the variance.
Another way of classifying variance may be
controllable and uncontrollable variances. If a variance is due
to inefficiency of a cost centre, it is said to be controllable
variance. Such variance can be corrected by taking a suitable
action. A variance due to external reasons like increase in
prices of material, labour etc it is a case of uncontrollable
variances.
Types of variances
Analysis of variances may be done in respect of each
element of cost and sales. It includes
1. Direct material variance
2. Direct labour variance
3. Overhead variance
4. Sales variance

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MATERIAL VARIANCES
It includes:
a. Material Cost Variance (MCV): It is the difference
between the standard cost of materials allowed for the output
achieved and the actual cost of materials used. It may be
expressed as: MCV=Standard cost of materials for actual
output – Actual cost of materials used
Std. cost of material = std qty x std price per unit Actual cost
of material = Actual qty x actual price
b. Material Price Variance (MPV): It is that portion of
the material cost variance which is due to the difference
between the standard cost of materials used for the output
achieved and the actualcost of materials used.
MPV = Actual qty x (std price – Actual price)
c. Material Usage Variance or Material Quantity
Variance (MQV): It is that portion of material cost variance
which is due to the difference between the standard quantity of
materials specified for the actual output and the actual quantity
of materials used.
MUV = Std price per unit (Std qty – Actual qty)
d. Material Mix Variance (MMV): It is that portion of
the material usage variance which is due to the difference
between standard and actual composition of a mixture. It is
calculated as the difference between the standard price of the
standard mix standard price of the actual mix.
In case of material mix variance, two situations may arise:

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Actual weight of mix and the A. Standard weight of mix do not

differ: - In this case material mix variance is calculated by
applying the following formula
MMV= Std price (Std qty x Actual qty)
If the standard is revised due to shortage of a particular type of
material, the material mix variance is calculated as follows:
MMV= Std price (Revised std qty – Actual qty)
B. Actual weight of mix differ from standard weight weight of
mix:- In such a case, material mix variance is calculated as
follows:
Total weight of actual mix
----------------------------------------- x Std cost of std mix - Std
Total weight of std mix cost of actual mix

e. Material Yield Variance :- It is that portion of the

material usage variance which is due to the difference between
the standard yield specified and the actual yield obtained. This
variance measures the abnormal loss or saving of material.
Illustration I. From the following information, compute Price,
usage and mix variances.

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Solution:
1. Material price variance:
Actual usage (Std price - Actual Price)
Material A = 15 (3 - 4) = Rs. 15 adverse
Material B = 25 (4 – 3) = Rs. 25 Favourable
Material C = 35 (2 – 2) = Nil
-----------------------
Total Price variance Rs. 10 Favourable
==============
2. Material Usage variance:
Standard rate (Std usage – actual usage)
Material A = 3( 10 – 15 ) =Rs. 15 Adverse
Material B = 4 (15 – 25 ) =Rs. 40 Adverse
Material C = 2 (25 – 35) = Rs. 20 Adverse
-------------------------
Total material usage Variance=Rs. 75 Adverse
3. Material Mix Variance:
Total weight of actual mix
----------------------------------------- x (Std cost of std mix - Std
Total weight of std mix cost of actual mix)

15+25+35
------------ x (10 x Rs. 15 x Rs4 + 25 x Rs. 2) - 15 x Rs. 3 +
10+15+25 25 x Rs. 4 + 35 x Rs. 2
=75/50 x Rs. 140 – Rs. 215
= Rs. 210 – Rs. 215 = Rs. 5 Adverse

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Illustration 2. It is estimated that a product requires 50 units

of material at the rate of Rs. 3 per unit. The actual
consumption of material for manufacturing the same product
came to 60 units at the rate of Rs. 2.9 per unit. Calculate
1. Material cost variance
2. Material price variance
3. Material usage variance
Solution:
1. Material cost variance = Std cost – Actual cost
Std cost = Std qty x Std price per unit = 50 x 3 = 150
Actual cost = Actual qty x Actual price per unit =
60 x 2.90 =174
Material Cost Variance = 150 – 174 = 24 un favourable
2. Material Price Variance = Actual qty x (Std price – actual
price)60 x (3 – 2.90) = 6 favourable
3. Material usage variance = Std price x (Std qty – Actual
qty)3x (50 -60 ) = Rs. 30 unfavourable
Labour Variance: When standard cost of labour differs from
actual wage cost, the labour variancearises. The following are
the important types of labour variances
1. Labour cost variance: It is the difference between
standard cost of labour allowed for actual output achieved and
the actual cost of labour.
LCV = Std cost of labour – Actual cost labour
2. Labour rate variance: It is that part of labour cost

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variance, which arises due to the difference between standard

rate specified and the actual rate paid.
LRV = Actual time x (Std rate – Actual rate)
3. Labour Efficiency Variance: It is that portion of
labour cost variance which arises due to the difference between
standard labour hours specified for the activity achieved and
the actual labour hours expended.
LEV = Standard rate x (Standard time for actual output –
Actual time)
It arises because of the following reasons:
a. Use of incorrect grade of labour
b. Insufficient training
c. Bad supervision
d. Incorrect instructions
e. Bad working conditions
f. Worker’s dissatisfaction
g. Defective equipment and machinery
h. Wrong item of equipments
i. Excessive labour turn over, and
j. Fixation of incorrect standards.
Illustration: I
Calculate labour cost variance from the following data:
Standard hours : 40
Rate : Rs. 3 per hour
Actual hours : 60
Rate : Rs. 4 per hour

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Solution:
Labour cost Variance = Standard cost of labour – Actual cost
of labour
= (40x3) – (60x4)
=120 – 240 =Rs. 120 Adverse
Illustration II
The standard and actual figures of a firm are as under
Standard time for the job : 1000 hrs
Standard rate per hour : Re.0.50
Actual time taken : 900 hours
Actual wages paid : Rs.360
Compute labour variances.
Solution:
Labour Cost Variance = Standard cost of labour –
Actual cost of labour
= (1000x0.50) – (900 x 0.40)
= 500 – 360
= Rs. 140 Fav
Labour Mix Variance = Actual time x
(Standard rate – Actual rate)
= 900x (0.50 – 0.40)
= Rs. 90 Fav
Labour efficiency Variance = Standard rate x (Standard time
for actual output – Actual time)

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= 0.50 x (1000 – 900)

= Rs. 50 Fav.
Overhead Variances:
The term overhead, which comprises indirect materials,
indirect labour and indirect expenses, may relate to factory,
office or selling and distribution. It is the sum of variable
overhead variance and fixed overhead variance. In other
words, it is the difference between standard overhead cost
charged to production and the actual overhead cost incurred.
Variable overhead Cost variance: This represents the
difference between the standard cost of variable overhead
allowed for actual output and the actual variable overhead
incurred during the period. Variable overhead cost variance is
made up of variable overhead expenditure variance and
variable overhead efficiency variance.
It is computed by the application of the following formula:
a. When OH rate per unit is used
VOH Cost Variance = (Actual output x Std variable OH rate
per unit) – Actual Variable OH
Std. VOH rate per unit = Std variable OH
Std out put
b. When OH rate per hour is used
VOH Cost Variance = (Std hours for actual output x Std
variable OH rate per hour) – ActualVOH

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Std VOH rate per hour = Std VOH

Std hours
Variable Over head Expenditure Variance:
It is the difference between the standard variable OH rate per
hour and the actual variable OH rateper hour, multiplied by
the actual hours worked.
Variable OH expenditure Variance = (Actual hours worked
x Std Variable OH rate perhour) – Actual variable OH
OR
(Std output for actual hours x Std OH rate per unit) – Actual
variable OH
Variable OH efficiency Variance: It is the difference
between the variable overhead allowed for production and the
variable overhead absorbed through production.
Variable OH Efficiency Variance = Std Variable OH rate
per hour (Std hours for actualproduction – Actual hours)
If actual hours is less, it is favourable variance and vice versa.
Illustration
From the following data for the month of Feb., Calculate OH
variances.
Budgeted production for the month - 150 units
Budgeted variable OHs - Rs. 3750
Std time for one unit - 10 hrs
Actual production for the month - 125 units

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Actual variable OHs -Rs. 3 600/

Actual hours worked - 2250 hrs
Solution
Std OHs for actual production (125 units) = 3750/150 x 125
= Rs. 3125
Std OH rate per hour:
Total std hours= 150 units x 10 =1500 hrs
Rate per hour = 3750/1500 = Rs. 2.5
Actual OH rate per hour = 3600/2250 hrs = Rs. 1.6Std.
hours for actual production = 125 units x 10 hours = 1250 hrs
1. VOH Cost Variance = (Actual output x Std variable OH
rate per unit) – Actual Variable OH
= (125 x 25) – 3600
=3125 – 3600 = 475 Adverse
2. Variable Overhead Expenditure Variance = (Actual
hours worked x Std Variable OH rate per hour) – Actual
variable OH
= (2250 x2.5) – 3600
= Rs. 2025 F
3. Variable Overhead Efficiency Variance = Std Variable
OH rate per hour(Std hours foractual production –
Actual hours)
=2.5 (1250 -2250)
= Rs. 2500 A

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Fixed Over head variance:

It is the difference between standard fixed overhead
allowed for actual output and the actual fixed overhead
incurred. Fixed overhead cost variance is calculated by using
the following equation
Fixed OH cost Variance = Std. fixed OH for actual Output –
Actual fixed OH
If actual OH is less, it is favourable variance and vice versa.
Fixed OH cost variance is divided into two – fixed overhead
expenditure variance and fixed overhead volume variance.
Fixed OH Expenditure variance: It is the difference between
budgeted fixed overhead and actualfixed overhead.
Fixed Overhead expenditure variance = Budgeted fixed OH –
Actual Fixed OH
Fixed OH volume Variance: It is the difference between Std
fixed OH allowed for actual output and the budgeted fixed
overhead for the period.
Fixed Overhead Volume Variance = Std. fixed overhead for
actual output – Budgeted fixedOverheads.
Illustration:
From the following data relating to June 2011, Calculate fixed
OH variances:Budgeted hours for the month = 180 hrs
Budgeted output for the month = 9,000 units
Budgeted fixed overheads = Rs. 27,000
Actual production for the month = 9,200 units

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Actual hours for production = 175 units

Actual fixed overheads = Rs. 28,000
Solution:
1. Fixed overhead cost variance = Std fixed overhead for
actual output – Actual fixed overhead
= 27600 – 28000 = Rs. 400 A
2. Fixed Overhead expenditure Variance = Budgeted fixed
overhead – Actual fixed overhead
= 27,000 - 28,000 = Rs. 1000 A
3. Fixed Overhead Volume Variance = Std fixed
overhead for actual output – Budgeted fixedoverheads
= 27600 - 27000 = Rs. 600 F
Note: Std. overhead for actual output (9200 units) =
27000/9000 x 9200
= Rs. 27600

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Reference Books:

1. S.P. Jain &K.L.Narang

2. N.K. Prasad: Cost Accounting
3. Nigam & Sharma: Cost Accounting
4. Khanna Pandey & Ahuja: Practical Costing
5. M.L. Agarwal: Cost Accounting
6. Jain &Narang: Cost Accounting
7. S.P. Iyengar: Cost Accounting
8. S.N. Maheshwari: Cost Accounting
9. Horngren: Cost Accounting: A Managerial Emphasis
10. M. N. Arora: Cost Accounting
11. Dutta: Cost Accounting

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