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COST ACCOUNTING

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Ms. Manisha Verma, Ms. Preeti Singh

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Department of Distance and Continuing Education

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 COST ACCOUNTING

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 Contents

PAGE

UNIT-I
Lesson 1: Cost Accounting: An Overview 3-60

Lesson 2: Cost Concepts and Classification 61-86

Lesson 3: Labour Cost  87-110

UNIT-II
Lesson 4: Time-Keeping and Time Booking 113-134

UNIT-III
Lesson 5: Overhead Cost 137-207

UNIT-IV
Lesson 6: Output Costing 211-236

Lesson 7: Job Costing 237-250

Lesson 8: Contract Costing 251-275

Lesson 9: Process Costing 276-309

Lesson 10: Operating Costing 310-326

UNIT-V
Lesson 11: Integral and Non-Integral Accounting System 329-351

Lesson 12: Reconciliation of Cost and Financial Accounts 352-370

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 UNIT - I

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Cost Accounting B.Com Sem-4_Unit 1 Lesson 1.indd 2 01-Feb-25 3:30:36 PM
 L E S S O N

1
Cost Accounting:
An Overview
Manisha Verma

STRUCTURE
1.1 Learning Objectives
1.2 Meaning of Costing and Cost Accounting
1.3 Objectives of Cost Accounting
1.4 Relationship with Financial Accounting
1.5 Limitations of Financial Accounting
1.6 Differences Between Financial Accounting and Cost Accounting
1.7 Advantages of Cost Accounting
1.8 Objections against Cost Accounting
1.9 Costing Methods and Techniques
1.10 Installation of Cost Accounting
1.11 Practical Difficulties in Installation
1.12 Essentials of a Good System
1.13 Answers to In-Text Questions
1.14 Self-Assessment Questions
1.15 Suggested Readings

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 COST ACCOUNTING

Notes
1.1 Learning Objectives
After reading this lesson, students will be able to:
‹ Discuss the meaning, objective and advantages of cost accounting.
‹ Draw difference between financial accounting & cost accounting.
‹ Describe different costing methods & techniques.

1.2 Meaning of Costing and Cost Accounting

The primary purpose of accounting is to provide financial information
relating to an economic/business activity. It is concerned with measuring,
recording, and reporting financial information by the management to
plan and control the activities of a business. The accounting system that
provides the information to measure product costs and performance, and
control the operations of a firm is called cost accounting.
The Chartered Institute of Management Accountants (CIMA), London
has defined costing as, “the techniques and processes of ascertaining
costs.” Wheldon has defined costing as, “the proper allocation of
expenditure and involves the collection of costs for every order, job,
process, service or unit.” Thus, costing simply means cost associated
to any process or technique. It consists of principles and rules which
are used for determining:
(a) T he cost of manufacturing a product, e.g., motor car, furniture,
chemical, steel, paper, etc., and
(b) The cost of providing a service, e.g., electricity, transport, education, etc.
The terms ‘costing’ and ‘cost accounting’ are often used interchangeably.
Cost accounting is a formal system of accounting for costs in the books
of account by means of which costs of products and services are ascer-
tained and controlled.
An authoritative definition of cost accounting has been given by CIMA,
London as follows: “the application of costing and cost accounting prin-
ciples, methods and techniques to the science, art and, practice of cost
control and the ascertainment of profitability. It includes the presentation

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 Cost Accounting: An Overview

of information derived therefrom for the purposes of managerial decision Notes

making.”
Cost accountancy is thus the science, art and practice of a cost accoun-
tant. It is a science in the sense that it is a body of systematic knowl-
edge which a cost accountant should possess for the proper discharge of
his duties and responsibilities. It is an art as it requires the ability and
skill on the part of a cost accountant in applying the principles of cost
accountancy to various managerial problems like price fixation, cost con-
trol, etc. Practice refers to constant efforts on the part of cost accountant
in the field of cost accountancy. Only theoretical knowledge would not
enable a cost accountant to deal with the various intricacies involved.
He should, thus, have sufficient practical training, and exposure to real
life costing dilemmas.

1.3 Objectives of Cost Accounting

The main objectives of cost accounting are as follows:
1. Ascertainment of Cost: The primary objective of cost accounting is
to determine the cost of product manufactured or service rendered, i.e.,
both aggregate cost and unit product costs. For cost ascertainment,
various methods are employed in different industries like job costing,
process costing, and operating costing etc.
2. Cost Control: Cost accounting aims at improving profitability by
controlling and reducing costs. For this purpose, various specialized
techniques like standard costing, budgetary control, inventory control,
and value analysis, etc., are used. This objective of cost control and
cost reduction is becoming increasingly important in the present
scenario because of growing competition in the business world.
3. Guide for Managerial Decision Making: Cost data provide guidelines
for various managerial decisions like make or buy, keep or replace,
accept or reject, continue or drop a product.
4. Determination of Selling Price: Cost accounting provides cost
information on the basis of which selling prices of products or
services may be fixed.

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 COST ACCOUNTING

Notes
FINANCIAL ACCOUNTING AND COST ACCOUNTING
Financial accounting aims at presenting a true and fair view of the
overall results of transactions and events which are recorded in the
books of accounts in terms of money, and in accordance with estab-
lished principles, accounting standards and legal requirements. The
financial statements, comprises of ­income statement, Balance Sheet
or financial position statement as well as the funds flow statement
reveal the overall performance and position of the business entity.
Such reporting is based on a post-mortem examination of past events.
Although management has some interest in the information contained
in these statements, the information is of little practical significance
from the point of view of planning, control and decision-making.
Cost accounting was thus evolved to overcome the limitations of
financial accounting.

1.4 Relationship with Financial Accounting

Cost accounting is a branch of accounting in much the same way as
financial accounting. In fact, financial accounting provides the database
for cost accounting. Necessary information relating to costs is obtained
from financial accounting records. As such, cost accounting and financial
accounting are complementary to each other. The similarities between the
two branches of accounting are:
(i) Both cost and financial accounting are the branches of accounting.
(ii) Both are concerned with recording and reporting accounting
information.
(iii) Both the sets of accounts use the same basic documents for
recording transactions and events.
(iv) Both record transactions and events on the basis of double entry.
(v) Both the sets of accounts record information in monetary terms
although cost accounting records contain additional information.

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 Cost Accounting: An Overview

(vi) Each of these branches is mutually helpful to the other. While Notes
financial accounting provides basic information for writing
up cost records, cost accounting assists financial accounting
in inventory valuation thereby facilitating the preparation of
financial statements.
(vii) Both the sets of accounting records furnish the required information
to interested parties.
(viii) Each of these branches facilitates performance appraisal in its
own way.
(ix) Both the sets of accounts are a means of control.

1.5 Limitations of Financial Accounting

In spite of its popularity, financial accounting suffers from the following
limitations:
(a) Historical in Nature: Financial accounting is essentially historical
in nature. It records transactions and events which have already
occurred. As such, the financial statements prepared and presented
at the end of the accounting period, report on past events as a part
of stewardship function of management. Although the information
is historically important, it does not provide the management with
day-to-day information for evaluating operational efficiency.
(b) Overall Performance: Financial accounting discloses and reports
profitability or other financial details of the business as a whole.
Since it does not classify accounts on the basis of departments
or segments, products, processes and sales territories, it fails to
provide information about costs and profit of these sub-divisions
of the organisation.
(c) No Objective Classification: In financial accounting, accounts are
classified under two major groups, viz. personal and impersonal.
Such a primary classification made subjectively, is of little use to
management to ascertain costs by products, jobs and processes.
(d) Distinction between Direct and Indirect Expenses: In the case of
financial accounting, expenses are not classified into direct and
indirect, fixed and variable, controllable and uncontrollable, and

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 COST ACCOUNTING

Notes assigned to departments, jobs or products. As such, controllable

items of expenses cannot be distinguished from uncontrollable
ones for purposes of cost control and cost reduction.
(e) Material Losses: There is no material control system operating under
financial accounting, there is no safeguard against material losses
consequent upon wastage, pilferage, deterioration and obsolescence
of materials.
(f) Labour Cost Control: In the case of financial accounting, there is
no means of comparing the time clocked with the time booked
since workers are paid on the basis of hours worked. Consequently,
losses resulting from idle time, evasion of work and loitering
cannot be controlled. Further, labour time is not recorded job-
wise. Hence, there is no means of judging the efficient utilization
of labour time and no incentive systems based upon results can
be introduced.
(g) Idle Facilities: Financial accounting does not reveal losses due to
idle plant and equipment. Such losses can neither be analyzed
nor controlled.
(h) No Cost Comparison: Financial accounting does not provide data
for comparison of costs of two periods, two firms, two jobs,
departments or processes. As such, it is not possible to arrive at
conclusions regarding the profitability or otherwise of different
products, jobs, departments, processes or sales territories.
(i) Distortion of Trading Results: In financial accounting, the values of
closing inventories are estimated for the purpose of income statement
and balance sheet. If the values are not stated accurately, matching
of costs with revenues cannot be done properly. Consequently,
trading results become distorted to the extent of variation in values.
(j) Only Monetary Information: Financial accounting records contain
information relating to transactions and events of a business entity
capable of being expressed in terms of money. There is no place
in these records for non-monetary information such as quantity
of materials and quality of labour, etc.

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 Cost Accounting: An Overview

(k) Fixation of Product Price: Financial accounting records do not Notes

furnish the required information regarding quantity and costs to
enable management to fix the price of products, jobs and processes
or services rendered. Financial accounting also fails to explain
the reason why there is rise or fall in cost of production.
(l) Inventory Levels cannot be fixed: Financial accounting fails to
supply the necessary information to management for fixation of
stock levels such as maximum level, minimum level, ordering
level, etc. In the absence of fixation of such levels, investment
in inventories cannot be optimized.
(m) Lack of Data for Decision-making: Decision-making is one of the
basic functions of management of any organisation. However,
financial accounting fails to furnish the required data for such
decisions as introduction of a product line, discontinuance of
production of a product or a department, whether to make or buy,
equipment replacement, suitable product-mix, etc.

1.6 D
 ifferences Between Financial Accounting and Cost
Accounting
In spite of the above points of similarity between financial and cost ac-
counting, the two branches of accounting differ from each other in the
following respects:
(i) Purpose: Financial accounting records disclose profitability or
otherwise, i.e., trading results as well as the financial position
of a business. The chief purpose of cost accounting is to provide
detailed cost information to management.
(ii) Nature: Financial accounting is historical in nature. The information
provided by the records is in respect of only monetary transactions
and events which have already occurred and about which nothing
can be done. Cost accounting, on the other hand, focuses not
only on past transactions but on the future ones also.
(iii) Legality: Financial accounting is legally necessary, especially in the
case of companies. Even in the case of other forms of business,
financial accounting has almost become mandatory by virtue
of the application of other enactments much as the Income Tax

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 COST ACCOUNTING

Notes Act and Sales Tax Act. Cost accounting is not legally necessary
except for certain specified industries.
(iv) Reporting: Financial accounting serves the interest of people
belonging to different groups outside the organization such as
shareholders, creditors, potential investors, workers, taxation
authorities, financial analyst, government, trade unions. Therefore
this branch of accounting accomplishes only external reporting
of financial information. Cost accounting, however, serves the
needs of management and thus accomplishes internal reporting.
(v) Periodicity: Financial accounting reports are prepared on annual
basis while cost accounting reports are prepared on weekly,
monthly, quarterly even daily basis depending on the needs of
management.
(vi) Analysis of profit: Financial accounts reveal the profit or loss
of business as a whole for a particular period. Cost accounts
show the detailed cost and profit data for each product line,
department, division, section, and process.
(vii) Focus: In Financial accounting focus is on recording, classifying
and summarizing the financial transactions. In cost accounting
the focus is on cost ascertainment and cost control.
(viii) Format of presenting information: Financial accounting has a
single uniform format of presenting information, i.e., Profit
and Loss Account, Balance Sheet and Cash flow statement Cost
accounting has varied forms of presenting cost information which
are tailored to meet the needs of management and thus lacks a
uniform format.
(ix) Analysis of cost: In financial accounting, no distinction is made
between direct and indirect costs, fixed and variable costs and
controllable and uncontrollable costs. In cost accounting, costs
are distinguished according to their identification with the cost
units (direct and indirect), according to variability (fixed and
variable), and according to responsibility (controllable and
uncontrollable costs).
(x) Use of standards: In financial accounting there are no predetermined
standards of cost and performance to evaluate the efficiency of

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 Cost Accounting: An Overview

operations as regards the use of material, labour and overhead Notes

facilities. Cost accounting makes the use of standard costs against
which actual costs are compared, variances are calculated and
analyzed into their causes so that corrective action may be taken.

1.7 Advantages of Cost Accounting

Cost accounting provides information that is useful to management in
planning, control and decision-making. The main advantages of cost
­accounting are listed below:
1. It reveals unprofitable activities, losses, and inefficiencies such as
wastage of material in the form of spoilage, excessive scrap, and
idle time of labour and idleness of plant facilities. Management can
take steps to check these wastes and losses.
2. It helps the management in fixation of prices. Accurate cost data
can be used as a guide for preparation of quotations and submission
of tenders.
3. It provides suitable data and information which helps the management
in taking decisions such as make or buy, shut down or continue
selection of most profitable product-mix, acceptance or rejection of
a special order, introduction of a new product, etc.
4. Detailed costs of materials, labour and overheads reveal actual and
potential sources of cost saving and reduction.
5. Maintenance of time and job records for workers reveals losses
incurred due to idle time. Such records assist in taking steps to
minimize those losses.
6. Centralization of purchasing is facilitated by the use of cost
accounting. This results in economical purchases.
7. A perpetual inventory system which facilitates continuous stock-
taking helps in the preparation of interim profit and loss account.
8. Cost accounting lays the basis of standard costing and budgetary
control systems. These two techniques help the management in cost
control. Variance analysis and comparison of actual performance
with budget estimates indicate areas where economies can be
achieved.

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 COST ACCOUNTING

Notes 9. A system of cost accounting provides an independent and reliable

check on the accuracy of financial accounts. A reconciliation is
made of the profit as shown by cost accounts with that shown by
financial accounts.
10. Installation of uniform costing enables management to make inter-
firm comparisons.

1.8 Objections against Cost Accounting

There are objections raised against the introduction of cost accounting.
(i) It is expensive: A cost accounting system involves recording,
classification, analysis, allocation and apportionment of costs
and absorption of overheads which require considerable amount
of clerical work.
(ii) It leads to increase in workload: The results shown by the cost
accounts differ materially from those shown by the financial
accounts. Preparation of reconciliation statements frequently is
necessary to verify their accuracy. This leads to unnecessary
increase in work load.
(iii) It is unnecessary: Introduction of costing system itself does not
control costs or contribute to operating efficiency of the concern.
It gives management information with which to control costs. If
the management is alert and efficient, it can control costs without
the aid of this system. This is, therefore, unnecessary.
The above arguments are untenable. The basic aim of cost accounting is
minimizing costs by avoiding wastes at all stages therefore, it would be
wrong to call it expensive, infact it is a profitable investment. Differences
in results shown by cost accounts and financial accounts arise on account of
over- and under-absorption of overheads, methods of material pricing used
and treatment of other incomes. An integrated system of accounts can help in
elimination of these differences. In this age of competition and globalization
costing is not unnecessary, but it is must for each manufacturer because he
must know the exact cost not only of each article made but also of each
process involved in its production so that he may be in a position to avoid
waste and minimise its cost. It is possible only when proper costing records
are maintained. Hence, it is wrong to say that it is unnecessary.

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 Cost Accounting: An Overview

IN-TEXT QUESTIONS Notes

1. What is the primary purpose of cost accounting?

(a) To prepare financial statements for shareholders
(b) To record historical transactions for auditing purposes
(c) To ascertain and control costs and provide data for
decision-making
(d) To classify accounts into personal and impersonal categories
2. Which of the following is NOT a limitation of financial accounting?
(a) Historical in nature
(b) Provides detailed cost data for departments or processes
(c) Lacks classification of expenses into direct and indirect
costs
(d) Does not assist in fixation of product prices
3. According to the Chartered Institute of Management Accountants
(CIMA), costing is defined as:
(a) The science and art of recording financial transactions
(b) A system for determining profits through financial statements
(c) The techniques and processes of ascertaining costs
(d) A practice for comparing financial and cost accounting
records

1.9 Costing Methods and Techniques

Methods: The methods of costing refer to the processes employed in the
ascertainment of costs. Several methods have been designed to suit the needs
of different industries. The methods of costing to be applied in a particular
concern depend upon the type and nature of manufacturing activity.
1. Job Costing is that form of specific order costing under which
each job is treated as a cost unit and costs are accumulated and
ascertained separately for each job. It is applied in those industries
where the goods are manufactured against specific orders as per
customer’s specifications, e.g., printing press, repair shop, interior
decoration, and painting.

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 COST ACCOUNTING

Notes 2. Contract Costing is that form of specific order costing under which
each contract is treated as a cost unit and costs are accumulated
and ascertained separately for each contract, e.g., construction of
buildings, roads, bridges or other construction work.
3. Batch Costing is that form of specific order costing under which
each batch is treated as a cost unit and costs are accumulated
and ascertained separately for each batch. It is applied in those
industries where similar articles are produced in definite batches,
e.g., readymade garments, toys manufacturing industries, tyres and
tubes, spare parts and components, pharmaceutical industries.
4. Process Costing is a method of costing under which all costs are
accumulated for each stage of production and the cost per unit of
product is ascertained at each stage of production. It is applied in those
industries where manufacturing activity is carried on continuously by
means of two or more processes and output of one process becomes
the input of the following process till completion, e.g., paper industries,
chemical industries, textile industries, sugar industries.
5. Unit/Single/Output Costing is applied in those industries where only
one product or a few grades of the same product are produced and
production involves only a single process or operation and production
is uniform and continuous and units of output are identical, e.g., cement
industry, steel industry, floor mills industry, bricks making industry.
6. Operating /Service Costing is used to ascertain the cost of providing
services in case of those undertakings which render services and
are not engaged in the manufacture of tangible products, e.g., road
transport, railways, airlines, hotels, hospitals, electricity, and cinemas.
7. Multiple/Composite Costing involves the application of two or
more methods of costing in respect of same product. It is used in
industries where number of components are separately produced
and then assembled in a final product, e.g., bicycle, motor cycle,
scooter, T.V., air conditioners, cars, and refrigerators.
Techniques: The techniques of costing are not alternatives to the meth-
ods of costing. These are the different ways of analyzing and presenting
costs for the purpose of controlling costs or making managerial decisions
irrespective of the method of costing being used. Some of the popular
techniques of costing are as follows:
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1. Standard Costing: This is a very valuable technique of controlling Notes

cost. In this technique, standard cost is pre-determined as target of
performance, and actual performance is measured against the standard.
The difference between standard and actual costs is analyzed to know
the reasons for the difference so that corrective actions may be taken.
2. Budgetary Control: A budget is an expression of a firm’s business
plan in financial form. Budgetary control is a technique applied to
the control of total expenditure on materials, wages and overheads
by comparing actual performance with the budgeted performance.
Thus, in addition to its use in planning, the budget is a control and
co-ordination of business operations.
3. Marginal Costing: In this technique, separation of costs into
fixed and variable is of special interest and importance. This is
so because marginal costing regards only variable costs as the
cost of the products. Fixed cost is treated as period cost and no
attempt is made to allocate or apportion these costs to cost centres
or cost units. It is transferred to costing profit and loss account of
the period. This technique is used to study the effect on profit of
changes in volume of output.
4. Total Absorption Costing: It is a traditional method of costing
whereby total costs (fixed and variable) are charged to products.
This is in complete contrast to marginal costing where only variable
costs are charged to products.
5. Uniform Costing: It is the practice of using the same costing
principles or practices by a number of firms in the same industry.
It helps in inter-firm comparisons, fixation of price, cost reduction
and in seeking tax relief or protection from government.

1.10 Installation of Cost Accounting

All cost accounting systems reflect the same principles and purposes,
although their application may vary with circumstances out of necessity.
Accordingly, the cost accounting system proposed to be installed should
be designed to suit the nature of the business. Further, the system should
be simple, and the expenses of operating it should be commensurate with
the expected benefits.

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Notes The preliminary considerations governing the design and installation of

a cost accounting system are:
(a) Nature of Business: The system which is to be designed and
introduced, should suit the nature of business. Accordingly, it is
necessary to be thoroughly acquainted with the technical aspects
and the methods of production. If the business engaged in is the
production of goods, it should further be seen whether it produces
a single product on a mass scale, or a multi-product concern
producing more than one product, or a job type of business, a
process type or an assembly unit.
(b) Nature of Organisation: It is equally necessary to study the
layout, na­ture and size of the organisation. Since the system to
be designed should suit the organisation, the existing types of
authority relationship, the number of layers and the extent of
authority and responsibility should also be studied.
(c) Methods and Procedures: The methods of manufacture and the
procedures existing for purchase, receipt, storage and issue of
materials, the methods of wage payment, computation and payment
of wages and of arriving at overheads also deserve careful study.
(d) Technical Aspects: Although the cost accountant is not a technical
expert, it is necessary for him to get acquainted with the nature
of product, the methods and stages of production, the operations
involved, varieties produced and such other technical aspects of
the business. Since production efficiency depends upon effective
production control, it is equally necessary to know the degree of
control exercised over production.
(e) Management’s Expectations and Policies: The cost accounting
system to be designed also depends upon management policy and
the management’s expectations from the system. If, for instance,
the management’s objective of installing a costing system is only
to ascertain the cost of each product, the cost account­ing system
should be simple enough to achieve that objective.
(f) Simplicity: The system to be introduced should be simple and easy to
operate. The operating personnel should be capable of understanding
the procedures laid down for working the system efficiently.

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 Cost Accounting: An Overview

(g) Co-operation and Support of Personnel: No system of cost accounting, Notes

however carefully designed, can be worked successfully without
enlisting the co-operation and support of the personnel involved
in the cost accounting process. As such, the system should not
be thrust upon them. They should be consulted, their views and
suggestions considered, and they should be made cost-conscious
and drawn into the cost accounting process.
(h) Standardization of Forms: Accumulation of cost information
necessarily involves the maintenance of detailed cost records. Since
this entails considerable clerical work, the staff may resent it. It
is, therefore, necessary to reduce clerical work to the minimum.
Printed forms should be used and they should be standardized as
regards size and contents with instructions printed.
(i) Accuracy of Data: It is also necessary to determine the degree of
accuracy of data to be supplied by the cost accounting system.
(j) Prompt Reporting: Since a cost accounting system is mainly intended
for internal reporting of cost information, cost data should be
made available promptly and regularly. It is also necessary that the
information supplied should be clear, non-technical and unambiguous.
There should be no duplication in reporting the same information.
(k) Flexibility: The costing system should be flexible and capable
of adaptation to changing circumstances. It requires periodical
scrutiny and change to avoid the danger of becoming obsolete
owing to changes and developments in the business.
(l) Reconciliation: Where cost records are maintained independently
of financial records, arrangements should be made for regular
reconciliation of the trading result as revealed by both the set
of books.
(m) Cost: It is equally necessary that the cost of installing a system
of cost accounting should be commensurate with the benefits of
installation. In other words, the benefits should not outweigh the
cost of installation and operation of the costing system.

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 COST ACCOUNTING

Notes
1.11 Practical Difficulties in Installation
Apart from technical problems, the practical difficulties which may arise in
connection with the introduction of a cost accounting system are the following:
(a) Lack of Support from Management: In many cases, the costing
system is thrust on the managerial personnel, without consulting
them and without explaining the benefits of the system. It may
also happen that the system introduced may not be supported by
the top management, probably because of the expenditure involved.
In either case, the system introduced arouses fear and suspicion in
the minds of line managers. Consequently, they view the system
as interference in their work, and are likely to resist the same.
The difficulty may be got over by explaining the benefits accruing
from the system to all those who would be involved in the cost
accounting process and instilling in their minds a sense of co-
operation. They should be made cost-conscious by being drawn
into the process of designing and installation.
(b) Resistance from the Accounting Staff: The accounting staff may offer
resistance to the introduction of cost accounting on the ground that
their work would increase, or that it is interference in their routine
work of accounting. Their resistance may also be due to their feeling
of losing impor­tance with the introduction of cost accounting. Even
this difficulty may easily be overcome by explaining to them the
need for cost accounting and assuring, at the same time that their
position would not, in any way, be affected. They should be made
to feel that it is absolutely necessary to supplement their accounting
work with cost accounting and that the system would neither increase
their work nor bring about unemployment, but on the contrary, the
system would create more employment opportunities.
(c) Non-co-operation of Operating Personnel: The foremen, supervisory
staff and operating personnel may also offer resistance to the
system due to ignorance and suspicion. As a result, they may not
supply the necessary data for the successful working of the cost
accounting system.
To overcome this difficulty, it is necessary to properly educate
them. They should be made aware of the benefits accruing from

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 Cost Accounting: An Overview

the system, and should be made cost-conscious by winning their Notes

confidence.
Shortage of Trained Staff: At the time of introduction of a
(d) 
suitable system of cost accounting, the concern may experience
non-availability or shortage of trained staff to handle the work
involved in operating it.
This difficulty need not be an excuse for non-introduction of the
system designed. It is necessary to train the existing staff and
introduce the system rather slowly, instead of thrusting a complete
system upon them irrespective of whether or not they are ready
to accept and handle the system.
(e) Cost of Installation: The use of standardized forms necessary for
recording and reporting involves additional expenditure which the
concern may not afford. The design of a system and the details
of the methods to be employed will vary widely according to the
nature of each concern. Accordingly, the system should be designed
to suit the concern, and the obtainable results should justify the
cost of additional staff and records involved. Cost-benefit analysis
should be made to justify the costs involved.

1.12 Essentials of a Good System

A suitably designed and an easily workable system of cost accounting
should reflect the following features:
1. The system designed should be appropriate to the organisation
structure and methods of production.
2. It should be capable of achieving the objectives and goals set by
the management.
3. The system should be simple enough to be understood by the operat­
ing personnel.
4. It should be flexible so as to permit easy adaptability to changed
conditions of business.
5. The reports and statements produced by the system should contain
the relevant information for the intended purpose.
6. The reports and statements produced should be timely, accurate and
effective.
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 COST ACCOUNTING

Notes IN-TEXT QUESTIONS

4. Which costing method is applied in industries where goods
are manufactured against specific orders as per customer
specifications?
(a) Process Costing
(b) Unit Costing
(c) Batch Costing
(d) Job Costing
5. Which technique of costing involves the separation of costs
into fixed and variable to study the effect on profit of changes
in output volume?
(a) Total Absorption Costing
(b) Marginal Costing
(c) Budgetary Control
(d) Uniform Costing
6. What is one of the preliminary considerations governing the
design and installation of a cost accounting system?
(a) Nature of Business
(b) Resistance from Accounting Staff
(c) Shortage of Trained Staff
(d) Non-cooperation of Operating Personnel

1.13 Answers to In-Text Questions

1. (c) To ascertain and control costs and provide data for decision-
making
2. (b) Provides detailed cost data for departments or processes
3. (c) The techniques and processes of ascertaining costs
4. (d) Job Costing
5. (b) Marginal Costing
6. (a) Nature of Business

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 Cost Accounting: An Overview

Notes
1.14 Self-Assessment Questions
1. “Limitations of financial accounting have made the management
realize the importance of cost accounting” Comment.
2. What is cost accounting? Discuss briefly its objectives and advantages?
3. State the main differences between cost accounting and financial
accounting?
4. You have been asked to install a costing system in a manufacturing
business. What practical difficulties would you expect and how do
you propose to overcome them?
5. “Cost accounting system is neither unnecessary nor expensive rather
it is a profitable investment” Comment.
6. What method of costing would you adopt for the following industries?
Give reasons
(a) Ship building
(b) Toy making
(c) Oil refinery
(d) Sugar
(e) Road transport company

1.15 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 COST ACCOUNTING

Notes Appendix
(CAS – 22)
COST ACCOUNTING STANDARD ON MANUFACTURING COST
The following is the COST ACCOUNTING STANDARD – 22 (CAS - 22)
issued by the Council of The Institute of Cost Accountants of India for de-
termination of “MANUFACTURING COST”. In this Standard, the standard
portions have been set in bold italic type. This standard should be read in
the context of the background material which has been set in normal type.
1. Introduction
‹ This standard deals with the principles and methods of determining
the Manufacturing Cost of excisable goods.
‹ This standard deals with the principles and methods of classification,
measurement and assignment for determination of the Manufacturing
Cost of excisable goods and the presentation and disclosure in
cost statements.
2. Objective
‹ The objective of this standard is to bring uniformity and consistency
in the principles and methods of determining the Manufacturing
Cost of excisable goods.
3. Scope
‹ This standard should be applied to cost statements which require
classification, measurement, assignment, presentation and disclosure
of Manufacturing Cost of excisable goods.
4. Definitions
The following terms are being used in this standard with the mean-
ing specified.
‹ Abnormal and non-recurring cost: An unusual or atypical cost
whose occurrence is usually irregular and unexpected and/or due
to some abnormal situation of the production or operation.
‹ Administrative Overheads: Cost of all activities relating to general
management and administration of an organisation.
‹ Administrative overheads need to be analysed in relation to
production/manufacturing activities and other activities. Administrative

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 Cost Accounting: An Overview

overheads in relation to production/manufacturing activities shall Notes

be included in the manufacturing cost.
‹ Administrative overheads in relation to marketing, projects management,
corporate office or any other expense not related to the manufacturing
activity shall be excluded from manufacturing cost.
Captive Consumption: Captive Consumption means the consumption of
goods manufactured by one division or unit and consumed by another division
or unit of the same organization or related undertaking for manufacturing
­another product(s), as defined in section 4(3) of the Central Excise Act, 1944.
Defectives: End Product and/or intermediate product units that do not
meet quality standards. This may include reworks or rejects.
An intermediate product is a product that might require further processing
before it is saleable to the ultimate consumer.
‹ Reworks: Defectives which can be brought up to the standards by
putting in additional resources. Rework includes repairs, reconditioning,
retro-fitment and refurbishing.
‹ Rejects: Defectives which cannot meet the quality standards even
after putting in additional resources.
‹ Rejects may be disposed off as waste or sold for salvage value or
recycled in the production process.
Depreciation: Depreciation is a measure of the wearing out, consumption
or other loss of value of a depreciable asset arising from use, efflux of
time or obsolescence through technology and market changes. Depreci-
ation does not include impairment loss.
Depreciation is allocated so as to charge a fair proportion of the depre-
ciable amount in each accounting period during the estimated useful life
of the asset.
Depreciable amount of a depreciable asset is its historical cost, or other
amount substituted for historical cost in the financial statements, less the
estimated residual value.
Useful Life of Asset is Either
‹ the period over which a depreciable asset is expected to be used
by the enterprise; or

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 COST ACCOUNTING

Notes ‹ the number of production or similar units expected to be obtained

from the use of the asset by the entity.
Depreciation that is charged in audited financial statement should be
considered.
Direct Expenses: Expenses relating to manufacture of an excisable goods,
which can be identified to such excisable goods other than direct material
cost and direct employee cost.
Employee Cost: The aggregate of all kinds of consideration paid, payable
and provisions made for future payments for the services rendered by
employees of an enterprise (including temporary, part time and contract
employees). Consideration includes wages, salary, contractual payments
and benefits, as applicable or any amount paid or payable on behalf of
employee. This is also known as Labour Cost.
‹ Direct Employee Cost: The cost of employees which can be
attributed to an excisable goods in an economically feasible way.
‹ Indirect Employee Cost: The cost of employees which cannot be
directly attributed to a particular excisable goods.
Interest and Finance Costs: Costs incurred by an enterprise in connec-
tion with the borrowing of funds.
Manufacturing Cost: Manufacturing cost of an excisable goods is the
aggregate of costs of all resources used in the process of its manufacturing.
Manufacturing cost includes cost of Materials (including process materials),
Employee Cost, Cost of Utilities, Packing Cost, Direct Expenses, Repairs
&Maintenance Cost, Pollution Control Cost, Quality Control Cost, Research
& Development Cost, Cost of Inputs received free of cost or received at
concessional value from the buyer of the excisable goods, Depreciation
and Amortisation (including amortisation cost of free tools, patterns,dies,
drawings, blue prints, technical maps, charts, engineering, development,
art work, design work, plans, sketches, packaging material and the like
necessary for production of excisable goods), Cost of Rework, recondi-
tioning, retro-fitment, Manufacturing Overheads, other costs allocable to
such activity, adjustment for stock of work-in-process and recoveries for
sales of scrap and wastages and the like but does not include expenses
of the above nature incurred for post manufacturing purposes.
Manufacturing Cost and Cost of Production are used interchangeably.

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 Cost Accounting: An Overview

Manufacturing Overheads: Indirect costs involved in the manufacturing Notes

process
The terms Manufacturing Overheads, Factory Overheads, Works Over-
heads and Production Overheads have the same meaning and are used
interchangeably. Manufacturing overheads shall include administration
cost relating to production, factory, works or manufacturing and depot.
Manufacturing Overheads shall be classified on the basis of behaviour as
Variable Manufacturing Overheads and Fixed Manufacturing Overheads.
Variable Manufacturing Overheads comprise of expenses which vary in propor-
tion to the change in volume of production. For example, cost of utilities etc.
Fixed Manufacturing overheads comprise of expenses which does not
change with the change in volume of production. For example, salaries,
rent, repairs & maintenance, etc.
Material Consumed: Material Consumed includes materials directly
identified for production of excisable goods such as:
(a) Indigenous materials
(b) Imported materials
(c) Bought out items
(d) Self-manufactured items
(e) Process materials and other items
Materials received free of cost or at concessional value from the
(f) 
buyer
Accessories, on which cenvat credit is admissible, and which are
(g) 
cleared along with the final product
(h) goods used for providing free warranty for excisable goods
Cost of material consumed consists of cost of material, duties and
taxes, freight inwards, insurance and other expenditure directly at-
tributable to procurement. Trade discount, rebates and other similar
items are deducted for determining the cost of materials. Cenvat
credit, credit for Countervailing Customs Duty, Sales Tax set off,
VAT, duty draw back and other similar duties subsequently recov-
ered/recoverable by the entity are also deducted.

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 COST ACCOUNTING

Notes Normal Capacity is the production achieved or achievable on an average

over a period or season under normal circumstances taking into account
the loss of capacity resulting from planned maintenance.
Capacity may be determined in terms of units of production or equivalent
machine or man hours.
Packing Material Cost: The cost of material of any nature used for the
purpose of packing of excisable goods.
Quality Control Cost: The quality control cost is the expenses incurred
relating to quality control activities for adhering to quality standard.
These expenses include salaries & wages relating to employees engaged
in quality control activity and other related expenses.
Repairs & Maintenance Cost: Cost of all activities which have the
objective of maintaining or restoring an asset in or to a state in which
it can perform its required function at intended capacity and efficiency.
Research and Development Cost: The research and development cost incurred
for development and improvement of the process or the excisable goods.
Royalty: Royalty is compensation/periodic payments for the use of as-
set (tangible and/or intangible) to the owner for use of his asset in the
production/manufacture, selling and distribution by an entity.
Scrap: Discarded material having some value in few cases and which is
usually either disposed of without further treatment (other than reclama-
tion and handling) or reintroduced into the production process.
Technical Know-how Fee: Technical Know-how Fee is a lump sum or
periodical amount payable to provider of Technical Know-how in the
form of design, drawings, training of personnel, or practical knowledge,
skills or experience.
Waste and Spoilage:
‹ Waste: Material lost during production or storage due to various
factors such as evaporation, chemical reaction, contamination,
unrecoverable residue, shrinkage, etc., and discarded material which
may or may not have any value.
‹ Spoilage: Production that does not meet with dimensional or quality
standards in such a way that it cannot be rectified economically and
is sold for a disposal value. Net Spoilage is the difference between
costs accumulated up to the point of rejection and the salvage value.
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5. Principles of Measurement Notes

Manufacturing cost for each excisable goods shall be measured separately.
Manufacturing cost of each excisable goods shall be the aggregate of
direct and indirect cost relating to manufacturing activity.
Material cost shall be measured separately for each type of material, that
is, for indigenous material, imported material, bought out components
and process materials, self-manufactured items, accessories for each type
of excisable goods.
Cost of Inputs received free of cost or at concessional value from the
buyer of the excisable goods shall be considered for determination of
manufacturing cost.
The material cost of normal scrap/defectives which are rejected shall be
included in the material cost of excisable goods manufactured. The ma-
terial cost of actual scrap/defectives, not exceeding the normal quantity
shall be adjusted in the material cost of good production. Realized or
realizable value of scrap or waste shall be deducted for determination of
manufacturing cost. Material Cost of abnormal scrap/defectives should
not be included in material cost but treated as loss after deducting the
realisable value of such scrap/defectives.
Employee Cost for each excisable goods shall be measured separately.
The cost of utilities consumed for manufacturing of excisable goods shall
be measured for each type of utility.
‹ Packing material cost used for each type of excisable goods shall
be measured separately.
‹ If excisable goods are transferred/dispatched duly packed, the cost
of such packing shall include cost of all types of packing in which
the excisable goods are removed from the place of removal.
‹ The Direct Expenses for manufacturing of excisable goods shall be
measured for each excisable goods separately.
‹ Repairs and maintenance cost for manufacturing of excisable goods
shall be measured for each excisable goods separately.
‹ Depreciation and Amortisation cost for manufacturing of excisable
goods shall be measured for each excisable goods separately.

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 COST ACCOUNTING

Notes ‹ Research & Development cost for manufacturing of excisable goods

shall be measured for each excisable goods separately.
‹ Cost incurred for manufacturing of excisable goods after split-off
point shall be measured for each Joint/By-Product.
‹ In case the manufacturing process generates scrap or waste, realized
or realizable value net of cost of disposal, of such scrap and waste
shall be deducted from the cost of Joint Product.
‹ Royalty and Technical Know-how Fee for manufacturing of excisable
goods paid or incurred in lump-sum or which are in the nature of
‘one-time’ payment, shall be amortised on the basis of the estimated
output or benefit to be derived from the related Technical Know-how.
Royalty paid on sales shall not form part of manufacturing cost of ex-
cisable goods.
Quality Control cost incurred in-house for manufacturing of excisable
goods shall be the aggregate of the cost of resources used in the Quality
Control activities in relation to each excisable goods. The cost of resourc-
es procured from outside shall be determined at invoice or agreed price
including duties and taxes, and other expenditure directly attributable
thereto net of discounts, taxes and duties refundable or to be credited
as input credit.
Manufacturing Overheads for excisable goods representing procurement
of resources shall be determined at invoice or agreed price including
duties and taxes, and other expenditure directly attributable thereto net of
discounts; taxes and duties refundable or to be credited as input credit.
Manufacturing Overheads other than those referred to above shall be
determined on the basis of cost incurred in connection therewith.
Any abnormal cost, where it is material and quantifiable, shall not form
part of the manufacturing cost of excisable goods.
Interest and other Finance costs are not part of manufacturing cost of
excisable goods.
Manufacturing cost of excisable goods shall include cost of inputs
received free of cost or at concessional value from the buyer of excis-
able goods and amortisation cost of free tools, pattern, dies, drawings,
blue prints, technical maps, charts, engineering, development, art work,

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design work, plans, sketches, and the like necessary for production of Notes
excisable goods. It shall also include cost of rework, reconditioning,
retro-fitment, Manufacturing Overheads and other costs allocable to
such activity, adjustment for stock of work-in-process and recoveries
from sales of scrap and wastages and the like necessary for production
of excisable goods.
In case any input material, whether of direct or indirect nature, including
packing material, is supplied free of cost or at concessional value by the
buyer of the excisable goods, the cost of such material shall be included
in the manufacturing cost.
For example: Amortisation Cost of Moulds, Tools, Dies & Patterns and
Cost of Packing Material etc. received free of cost or at concessional
value from the buyer of excisable goods shall be included in manufac-
turing cost.
Any Subsidy/Grant/Incentive or any such payment received/receivable,
from other entity, other than the buyer with respect to any manufactur-
ing cost of excisable goods shall be deducted for ascertainment of the
manufacturing cost of excisable goods to which such amounts are related.
The manufacturing cost of excisable goods shall be determined based on
the normal capacity or actual capacity utilization whichever is higher and
unabsorbed cost, if any, shall be treated as abnormal cost.
Fines, penalties, damages, demurrage and similar levies paid to statutory
authorities or other third parties shall not form part of the manufacturing
cost of excisable goods.
The forex component of imported material or other element of cost shall
be converted at the rate on the date of the transaction. Any subsequent
change in the exchange rate till payment or otherwise shall not form part
of manufacturing cost of excisable goods.
Credits/recoveries relating to the manufacturing cost, which are material
and quantifiable, shall be deducted from the total manufacturing cost to
arrive at the net manufacturing cost of excisable goods.
Work in process/progress stock shall be measured at cost computed for
different stages of completion.
Stock of work-in-process/progress shall be valued at cost on the basis
of stages of completion as per cost accounting principles. Opening and

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 COST ACCOUNTING

Notes closing stock of work-in-process/progress shall be adjusted for compu-

tation of manufacturing cost of an excisable goods.
Assignment of Cost
While assigning various elements of manufacturing cost of excisable goods,
traceability to an excisable goods in an economically feasible manner
shall be the guiding principle. The cost which can be traced directly to
each excisable goods shall be directly assigned.
Assignment of manufacturing cost of excisable goods, which are not
directly traceable to the excisable goods shall be based on either of the
following two principles;
‹ Cause and Effect: Cause is the process or operation or activity
and effect is the incurrence of cost.
‹ Benefits received: To be apportioned to various cost objects in
proportion to the benefits received by them.
The variable manufacturing/production overheads shall be absorbed based
on actual production.
The fixed manufacturing/production overheads and other similar item of
fixed costs such as quality control cost, research and development costs
and administrative overheads relating to manufacturing shall be absorbed
in the manufacturing cost on the basis of the normal capacity or actual
capacity utilization of the plant, whichever is higher.
In case a production process results in more than one product being
produced simultaneously, treatment of joint products and by-products
shall be as under:
‹ In case joint products are produced, joint costs are allocated between
the products on a rational and consistent basis.
‹ In case by-products are produced, the net realisable value of by-
products is credited to the manufacturing cost of the main product.
Miscellaneous Income relating to production/manufacture shall be adjusted
in the determination of manufacturing cost.
For example, income from sale of empty containers used for procurement
of raw material shall be deducted in determination of manufacturing cost.

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Presentation Notes
Cost statement as per Appendix 1 to this standard or as near thereto shall
present following information:
‹ Actual capacity utilization in absolute terms and as a percentage
of normal capacity.
‹ Cost information relating to various elements of Cost shall be
presented separately.
Disclosures
Disclosure shall be made only where material, significant and quantifiable.
If there is any change in cost accounting principles and practices during
the period under review which may materially affect the manufacturing
cost of excisable goods in terms of comparability with previous period(s),
the same shall be disclosed.
Effective Date
This Cost Accounting Standard shall be effective from the period com-
mencing on or after 1st April 2015 for being applied for the preparation
and certification of Cost Accounting Statements for excisable goods.
Appendix 1
Cost Statement Showing Manufacturing Cost of
(Name of excisable goods) for the Period:
Name of the Manufacturer
Address of the Manufacturer
Excise Registration Number
Name of the unit
Address of the unit
Central Excise Tariff Heading
A Quantitative Information Unit Quantity
1 Normal/Installed Capacity
2 Production
3 Captive Consumption
4 Production as Percentage of Normal/
Installed Capacity

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 COST ACCOUNTING

Notes Cost Per

B Cost Information Unit Quantity Rate Amount Unit
Materials (specify)
1 A.
B.
C.
D…..
Total Materials
Consumed
2 Process Materials
3 Utilities
4 Direct Employee Cost
5 Direct Expenses
6 Consumable Stores
and Spares
7 Repairs and Mainte-
nance Cost
8 Quality Control Cost
9 Research & Develop-
ment Cost
10 Technical Know-how
Fee/Royalty, if any
11 Depreciation/
Amortization
12 Other Manufacturing
Overheads
13 Total (1 to 12)
14 Add/Less Work-in-
Progress Adjustments
15 Less Credit for
Recoveries, if any
16 Packing Cost

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 Cost Accounting: An Overview

Cost Per Notes

B Cost Information Unit Quantity Rate Amount Unit
17 Cost of Inputs
Received Free or at
concessional value
from the buyer of
the excisable good
18 Manufacturing Cost
(13 to 17)

Date:  eal & Signature of the Company’s

S
Authorised Representative
I/We have verified above data on test check basis with reference to the
books of account, cost accounting records and other records. Based on
the information and explanations given to me/us, and on the basis of
generally accepted cost accounting principles and practices and Cost
Accounting Standards followed by the entity, I/we certify that the above
cost data reflects true and fair view of the manufacturing cost of the
above excisable good.

Date: Seal & Signature of Cost Accountant

Place: Membership No.: Firm Regn. No.:
Note: Separate Cost Statement(s) shall be prepared
for each excisable good

CAS-4 (REVISED 2018)

COST ACCOUNTING STANDARD ON COST OF PRODUCTION /
ACQUISITION / SUPPLY OF GOODS / PROVISION OF SERVICES
The following is the Cost Accounting Standard (CAS-4) (Revised 2018)
on “COST OF PRODUCTION / ACQUISITION / SUPPLY OF GOODS
/ PROVISION OF SERVICES” issued by the Council of the Institute
of Cost Accountants of India (ICAI). This Standard replaces CAS-4 on
Cost of Production for Captive Consumption issued earlier. The CAS-4
(Revised 2018) deals with the determination of cost of production or
acquisition or supply of goods or provision of services or both. In this
Standard, the standard portions have been set in bold italic type. These

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 COST ACCOUNTING

Notes should be read in the context of the background material which has been
set in normal type.
1. Introduction
1.1. 
C ost Accounting Standard 4 (CAS-4) was issued to specify
the principles for determination of cost of production for
valuation of goods meant for captive consumption, as required
under the Central Excise Valuation (Determination of Price
of Excisable Goods) Rules 2000. CBEC, vide circular No.
692/8/2003-CX dated 13-2-2003 had clarified that in case
of captive consumption, cost calculation should be as per
CAS-4 only.
1.2. 
With the introduction of Goods and Services Tax [GST] with
effect from July 1, 2017, the concept of ‘captive consumption’
is no more relevant for computing the tax incidence. However,
the concept of cost of production or manufacture is relevant
under the GST laws where the value of supply of goods or
services or both are determined based on cost.
1.2.1. As per section 15(1) of the CGST Act, where the supplier
and the recipient of the supply are not related and price is
the sole consideration for the supply, the value of supply
of goods or services or both shall be the transaction value.
Section 15(4) provides that where the value of the supply
of goods or services or both cannot be determined under
sub-section (1), the same shall be determined in such
manner as may be prescribed. These have been prescribed
under Chapter IV of the CGST Rules, 2017.
1.2.2. 
Rules 27, 28, & 29 of the CGST Rules provide for
methodologies for determination of value of supply un-
der certain situations. As per Rule 27, where the supply
of goods or services is for a consideration not wholly
in money, the value of the supply shall be the open
market value of Cost Accounting Standards Board such
supply; or the sum total of consideration in money and
equivalent; or the value of supply of goods or services
or both of like kind and quality.

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 Cost Accounting: An Overview

As per Rule 28, value of the supply of goods or ser- Notes

vices or both between distinct or related persons other
than where the supply is made through an agent, shall
be the open market value of such supply; or the value
of supply of goods or services of like kind and quality.
Proviso to Rule 28 provides that where goods are
intended for further supply as such by the recipient,
the value shall be an amount equivalent to 90% of the
price charged for the supply of goods of like kind and
quality by the recipient to his customer not being a
related person.
Where a recipient is eligible for input tax credit, the
value declared in the invoice shall be deemed to be the
open market value of the goods or services.
As per Rule 29, value of supply of goods between the
principal and his agent shall be the open market value
of the goods being supplied, or at the option of the
supplier, be 90% of the price charged for the supply of
goods of like kind and quality by the recipient to his
customer not being a related person, where the goods
are intended for further supply by the said recipient.
1.2.3. Rules 27, 28, & 29, however, further provide that if the
value of supply is not determinable under the said Rules,
the same shall be determined by the application of Rule
30 or Rule 31 in that order.
As per Rule 30, the value shall be one hundred and
ten percent of the cost of production or the cost of
acquisition of such goods or the cost of provision of
such services.
Rule 31 specifies residual method for determination of
value of supply of goods or services or both. Where
the value of supply of goods or services or both cannot
be determined under Rule 27 to 30, the same shall be
determined using reasonable means consistent with the
principles and the general provisions of section 15 and
the provisions of Chapter-IV of CGST Rules.
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 COST ACCOUNTING

Notes In the case of supply of services, the supplier may opt

directly for Rule 31, ignoring Rule 30.
This Standard deals with the principles and methods of classifica-
tion, measurement and assignment for the determination of cost of
production or acquisition or supply of goods or provision of services
as required under the provisions of GST Acts/Rules.
2. Objective
The objective of this Standard is to bring uniformity and consistency
in the principles and methods of determining the cost of produc-
tion or acquisition or supply of goods or provision of services as
required under the provisions of GST Acts/Rules.
The cost statements prepared based on this Standard will be used
for determination of value of supply of goods or services or both.
This Standard and its disclosure requirement will provide transpar-
ency in the valuation of goods and services.
This standard shall further ensure adequate accuracy in computing
Transaction Value of supply for goods or services or both, where
the open market value of supply of goods and services or value of
supply of goods or services of like kind and quality are not avail-
able or same is not verifiable.
3. Scope
This standard should be applied to cost statements which require
classification, surement, assignment, presentation, and disclosure of
related costs for determination of the following under the relevant
provisions of GST Acts/Rules.
(i) Determination of cost of production of goods;
(ii) Determination of cost of acquisition of goods;
(iii) Determination of cost of supply of goods;
(iv) Determination of cost of provision/supply of services ; and
(v) Determination of value of supply of goods or services as per open
market value or as per goods or services of like kind and quality.
4. Definitions
The following terms are being used in this standard with the mean-
ing specified.
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 Cost Accounting: An Overview

4.1. Abnormal Cost: An unusual or atypical cost whose occurrence Notes

is usually irregular and unexpected and/or due to some abnor-
mal situation of the production or operation.
4.2. Actual Capacity Utilization: Actual capacity utilization is the
volume of production achieved or services provided in a spec-
ified period, expressed as a percentage of installed capacity.
Volume may be measured in terms of units produced or services
provided or equivalent machine or man hours, as applicable.
Actual capacity utilization is usually expressed as a percentage
of installed capacity.
4.3. Administrative Overheads: Cost of all activities relating to
general management and administration of an entity.
Administrative overheads shall exclude production overheads,
marketing overheads and finance cost. Production overheads
include administration cost relating to production, factory, work
or manufacturing.
4.4. Allocation of Overheads: Allocation of overheads is assigning
total amount of an item of cost directly to a cost object.
4.5. Amortization: Amortisation is the systematic allocation of the
depreciable amount of an intangible asset over its useful life.
4.6. Apportionment of Overheads: Distribution of overheads to
more than one cost objects on some equitable basis.
4.7. By-product: Product with relatively low value produced inci-
dentally in the manufacturing of the product or service.
4.8. Cost: Cost is a measurement, in monetary terms, of the amount
of resources used for the purpose of production of goods or
rendering services.
4.9. Cost of Purchase/Acquisition: The costs of purchase/ acquisi-
tion of Goods comprise the purchase price, import duties and
other taxes (net of trade discounts, rebate, taxes and duties),
and transport, handling, storage and other costs directly attrib-
utable to the acquisition of goods and services.
Cost of acquisition of goods or services is conceptually syn-
onymous to cost of purchase of goods.

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 COST ACCOUNTING

Notes 4.10. Cost of Production of Goods: Cost of production of a product

consists of materials consumed, Direct Wages and Salaries,
direct expenses, works overheads, quality control costs, re-
search and development costs, packing costs, administrative
overheads relating to production.
To arrive at cost of production of goods dispatched for cap-
tive consumption, adjustment for stock of Work-in-progress,
finished goods, recoveries for sales of scrap, wastages etc.
shall be made.
The terms Cost of Production or Cost of Manufacturing or
Cost or Processing denote the same meaning and are used
interchangeably.
4.11. Cost of Provision of Service: Cost of provision of services
consists of cost of materials consumed, direct employee costs,
direct expenses, quality control costs, research and develop-
ment costs, operation overheads and administrative overheads
relating to provision of services.
4.12. Defectives: Materials Product or intermediate products that
do not meet quality standards. This may include reworks or
rejects.
An intermediate product is a product that might require further
processing before it is saleable to the ultimate consumer.
4.12.1. Reworks: Defectives which can be brought up to the
standards by putting in additional resources.
Rework includes repairs, reconditioning, retro-fitment and
refurbishing.
4.12.2. Rejects: Defectives which cannot meet the quality
standards even after putting in additional resources.
Rejects may be disposed off as waste or sold for salvage
value or recycled in the production process.
4.13. Depreciation: Depreciation is the systematic allocation of the
depreciable amount of an asset over its useful life.
4.13.1 Depreciable amount: The cost of an asset, or other
amount substituted for cost in the financial statement, less
its residual value.
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 Cost Accounting: An Overview

4.13.2 Depreciable property, plant and equipment are tangible Notes

assets that:
‹ are held for use in the production of goods or supply of
services, for rental to other, for administrative, selling or
distribution purposes; and
‹ are expected to be used during more than one accounting
period.
Land is not a depreciable asset as it does not have a defined
useful life.
4.13.3 Useful life of asset: Useful life of asset is either:
‹ the period over which a asset is expected to be available
for use by an entity: or
‹ the number of production or similar units expected to be
obtained from use of the asset by the entity.
4.14. Development Cost: Development cost Development cost is the
cost for application of research findings or other knowledge
to a plan or design for the production of new or substantially
improved materials, devices, products, processes, systems or
services before the start of commercial production or use.
4.15. Direct Expenses: Expenses relating to manufacture of a prod-
uct or rendering a service, which can be identified or linked
with the cost object other than direct material cost and direct
employee cost.
4.16. Employee Cost: Employee Benefits paid or payable in all forms
of consideration given for the service rendered by employees
(including temporary, part time and contract employees) of
an entity.
Explanation:
1. Contract employees include employees directly engaged
by the employer on contract basis but does not include
employees of any contractor engaged in the organisation.
2. Compensation paid to employees for the past period on
account of any dispute / court orders shall not form part
of Employee Cost.

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 COST ACCOUNTING

Notes 3. Short provisions of prior period made up in current period

shall not form part of the employee cost in the current period.
Employee cost includes payment made in cash or kind.
4.16.1. Direct Employee Cost: Employee cost, which can be
attributed to a Cost object in an economically feasible way.
4.16.2. Indirect Employee Cost: Employee cost, which cannot
be directly attributed to a particular cost object.
4.17. 
E xcess Capacity Utilization: Excess capacity utilization
is the difference between installed capacity and the actual
capacity utilization when actual capacity utilization is more
than installed capacity.
4.18. Idle Capacity: Idle capacity is the difference between in-
stalled capacity and the actual capacity utilization when actual
capacity utilization is less than installed capacity.
4.18.1. Abnormal Idle Capacity: Abnormal idle capacity is
the difference between normal capacity and actual capacity
utilization where the actual capacity is lower than the normal
capacity.
4.18.2. Normal Idle Capacity: Normal idle capacity is the
difference between installed capacity and normal capacity.
4.19. Installed Capacity: Installed capacity is the maximum ca-
pacity of producing goods or providing services, according to the
manufacturer’s specifications or determined through an expert study.
4.20. Interest and Finance Costs: Interest and Financing Charges
are interest and other costs incurred by an entity in connection with
the arrangements.
Examples are:
1. 
Interest and commitments charges on bank borrowings, other
short term and long term borrowings:
2. Financing charges in respect of finance leases and other similar
arrangements: and
3. Exchange difference arising out from foreign currency borrowings to
the extent they are regarded as an adjustment to the interest costs.

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 Cost Accounting: An Overview

The terms interest and financing charges, finance costs and bor- Notes
rowing costs are used interchangeably.
4.21. Joint Costs: Joint costs are the cost of common resources used
to produce two or more products or services simultaneously.
4.22. Joint Product: Products or services that are produced simul-
taneously, by the same process, identifiable at the end of the
process and recognised as main products or services having
sufficient value.
4.23. Material Consumed: Material Consumed includes materials
directly identified for production of goods or provision of
Services such as:
(a) Indigenous materials;
(b) Imported materials;
(c) Bought out items;
(d) Self-manufactured items;
(e) Process materials and other items;
(f) M
 aterials received free of cost or at concessional value
from the buyer;
(g) Accessories which are supplied along with the final product.
Cost of material consumed consists of cost of material, freight in-
wards, insurance and other expenditure directly attributable to pro-
curement and goods used for providing free warranty. (Net off duties
and taxes, Trade discount, rebates, subsidies and other similar items)
4.24. Materials Cost: The cost of material used for the purpose of
production of a product or rendering a service.
4.24.1. Direct Materials: Materials, the costs of which can
be attributed to a cost object in an economically feasible way.
4.24.2. Indirect Materials: Materials, the costs of which
cannot be directly attributed to a particular cost object.
4.25. Normal Capacity: Normal Capacity is the production achieved
or achievable on an average over a numbers of period or sea-
son under normal circumstances taking into account the loss
of capacity resulting from planned maintenance.

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 COST ACCOUNTING

Notes 4.26. Overheads: Overheads comprise costs of indirect materials,

indirect employees and indirect expenses.
4.27. Packing Materials: Materials used to hold, identify, describe,
store, protect, display, transport, promote and make the prod-
uct marketable.
4.28. P
 acking Material Cost: The cost of material of any nature
used for the purpose of packing of product.
4.29. P
 roduction or Operation Overheads: Indirect costs involved
in the production of a product or in providing service.
The terms Production Overheads, Operation Overheads, Factory
Overheads, Works Overheads and Manufacturing Overheads
denotes the same meaning and are used interchangeably.
Production or Operation Overheads shall include administration
cost relating to production, factory, works or manufacturing
and providing of services.
In addition, Production or Operation Overheads shall be clas-
sified on the basis of behaviour such as variable Production or
Operation Overheads, semi-variable Production or Operation
Overheads and fixed Production or Operation Overheads.
‹ Variable Production or Operation Overheads comprise of
expenses which vary in proportion to the change of volume
of production or activity or services provided.
‹ Semi-variable Costs are the costs that contain both fixed
and variable elements. They partly change with the change
in the level of activity.
‹ Fixed Overheads are the costs which do not vary with
the change in volume of production or activity or service
provided.
4.30. Quality Control Cost: Cost of resources consumed towards
quality control procedures.
4.31. R
 epairs & Maintenance Cost: Cost of all activities which
have the objective of maintaining or restoring an asset in or
to a state in which it can perform its required function at
intended capacity and efficiency.

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 Cost Accounting: An Overview

4.32. R esearch cost: Research cost is the cost of original and Notes
planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.
4.33. Royalty: Royalty is any consideration for the use of asset
(tangible and/or intangible) to the owner.
4.34. Scrap: Discarded material having no or insignificant value
and which is usually either disposed of without further treat-
ment (other than reclamation and handling) or reintroduced
in place of raw material.
4.35. Selling Overheads: Selling overheads are the expenses re-
lated to sale of products or services and include all indirect
expenses incurred in selling the products or services.
4.36. Standard Cost: A predetermined cost of a product or ser-
vice based on technical specifications and efficient operating
conditions.
4.37. S
 upport Service Cost Centre: The cost centre which primarily
provides auxiliary services across the entity.
4.38. T
 echnical Know-how Fee: Technical Know-how Fee is a lump
sum or periodical amount payable to provider of Technical
Know-how in the form of design, drawings, training of per-
sonnel, or practical knowledge, skills or experience.
4.39. Waste and Spoilage:
4.39.1. Waste: Material lost during production or storage and
discarded material which may or may not have any value.
4.39.2. Spoilage: Production that does not meet the quality
requirements or specification cannot be rectified economically.
5. Principles of Measurement
5.1. C
 ost of production or acquisition of goods or provision of services
shall be measured for each type of goods or services separately.
5.2. C
 ost of production or acquisition or supply of each type of goods
shall be the aggregate of direct and indirect costs relating to
the production or acquisition or supply activity of those goods.
5.3. C
 ost of provision of each type of service shall be the aggregate
of direct and indirect cost relating to that service activity.

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 COST ACCOUNTING

Notes 5.4. M
 aterial cost shall be measured separately for each type of
material, that is, for indigenous material, imported material,
bought out components, process materials, self-manufactured
items, and accessories for each type of goods or services.
5.5. T
 he material cost of normal scrap/defectives which are rejected
shall be included in the material cost of goods produced or
services provided. The material cost of actual scrap/ defectives,
not exceeding the normal quantity shall be adjusted in the
material cost of good production. Realized or realizable value
of scrap or waste shall be deducted for determination of cost
of production or acquisition of goods or provision of services.
Material Cost of abnormal scrap /defectives should not be in-
cluded in material cost but treated as loss after deducting the
realisable value of such scrap/defectives.
5.6. E
 mployee Cost for each type of goods or services shall be
measured separately.
5.7. T
 he cost of utilities consumed for the production or acquisi-
tion or supply of each type of goods or provision of services
shall be measured for each type of utility separately i.e. power,
electricity, water, steam & gas.
5.8. C
 ost of packing material used for the production or acquisition
or supply of goods or provision of services shall be measured
for each type of goods or services separately.
If goods are transferred / dispatched or supplied duly packed,
the cost of such packing shall be included in the cost of goods
transferred/dispatched or supplied.
5.9. D
 irect Expenses for the production or acquisition or supply
of goods or provision of services shall be measured for each
type of goods or services separately.
5.10. H
 igh value spare shall be recognised as property, plant and
equipment when they meet the definition of property, plant
and equipment and depreciated accordingly.
Otherwise, such items are classified as inventory and rec-
ognised in cost as and when they are consumed.

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 Cost Accounting: An Overview

5.11. R
 epairs and maintenance cost for the production or acquisition Notes
or supply of goods or provision of services shall be measured
for each type of goods or services separately.
5.12. D
 epreciation and Amortisation cost for the production or
acquisition or supply of goods or provision of services shall
be measured for each type of goods or services separately.
Depreciation of an asset begins when it is available for
use, i.e. when it is in the location and condition necessary
for it to be capable of operating in the manner intended by
management.
5.13. Research & Development cost for the production or acquisition
or supply of goods or provision of services shall be measured
for each type of goods or services separately.
5.14. C
 ost incurred for the production or acquisition or supply of
goods or provision of services after split-off point shall be
measured for each type of Joint/By-Product or service for the
resources consumed.
In case the production process generates scrap or waste, real-
ized or realizable value net of cost of disposal, of such scrap
and waste shall be deducted from the cost of Joint Product.
5.15. R
 oyalty and Technical Know-how Fee for production or ac-
quisition or supply of goods or provision of services paid or
incurred in lump-sum or which are in the nature of ‘one-time’
payment, shall be amortised on the basis of the estimated
output or benefit to be derived from the related Technical
Know-how.
5.16. R
 oyalty paid as a consideration for use of asset or on technology
transfer, in any form, will form part of cost, however royalty
paid on brand usage shall not form part of cost of production.
5.17. Q
 uality Control cost incurred in-house for the production or
acquisition or supply of goods or provision of services shall
be the aggregate of the cost of resources used in the Quality
Control activities in relation to each type of goods or ser-
vice. The cost of resources procured from outside shall be
determined at invoice or agreed price including duties and

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 COST ACCOUNTING

Notes taxes, and other expenditure directly attributable thereto net

of discounts, taxes and duties refundable or to be credited as
input tax credit.
5.18. P
 roduction or Operation Overheads representing procurement
of resources shall be determined at invoice or agreed price
including duties and taxes, and other expenditure directly at-
tributable thereto net of discounts; taxes and duties refundable
or to be credited as input tax credit. Production or Operation
Overheads other than those referred to above shall be deter-
mined on the basis of cost incurred in connection therewith.
Industry Specific Operating Expenses: In case of process
peculiarity of a particular industry, it may not be easily
practicable to determine element- wise conversion cost of a
product. In such situation, the company may calculate cost
center/cost object wise conversion cost. It may be summa-
rized under ‘industry specific operating expenses’, instead of
element-wise conversion cost, e.g., Textile industry-spinning,
weaving, processing.
5.19. A
 ny abnormal cost, where it is material and quantifiable,
shall not form part of the cost of production or acquisition
or supply of goods or provision of service.
5.20. I nterest and other Finance costs shall not form part of cost of
production or acquisition of goods or provision of services.
5.21. Impairment loss on assets shall not form part of cost of
production or acquisition or supply of goods or provision of
services.
5.22. Imputed costs shall not form part of cost of production or
acquisition or supply of goods or provision of services.
5.23. C
 ost of production or acquisition or supply of goods or pro-
vision of services shall include cost of inputs received free
of cost or at concessional value, net of input tax credit, from
the recipient of goods or services and amortisation cost of
free tools, pattern, dies, drawings, blue prints, technical maps,
charts, engineering, development, art work, design work,
plans, sketches, and the like necessary for the production or
acquisition or supply of goods or provision of services.
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 Cost Accounting: An Overview

5.24. C
 ost of production or acquisition or supply of goods or pro- Notes
vision of services shall also include cost of rework, recondi-
tioning, retro-fitment, production or operation overheads and
other costs allocable to such activity, adjustment for stock of
work-in-process and recoveries from sales of scrap and wast-
ages and the like necessary for the production or acquisition
or supply of goods or provision of services.
5.25. Subsidy or Grant or Incentive or any such payment received
or receivable, from any entity other than the recipient of
goods or service, with respect to any element of cost shall
be deducted for ascertainment of the cost of production or
acquisition or supply of goods or provision of services to
which such amounts are related.
5.26. A
 ny Grants recognized as deferred income in the financial
statements shall also be reduced from the relevant element
of cost of production or acquisition or supply of goods or
provision of services.
5.27. T
 he cost of production or acquisition or supply of goods or
provision of services shall be determined based on the normal
capacity or actual capacity utilization whichever is higher and
unabsorbed cost, if any, shall be treated as abnormal cost.
5.28. F
 ines, penalties, damages, demurrage and similar levies paid
to statutory authorities or other third parties shall not form
part of the cost of production or acquisition or supply of
goods or provision of services.
5.29. T
 he forex component of imported material or other element of
cost shall be converted at the rate on the date of the transac-
tion. Any subsequent change in the exchange rate till payment
or otherwise shall not form part of the cost of production or
acquisition or supply of goods or provision of services.
5.30. C
 redits or recoveries relating to any element of cost including
the facilities provided to outside parties, which are material
and quantifiable, shall be deducted from the total cost of
production or acquisition or supply of goods or provision of
services.

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 COST ACCOUNTING

Notes 5.31. W
 ork in process/progress stock shall be measured at cost
computed for different stages of completion.
Stock of work-in-process/progress shall be valued at cost on
the basis of stages of completion as per cost accounting prin-
ciples. Opening and closing stock of work-in-process/progress
shall be adjusted for computation of cost of production or
acquisition of goods or provision of services.
6. Assignment of Cost
6.1. C
 ost of production or acquisition or supply of goods or provision
of services shall be determined on ‘normal cost’ basis. For this
purpose, any abnormal and non-recurring costs, abnormally low
plant utilization, abnormal rejections, accidents, strikes, fires,
unexpected Court orders etc. shall be ignored.
6.2. W
 hile assigning various elements of cost, traceability to goods
or services in an economically feasible manner shall be the
guiding principle. The cost which can be traced directly to each
type of goods or services shall be directly assigned.
6.3. A
 ssignment of cost of producing or acquisition or supply of
goods or providing services, which are not directly traceable to
the goods or services shall be based on either of the following
two principles;
6.3.1. Cause and Effect – Cause is the process or operation or
activity and effect is the incurrence of cost.
6.3.2. Benefits received – To be apportioned to various cost
objects in proportion to the benefits received by them.
6.4. T
 he variable production or operation overheads shall be ab-
sorbed based on actual production.
6.5. T
 he fixed production or operation overheads and other similar
item of fixed costs such as quality control cost, research and
development costs and administrative overheads relating to
manufacturing shall be absorbed in the cost of production or
acquisition or supply of goods or provision of services on the
basis of the normal capacity or actual capacity utilization of
the plant or service centre, whichever is higher.

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 Cost Accounting: An Overview

6.6. In case a production process results in more than one product Notes
being produced simultaneously, treatment of joint products and
by-products shall be as under:
6.6.1. In case joint products are produced, joint costs incurred
upto the split off point are allocated between the products on a
rational, equitable, and consistent basis. Joint cost incurred shall
be assigned to the joint products based on benefits received
measured by using the physical unit method or equivalent cost
or net realisable value at split off point. Net realisable value
for this purpose means the net selling price per unit multiplied
by quantity sold, adjusted for the post-split off costs.
6.6.2. In case by-products are produced, the net realisable
value of by-products is credited to the manufacturing cost of
the main product.
6.7. In case a process results in more than one service being pro-
duced simultaneously, joint costs incurred upto the split off
point are allocated between the services on a rational, equitable,
and consistent basis.
6.8. M
 iscellaneous Income relating to production or operations
shall be adjusted in the determination of cost of production
or acquisition or supply of goods or of cost of providing a
service.
For example, income from sale of empty containers used for pro-
curement of raw material shall be deducted in determination of
manufacturing cost.
7. Presentation
7.1. C
 ost Statements should be prepared as per the applicable format
given in the Appendix to this Standard or as near thereto as
possible, as listed below:
7.1.1. Appendix-1: Statement of Cost of Production of the
taxable goods
7.1.2. Appendix-2: Statement of Cost of Provision/Supply of
the taxable Services
7.1.3. Appendix-3: Statement of Cost of Acquisition of taxable
goods
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 COST ACCOUNTING

Notes 7.1.4. Appendix-4: Statement of Open Market Value/Value as

per Goods or Services of like kind and quality
7.2. C
 ompanies covered under the Companies (Cost Records and
Audit) Rules, 2014 issued under section 148 of the Companies
Act, 2013 shall prepare and present the cost records and cost
statements in compliance with the said Rules, applicable Cost
Accounting Standards, and Generally Accepted Cost Accounting
Principles issued by the Institute.
7.3. C
 ompanies not covered under these Rules and all other entities
shall prepare and present the cost records and cost statements
in compliance with the applicable Cost Accounting Standards
and Generally Accepted Cost Accounting Principles issued by
the Institute.
7.4. C
 ost Statements as certified by the Cost Accountant in practice
should enable the business entity to determine value of taxable
goods or services at the time of supply and issue of tax invoice
as required under section 31 of the CGST Act.
7.5. I n cases where it may not be possible to determine true and fair
cost of goods or services at the time of supply of such goods
or services or both, the company should compute the cost on
budgeted/estimated/standard cost basis and the Cost Accountant
may issue provisional Cost certificate on such basis. In such
cases, final certificate shall be issued after costs are finalized.
In case of any variations in the costs and hence the value of
goods or services, the supplier shall issue a Debit or Credit
Note as per provisions of section 34 of the CGST Act.
Examples of such cases are – Input costs or prices based on the
LME prices; existence of cost escalation clauses in the supply
contract; or where future costs of inputs and input services are
unpredictable, uncertain and volatile, etc.
7.6. C
 ertified Cost Statements Shall Be Presented with the Fol-
lowing Periodicity:
7.6.1. In case of registered person, whose aggregate turnover
in the preceding financial year did not exceed the limits pre-
scribed in Section 10(1) of the CGST Act 2017, the Certified

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 Cost Accounting: An Overview

Cost Statement shall be issued for a six month period. For Notes
example, costs for April to September shall be certified in
March of the same year.
7.6.2. In case of registered person, whose aggregate turnover
in the preceding financial year exceeds the limits prescribed
in Section 10(1) of the CGST Act 2017, Certified Cost State-
ment shall be issued on quarterly basis, e.g., costs for July to
September shall be certified in June of the same year.
7.6.3. Certified Cost Statement shall also be issued for the
completed financial year, annually based on audited accounts
on or before 31st December of the next financial year.
7.7. T
 he cost statements shall be prepared by the Management and
authenticated & signed by any Key Management Personnel
in case of company, partner in case of partnership firm and
proprietor in case of proprietary firm.
7.8. T
 he statement shall be certified by a Cost Accountant in practice
after the same is duly authenticated as above. The certificate
may contain any qualification or disclosures as required.
8. Disclosures
8.1. D
 isclosure shall be made only where material, significant, and
quantifiable.
8.2. I f there is any change in cost accounting principles and practices
during the period under review which may materially affect
the cost of production or acquisition of goods or provision
services in terms of comparability with previous period(s), the
same shall be disclosed.
8.3. I f opening stock and closing stock of work-in-progress are not
readily available for certification purpose, the same should be
disclosed.
8.4. A
 ny fact which may have material impact on the costs as cer-
tified should be disclosed.
9. Effective Date
This Cost Accounting Standard shall be effective from 1st March
2019 and will apply for preparation and certification of Cost State-

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 COST ACCOUNTING

Notes ments for determining the Cost of Production / Acquisition / Supply

of Goods / Provision of Services as required under the provisions
of GST Act/Rules, from the financial year 2018-19.

Appendix 1
Statement of Cost of Production of the Taxable Goods
(refer Rule 30 of the CGST Rules, 2017)
A General Information
1 Name of the Manufacturer
2 Address of the Manufacturer
3 GSTIN of the Manufacturer
4 Description of the Product
5 HSN Code of the Product
6 Period of validity of Cost
Statement
B Quantitative Information Unit Quantity
1 Quantity produced
C Cost Unit Quantity Rate Amount Cost Per Unit
1 Cost of Material (Specify)
A.
B.
C.
Others
2 Process Materials/Chemicals
3 Cost of Utilities (specify)
A.
B.
C…..
4 Direct Employee Cost
5 Direct Expenses
6 Consumable Stores and
Spares
7 Repairs and Maintenance
Cost
8 Quality Control Cost
9 Research & Development
Cost
10 Technical Know-how Fee/
Royalty, if any
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 Cost Accounting: An Overview

11 Depreciation/Amortization Notes
12 Other Production Overheads
13 Administrative Overheads re-
lating to cost of
production
14 Industry specific Operating
Expenses
15 Total (1 to 14)
16 Work-in-Progress
Adjustments
17 Less Credit for Recoveries,
if any
18 Net Amount (15+/-16-17)
19 Packing Cost
20 Cost of Inputs received free or
at concessional value from or
on behalf the recipient of the
taxable goods (net of input
tax credit)
21 Amortised cost of moulds, tools,
dies and patterns, etc. received
free of cost from or on behalf
of the recipient of the taxable
goods.
22 Cost of Production (18 to 21)
We hereby affirm as follows
1. We have maintained the cost records as required.
2. The cost statement has been prepared in compliance with the ap-
plicable Cost Accounting Standards and generally accepted cost
accounting principles.

Date:  eal & Signature of the Company’s

S
Authorised Representative
I/We have verified the aforesaid cost data on test check basis with refer-
ence to the books of account, cost accounting records and other records.
Based on the information and explanations given to me/us, and our test
checks performed and on the basis of Cost Accounting Standards and
generally accepted cost accounting principles and practices followed by

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 COST ACCOUNTING

Notes the Industry, I/we certify that the above cost data reflects true and fair
view of the cost of production or manufacture of the above good.

Date: Seal & Signature of the Cost Accountant

Place: Membership No. Firm Reg. No.:
Note:
1. Separate Cost Statement(s) shall be prepared for each type of goods.
2. Any other material and significant fact in relation of the cost
statement(s) should be disclosed by way of Notes.

Appendix 2
Statement of Cost of Production of the Taxable Goods
(refer Rule 30 of the CGST Rules, 2017)
A General Information
1 Name of the Supplier of
service
2 Address of the Supplier
of service
3 GSTIN of the Supplier
of service
4 Description of the Product
5 Service Code
6 Period of validity of
Cost Statement
B Quantitative Informa- Unit Quantity
tion (if applicable)
Quantity of Service
Provided
C Cost Information Unit Quantity Rate Amount Cost per Unit
1 Material Consumed
(specify major items)
A.
B.

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 Cost Accounting: An Overview

C. Notes
Others
2 Utilities (specify)
A.
B.
C…..
3 Direct Employee Cost
4 Direct Expenses
5 Consumable Stores and
Spares
6 Repairs and Maintenance
Cost
7 Quality Control Cost
8 Research & Develop-
ment Expenses
9 Technical Know-how
Fee/Royalty, if any
10 Depreciation/
Amortization
11 Other Overheads relating
to provision of services
12 Administrative Over-
heads relating to cost
of production
13 Industry specific Operat-
ing Expenses
14 Free supplies received
from recipient or sup-
plied on behalf of recip-
ient, if any (net of input
tax credit)
15 Total (1 to 14)
16 Less Credit for Recover-
ies, if any
17 Cost of Services Provid-
ed (15-16)
We hereby affirm as follows –
1. We have maintained the cost records as required.

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 COST ACCOUNTING

Notes 2. T
 he cost statement has been prepared in compliance with the ap-
plicable Cost Accounting Standards and generally accepted cost
accounting principles.

Date: Seal & Signature of the Company’s

Representative Authorised
I/We have verified the aforesaid cost data on test check basis with refer-
ence to the books of account, cost accounting records and other records.

Based on the information and explanations given to me/us, and our test
checks performed and on the basis of Cost Accounting Standards and
generally accepted cost accounting principles and practices followed
by the Industry, I/we certify that the above cost data reflects true and
fair view of the cost of production or manufacture of the above good.

Date: Seal & Signature of the Cost Accountant

Place: Membership No. Firm Reg. No.:

Note:
1. Separate Cost Statement (s) shall be prepared for each type of goods.
2. Any other material and significant fact in relation of the cost
statement (s) should be disclosed by way of Notes.
Appendix 3
Statement Showing Cost of Acquisition of the Taxable Goods
(refer Rule 30 of the CGST Rules, 2017)
A General Information
1 Name of the Acquirer
2 Address of the Acquirer
3 GSTIN of the Acquirer
4 Description of the Product
acquired
5 HSN Code of the Product
6 Period during which the
goods were acquired

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 Cost Accounting: An Overview

7 Source by which acquired Indigenous/Imported Notes

B Quantitative Information Unit Quantity
1 Opening Stock of acquired
Goods
2 Goods acquired during
the period
3 Closing Stock of acquired
goods
4 Quantity of acquired goods
sold
C Cost Information (when Unit Quantity Rate Amount Cost per Unit
acquired from Indigenous
sources)
1 Purchase Cost of the Goods
acquired
2 Inward Freight
3 Inwards Insurance
4 Packing cost charged by
the Supplier
5 Incidental Expenses charged
by the Supplier
6 Commission charged by
the Supplier
7 Taxes, duties, cesses, fees and
charges levied under any law
other than the GST Laws
8 Interest or late fee or penalty
for delayed payment charged
by the Supplier
9 Less: Subsidy/Grants etc. re-
ceived from the Government
10 Storage Charges
11 Administrative Overheads re-
lating to acquisition of goods
12 L/C Commission and other
expenses directly connected
with acquisition of goods
13 Total (1 to 12)
14 Less: Trade Discount or
Rebate given by the Supplier
15 Less: Credit for Recoveries,
if any

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 COST ACCOUNTING

Notes 16 Less: Input Tax Credit availed

17 Cost of Acquisition (13 to 17)
D Cost Information (when Unit Quantity Rate Amount Cost per Unit
acquired from Foreign (Rs) (Rs) (Rs)
sources)
1 Purchase Cost of the Goods
acquired
2 Inward Ocean/sea Freight
from out of India to
customs port
3 Maritime Insurance
4 Clearing & Forwarding
Charges
5 Inland Inward Freight
6 Inward Insurance within India
7 Packing cost charged by
the Supplier
8 Incidental Expenses charged
by the Supplier
9 Commission charged by the
Supplier
10 Taxes, duties, cesses, fees and
charged levied under any law
other than the GST Laws,
where Input Tax Credit is
not available
11 Interest or late fee or penalty
for delayed payment charged
by the Supplier
12 Subsidy/Grant etc. paid
by the person other than
Government
13 Storage Charges
14 Administrative Overheads re-
lating to acquisition of goods
15 L/C Commission Charged
16 Total (1 to 15)
17 Less: Trade Discount or
Rebate given by the Supplier
18 Less: Credit for Recoveries,
if any
19 Less: Input Tax Credit availed
20 Cost of Acquisition (16 to 19)

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 Cost Accounting: An Overview

On the basis of aforesaid documents and other details available with Notes
us, we hereby affirm that the open market value/value as per goods
or services or both of the like kind and quality as stated above is
Rs. ______________.

Date: Seal & Signature of the Company’s

Representative Authorised
I/We have verified the aforesaid cost data on test check basis with refer-
ence to the books of account, cost accounting records and other records.
Based on the information and explanations given to me/us, and our test
checks performed and on the basis of Cost Accounting Standards and
generally accepted cost accounting principles and practices followed by
the Industry, I/we certify that the above cost data reflects true and fair
view of the cost of acquisition of the above taxable good.

Date: Seal & Signature of the Cost Accountant

Place: Membership No. Firm Reg. No.:

Note:
1. Separate Cost Statement (s) shall be prepared for each type of goods.
2. Any other material and significant fact in relation of the cost
statement (s) should be disclosed by way of Notes.
Appendix 4
Statement of Open Market Value/Value as Per Goods
or Services of Like Kind and Quality
(refer Rules 27 to 29 of the CGST Rules, 2017)
A General Information
1 Name of the Supplier of goods or ser-
vices or both*
2 Address of the Supplier of goods or
services or both*
3 GSTIN of the Supplier of goods or
services or both*
4 Description of the Product/Service*
5 HSN Code of the Product/Service Code*

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 COST ACCOUNTING

Notes 6 Period of validity of Cost Statement

7 List of Documents Verified

On the basis of aforesaid documents and other details available with

us, we hereby affirm that the open market value/value as per goods
or services or both of the like kind and quality as stated above is
Rs. __________________.

Date: Seal & Signature of the Company’s

Representative Authorised
I/We have verified the aforesaid documents on test check basis.
Based on the information and explanations given to me/us, and our test
checks performed, I/we certify that the above value reflects true and
fair value of the above taxable goods or services or both.

Date: Seal & Signature of the Cost Accountant

Place: Membership No. Firm Reg. No.:

Note:
1. Separate Statement(s) shall be prepared for each goods or for
each service.
2. Any other material and significant fact in relation of the cost
statement(s) should be disclosed by way of Notes.
*strike off whatever not relevant

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 L E S S O N

2
Cost Concepts
and Classification
Manisha Verma

STRUCTURE
2.1 Learning Objectives
2.2 Costs vs. Expense and Loss
2.3 Cost Classifications
2.4 Elements of Cost
2.5 Items Excluded from Cost Accounts
2.6 Cost Sheet
2.7 Answers to In-Text Questions
2.8 Self-Assessment Questions
2.9 Suggested Readings

2.1 Learning Objectives

After reading this lesson, student will be able to:
‹ Discuss the concept of costs vs. expense and loss.
‹ Describe cost classifications, and cost elements.
‹ Analyse the items to be excluded from cost accounts.
‹ Explain the concept & format of cost sheet.

2.2 Costs vs. Expense and Loss

The term ‘cost’ does not have a definite meaning and its scope is extremely broad and
general. It is, therefore, not easy to define or explain this term without leaving any doubt
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 COST ACCOUNTING

Notes concerning its meaning. Cost accountants, economists and others devel-
op the concept of cost according to their needs because one complete
description of `cost’ to suit all situations is not possible.
According to the Oxford Dictionary, cost means “the price paid for
something.” Some other definitions of cost are given below:
According to CIMA, London, “Cost is the amount of expenditure (actual
or notional) incurred or attributable to a given thing.”
According to WM Harper, “A cost is the value of economic resources
used as a result of producing or doing the things coasted.”
According to ICWA of India, “Cost is a measurement, in monetary terms,
of the amount of resources used for the purpose of production of goods
or rendering of services”.
Often the terms ‘cost’ and ‘expense’ are used interchangeably. But cost
should be distinguished from expense and loss.
Expense is defined as “an expired cost resulting from a productive usage
of an asset.” It is that cost which has been applied against revenue of a
particular accounting period in accordance with the principle of matching
costs to revenue. In other words, an expense is that portion of the revenue
earning potential of an asset which has been consumed in the generation
of revenue. Unexpired or unconsumed part of the cost is recorded as an
asset in the balance sheet. Such an unexpired cost is converted into an
expense when it expires while helping to earn revenue. For example: when
a plant is purchased, depreciation on plant (expired cost) is charged to
profit and loss account as an expense and cost of plant remaining after
providing depreciation (unexpired cost) is shown as an asset in the balance
sheet. Every year, depreciation on plant representing expense is debited
to profit and loss account and depreciated value representing unexpired
cost is shown in the balance sheet. Pre-paid insurance is also an example
of unexpired cost which is shown in the balance sheet as an asset.
Loss is defined as “reduction in, a firm’s equity other than from withdrawals
of capital for which no compensating value has been received.” A loss is
an expired cost resulting from the decline in the service p­ otential of an
asset that generated no benefit to the firm. Obsolescence or destruction
of stock by fire are examples of loss.

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 Cost Concepts and Classification

Notes
2.3 Cost Classifications
Classification is the process of grouping costs according to their com-
mon characteristics. It is a systematic placement of like items together
according to their common features.
The principal bases on which costs are classified are:
1. Variability (behavioral classification)
2. Functional areas (functional classification)
3. Responsibility (controllable and uncontrollable costs)
4. Traceability/identifiability (direct and indirect costs)
5. The accounting period charged to revenue (product costs and period
costs)
6. Decision-making (relevant and irrelevant costs).

2.3.1 Behavioral Classification

The basis of classification, the behaviour pattern of costs considers how
the costs respond, i.e. change with a given change in the volume of
production. While some costs vary with the change in the quantity of
output, others do not. Accordingly, there are three categories of costs:
fixed, variable and semi-variable.
Fixed costs: These are unaffected by variations in the volume of activity.
The total fixed costs remain constant over a relevant range of output,
while the fixed cost per unit varies with the output. Fixed costs have no
particular relation to the volume of activity. These are incurred irrespec-
tive of production and sales. These are usually time based. Some typical
examples are rent, insurance, taxes and managerial salaries.
Variable cost: These are the costs which vary in direct proportion to
changes in volume. They increase or decrease in the same proportion in
which the output increases or decreases. The total amount of variable
costs tends to change in respect to changes in production volume, but the
variable cost per unit stays at the same level for a considerable period
of time. Examples of such costs are direct material, direct labour, small
tools, commission of salesmen, and power.

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 COST ACCOUNTING

Notes Semi-variable costs: Also known as `mixed costs’. These costs include
both a fixed and a variable component, i.e. these are partly fixed and
partly variable. A semi-variable cost often has a fixed element below
which it will not fall at any level of output. The variable element in
semi-variable costs changes either at a constant rate or in lumps. For
example, introduction of an additional shift in the factory will require
additional supervisors and certain costs will increase by steps. In the case
of a telephone connection, there is a minimum rent and beyond a spec-
ified number of calls, the charges vary according to the number of calls
made. In fact, there is no definite pattern of behaviour of semi-variable
costs. Examples of such costs are supervision, maintenance and repairs,
telephone expenses, light and power, and depreciation.

2.3.2 Functional Classification

Costs classified according to managerial functions are accumulated
­according to the activity performed. The costs of a typical organization
may be divided into manufacturing, marketing, administrative and fi-
nancing groups.
Manufacturing cost: These are related to the production of an item. These
are the sum of direct materials, direct labour and factory overhead. In
other words, these include all the costs incurred in the factory up to that
stage when the goods are ready for dispatch. Examples are: salaries of
factory manager, supervisors and foremen, rent, rates and insurance of
the factory, power and fuel used in the factory, depreciation, maintenance
and repairs of building, plant, machinery tools, etc.
Administrative costs: These include all expenditures incurred in formu-
lating the plans, directing the organization and controlling the operations.
A major portion of these costs are policy costs which are of fixed nature
and, therefore, uncontrollable. These include salaries paid to manage-
ment and clerical staff, rent, rates and insurance of general offices, their
lighting, heating and air-conditioning, depreciation of office buildings,
furniture, machinery, etc.
Selling and distribution costs: Selling Cost: These are incurred to create
and stimulate demand and to secure orders. These include salaries, com-
mission and traveling expenses of salesmen and technical representatives
and sales managers, advertising, catalogues, price lists, bad debts and
collection charges, cost of market research, etc.
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 Cost Concepts and Classification

Distribution Cost: These are .the costs incurred in moving the goods Notes
from the point of production to the point of consumption. These include:
warehouse expenses, carriage outwards, depreciation and upkeep of de-
livery vans, wages of packers, van drivers, etc.
Financing costs: These are costs incurred for raising and using capital,
e.g., interest on loans and debentures, commission or brokerage on issue of
shares and debentures, discount on the issue of shares and debentures, etc.

2.3.3 Controllability Classification

Costs are also classified in terms of responsibility over them. Responsibility
carries the authority of the manager to influence costs-increase or decrease
their amount. As such, there are two groups: Controllable and uncontrollable.
Controllable Costs: Costs are said to be controllable when the amount of
the cost incurred can be influenced by the action of a specified member
(manager or supervisor) of an undertaking.
Uncontrollable Costs: Costs which cannot be influenced by the action of
a specified member (manager or supervisor) of an undertaking are known
as uncontrollable costs.
The distinction between controllable and uncontrollable costs depends
upon a point of reference. An item of cost may be uncontrollable at one
level of management but the same item may be controllable at another
level of management. Almost all costs are controllable at some level of
management. Segregation of costs into controllable and uncontrollable
categories will help the management in fixing responsibilities of different
executives for unfavourable cost variances. An executive should be held
responsible only for those costs which are under his control.

2.3.4 Manufacturing Classification

Costs are also classified as to when they are charged against revenue. The
basis as the period benefited by the particular cost. This is essential in
matching expenses against revenues in the relevant period. Such a grouping
helps management in income measurement for the preparation of financial
statements. Here, two categories are product costs and period costs.
Product Costs: These are the costs directly identified with the product.
These are the cost of goods produced and kept ready for sale. They are
direct materials, direct labour, variable factory overheads. These costs
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 COST ACCOUNTING

Notes provide no benefit till the product is sold, and are, therefore, inventoried.
When the products are sold, the total product costs are recorded as an
expense, and is called “cost of goods sold”. It is matched against revenue
for the period in which products are sold.
Period Costs: These are not directly related to the product and, therefore,
not inventoried. If the period costs benefit only one accounting period,
it is called revenue expenditure. If they benefit two or more accounting
periods, they are treated as assets till they are charged as expenditure for
the relevant years. Normally, expense of fixed nature like depreciation
of assets, insurance premium, rent and rates are treated as fixed costs.
These costs represent non-operating items and are related to passage of
time and not to the production and sales of the period.
In a manufacturing organisation all manufacturing costs are regarded as
product costs and non-manufacturing costs are regarded as period cost.
In retailing and wholesaling organisations goods are purchased for re-
sale without changing their basic form. The cost of goods purchased is
regarded as product cost and all other costs such as administration and
selling and distribution are considered to be period costs.

2.3.5 Identification/Traceability Classification

Costs are classified as direct and indirect costs on the basis of their
identification with particular jobs, products or processes.
Direct Cost: It is a cost which can be directly identified with a product,
process or department. Materials used and labour employed in manufac-
turing an article or in a particular process of production, are common
examples of direct costs.
Indirect Costs: These costs are not traceable to any particular product,
process or department, but are common to different products, processes
or departments. Factory manager’s salary, factory rent, depreciation of
machinery, etc., are typical examples of indirect costs.
The distinction between direct and indirect costs depends upon whether
or not the cost can be identified with the activity or other relevant unit.
A cost such as the plant superintendent’s salary can be readily identified
with the plant and hence is a direct cost of the plant. However, it is an
indirect cost of any department within the plant or of any line of prod-
uct manufactured. Thus the nature of business and cost unit chosen will

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 Cost Concepts and Classification

determine which are direct and which are indirect costs Direct costs are Notes
allocated whereas indirect costs are apportioned to different jobs, products
or services on a reasonable basis.

2.3.6 Decision-Making Classification

For managerial decision-making, costs are sub-divided as under:
(i) Relevant costs and
(ii) Irrelevant costs.
Relevant costs: These are costs which are relevant for decision-making
(for the future) such as differential or incremental costs, opportunity
costs, out-of-pocket costs, etc.
Differential Costs: Management is expected to make decisions and in doing
so compares alternatives. In making a decision, management compares the
costs of the alternatives. The costs that remain the same in any case can be
disregarded but the difference in cost between alternatives is relevant to de-
cision-making. A difference in cost between one course of action and another
is differential cost. If a decision results in an increased cost, the differential
cost may be called incremental cost. If the cost is decreased, the differential
cost may be referred to as a decremental cost. A decision in favour of an
alternative is taken only when, the incremental revenue between two levels
of output is greater than differential cost of those levels of activity. This
differential cost is the difference in net costs and benefits between two or
more alternative courses of action. If the selection of an alternative involves
changes in variable costs only, marginal cost and differential costs are the
same. However, a decision may involve changes in fixed costs also.
Opportunity Costs: In choosing between alternative management has to
select the best alternative but in doing so, has to give up the returns that
could have been derived from the rejected alternatives. The sacrifice of
a return or benefit from a rejected alternative is known as the opportu-
nity cost of the alternative accepted. Opportunity costs are not entered
in the accounting records, yet they are used in decision-making. Often
management is confronted with alternatives, each having its advantages.
Out-of-Pocket Costs: An out-of-pocket cost signifies the relevant cash
expenditure which is involved in a particular situation. Management de-
cisions are directly affected by such costs. Thus, an out-of-pocket cost is
the present or future cash expenditure connected with a certain decision
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 COST ACCOUNTING

Notes which will change according to the nature of the decision made. For
example, if it is proposed to replace the company’s delivery trucks by
an arrangement to deliver goods through public carriers, the depreciated
value of the truck is irrelevant (being a sunk cost) to decide upon the
proposal. But, the cost of fuel, driver’s salary and maintenance expenditure
involved in using the truck should be relevant costs in deciding whether
the delivery system should be changed. These are out-of-pocket costs.
Irrelevant costs: These are those which are not pertinent to a decision.
These are the costs that will not be changed by a decision. Because irrel-
evant costs will not be affected, they may be ignored in decision-making
process. An example of irrelevant cost is that of sunk cost.
Sunk Cost: It is a cost incurred as a result of decision made in the past
which cannot be reversed or altered by any decision in the future. Sunk
costs are irrelevant for decision-making. The written down values of assets
previously purchased are sunk costs. Let us suppose the management of a
company is considering the desirability of replacing an existing machine
with a new one. Suppose, an old machine originally costs Rs. 20,000
and it has been depreciated to the extent of Rs. 15000 so far. If it is
scrapped (no value being realisable on sale) there will be an accounting
loss of Rs. 5000. It would be wrong to recognise this loss as a cost for
deciding upon the proposed replacement. The book value of the existing
machine is really a sunk cost and the decision to replace or not to replace
the machine will not make any difference to its undepreciated value. It
is irrelevant to the question of replacing the existing machine. The dif-
ference in income which will result from the installation of new machine
and expected return on capital investment should be the deciding factor.
IN-TEXT QUESTIONS
1. What is the primary distinction between “cost” and “expense”?
(a) Cost is always recorded as an asset, whereas expense is
recorded as a liability.
(b) Cost refers to the price paid for something, while expense
is an expired cost applied against revenue.
(c) Cost and expense are interchangeable terms with no
differences.
(d) Cost is a broader term, whereas expense only applies to
the unconsumed portion of cost.
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 Cost Concepts and Classification

2. Which of the following costs is considered a “semi-variable Notes

cost”?
(a) Depreciation on plant
(b) Direct material
(c) Telephone expenses with a fixed rent and variable charges
(d) Sales commission
3. What is an example of a “sunk cost”?
(a) Depreciated value of an old machine being replaced
(b) Opportunity cost of choosing one project over another
(c) Fuel costs incurred for delivery trucks
(d) Research costs for a future product
4. What type of cost is classified as relevant for decision-making?
(a) Sunk cost
(b) Differential cost
(c) Indirect cost
(d) Period cost

2.3.7 Other Cost Concepts

Shut down cost: These are the costs which will still be incurred although
a plant is shut down temporarily, e.g., rent, rates, depreciation, mainte-
nance of plant, etc.
Research cost: It is the cost of searching for new or improved products,
new application of materials or new or improved methods of production.
Development cost: It is the cost of the process which begins with the
implementation of the decisions to produce a new/improved product. It
ends with the commencement of production of that product or method.
Thus, it is the cost of commercial exploitation of successful research.
Development cost of new products is treated as an item of deferred ex-
penditure to be spread over a number of years. It is charged to product
costs when production is fully established.
Joint cost: These are the costs incurred up to the point in a given pro-
cess where individual products can be identified. Whenever two or more

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 COST ACCOUNTING

Notes products are produced out of the same basic raw material or process, the
cost of material purchased and processing are called joint costs. Such
costs have to be apportioned to various products on some basis.

2.4 Elements of Cost

A cost is composed of three elements, i.e., material, labour and expense.
Each of these elements may be direct or indirect.
Material Cost: According to CIMA, London, material cost is “the cost of
commodities supplied to an undertaking.” Material cost includes cost of
procurement, freight inwards, taxes, insurance, etc., directly attributable
to the acquisition. Trade discounts, rebates, duty drawbacks, refund on
account of modvat, sales tax, etc., are deducted in determining the cost
of material. Materials may be direct or indirect.
Direct materials: Direct material cost is that which can be conveniently
identified with and allocated to cost units. Direct materials generally
become a part of the finished product. For example, cotton used in a
textile, clay in bricks, leather in shoes, steel in machines, cloth in gar-
ments, timber in furniture.
Indirect materials: These are those materials which cannot be conveniently
identified with individual cost units. These are minor in importance, such as
(i) small and relatively inexpensive items which may become a part of the
finished product, e.g., pins, screws, nuts and bolts, thread, etc., (ii) those
items which do not physically become a part of the finished products, e.g.,
coal, lubricating oil and grease, sand paper used in polishing, soap, etc.
Labour Cost: According to CIMA, London, labour cost is “the cost of
remuneration (wages, salaries, commission,bonuses etc) of the employees
of an undertaking.” It includes all fringe benefits like PF contribution,
gratuity, ESI, overtime, incentive bonus, wages for holidays, idle time
etc. Labour may be direct or indirect.
Direct labour cost consists of wages paid to workers directly engaged
in converting raw materials into finished products. These wages can be
conveniently identified with a particular product, job or process. Wages
paid to a machine operator, shoe-maker carpenter, weaver, tailor is a
case of direct wages.

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 Cost Concepts and Classification

Notes
Indirect labour: It is of general character and cannot be conveniently
identified with a particular cost unit. In other words, indirect labour is
not directly engaged in the production operations but only to assist or
help in production operations. Supervisor, Inspector, Cleaner, Clerk, Peon,
Watchmen are examples of indirect labour.
Expenses: All costs other than material and labour are termed as expens-
es. According to CIMA, London. It is defined as “the cost of services
provided, to an undertaking and the notional cost of the use of owned
assets.” Expenses may be direct or indirect.
Direct expenses: are those expenses which can be identified with and
allocated to cost centres or units. These are those expenses which are
specifically incurred in connection with a particular job or cost unit. Direct
expenses are also known as chargeable expenses. Hire of special plant for
a particular job, Travelling expenses in securing a particular contract, Cost
of patent rights, Experimental costs, Cost of special drawings, designs
and layouts, Job processing charges, Royalty paid in mining, Depreciation
or hire of a plant used on a contract at site are examples of direct costs.
Indirect expenses: All indirect costs, other than indirect materials and
indirect labour costs, are termed as indirect expenses. These cannot be
directly identified with a particular job, process or work order and are
common to cost units or cost centres. Rent and rates, Depreciation,
Lighting and power, Advertising, Insurance, and Repairs are examples
of indirect expenses.
Direct material + Direct labour + Direct expenses = Prime Cost
Indirect material + Indirect labour + Indirect expenses = Overhead
Overheads are divided into three groups as follows:
Manufacturing (works, factory or production) overheads: Such
(a) 
indirect expenses which are incurred in the factory and concerned
with the running of the factory or plant are known as manufacturing
overheads. Following are a few items of such expenses: Rent, rates
and insurance of factory premises, power used in factory building,
plant and machinery, etc.
O ffice and Administrative Overheads. These indirect expenses
(b) 
are not related to factory but they pertain to the management and

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 COST ACCOUNTING

Notes administration of business. Such expenses are incurred on the

direction and control of an undertaking. Examples are: Office rent,
lighting and heating, postage and telegrams, telephones and other
charges, depreciation of office building, furniture and equipment,
bank charges, legal charges, audit fee etc.
Selling and Distribution Overheads. Indirect Expenses incurred
(c) 
for marketing of a commodity, for securing orders for the articles,
despatching goods sold, and for making efforts to find and retain
customers, are called selling and distribution overheads. Examples
are advertisement expenses, cost of preparing tenders, travelling
expenses, bad debts, collection charges, warehouse charges, packing
and loading charges, carriage outwards, etc.

2.5 Items Excluded from Cost Accounts

There are certain items which are included in financial accounts but not
in cost accounts. These items fall into three categories:
Appropriation of Profits
(i) Appropriation to sinking funds.
(ii) Dividends paid.
(iii) Taxes on income and profits.
(iv) Transfers to general reserves.
(v) Amount written off-goodwill, preliminary expenses, underwriting
commission, discount on debentures issued, expenses on capital issue.
(vi) Capital expenditure specifically charged to revenue.
(vii) Charitable donations.
Matters of Pure Finance
(a) Purely financial charges:
(i) Losses on sale of investments, buildings, etc.
(ii) Expenses on transfer of company’s office.
(iii) Interest on bank loan, debentures, mortgages, etc.
(iv) Penalties and fines.

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 Cost Concepts and Classification

(v) Losses due to scrapping of machinery. Notes

(vi) Remuneration paid to the proprietor in excess of a fair reward
for services rendered.
(b) Purely financial income:
(i) Interest received on bank deposits.
(ii) Profits made on the sale of investments, fixed assets, etc.
(iii) Transfer fees received.
(iv) Rent receivable.
(v) Interest, dividends, etc., received on investments.
(vi) Brokerage received.
(vii) Discount, commission received.
Abnormal Gains and Losses
(i) Losses or gains on sale of fixed assets.
(ii) Loss to business property on account of theft, fire or other natural
calamities.

2.6 Cost Sheet

The statement of cost according to element-wise is known as cost sheet.
The preparation of cost-sheet is one of the most important and primary
function of cost accounting. The statement discloses the following:
1. Prime cost
2. Work cost
3. Cost of production
4. Total cost
When the total cost is divided by the number of units produced, quotient
is the average cost per unit of the work performed. Separate columns
could be provided for the total and unit cost of each element of cost.
Columns could also be drawn for the current and the past periods. Cost
sheet is prepared at weekly, monthly or other intervals.

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 COST ACCOUNTING

Notes ABC Ltd.

COST SHEET FOR THE PERIOD…….
Production-Units
Total cost (Rs.) Cost per unit(Rs.)
Direct Materials:
Opening stock
Purchases
Carriage inwards
Less: Closing stock
Direct materials consumed
Direct wages
Direct expenses
Prime Cost:
Add: Works or Factory Overheads:
Indirect materials
Indirect wages
Rent and rates (factory)
Lighting and heating
Power and Fuel
Repairs and maintenance
Cleaning
Drawing office expenses
Cost of research & experiments
Depreciation of factory plant
Works stationery
State insurance
Welfare service expenses Insurance-Fixed assets etc.
–Stock and finished goods
Loose tools-Very small
Works manager’s salaries etc.

Works or Factory Cost:

Add: Office and Administrative Overheads:
Rent and rates
Salaries
Lighting and heating
Insurance Cleaning

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 Cost Concepts and Classification

Telephone and postage Notes

Printing and stationery
Depreciation of furniture and office Equipments and buildings
Legal expenses
Audit fees
Bank charges
Cost of Production:
Add: Selling and Distribution Overheads:
Showroom rent and rates
Lighting and heating
Salemen’s salaries
Commission
Travelling expenses
Sales printing and stationery
Advertising
Bad debts
Postage
Depreciation and expenses of delivery vans
Debt collection expenses
Carriage freight outwards
Samples and other free gifts

Cost of Sales:
Add: Profit
Sales
While preparing cost sheet, special attention must be paid to the stock.
Stocks may be of raw materials, work-in-progress, and finished goods.
Stock of raw materials. In a manufacturing enterprise, besides normal
purchases, there is always a certain amount of opening and closing stock
of raw materials. For the purpose of cost sheet, the value of raw materials
used can be ascertained with the help of the following formula:
Value of materials consumed = Opening stock of raw materials + Net
purchases + Expenses on Purchase – Closing stock of raw materials
Stock of work-in-progress: It rarely happens that every unit initiated
during a period is finished in that very period. These incomplete units
are called ‘work-in-progress’. It may be valued either on the basis of
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 COST ACCOUNTING

Notes prime cost or works cost. However, its valuation on works cost basis
i.e. prime cost plus proportionate factory overheads, is more scientific.
Treatment of work-in-progress in the cost sheet or production account
is made as follows:
Prime cost + Factory overheads + Opening balance (stock) of work-in-
Progress – Closing balance (stock) of work-in-progress
Stock of finished goods: If the opening and closing stocks of finished
goods are also given, these must be adjusted before calculating cost of
goods sold as follows:
Cost of production + Opening stock of finished goods – closing stock
of finished goods = Cost of goods sold
Treatment of scrap: Scrap is the incidental residue from certain types of
manufacture. It is generally, of small amount and low value, recoverable
without further processing. Such realizable value of scrap is deducted
from the factory overheads or the factory cost.
IN-TEXT QUESTIONS
5. What are the three main elements of cost as per the given
content?
(a) Fixed, Variable, and Semi-variable Costs
(b) Material, Labour, and Expense
(c) Direct, Indirect, and Overhead Costs
(d) Manufacturing, Administrative, and Selling Costs
6. Which of the following is NOT included in the cost of material?
(a) Freight inwards
(b) Trade discounts
(c) Taxes on acquisition
(d) Wages paid to workers
7. What is an example of indirect labour?
(a) Machine operator
(b) Shoe-maker
(c) Supervisor
(d) Weaver

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 Cost Concepts and Classification

8. Which of the following is an example of selling and distribution Notes

overheads?
(a) Depreciation of office furniture
(b) Rent of factory premises
(c) Advertisement expenses
(d) Power used in the factory

2.7 Answers to In-Text Questions

1. (b) Cost refers to the price paid for something, while expense is
an expired cost applied against revenue.
2. (c) Telephone expenses with a fixed rent and variable charges
3. (a) Depreciated value of an old machine being replaced
4. (b) Differential cost
5. (b) Material, Labour, and Expense
6. (d) Wages paid to workers
7. (c) Supervisor
8. (c) Advertisement expenses

2.8 Self-Assessment Questions

1. Prepare a cost sheet for the period ended 31 March 2007
Cost of raw material Rs. 200000
Productive wages Rs. 150000
Indirect labour Rs. 10000
Carriage inwards Rs. 20000
Other factory expenses Rs. 25000
Office expenses Rs. 40000
Legal expenses Rs. 10000
Expenses for testing the quality of goods Rs. 5000
General managers salary Rs. 30000
Selling expenses Rs. 20000
Profit 20% on total cost

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 COST ACCOUNTING

Notes Answer: Rs.

Direct Material: Cost of raw material 200000
Direct Wages: Productive wages 150000
Direct expenses: Carriage inwards   20000
PRIME COST 370000
Add Factory Overheads
Indirect labour 10000
Other factory expenses   25000
FACTORY COST 405000
Add Office Overheads
Office expenses 40000
Legal expenses 10000
General manager’s salary   30000
COST OF PRODUCTION 485000
Add Selling & Distribution Overheads
Expenses for testing the quality of goods 5000
Selling expenses 20000
COST OF SALES/TOTAL COST 510000
PROFIT 20% on cost 102000
SALES 612000
2. Find cost of sales and profit.
Opening Stock Closing Stock
Raw material 25000 26000
Finished goods 17000 16000
Work in progress 8000 9000
Purchases of raw material 30000
Direct wages 17000
Work expenses 8800
Office expenses 3000
Selling expenses 4000
Sale of finished goods 77000
Depreciation of plant and machinery 8000
Sale of scrap 3000

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 Cost Concepts and Classification

Answer Notes
Direct Material: Opening Stock Raw material 25000
Add Purchases of raw material 30000
Less Closing Stock of raw material 26000
Direct wages 17000
PRIME COST 46000
Add Factory Overheads
Work expenses 8800
Depreciation of plant and machinery   8000
62800
Less Sale of scrap   3000
GROSS FACTORY COST 59800
Add Opening Stock WIP 8000
Less Closing stock WIP   9000
NET FACTORY COST 58800
Add Office Overheads
Office expenses   3000
COST OF PRODUCTION 61800
Add Opening Stock of finished goods 17000
Less Closing stock of finished goods 16000
COST OF GOODS SOLD 62800
Add Selling & Distribution Overheads
Selling expenses   4000
COST OF SALES 66800
Profit 10200
SALES 77000

2.9 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 COST ACCOUNTING

Notes Appendix

COST ACCOUNTING

Introduction to Cost Accounting Standards

The Institute of Cost Accountants of India has constituted Cost Account-
ing Standards Board (CASB) with the objective of formulating the Cost
Accounting Standards keeping in view latest legal and contemporary
developments. This was done to achieve a structured approach to the
measurement of cost in both manufacturing and service sectors. It helps
the user organisations, government bodies, regulators, research agencies
and academic institutions to achieve uniformity and consistency in clas-
sification, measurement and assignment of cost to product and services.
Starting from 2001-02, CASB meets a number of times as and when
required under the Chairmanship of the Chairperson. CASB also issues
Guidance Notes to explain the requirements of Standards and provide
the guidance with practical examples and illustrations on technical issues
relating to Cost Accounting Standards issued by the Institute. There may
be other technical issues relating to topics of importance for which the
Cost Accounting Standards are not necessary but these technical issues
need guidance to members and industry with respect to measurement,
classification, assignment and presentation of cost in cost statements.
CASB issues Guidance Notes on such topics. The Institute/Board has so
far issued:
‹ 24 Cost Accounting Standards (CASs).
‹ Generally Accepted Cost Accounting Principles (GACAP).
‹ 9 Guidance Notes on Cost Accounting Standards (CAS-2 (Revised
2015), CAS-4, CAS-6, CAS-7, CAS-8, CAS-9, CAS-10, CAS-11
and CAS-12] and
‹ 2 Guidance Notes on “Treatment of Costs Relating to Corporate
Social Responsibility (CSR) Activities” and “Maintenance of Cost
Accounting Records for Construction Industry Including Real Estate
and Property Development Activity”.

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 Cost Concepts and Classification

Notes
CASB issued limited Revision of Guidance Notes on the above CASs in
view of changes brought out by Companies (Cost Records and ­Audit) Rules
2014 with respect to maintenance of cost records. The Cost ­Accounting
Standard consists of Introduction, Objectives of issuing standards, Scope
of standard, Definitions and explanations of the terms used in the stan-
dard, Principles of Measurement, Assignment of Cost, Presentation and
Disclosure.
Periodically the CASB Secretariat organises a number of programmes
on Cost Accounting Standards for members and others throughout India.
It also organises meetings with the stakeholders to discuss the various
flagged issues to arrive at consensus on the same. CASB issues clarifi-
cations and opinions on the queries received from Regulators, Industry
and other Stakeholders.

List of Cost Accounting Standards (CAS)

and Guidance Notes Issued as on Date
Effective Date (for
the Period Com-
CAS No. Title mencing from) Guidance Note
CAS 1 Classification of 1st April 2015
(Revised 2015) Cost
CAS 2 Capacity Determi- 1st April 2016
(Revised 2015) nation Guidance Note
CAS 2 1st April 2012 on Capacity
(Revised 2012) Capacity Determi- Determination
nation CAS-2
(Revised 2015)
CAS 3 Production and 1st April 2016
(Revised 2015) Operation Over-
CAS 3 heads
1st April 2012
(Revised 2011) Overheads
CAS 4 Cost of Production 1st April, 2010 Revised Guidance
for Captive Con- Note on Cost of
sumption Production for
Captive Consump-
tion (CAS-4)

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 COST ACCOUNTING

Notes CAS 5 Average (Equal- 1st April 2010

ized) Cost of
Transportation
CAS 6 Material Cost 1st April 2010 Guidance Note
on Material Cost
(CAS-6)
CAS 7 Employee Cost 1st April 2010 Guidance Note
on Employee
Cost (CAS-7)
CAS 8 Cost of Utilities 1st April 2010 Guidance Note
on Cost of Utili-
ties (CAS-8)
CAS 9 Packing Material 1st April 2010 Guidance Note
Cost on Packing Mate-
rial Cost (CAS-9)
CAS 10 Direct Expenses 1st April 2010 Guidance Note
on Direct Ex-
penses (CAS-10)
CAS 11 Administrative 1st April 2010 Guidance Note
Overheads on Administra-
tive Overheads
(CAS-11)
CAS 12 Repairs and Main- 1st April 2010 Guidance Note
tenance Cost on Repairs and
Maintenance Cost
(CAS-12)
CAS 13 Cost of Service 1st April 2011
Cost Centre
CAS 14 Pollution Control 1st April 2012
Cost
CAS 15 Selling and Distri- 1st April 2013
bution Overheads
CAS 16 Depreciation and 1st April 2014
Amortisation
CAS 17 Interest and Fi- 1st April 2014
nancing Charges
CAS 18 Research and De- 1st April 2014
velopment Costs

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 Cost Concepts and Classification

CAS 19 Joint Costs 1st April 2014 Notes

CAS 20 Royalty and Techni- 1st April 2014
cal Know-How Fee
CAS 21 Quality Control 1st April 2014
CAS 22 Manufacturing Cost 1st April 2015
CAS 23 Overburden Removal 1st April 2017
Cost
CAS 24 Treatment of Rev- 1st April 2017
enue in Cost State-
ments
Guidance Note
on “Treatment of
Costs Relating to
Corporate Social
Responsibility
(CSR) Activities”.
Guidance Note
on “Maintenance
of Cost Account-
ing Records for
Construction In-
dustry Including
Real Estate and
Property Devel-
opment Activity”.
Source: The Institute of Cost Accountants of India, CASB.

Introduction to Cost Accounting Records and Audit Rules

The Companies Act, 2013 empowers the Central Government to make the rules
regarding the maintenance of cost records by the companies engaged in the spec-
ified industries and getting it audited, vide Section 148. The Central Government
has made several notifications or orders, from time to time, in this regard ever
since the provisions were made in the Companies Act, 1956, as well as under the
Companies Act, 2013. The Companies (Cost Records and Audit) Rules, 2014
came into force on 30th June, 2014. These rules were amended on 31st
December 2014; 12th June 2015 and further amended on 14th July 2016.

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 COST ACCOUNTING

Notes Details of the Companies (Cost Records and Audit) Rules and Forms
Rules/Forms Details
Rule 1: Short title and(1) These rules may be called the Companies
commencement (Cost Records and Audit) Rules, 2014.
(2) T hey shall come into force on the date of publi-
cation in the Official Gazette i.e. 30.06.2014.
Rule 2: Definitions In these rules, defined various points - (a) Act;
(aa) Central Excise Tariff Act Heading; (b) Cost
Accountant in practice; (c) cost auditor (d) cost
audit report; (e) cost records; (f) form; (g) insti-
tute; (h) all other words and expressions used in
these rules but not defined, and defined in the Act
or in the Companies (Specification of Definition
Details) Rules, 2014 shall have the same meanings
as assigned to them in the Act or in the said rules.
Rule 3: Application of Two categories (regulated sectors and nonregu-
Cost Records lated sectors) have been retained and a general
threshold of turnover of 35 crores or more has
been prescribed for companies covered. Micro en-
terprise or a small enterprise as per MSMED Act,
2006 have been taken out of the purview.
Rule 4: Applicability Even for regulated sectors like Telecommunica-
for Cost Audit tion, Electricity, Petroleum and Gas, Drugs and
Pharma, Fertilizers and Sugar, Cost Audit require-
ment has been made subject to a turnover based
threshold of 50 crores for all product and services
and 25 crores for individual product or services.
For Non-regulated sector the threshold is 100
crores and 35 crores respectively.
Rule 5: Maintenance of The requirement to maintain cost records in Form
Cost Records CRA-1 have been postponed to Financial Year
2015-16 for the following companies in some non-
regulated sectors, namely; Coffee and Tea, Milk
Powder and Electricals and Electronic machinery.
Rule 6: Cost Audit Any casual vacancy in the office of a cost auditor,
whether due to resignation, death or removal to be
filled by the Board of Directors within thirty days
of occurrence of such vacancy and the compa-
ny shall inform the Central Government in Form
CRA-2 within thirty days of such appointment of
cost auditor.
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 Cost Concepts and Classification

CRA-1: Forms in The form CRA-1 prescribes the form in which Notes
which cost records cost records shall be maintained. The form
shall be maintained categorises the requirement of maintaining proper
[Pursuant to rule 5(1)] details as per 30 headings. The headings are as
follows: (1) Material Cost, (2) Employee Cost,
(3) Utilities, (4) Direct Expenses, (5) Repair and
Maintenance, (6) Fixed Assets and Depreciation,
(7) Overheads, (8) Administrative Overheads,
(9) Transportation Cost, (10) Royalty and
Technical know-how, (11) Research and
Development expenses, (12) Quality Control
Expenses, (13) Pollution Control Expenses,
(14) Service Department Expenses, (15) Packing
Expenses, (16) Interest and Financing Charges,
(17) Any other item of Cost, (18) Capacity
Determination, (19) Work in-progress and finished
stock, (20) Captive Consumption,
(21) By Products and Joint Products,
(22) Adjustment of Cost ­Variances,
(23) Reconciliation of Cost and Financial
Accounts, (24) Related Party Transactions,
(25). Expenses or Incentives on Exports,
(26). Production records, (27) Sales records,
(28) Cost Statements, (29) Statistical Records,
(30) Records of Physical Verification.
CRA-2: Form of inti- (1) Corporate Identity Number (CIN) or Foreign
mation of appointment ­Company Registration Number (FCRN) of the
of cost auditor by the company (2) General Information (3) Product(s)/­
company to Central Service(s) to which Cost Audit relates (4) Details of
Government [Pursuant all the Cost ­Auditor(s) appointed (5) Financial year
to rule 6(2) & (3A)] to be covered under the Cost Audit (6) Details of
previous Cost ­Auditor which has not been reappoint-
ed (7) ­Attachments - Copy of the Board resolution
of the company - Optional attachment - if any.
CRA-3: Form of Cost Clause (vii) have been added to auditor’s report as
Audit Report [Pursuant under: Detailed unit-wise and product/servicewise
to rule 6(4)] cost statements and schedules thereto. In respect
of the product/services under reference of the
company duly audited and certified by me/us are/
are not kept in the company.

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 COST ACCOUNTING

Notes CRA - 4: Form for fil- (1) Corporate Identity Number (CIN) or Foreign
ing Cost Audit Report Company Registration Number (FCRN) of the
with the Central Gov- company (2) General Information (3) Corporate
ernment [Pursuant to Identity Number (CIN) or Foreign Company Regis-
rule 6(6)] tration Number (FCRN) of the company (4) Details
of Industries/Sectors/Product(s)/Service(s) (CETA
headling level, wherever applicable as per Rules for
Regulated and Non-regulated sector) for which the
Cost Audit Report is being submitted (5) Details
of Industries/Sectors/Product(s)/ Service(s) (CETA
headling level, wherever applicable as per Rules for
Regulated and Non-regulated sector) not covered in
the Cost Audit Report (6) Details of the cost au-
ditor(s) appointed (7) Details of observation of the
Cost Audit report (8) Attachment - XBRL document
in respect of the cost audit report and Company’s
information and explanation on every Qualification
and reservation contained therein - Optional attach-
ment, if any.
Source: The Companies (Cost Records and Audit) Rules, 2014 [as amended up to
15th July 2016], The Institute of Cost Accountants of India.

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 L E S S O N

3
Labour Cost
Manisha Verma

STRUCTURE
3.1 Learning Objectives
3.2 Meaning of Labour
3.3 Control Over Labour Costs
3.4 Personnel Department
3.5 Engineering Department
3.6 Labour Remuneration
3.7 Answers to In-Text Questions
3.8 Self-Assessment Questions
3.9 Suggested Readings

3.1 Learning Objectives

After reading this lesson, student will be able to:
‹ Describe the meaning of labour & concept of control over labour costs.
‹ Discuss about personnel and engineering department.
‹ Explaint the concept of labour remuneration.
‹ Discuss the different method of wages payments in incentive schemes.

3.2 Meaning of Labour

Labour is the physical or mental effort expended, in manufacturing a product. Labour cost
is the price paid for using human resources. The compensation to employees who work
in production represents labour cost. Total labour, cost like material costs can broadly be
classified into: (a) direct and (b) indirect. Direct labour is defined, as labour that is d­ irectly
involved in the production of a finished product. It can be associated directly with the
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 COST ACCOUNTING

Notes product. Examples are: assembly line workers in an automobile factory or

knitting machine operators in a sweater factory. Indirect labour includes
wages paid for all labour which is not directly engaged in changing the
shape or composition of raw material. It cannot be traced directly to the
product Examples of indirect labour cost are wages paid to foremen,
supervisors, storekeeper, timekeepers, salaries of office executives and
the commission payable to sales representatives.

3.3 Control Over Labour Costs

Labour cost control is based upon predetermined standards of efficiency
and comparisons of actual costs with the standards as production pro-
gresses. Effective control is achieved through (a) production planning;
(b) use of labour budgets and labour standards; (c) labour performance
reports; and (d) appropriate payment for labour performance including
wage incentive schemes. Production schedules, performance standards and
labour budgets represent plans and expectations. But efficient control of
labour efficiency and costs depends on meaningful and timely performance
reports sent to foremen and supervisors, who are directly responsible for
departmental production. Performance reports are designed to compare
budgets and standards with actual results attained thereby pointing to
variances from planned and expected performance. Control of labour
cost is effected in a large industrial concern by the concerted efforts of
the following departments:
1. Personnel
2. Engineering
3. Time-keeping
4. Pay-roll
5. Cost accounting.

3.4 Personnel Department

The chief function of the personnel department is to provide an efficient
labour force. Personnel functions most directly related to labour cost
control involve employment procedures, job descriptions, job evaluation
and time and motion study. Hiring of employees may be for replacement

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 Labour Cost

or for expansion. Recruitment, interviewing, testing, physical examina- Notes

tion, induction procedures and assignment to jobs are carried out by this
department.

3.4.1 Employee’s History Card

The personnel department maintains a complete record of each ­worker of
the organisation. As soon as an employee joins the organisation a personal
file is maintained for him. This file is known as worker’s history card
or personal record card. The service history card gives full details of the
employee and essential information about him during his employment
in the concern. A specimen of the service history card with necessary
columns is given.
Besides permanent recruitment of workers, an organisation needs workers
for short period known as casual or temporary workers. In the interest
of the organization and effective cost control, it is advisable that (a) all
recruitments are made through the personnel department, (b) frequent
reviews of all placements for promotion/transfer be made; (c) labour
utilisation report should be introduced in each department and (d) absen-
teeism and labour turnover should be kept at a minimal.

EMPLOYEE’S HISTORY CARD

EMPLOYEE’S HISTORY (OR PERSONAL RECORD) CARD
Clock Number������������������������������
Name��������������������������������������������
Address����������������������������������������� Marital Status�������������������������������
Date of Birth�������������������������������� Children����������������������������������������
Education�������������������������������������� Previous Experience���������������������
Date of Employment�������������������� Grade��������������������������������������������
Department����������������������������������� Starting Pay����������������������������������
Category��������������������������������������� Engaged as�����������������������������������
Date left���������������������������������������� Previous Employer������������������������
Reason for leaving����������������������� Re-engaged�����������������������������������

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 COST ACCOUNTING

Notes
PARTICULARS OF CHANGES IN PAY AND SERVICE
Date Occupation Grade Pay Reason for change (increment,
transfer, promotion or demotion etc.)

3.4.2 Labour Turnover

Labour turnover is the rate of displacement of personnel employed in an
organisation. A high labour turnover is a sign of instability of labour. It
results in low morale with the attendant costs associated with demoralised
staff. It is important that labour turnover is kept-as low as possible. The
low labour turnover rate is an indication of.
1. Well managed organization.
2. Higher preventive costs being incurred by the management for the
satisfaction of employees.
3. Strong and well organised trade union exerting considerable influence
over the management.
4. Considerable state regulatory control over the policy of the management
in respect of employment and retrenchment.
5. Absence of alternative avenues for better employment and
6. Widespread unemployment as in India.
Labour turnover arises because of various factors including dissatisfac-
tion with job, low rate of wages, unsatisfactory working conditions, and
non-availability of adequate basic amenities. The causes of labour turnover
may be sub-divided into:
1. Personal causes;
2. Avoidable causes, and
3. Unavoidable causes.
(i) Personal causes: These causes induce or compel workers to leave
their jobs purely on personal grounds, including the following:
(a) Change of job for betterment.
(b) Premature retirement due to ill health and old age.

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 Labour Cost

(c) Domestic responsibilities to look after old parents. Notes

(d) Discontentment over the job and working environment.
(e) Marriage, especially female workers or later on childbirth.
(f) During seasons of festivals, marriage or harvesting, the workers
in the cities leave for home in large batches.
(ii) Avoidable causes: These include:
(a) Low wages in the present organisation and the worker may
look for higher wages elsewhere,
(b) Dissatisfaction with job,
(c) Bad working conditions,
(d) Long and odd working hours,
(e) Unsatisfactory relationship with the supervisors,
(f) Bad relationship with the fellow workers,
(g) Lack of adequate recreational facilities,
(h) Inadequate housing, medical facilities,
(i) Unfair methods of promotion and lack of promotional avenues,
(j) Lack of planning and foresight on the part of management,
seasonal nature of industry, non­availability of raw materials,
power, etc.
(iii) Unavoidable causes: These include:
(a) Seasonal nature of business,
(b) Change in the plant location,
(c) Shortage of raw material; power; slack market for the product,
(d) Accident or illness rendering workers permanently incapable
to work,
(e) D ismissal or discharge due to insubordination, negligence,
inefficiency, etc.,
(f) Marriage, specially in case of women workers.
Effect of Labour Turnover: The higher rate of labour turnover results
in increased cost of production. This is due to:
1. Increased cost of new recruitment and training,

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 COST ACCOUNTING

Notes 2. Interruption of production,

3. Decrease in production due to inefficiency and inexperience of
newly recruited workers,
4. The new workers are more accident prone and are liable to cause
more damage to machinery, tools than old employees,
5. Losses due to wastage, spoilage and defectives,
6. Increased number of accidents causing loss of output and increase
in medical expenses and cost of repairs.
7. Lack of cooperation and coordination between old and new employees
resulting in fall in output and increased cost of production.
Labour turnover is measured by any of the following methods:
1. Separation Method: This method takes into account only those
workers who have left during a particular period. It is calculated
as follows:
No. of workers left during a period
Labour turnover Rate   100,
Average number of workers in the period

2. Replacement Method: This method takes into consideration only the

actual replacement of labour irrespective of the number of persons
leaving. If new workers are employed on account of expansion of
business, they are not included in replacements. It is calculated as
follows:
No. of workers replaced during a period
Labour turnover Rate   100,
Average number of workers in the period

3. Flux Method: It denotes total change in the composition of labour

force due to addition and separations of workers. It is calculated
as follows:
No. of separation  No. of additions
Labour Turnover Rate   100
Average number of workers in the period

From the management point of view, the cost of labour turnover can be
divided into two groups:
‹ Preventive costs,
‹ Replacement costs.

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 Labour Cost

Preventive Costs: These include costs incurred to keep the labour turn- Notes
over rate as low as possible. The object of incurring preventive costs is
to keep the workers satisfied and induce them to stay in the organisation.
The preventive costs include:
1. Cost of providing medical, housing and other recreational facilities,
2 Cost of providing benefits like pension, gratuity,
3. Cost of providing educational facilities to the children of the
employees,
4. Cost of providing good working conditions, and.
5. Cost of providing other welfare facilities.
If a company incurs high preventive costs, the rate of labour turnover
is likely to be low.
Replacement Costs: These costs arise on account of labour turnover and
consequential replacement of employees. These costs include:
1. Cost of recruitment and training of new workers,
2. Loss of output due to (a) interruption of production (b) inefficiency
of new workers, (c) delay in obtaining new workers, (d) abnormal
breakage of tools, accidents and scrap, etc.
Treatment of Labour Turnover Costs: Labour turnover costs usually be
treated as factory overhead costs. The preventive costs should be distributed
among different departments on the basis of workers in each department.
The replacement costs are to be shared by the departments affected by
the labour turnover on the basis of number of workers replaced.
Reduction and Control of Labour Turnover: It is important that labour
turnover is kept as low as possible. The following steps may be taken to
reduce the labour turnover:
1. A suitable personnel policy should be framed for employing the
right man for the right job.
2. Providing working conditions conductive to health and efficiency.
3. Fair rates of pay and allowances and other monetary benefits should
be introduced.
4. Maximum non-monetary benefits (i.e. fringe benefits) should be
introduced

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 COST ACCOUNTING

Notes 5. Distinction should be made between efficient and inefficient workers

by introducing incentive plans.
6. Encouraging labour participation in management.
7. An employee suggestion box scheme should be introduced whereby
workers who suggest improvements in the method of production
should be suitably rewarded.
8. An effective employee-grievance redressal procedure should be
introduced.
In addition to the above steps, the personnel department may be asked
to prepare a report monthly or quarterly giving the turnover rate and the
normal reasons given for leaving.
Illustration 1: From the following information calculate labour turnover
rates:
No. of workers as on 01-01-2006 = 7600
No. of workers as on 31-12-2006 = 8400
During the year, 80 workers left while 320 workers were discharged,
1500 workers were recruited during the year of whom 300 workers were
recruited because of exists and the rest were recruited in accordance with
expansion plans.
Answer:
Labour turnover rates
workers left  discharged
(i) Separation method   100,
Average number of workers
80  320 400
   100
(7600  8400) / 2 8000
 5%

(ii) Replacement method  workers replaced

 100
Average number of workers
300
  100
8000
 3.75%

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 Labour Cost

separations  replacements Notes

(iii) Flux rate   100
Average number of workers
400  300
  100
8000
 8.75%
Alternatively,
separations  accessions
(iv) Flux rate   100
Average number of workers
400  1500
  100
8000
 23.75%

3.5 Engineering Department

This department is required to maintain control over working conditions
and production methods for each job and department by performing the
following functions:
1. Preparation of plans and specifications for each job scheduled for
production.
2. Making job analysis.
3. Inspection of jobs at successive stages production to make sure that jobs
are being done according to the plans and specifications laid down.
4. Inspection of jobs after they are completed to ensure that they are
satisfactorily completed.
5. Making provision for safe working conditions.
6. Conducting research and developmental work before undertaking
new jobs.
7. Conducting time and motion studies.
8. Conducting job evaluation and merit rating.
Some of these functions are being discussed below:

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 COST ACCOUNTING

Notes 3.5.1 Job Evaluation

Job evaluation is a technique for determining the worth of each job relative
to other jobs. The procedure has certain steps. First, the job factors involved
in the evaluation are determined. These include training, experience, intelli-
gence, responsibility, working conditions. Secondly, a range of points for each
factor is determined. The hourly rate is then adjusted to take into account
the total number of points awarded: The advantages of job evaluation are:
1. Job evaluation process helps in the development of rational wage
and salary structure because rates are fixed according to the
characteristics of the jobs held by the job-holders.
2. It is helpful in developing harmonious relationship between the
employer and the employees because no scope is left for personal
bias of the employer for fixing the wage rates.
3. It brings into focus the particular needs of a job and a worker who
possesses the particular needs is asked to do the job.
4. As job evaluation is followed by job analysis so advantages of job
analysis are available with job evaluation. These advantages may
be proper recruitment, selection, placement, training, promotion,
transfer etc.
5. It helps in job classification and work simplification.
6. It helps in bringing uniformity in wage structure.

3.5.2 Merit Rating

Promotion and placement of workers must be made on their personal per-
formance. The personal performance of an employee is judged by his merit
rating. It is a technique for determining any addition that should be made
to an individual’s normal rate, to reward him for above average service. It
should be carefully distinguished from job evaluation which evaluates the
employee doing the job. To conduct a merit rating, each employee is rated
in respect of a number of personal attributes. These could bee initiative,
responsibility, attendance, punctuality, accuracy, safety, co-operativeness,
etc. He is often- given points for each attribute. The total of his points is
then related to some predetermined scale which sets out the merit addition
to be made to his rate of pay. The assignment of merit rating should be
done periodically, say at quarterly or six-monthly intervals, by the manager
or foreman. The following are some important advantages of merit rating:
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1. Merit rating helps in determining fair rates of pay for different Notes
workers on the basis of their performance.
2. Merit rating is helpful in transfer, promotion, placement and discharge
of employees.
3. It helps in judging the effectiveness of the employment office of
the company as it reveals the defects, in selection and placement
procedures of workers.
4. On the basis of merit rating the right types of employees are recruited
by eliminating unfit and misfit workers.
5. On the basis or merit rating permanent disciplinary and performance
records of employees are maintained. Such records protect management
from the charges of discrimination, favouritism and unfair labour
practices.
6. The merit rating distinguishes between the good workers and
inefficient workers. Workers with high rating are suitably rewarded
while those in the very low rating group are exposed. Such exposure
provides them an opportunity to improve their performance.
7. It also helps in developing a sense of competition among the workers,
and hence the ultimate result is an increase in production.

3.5.3 Work Study

Almost all incentive schemes operate from an allowed time. Ideally, this
should be calculated by the work-study engineers after the job, methods
and equipment have been studied to ensure that the best way to do the
job has been found. Work-study involves an objective and effective study
of work activity in order to effect improvement. It is divided into two
sections: method study and work measurement.

3.5.4 Method Study

Method study examines the way a particular task is carried out. Careful,
meticulous study of the existing method followed by a critical analysis
generally reveals an improved way of carrying out the work. Method
study is undertaken to improve methods of production and to achieve
the most effective use of materials, manpower and plant.

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 COST ACCOUNTING

Notes 3.5.5 Work Measurement

Work measurement involves ascertaining the time it should take to carry
out a specified task. The best known technique here is stop-watch timing.
Work measurement is undertaken to establish the time required to per-
form the work. The time may be used for incentive schemes, production
planning and estimating selling prices.
IN-TEXT QUESTIONS
1. What is the primary classification of labour costs?
(a) Fixed and Variable
(b) Preventive and Replacement
(c) Personal and Avoidable
(d) Direct and Indirect
2. Which of the following is an avoidable cause of labour turnover?
(a) Seasonal nature of the industry
(b) Marriage, especially for female workers
(c) Dissatisfaction with job
(d) Relocation of the plant
3. What is the primary function of the personnel department in
labour cost control?
(a) Conducting time and motion studies
(b) Providing an efficient labour force through recruitment and
training
(c) Ensuring safe working conditions
(d) Preparing production performance reports
4. Which of the following is a preventive cost associated with
controlling labour turnover?
(a) Cost of recruitment and training of new workers
(b) Loss of output due to inefficiency of new workers
(c) Cost of providing medical, housing, and recreational facilities
(d) Increased accidents and spoilage costs

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 Labour Cost

Notes
3.6 Labour Remuneration
The term remuneration is used to cover the total monetary earnings of
employees. It includes wages according to time or piece basis and other
financial incentives. The efficiency in production can be increased by
using improved equipment, by more effective utilisation of plant and
by adoption of better methods of production, but the most important
contribution must come from labour. Accordingly, the methods of re-
muneration of labour should be so designed as to encourage workers
to do their best. Methods of remuneration which allow high wages to
be paid have the effect of increasing labour cost but may also result
in increased production and productivity thereby reducing the labour
cost per unit. On the other hand, low wages generally result in high
labour cost per unit due to lower productivity, high rate of labour
turnover, etc.

3.6.1 Requisites of a Satisfactory System of Labour Remuneration

Before deciding on a particular system of labour remuneration, the fol-
lowing factors should be taken into account:
1. The system should be such as will produce the best quality and
quantity of work.
2. It should be satisfactory from the point of view of both employer
and employee and reward should be related to effort.
3. The scheme should be clearly defined and intelligible to workers.
The workers should be able to calculate wages on their own. If
the workers do not understand the system, they may view it with
suspicion.
4. It should guarantee a minimum living wage to each worker irrespective
of his efficiency.
5. No maximum limit should be placed on the amount of individual
earnings.
6. The earnings of the workers should not be affected by matters
beyond their control. They should not, for example, be penalised
for production losses due to power failure, machine breakdown,
etc., for which they are not responsible.

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 COST ACCOUNTING

Notes 7. It should reduce labour turnover and labour absenteeism.

8. The system should be flexible so that changes may be introduced
as and when necessary.
9. The system should be capable of operation without excessive
clerical work. Those methods should be avoided which demand
much detailed recording of time, quantity of output, etc.
10. If possible, the system adopted should be one which is in vogue
in that particular industry or in that particular locality.

3.6.2 Methods of Remuneration (Systems of Wage Payment)

There are two basic methods of labour remuneration: (a) Time Rate
System; and (b) Piece Rate System.
In addition, there are a number of incentive plans to induce workers to
work hard so as to produce more and earn more.

3.6.3 Time Rate System

Under time rate system, workers are paid according to the time for which they
work Payment may be on hourly basis; daily basis or monthly basis. In this
system consideration is given to the quantity and quality of work done. When
payment is made on hourly basis, total wages payable are calculated as follows:
Wages = No. of hours worked × Rate per hour
For example, if a worker is paid at the rate of Rs. 25 per hour, his wages
for a day of 8 hours will be: 8 hours × Rs. 25 = Rs. 200. Though this is
the oldest system of wage payment, it is still commonly used these days.
Time wage system is suitable for the following types of situations:
(i) Where quality of work is more important than quantity, e.g., high
class tailoring.
(ii) Where output cannot be measured in quantitative terms, e.g., in the
case of indirect workers like watchman, cleaners and sweepers, etc.
(iii) Where output is beyond the control of the worker, e.g., in process
industries the flow of work is regulated by the speed of conveyor
belt or where the work of a worker is dependent on the work of
other workers.
(iv) Where work is being done on a small scale so that close supervision
is possible.
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 Labour Cost

(v) Where the worker is a learner or an apprentice. Notes

Advantages: The main advantages of time rate system are:
(i) Simplicity: The system is simple and calculation of wages is easily
understood by workers.
(ii) Security to workers: Workers are assured of a certain amount
of wages payable if there is stoppage of work due to power
failure, machine breakdown, etc. This gives a sense of security
to workers.
(iii) Quality of work: As this method does not give weight to the
quantity of work done, workers can concentrate on the quality
of goods produced thus the quality of work under this method
is better.
(iv) Accepted by trade unions: Trade unions mostly favour this method
because it treats all workers alike and no distinction is made
between efficient and inefficient workers.
(v) Economical: Under this method, no detailed records are required to
be maintained regarding the work done by workers. This results
in saving of clerical costs. Moreover workers avoid over-speeding
and cause less damage to plant and machinery and materials. This
also results in economy.
Disadvantages: The main disadvantages are:
(i) No incentive: It offers no positive inducement to workers to
improve performance as it does not distinguish between efficient
and inefficient workers.
(ii) Low quantity: When workers are-paid on time basis, they tend to
be slow in work. This results in lower production quantity.
(iii) Extra supervision costs: Under this method, extra supervision
is needed so that workers do not waste time. Appointment of
additional supervisors increases cost.
(iv) Costing difficulties: From costing point of view, it creates difficulties
in the calculation of labour cost per unit because the output is
constantly, fluctuating.
(v) Idle time: Workers waste a lot of time resulting in increase in idle
time.

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Notes Illustration 2: Compute earnings of X and Y for the month of August

2005 on the basis of the following information.
Hours worked of X – 150 hrs Y – 200 hrs
Rate per hour X – Rs.10 per hour Y – Rs.15 per hour

Answer:
Earnings = Hours worked × Rate per hour
Earnings of X = 150 hours × Rs.10 per hour = Rs. 1500
Earnings of Y = 200 hours × Rs.15 per hour = Rs. 3000

3.6.4 Piece Rate System

Wages under this system are paid according to the quantity of work done.
A rate is fixed per unit of production and wages are calculated by the
following formula
Wages = Rate per unit × No. of units produced
For instance, if rate per unit is Rs. 17 and during a day a worker has
completed 10 units, then his wages will be Rs. 17 × 10 units = Rs. 170.
This method does not give any consideration to the time taken by the
worker completing the work. Only quantity of work is taken into account
for calculating wages.
Suitability of piece rate system Conditions under which piece rates may
be useful employed are:
(a) Where production is standardised and repetitive in nature.
(b) When the aim is continuous maximum production.
(c) Where the output of workers can be measured.
(d) Where workers continue at the same job for long periods.
Where the standard time required to complete a job can be measured
(e) 
accurately.
Advantages: Piece rate system has the following advantages:
1. Incentive to Efficient Workers: As remuneration is in proportion
to the worker effort, the method provides a strong incentive to work
more.
2. Increase in Production: Each worker tries his best to produce
more to earn higher wages. This results in increase in production.

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3. Lower Cost: On account of increase in production, fixed cost per Notes

unit is reduced resulting in higher profit.
4. Equitable: This system is more equitable than time rate system
because wages are paid according to the efficiency of each worker.
5. Decrease in Supervision: Strict supervision is not necessary because
the workers interested in maximising their earnings through the
maximization of output.
6. Simplifies Costing: As wages are paid at a rate per unit, this
method simplifies cost ascertainment because labour cost per unit
is known in advance.
7. Simple and Easy: This method is simple and is easily understood
by the workers.
Disadvantages: Piece rate system suffers from the following limitations:
1. Poor Quality of Work: This method lays too much emphasis
on quantity of production and ignores quality of work. In order
to maximise their wages, workers try to produce more and more
without caring for the quality of production.
2. No Security of Wages: This system does not guarantee a minimum
wage to a worker If a worker is not able to complete his day’s work,
for any reason, he is paid less, thus earnings of workers are uncertain.
3. Misuse of Materials and Equipment: In the greed to produce more,
workers may of materials and damage to plant and machinery.
4. Injurious to Health of Workers: In an effort to earn more wages,
workers try to work excessively and with speed. This proves injurious
to the health of workers.
5. Opposed by Trade Unions: Piece rate system is generally opposed
by trade unions because it creates inequality in the wages of workers.
Slow and inefficient workers feel jealous of the higher wages of
their fellow workers.
6. Difficulties in Fixing Piece Rate: Fixing equitable piece rate is
quite a difficult task and may require considerable amount of work
in the form of time studies.
7. Unsuitable in Certain Cases: This method does not suit where
work is of artistic and refined nature.

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Notes Illustration 3: Compute earnings of X and Y for the month of August

2005 on the basis of the following information.
No. of units produced X – 3000 units
Y – 2500 units
Rate per unit Rs. 1.50
Answer:
Earnings = No. of units produced × rate per unit
Earnings of X = 3000 Units × Rs. 1.50 per unit = Rs. 4500
Earnings of Y = 2500 Units × Rs. 1.50 per unit = Rs. 3750
IN-TEXT QUESTIONS
5. What does the term “labour remuneration” include?
(a) Only wages based on time
(b) Only wages based on output
(c) Rewards unrelated to monetary factors
(d) Total monetary earnings of employees, including financial
incentives
6. Which of the following is a requisite for a satisfactory system
of labour remuneration?
(a) It should guarantee a maximum limit on individual earnings
(b) It should involve excessive clerical work
(c) It should reduce labour turnover and absenteeism
(d) It should ignore the effort made by employees
7. In which scenario is the Time Rate System most suitable?
(a) When quality is more important than quantity
(b) When output is standardized and repetitive
(c) When maximum production is required
(d) When workers are highly efficient
8. What is a key advantage of the Piece Rate System?
(a) It ensures uniform wages for all workers
(b) It encourages workers to produce more and earn higher
wages
(c) It focuses on quality rather than quantity
(d) It reduces the health risks to workers
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Notes
Halsey Plan
Under this method, standard time for doing a job is ascertained and
workers are encouraged to do the job in less than the standard time.
They are given wages for the actual time taken by them to do the job
at agreed rate plus a bonus equal to one-half of the wages of the time
saved. Thus, if S is the standard time, T is the actual time taken and R
is the rate of wages per hour, total earnings will be:

ST
TR  R
2
For example:
Standard Time for a job 10 hours
Actual Time Taken 6 hours
Rate per hour 75 paise
The earnings of the worker = 6 × 0.75 + 4/2 × 0.75 = Rs. 6.00
An important limitation of this method is the fixation of standard time.
It may be fixed on the basis of the performance of average workers
working under normal conditions. However, if proper time and motion
studies are conducted, this limitation can be overcome. As the workers
do not get the entire benefit of the time saved by them, they usually are
not happy with this method. But this limitation may be overcome if the
saving in time is obtained with the co-operation of management. This
method is easy to administer because guarantee hourly wages are there
for the actual time spent by the workers.

Rowan Plan
This plan is similar to that of Halsey Plan. Under this plan, wages at
the ordinary rate for actual time spent by a worker are guaranteed and a
bonus is given if the worker saves time but of the standard time set for
him. The difference in the two plans is only with respect to the calcu-
lation of the bonus. Under Rowan Plan, the bonus is that proportion of
wages of actual time taken which time saved bears to the standard time,
whereas in the Halsey Plan the bonus is one-half of wages of the time

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Notes saved. Thus, in the Rowan Plan, if standard time is S, actual time is T
and hourly rate is R, the bonus will be:

ST
TR
S
And the earnings will be:

ST
TR TR
S
In the same example given above, earnings of the worker under Rowan
Plan = 6 × 0.75 + 4/10 × 6 × 0.75 = Rs. 6.30.
This plan is also subject to the same objection as that of Halsey Plan.
Along with this, there is another objection that two workers, one very
efficient and the other not quite so efficient, may earn the same bonus
under certain circumstances. In the above example, where a worker saves
4 hours, his bonus is Rs. 1.80. If a worker saves 6 hours, spending only
4 hours to do the job, his bonus will also be 6/10 × 4 × 0.75 = Rs. 1.80.

Comparison of the Two Plans

The two plans will yield equal wages if a worker saves exactly half the
time set for him since under the Halsey Plan 50% of the wages of the
time saved are to be paid to the worker as bonus. For example, in the
above case with actual time as five hours we can find out that under both
systems the worker will yield equal wages. Moreover, if a worker saves
less than half the time, he will be better off under the Rowan Plan. But
if he saves more than half the time, he will earn more under the Halsey
Plan. Thus, if in the above example the actual time is only 3 hours, the
earnings of the worker under the Halsey Plan will be:
3 × 0.75 + 7/2 × 0.75 = Rs. 4.875
and the earnings under the Rowan Plan will be:
3 × 0.75 + 7/10 × 3 × 0.75 = Rs. 3.825
Moreover, if the actual time is zero hours (even though it is impossible),
then the worker will get no wages under the Rowan Plan but will get
wages for five hours under the Halsey Plan. And it is impossible for a
worker to double his wages under the Rowan Plan.

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 Labour Cost

Question: Standard time allowed for a job is 20 hours and the rate per Notes
hour is Rs. 30 plus a dearness allowance @ Rs. 9 per hour worked. Ac-
tual time taken by a worker is 15 hours.
Calculate earnings under:
(a) Time Wages System
(b) Piece Wage System
(c) Halsey Plan
(d) Rowan Scheme
Solution: Calculation of earnings under various wage systems:
(a) Time Wages System Rs.
Basic Wages for 15 hours @ Rs. 30 per hour 450.00
Dearness Allowance (D.A.) for 15 hours
@ Rs. 9 per hour 135.00
Total 585.00
(b) Piece Wage System Rs.
Basic Wages for 20 hours @ Rs. 30 per hour 600.00
Dearness Allowance (D.A.) for 15 hours
  @ Rs. 9 per hour 135.00
Total 735.00
(c) Halsey Plan Rs.
Basic Wages for 15 hours @ Rs. 30 per hour 450.00
Dearness Allowance (D.A.) for 15 hours
  @ Rs. 9 per hour 135.00
Bonus = 50% of Time Saved × Time Rate
    = (50% × 5 hours × Rs. 30)   75.00
Total 660.00
(d) Rowan Scheme Rs.
Basic Wages for 15 hours @ Rs. 30 per hour 450.00
Dearness Allowance (D.A.) for 15 hours
  @ Rs. 9 per hour 135.00
Bonus (see working note) 112.00
Total 697.50
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Notes Calculation of Bonus = Time Saved × Actual Time/Standard Time

× Wage Rate per hour.
= 5 hrs. × 15 hrs./20 hrs. × Rs. 30 = Rs. 112.50.

Taylor’s Differential Piece-Rate System

For maximising the output, Taylor, the father of Scientific Management
developed a differential piece-rate system. As discussed above in the
Piece-Rate System, lower output causes total cost of production to rise
and higher output causes cost of production to fall. Taylor wanted the
output to rise as rapid as possible. He fixed a standard of output per
unit of time on the basis of time and motion studies. As per Taylor’s
differential piece-rate system the worker who exceeds the standard output
within the stipulated time must be paid a high rate for high production.
On the other hand, the worker is paid a low rate if he fails to reach the
level of standard output within the stipulated time. Thus, there are two
piece-rates, one for the worker who reaches the standard output or exceeds
it, is paid wages at the rate of 120 per cent of the piece rate. While the
one who fails to reach the standard level of output, is paid at the rate
of 80 per cent of the piece-rate. Those workers who reach the standard
have a double advantage of large output and higher rate. Whereas those
workers who do not achieve the standard, earn less wages because of
lower output and lower rate.
There is a disadvantage under this method from the point of view of
the workers that no minimum wages are guaranteed. Moreover, a worker
falling just short of the standard would suffer very much. Since Taylor’s
philosophy lays out that work ought to be done by the most efficient
worker and not by others, the workers might fear that their failure to
reach the standard would lead to dismissal. However, the advantage of
this plan is that the workers have double incentive for increasing the
output. But this plan is not much in use nowadays.
Question: The following information is available about a work process:
Standard time allowed 5 units per hour
Normal time wage rate per hour Rs. 25
Differential piece rates to be applicable:
80 per cent of piece rate when output is below standard.
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 Labour Cost

120 per cent of piece rate when output is at standard or above Notes
standard.
In an 8 hour day: Worker A produces 35 units, Worker B produces
45 units.
Calculate the wages payable to A and B for the day under Taylor’s dif-
ferential piece rate plane.
Solution:
Normal piece rate per unit = Rs. 5 (Rs. 25 ÷ 5 units)
At 100% efficiency, standard output in 8 hours = 5 × 8 = 40 units
Efficiency level achieved by A = 100/40 × 35 = 87.5%
Efficiency level achieved by B = 100/40 × 45 = 112.5%
Piece-rate applicable to A = 80% of Rs. 5 = Rs. 4 per unit
Piece-rate applicable to B = 120% to Rs. 5 = Rs. 6 per unit
Total wages of A = 35 × 5 Rs. 4 = Rs. 140
Total wages of B = 45 × Rs. 6 = Rs. 270

3.7 Answers to In-Text Questions

1. (d) Direct and Indirect
2. (c) Dissatisfaction with job
3. (b) Providing an efficient labour force through recruitment and
training
4. (c) Cost of providing medical, housing, and recreational facilities
5. (d) Total monetary earnings of employees, including financial
incentives
6. (c) It should reduce labour turnover and absenteeism
7. (a) When quality is more important than quantity
8. (b) It encourages workers to produce more and earn higher wages

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Notes
3.8 Self-Assessment Questions
1. Discuss the different methods of wage payment to workers.
2. What do you understand by labour turnover? Enumerate the causes
of such labour turnover and indicate some steps which may reduce
labour turnover.
3. The cost accountant of K limited has computed labour turnover
rates for the quarter ended 31st march 2005 as 10%, 5%, and 3%
under flux method, replacement method and separation method
respectively. If the number of workers replaced during that quarter
is 30, find out the number of
(a) workers recruited and joined
(b) workers left and discharged
4. In a factory Ram and Shyam produce the same product using the
same input of same material and at the same normal wage rate.
Bonus is paid to both of them in the form of normal time wage rate
adjusted by the proportion which time saved bears to the standard
time for the completion of time. The time allotted to the product
is 50 hours. Ram takes 30 hrs and Shyam takes 40 hrs to produce
the product. The factory cost of the product for Ram is Rs 3100
and for Shyam Rs 3280. The factory overhead rate is Rs. 12 per
man hour. Calculate
(a) Normal wage rate,
(b) Cost of material used for the product,
(c) Input of material, if unit material cost is Rs. 16.

3.9 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 UNIT - II

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Cost Accounting B.Com Sem-4_Unit 2 Lesson 4.indd 112 01-Feb-25 3:59:59 PM
 L E S S O N

4
Time-Keeping
and Time Booking
Manisha Verma

STRUCTURE
4.1 Learning Objectives
4.2 Time-Keeping Department
4.3 Job Time Booking
4.4 Idle Time
4.5 Overtime
4.6 Payroll Department
4.7 Cost Accounting Department
4.8 Answers to In-Text Questions
4.9 Self-Assessment Questions
4.10 Suggested Readings

4.1 Learning Objectives

After reading this lesson, you will be able to:
‹ Explain the concept of Time-Keeping.
‹ Discuss the concept of Time Booking.
‹ Describe what Idle Time is.
‹ Explain the concept of Overtime.
‹ Discuss what Payroll department is.

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 COST ACCOUNTING

Notes
4.2 Time-Keeping Department
Time-keeping forms a most valuable link in a harmonious labour-man-
agement relationship. Most companies have a separate time-keeping
department accumulating the total numbers of hours worked for each
employee. It embraces two functions:
1. Time-keeping, i.e. recording of time of workers for purpose of
attendance and wage calculations.
2. Time-booking, i.e. reporting of each worker’s time for each department,
operation and job for the purpose of cost analysis and apportionment
of labour costs between various jobs and departments.
Purposes of Time-Keeping
Recording of time is essential for the following purposes:
1. Preparation of pay rolls, where the workers are paid on time basis.
2. Meeting the statutory requirements.
3. For internal administration, like increments, pension, provident fund,
gratuity and leave benefits.
4. For proper distinction between direct and indirect costs, normal
time and overtime, and regular and late comers.
5. For overhead rates, if based on labour hours.
6. For enforcing regularity, discipline and ensuring daily requirement
of labour force in the factory.
Methods of Time-Keeping or Recording
The following are the usual methods of recording attendance of workers
at the gate of a factory:
1. Manual Methods:
(a) Attendance Register, and (b) Disc or Token system.
2. Mechanical Methods:
(a) Time Recording Clock, and (b) Dial Time Recorders.
Manual Methods.
(i) Attendance Register Method (Hand-Written Record): Under this
method, a register, with necessary column like name, identity no.
of the employee and arrival and departure time is maintained.
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 Time-Keeping and Time Booking

In a large factory separate registers may be maintained for each Notes

department but in a small factory one register may serve the needs
of the entire factory. The practice of recording attendance or roll
calls may conveniently be adopted depending upon the nature of
employees and their number. As soon as a worker enters into the
premises of the factory, the necessary entries in the attendance
register are completed either by calling name of each worker or
by some other physical method.
If the workers are literate, they may be required to sign the
­attendance register. This method is very popular in government
departments and administrative wings of other organizations. This
method is very simple and inexpensive. But in a larger factory
this method may become inconvenient. Moreover, this method is
liable for many undesirable practices on the part of the persons
who record the attendance in collusion with some workers. This
method is most suitable for small factories and outdoor workers.
(ii) Disc or token or check method: Under this method, each worker
is allotted a metal disc or token bearing his identification. On each
disc the name and number of the worker is engraved or painted. All
the tokens or discs are hung on a board serially before the arrival
time of the workers as soon as a worker reports for duty on the
appointed time, he removes his/her disc from the board and puts into
a box. Immediately after the scheduled time for entering into the
premises of the factory the board is removed and a list is prepared
of all such discs or tokens not collected and dropped into the box
by the workers. The late-comers collect their discs and hand over
personally to the time-keeper. The list of late-comers is prepared
separately. The tokens not removed from the board represent the
absentee workers. This method may be adopted with some variations
such as: (a) the discs or tokens instead of dropping into the box by
the workers at the gate of the factory are deposited in the respective
departments. Factories may adopt either of these methods, convenient
to them keeping in view the number of workers and the distance
between gate and the work point. With the help of these- lists the
time-keeper records the attendance in the register known as Muster
Roll for the purpose of pay rolls.

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 COST ACCOUNTING

Notes Although these methods are simple and economical, they are open
to many abuses. The disadvantages are:
1. A worker may remove the disc of his fellow-worker to ensure
his presence who is either late or absent.
2. There is no certainty that the exact arrival time of the workers
has been recorded. The timekeeper marking the attendance may
commit errors deliberately or through carelessness and this may
result in many disputes.
3. The time-keeper may include the dummy or ghost workers
in the muster roll that cannot be easily detected except by a
surprise check by some responsible officials.
The manual methods of recording attendance of the workers,
therefore, cannot be taken as being foolproof.
Mechanical Methods:
Different mechanical devices have been designed for recording the exact
time of the workers. These include:
‹ Time Record or Recording Clocks.
‹ Dial Time Records.
Time Record Clocks: The attendance under this system is marked by a
time recording clock on a card. Each worker is given a time card usually
for one week duration. These time or clock cards are serially arranged
and kept in a tray at the gate of the factory and as the worker enters into
the gate, he picks up his/her time card from the tray, puts it in the time
recording clock that records the exact arrival time at the space provided
on the card against the particular day.
This process is repeated when the worker leaves the factory after his/her
day’s work. Other particulars of time in respect of lunch, late arrivals,
early leaving and overtime are printed in red so as to distinguish these
from normal period spent in the factory. This is a very popular method
of recording the attendance of workers.
Dial Time Recorders: This is a machine which records correct atten-
dance time of worker automatically. There are a number of holes (about
1600) around a dial. Each hole represents a number which corresponds
to the identification or token number of the worker concerned. There

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 Time-Keeping and Time Booking

is a radial arm in the centre of the dial. While entering into the gate Notes
of the factory, a worker has to press the dial arm into a hole and the
time is automatically recorded on the roll of the paper placed inside
the dial time recorder against his number. The rolled paper placed
­inside the machine provides a running account of workers’ timing and
may be used as a part of the pay roll obviating further copying of the
attendance records.
Advantages of mechanical methods of time keeping
1. They record correct attendance time at the gate of the factory.
2. They reduce chances of incorrect recording of attendance time and
this avoids the disputes regarding time.
3. Possibility of inclusion of dummy or ghost workers in the muster
roll is minimised.
4. The mechanical system is clean, safe and quick. The printed record
is more reliable and avoids unnecessary disputes.
5. The system is economical, reduces workload in connection with the
preparation of pay rolls.
6. The overtime, idle time and late time are recorded separately and
correctly.
However, the most difficult problem of this system is initial capital outlay
and secondly any mechanical defects may adversely affect the working
of the entire time recording to system of the factory.

4.3 Job Time Booking

For proper labour cost analysis, it is essential that the worker records,
(in details), his activities of production and time he spends on each job
correctly. Time spent by a worker on the job, process or activity may be
recorded manually or mechanically depending upon the nature and size
of an enterprise. Recording of time spent by the worker on the job is
better known as time booking. The objects of time booking are:
1. To ensure that the time paid for is properly utilized.
2. To ascertain the labour cost for each individual job and the cost of
work done.

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 COST ACCOUNTING

Notes 3. To determine the rate of absorption of overhead expenses based on

direct labour and machine hour methods against each job.
4. To ascertain and minimise idle time.
5. To evaluate each employee’s performance by comparing the actual
time taken with the budgeted time.
For achieving these objectives, it is very important that clear instructions
should be issued and proper forms designed for recording work-time.
The following are some important forms generally used for time booking:
1. Daily Time Sheet 2. Weekly Time Sheet 3. Job Card or Ticket 4.
Labour Cost Card.
Daily Time Sheet
This is the record of each day’s work done by a worker. Every worker is
given a Daily Time Sheet on which he records the time spent by him on
each job or work. At the end of the day, all sheets, duly countersigned
by the foreman, are collected.
This method of time booking is very simple and practicable but it suffers
from many drawbacks. This method is suitable only for small concerns;
secondly, if a daily time sheet is lost or misplaced then it becomes difficult
to ascertain the daily wages of worker and finally, it is very expensive
since a large number of sheets have to be used for calculation of wages.
It is time consuming also.

Daily Time Sheet

Name of the worker…………………………………………………………………..
Ticket no………………………………….. date……………………………………..
Total
Job no. Department Time Total hours Wage rate wages
Start Finish Ordinary Overtime Ordinary Overtime
Rs. Rs.

Worker………………………... Foreman……………......….
Cost clerk……………………..

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Weekly Time Sheet Notes

Instead of recording time on daily time sheets, a worker is given a sheet
on which he records his time for a week. This method of recording is an
improvement over the daily time sheet since the number of documents
to be prepared is considerably reduced. The weekly time sheet provides
a consolidated time spent by a worker on a job and can conveniently be
reconciled with the attendance record. Weekly time sheets are suitable
where the worker has to handle a few jobs and the foreman can ascertain
the work done by a worker during the week.
These sheets are liable to be mutilated or lost. The workers may fill wrong
time and hence strict supervision is required. It is always advisable that
these sheets are filled by the departmental clerk so that these disadvantages
are avoided and the foreman exercises effective supervision on the jobs.

Weekly Time Sheet

Name of the worker……………………………………….........................……………..
Ticket no……………………........................….Week ended……………………………
Day Job no. Job no. Job no. Total hours Wage rate Total Rs.
On Off On Off On Off Ordinary Overtime Ordinary Overtime
Rs. Rs.
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
Sunday
Worker………………………... Foreman……………….
Cost clerk……………………..

Job Card/Ticket
A job or time card is a document made out for each job. Its basic func-
tion is to show the time spent by an employee on each job or -process
on which he works during the day. It shows the time an employee starts
work on a particular job, the time he finishes, the department, for which
the worker is done, and the job number. If he spends some of his time on
work other than individual jobs or processes, for example, on maintenance
and repairs, the time is shown as indirect labour on the time card. It is
unlike time-sheets which are made out for each employee. Generally five
different types of job cards are used and these are:
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Notes 1. Job card for each job

2. Job card for each operation
3. Job card for each worker.
4. Combined time and job card.
5. Piece work card.
1. Job Card for Each Job: With this kind of job card, the card travels
round with the job and labour times are recorded upon each after
each operation. This has the advantage that when the card reaches
the cost office, all labour times are listed, and the cost clerks have
only to insert the labour rates, multiply and add to obtain the full
labour cost. It has, however, a serious disadvantage that unless the
job is fully complete, none of the times are known in the cost office.
As some jobs may take many weeks to get completed, it is ­virtually
impossible to reconcile labour time with gate times each week.
Job Card for Each Job
Job No…………………………….. Time started………………………..
Job description………………….... Time finished……………………....
Drawing No………………………. Hours or job…………………….....
Operation No……………………... Time allowance…………………....
Date Operation Dept. Worker No. Hourly rate Time Hours Cost
Start Finish

Total for the job

Checked and verified............................. Cost office...........................
Foreman................................................. Reference..............................

2. Job Card for Each Operation: This method of recording means

that a single job will have a number of job cards, one for each
operation. This involves considerable paper work, but it does enable
time bookings to reach the cost office quickly.

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Job Card for Each Operation Notes

Work order No………………………...........
Work drawing No…………………………... Quantity………….....................
Description of job…………………………..
Operation no. Particulars Clock No. Date Time Hours Rate Cost
Start Finish
1. Turning
2. Thread roll
3. Drilling
4. Removing
5. Inspecting
6. Packing
7. ----------
Total
Material required.................. Date started...... Date finished.... Passed inspection......
Signed............... foreman......... Cost office reference....
3. Job Card for Each Worker: This is a card issued to each worker
for job at the beginning of each day or week depending upon the
number of jobs he has to work on. The necessary job numbers are
mentioned either by the foreman or the departmental clerk.

Job Card for Each Worker

Name………………………………................................. Clock no.……………….......

Department…………….... Hourly rate…………........… Week ending…………………
Job no. Mon Tue Wed Thurs Fri Sat Total hours Cost
Start
finish
Start
Finish
Start
Finish
Total hours.................... Normal Idle time.........................
overtime...................
Checked and verified Worker/department Cost office
.................................... .................................. reference...................................
Foreman....................... Clerk...........................

4. Combined Time and Job Card: Time cum job card is used by
small organizations where there is no need of recording time at the
gate of the factory and then on the job. The special of the card
is that it records both the attendance, time and the job time of a
worker on one card.

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Notes Combined Time and Job Card

Workers name……………………........
Workers No.……………………........... Week Ending……………………........
Department…………………….............
Day Job No. Time Time For cost office
On Off Normal Overtime Rate Amount
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
Sunday
Worker…………….................. Foreman……............…… Costed by ……..........…….
Entered in wage sheet by………………..

5. Piece Work Card: This card is most suitable for an organisation

where the workers are paid wages on piece rate basis. A record of
units manufactured by a worker with reference to their quality and
time is to be kept on this card. Besides wages, bonus is to be paid
to worker for time saved and his efficiency is to be judged on the
basis of units produced during the specified period.

Piece Work Card

Form No...................................................
Name......................................................... Card no. .........................
Department................................................ Week ending....................
Days No. of units No. Rejected Good units Rate Amount

Worker:............ Foreman:............ Inspector:............ Cost office:............

Dept clerk: ..........................................

Reconciliation of Gate Time with Time Booked

While preparing the wage sheets it becomes necessary to reconcile
the time recorded at the gate of the factory with the time booked to
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different jobs of each worker. Time recorded at two different places Notes
must agree. But sometimes there is some discrepancy between the gate
time and time booked to different jobs. This discrepancy is known
as idle time.

4.4 Idle Time

Idle time is that time for which the worker has been paid, without giving
any production to the employer. Idle time normally results from poor
production scheduling and lack of sales order. It is necessary to ­identify
the reasons for the idle time, otherwise it would be difficult for the
management to exercise effective control over the labour costs. The idle
time normally arises due to normal and abnormal causes:
(i) Normal Causes: Whatever precautions may be taken, some idle
time is inherent in every situation. Normal causes for which idle
time arises are:
1. Time lost between factory gate and place of work.
2. Time taken in picking up the work for the day.
3. The interval between one job and another.
4. The setting-up time for the machine.
5. Time taken for personal needs, and
6. Time lost due to normal fatigue
If the time lost is due to the above-mentioned reasons, it is known
as normal idle time.
(ii) Abnormal Causes: Idle time may also arise, due to abnormal
factors.
1. Temporary lack of work.
2. Breakdown of machinery.
3. Power failure.
4. Non-availability of raw materials, and
5. Strikes, lockouts, floods, fires etc.
Treatment of normal idle time cost. Normal idle time cost can be
treated in the following two ways in the cost accounting.

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Notes 1. The labour cost of normal idle time be treated as a part of the cost
of production. Normal idle time cost of direct workers be treated as
direct wages. Assuming a worker is paid Re. 1 per hour for 8 hours
a day, he actually spends 7 hours on the job and one hour is lost due
to routine work. Since it is a case of normal idle time, the worker
will be paid Rs. 8 for the day. Thus, in case of direct workers an
allowance for normal idle time is built into the labour costing rates.
In case of indirect workers, the normal idle time is spread over
all the products or jobs. In this case, it is treated as factory indi-
rect wages and, is distributed through the process of absorption of
­factory overheads.
2. The entire normal idle time cost be treated as an item of factory
expenses and be recovered as indirect charge.
Treatment of abnormal idle time cost: A basic principle of cost ac-
counting is that abnormal expenses and losses should not be included
in costs while ascertaining the cost of a unit or activity. It is on the
principle that the abnormal idle time costs are excluded from, the cost
of production. Abnormal idle time cost is directly transferred to Costing
Profit and Loss Account without disturbing the normal costs. Such treat-
ment at once attracts the attention of the management towards the losses
due to abnormal idle time.
Control of idle time. The abnormal idle time, costs should be further
categorised into controllable and uncontrollable. This would help the
management in fixing responsibility of controllable idle time. Idle time
cards should be prepared to know the reasons which are responsible for
such a time. Timely provisioning of materials and regular maintenance
of plant and machinery will also go a long way in reducing the idle
time. The management should aim at eliminating abnormal idle time and
reducing the normal idle time to the minimum.

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 Time-Keeping and Time Booking

Idle Time Card Notes

Workers name………………
Workers No………………...
Department………………....
Reasons of idle time Time Ti m e For cost office Remarks
lost
On Off Rate Amount
1. Waiting for materials
2. Waiting for tools
3. Waiting for instructions
4. Machine breakdown
5. Power failure
6. Inspections
7. Other reasons
Worker…………. Foreman…………….. Costed by……………………
Idle Time and Idle Capacity
Idle capacity means that plant and machinery is available for utilisation
but is not fully used due to normal or abnormal reasons. This generally
arises from market constraints or defective management policy. The nor-
mal reasons for idle facilities are, generally, preventive maintenance and
intermittent use of machine during processes. The abnormal reasons may
be trade depression, flood, recession etc. The cost of normal idle facilities
should be charged as overhead expenses and the abnormal idle facilities
should be charged to Costing Profit and Loss Account. It should be noted
that idle time of labour is different from idle capacity of the plant. Care,
should be taken to calculate the capacity usage ratio of each machine and
adopt measures to raise the ratio to unity wherever possible.

4.5 Overtime
Over and above the normal working hours, if a worker spends more time
on the job, it is generally known as overtime. In India, the Factories Act
provides for payment of overtime wages. If a worker works for more than
8 hours on any day or for more than 48 hours in a week, he is treated
to be engaged in overtime and is given wages at double the basic hourly
rate for the overtime put in by him. The main causes of overtime are:

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Notes 1. It is usually necessitated high due to temporary increase in demand.

2. It may be, necessary to complete urgent work or execute rush orders.
3. If there is unavoidable interruption in work during normal hours
due to power failure, voltage fluctuation, or bottleneck in workflow,
the scheduled work may have to be completed with overtime work.
4. Slackness during regular working hours, due to inadequate supervision,
may cause overtime work.
5. Often overtime work is also necessary to make up production
deficiency or arrears of work which could not be done due to
official holidays, strike or lockout.
Treatment in cost accounts:. Overtime wages and overtime premium
should be treated in the cost Accounts as follows:
1. When overtime is regular feature undertaken for increasing
production; the normal wage rate should be proportionately
increased so as to include the overtime premium. Overtime wages
should be treated in this case as cost of labour-direct or indirect
as the case may be.
2. If overtime is a direct result of a customer’s urgent request for the
completion of the order and not due to general pressure of factory
work, then the overtime should be charged directly to the job.
3. If overtime work is of an intermittent nature i.e. caused by interruptions
during normal work time which are beyond the control of management;
e.g. power failure, breakdown of machinery etc. then it should be
treated as a part of factory overheads.
4. When overtime work is caused by loss of time (abnormal idle time)
which was avoidable, overtime wages should be, treated as a loss
and charged to Costing Profit and Loss Account.
However, it maybe noted that overtime should be avoided as far as
possible because it adversely affects the cost of production due to the
following reasons.
1. Overtime wages are paid at higher rate;
2. Overtime work is done when the efficiency of the worker is generally
falling after day’s work or is at its lowest ebb;
3. Workers develop a tendency of postponing the normal work to be
done in overtime; and,
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4. Other, overhead expenses increase proportionately during the overtime. Notes

Control over overtime: For cost control purposes, overtime should be
analyzed by responsibility centres. It is also necessary to prepare overtime
reports them regularly to the works managers. These reports will indicate
the justification or otherwise of the overtime.

4.6 Payroll Department

A payroll or wage sheet is a list of all employees showing major details
relating to their pay particularly their gross pay, deductions and net pay.
Most manufacturing companies have a separate payroll department whose
function is to compute the total payroll indicating the gross amount earned
and the net amount payable to employees after deductions. The payroll
department also pays the employees and maintains records of their earn-
ings, their wage rate and job classification. Payroll accounting requires
the provision of certain information relating to employees’ attendance,
time, details of absenteeism, hourly rates of pay and details of various
deductions such as tax, provident fund, employees state-insurance,etc.
The wage sheets are generally prepared department wise. Departmental
wages sheets are summarized in a master wages sheet which forms the
basis for the preparation of the payroll voucher entry in the general ledger
in cost control account.
The gross wages of each employee is computed by reference to the fol-
lowing documents:
1. Clock or Time cards.
2. Piecework cards.
3. Job cards.
4. Employee’s record card.
The Payment of Wages Act, 1936, authorizes the following deductions
as per rules given in the Act:
1. Fines and deductions for absence from duty.
2. Deductions for damage or loss of goods or money, expressly entrusted
to, employed persons.
3. House rent and supply of other amenities and services.

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 COST ACCOUNTING

Notes 4. Deduction for recovery of advance.

5. Income tax.
6. Deductions in respect of an order of a court or other competent
authority.
7. Provident Fund.
8. Deduction of cooperative society dues.
9. Deduction for life insurance premium.
10. Employee’s state insurance contribution.
The total deductions in respect of an employee are deducted from his gross
wages, and net amount due to him is paid. In many organizations, the
payroll accounting function is now likely to be carried out by a computer.
Frauds in the Payment of Wages
Calculations and disbursement of wages to the employees must be made
with utmost care. Cases of fraud in the calculation and payment of wages
are not unknown. The following kinds of fraud are generally perpetuated
in the payroll and wage payment:
1. Inclusion of dummy workers in the payroll.
2. Inclusion of wrong hours in the time and job cards.
3. Payment of leave wages, holiday wages, allowances or other
perquisites to workers not entitled thereto.
4. Use of high rate of pay in the payroll.
5. Wrong inclusion of Rs. bonus or inclusion of bonus amount more
than the entitlement.
6. Recording overtime not actually worked by workers.
7. Payment of work not done(if payment is on the basis of piece rate).
8. Omission to make deductions, partial or total.
9. Payment of wages to wrong persons.
10. Paying excess wages to workers.
Precautions and internal check: Rigid control over, the calculation and
payment of wages should be exercised to minimise the risk of fraud. The
following steps are
1. All the workers should be asked to record correct time of their
arrival in the factory, and departure from the factory.
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 Time-Keeping and Time Booking

2. Job and time cards should be properly designed and the workers Notes
should be asked to book the time started on and off correctly.
3. Workers who are paid on piece rate basis should be asked to book
time for the work done and their cards duly initialled by the foreman.
4. All the cards should be kept in the custody of time office.
5. In the payroll, details of worker’s time/hours worked, piece produced,
rate of pay, overtime and bonus etc. should be carefully recorded.
Calculations should be made with care and precision.
6. Payments for idle time, rejected and spoiled production, special
allowance etc. should only be made if sanctioned by the proper
authority.
7. A number of persons should be engaged in the compilation of the
records of the wages payable.
8. The payroll should bear the initials of each person concerned in its
preparation with details of the work carried out.
9. Deductions should be recorded properly.
10. A cheque of the net amount payable to the workers should be drawn
for each payroll and, the amount entrusted to some responsible
person and he should be different from those who prepared and
checked the payrolls.
11. Pay envelopes should be prepared for each worker for the exact
amount by one person and checked by another person.
12. Actual payment to the workers should be made, as far as possible,
in the department after proper identification. Each worker should
be asked to present himself/herself personally.
13. The foreman should be present to ensure that the envelope is given
to the right person and employees may be asked too sign a receipt.
14. From time to time a senior officer of the company should personally
be present when wages are being paid.
15. Unpaid wages should be tallied with the payrolls and be returned
to the pay office. Workers, absenting themselves on the pay day
should be paid on some other fixed date.
16. The reason for all unclaimed payment should be established.
17. Payment of wages to out workers or casual workers who work on
the locations away from the factory or head office should be made
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 COST ACCOUNTING

Notes on the site by the persons deputed from the head office for the
purpose.
18. The wages rolls should occasionally be scrutinised .by the Personnel
Officer or Works Manager to guard against inclusion of dummy
workers on the payroll.

4.7 Cost Accounting Department

Using time cards, job cards and payrolls as a guide, the cost accounting de-
partment must allocate the total payroll costs to individual jobs, d­ epartments
or products. The total payroll cost for one period must equal the sum of
the labour costs allocated to individual jobs, departments or products.
Wages Analysis Sheet or Wages Abstract
The cost accounting department prepares the wages abstract in order
to determine the direct labour costs, indirect labour costs, departmental
labour costs and difference between the budgeted labour costs and the
actual labour costs and to inform the management of the effectiveness
of labour policies. The wages abstract is like materials abstract and it is
prepared with the help of the time cards, job cards and wages sheet. A
specimen of wage abstract is given below:
Wages Analysis Sheet or Wages Abstract
Total No. ………… Week ending……………
Job No 101 Job No 102 Job No 103 Job No 104 Overheads Cost
ledger
folio
Clock Hrs Amt Clock Hrs Amt Clock Hrs Amt Clock Hrs Amt Clock Hrs Amt
No. No. No. No. No.

Prepared by…… Cost ledger posted by……. Checked by…………….

IN-TEXT QUESTIONS
1. What is the primary purpose of time-keeping in cost accounting?
(a) To calculate the amount of material consumed
(b) To record the attendance of workers and the time they
spend on their jobs
(c) To determine the selling price of a product
(d) To monitor the quality of production

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 Time-Keeping and Time Booking

2. Which of the following methods is commonly used for time- Notes

keeping?
(a) Perpetual inventory system
(b) Clock or Time card
(c) Economic order quantity method
(d) FIFO method
3. Time-booking refers to which of the following activities?
(a) Recording the total hours worked by an employee
(b) Recording the time spent by workers to specific jobs,
departments, or projects
(c) Preparing salary slips for employees
(d) Estimating the cost of raw materials
4. What is a key objective of time-booking?
(a) To calculate overtime pay
(b) To determine the labor cost associated with specific jobs
or products
(c) To ensure compliance with taxation laws
(d) To track the depreciation of machinery
5. Which document is typically used for time-booking?
(a) Material requisition form
(b) Job card or time card
(c) Trial balance
(d) Purchase order
6. How does accurate time-keeping benefit an organization?
(a) It ensures that indirect expenses are ignored
(b) It prevents underutilization of machines
(c) It helps track worker attendance and control idle time
(d) It reduces the need for budgeting

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 COST ACCOUNTING

Notes 7. Which of the following is a manual method of time-keeping?

(a) Dial time recorder
(b) Attendance register
(c) Time recording clock
(d) Barcode scanner
8. The disc or token system is classified under which category of
time-keeping methods?
(a) Electronic methods
(b) Mechanical methods
(c) Manual methods
(d) Automated methods
9. Which of the following methods involves recording attendance
using a clock machine?
(a) Attendance register
(b) Disc or token system
(c) Time recording clock
(d) Biometric scanner
10. Mechanical methods of time-keeping are generally preferred over
manual methods because they:
(a) Reduce errors and save time
(b) Are less expensive to implement
(c) Require no equipment
(d) Allow for manual adjustments of records

4.8 Answers to In-Text Questions

1. (b) To record the attendance of workers and the time they spend
on their jobs
2. (b) Clock or Time card
3. (b) Recording the time spent by workers to specific jobs, departments,
or projects

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 Time-Keeping and Time Booking

4. (b) To determine the labor cost associated with specific jobs or Notes
products
5. (b) Job card or time card
6. (c) It helps track worker attendance and control idle time
7. (b) Attendance register
8. (c) Manual methods
9. (c) Time recording clock
10. (a) Reduce errors and save time

4.9 Self-Assessment Questions

1. What is idle time? Give reasons for idle time. How do you treat
idle time in cost accounts?
2. What are the various methods of time booking? State the advantages
and disadvantages of each method.
3. A worker is paid 50 paise per hour and the 5 days working week
contains 42 hours. The daily allowance for approved absence from
his place of work, maintenance of machine etc. is 12 minutes and
his job card shows that his time chargeable during the week to
various jobs is as follows:
Job no. 305 20 hours
Job no. 310 10 hours
Job no. 320 8 hours
The unaccounted time is caused by a power failure. Show how his
wages for the week would be dealt with in cost accounts.
4. Calculate the normal and overtime wages payable to a workman from
the following data:
Days Hours Worked
Monday 8
Tuesday 10
Wednesday 9
Thursday 11
Friday 9
Saturday 4
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 COST ACCOUNTING

Notes Normal working hours 8 hours a day

Normal rate Rs.10 per hour Overtime rate upto 9 hours
in a day at single rate and over 9 hours
in a day at double rate
Or
upto 48 hours per week at single rate and
over 48 hours at double rate, whichever
is more beneficial to the workman.
5. An employee of XYZ Co. gets the following emoluments and
benefits:
(a) Salary Rs. 250 pm
(b) Dearness allowance
On 1st Rs.100 of salary Rs. 400
On next Rs.100 of salary Rs. 100
On balance of every Rs. 100 Rs. 50 or part thereof
(c) Employers contribution
-to provident fund 8% of salary and D.A.
-to ESI 4% of salary and D.A.
(d) Bonus 20% of salary and D.A.
(e) Other allowances Rs. 2725 per annum
A works for 2400 hours per annum out of which 400 hours are non-pro-
ductive but treated as normal idle time. A worked for 18 effective hours
on job no. 13 where the cost of direct materials equals A’s earnings and
the overhead applied is 100% of prime cost. The sale value of the job is
quoted to earn a profit of 10% on such value. You are required to find out
1. Effective hourly cost of A
2. Effective sale value of job No. 13

4.10 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 UNIT - III

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Cost Accounting B.Com Sem-4_Unit 3 Lesson 5.indd 136 01-Feb-25 4:01:06 PM
 L E S S O N

5
Overhead Cost
Ms. Preeti Singh

STRUCTURE
5.1 Learning Objectives
5.2 Introduction
5.3 Meaning of Overheads
5.4 Procedure for Accounting and Control of Overheads
5.5 Classification of Overheads
5.6 Segregation of Semi-Variable Overheads into Fixed and Variable Overheads
5.7 Advantages of Classification of Overheads into Fixed and Variable
5.8 Codification of Overheads
5.9 Collection of Overheads
5.10 Departmentalization of Overheads
5.11 Allocation of Overheads
5.12 Apportionment of Overheads (Primary Distribution)
5.13 Re-Apportionment of Service Department Costs (Secondary Distribution of Overheads)
5.14 Absorption of Production Overheads
5.15 Methods of Absorption of Factory Overheads
5.16 Computation of Machine Hour Rate
5.17 Requisites of a Good Method of Absorption of Production Overheads
5.18 Types of Overhead Rates
5.19 Distribution of Administration Overheads
5.20 Distribution of Selling and Distribution Overheads
5.21 Under-Absorption and Over-Absorption of Overheads
5.22 Meaning and Types of Capacity
5.23 Treatment of Certain Items in Cost Accounts

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 COST ACCOUNTING

Notes 5.24 Absorption of Overheads: Activity Based Costing Approach

5.25 Answers to In-Text Questions
5.26 Self-Assessment Questions
5.27 Suggested Readings

5.1 Learning Objectives

After reading this lesson, the students will be able to:
‹ Explain the meaning of overheads.
‹ Discuss about the classification, allocation and apportionment of
overheads.
‹ Identify different absorption rate.
‹ Describe the accounting treatment of special items of overheads.
‹ Discuss about new concept of absorption of overheads i.e. activity
based costing.

5.2 Introduction
In Unit 1, under classification of cost, it was explained that costs can be
classified into direct costs and indirect costs on the basis of their identifi-
ability with cost units or jobs or processes or cost centres. ­Direct costs are
those which can be easily identifiable with a cost object or a cost center
while indirect costs are not traceable to cost object or cost center and are
general costs. In other words, indirect costs cannot be linked with the prod-
uct offered by the firm. If a firm manufactures only one product, all costs
are direct and conveniently identified with a unit of product or other cost
object. But if it manufactures more than one product, the costs cannot be
easily and conveniently identified with a unit of product. In this situation,
the indirect costs incurred are not traceable with a particular product. So,
while direct costs are allocable to a job, process, service, cost unit or a
cost center, indirect costs cannot be so allocated.

5.3 Meaning of Overheads

Indirect costs refer to overhead costs. Such costs cannot be conveniently
identified with a particular product, process or department. It consists of
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 Overhead Cost

those costs, which the cost accountant is unable or unwilling to allocate to Notes
particular cost units. These are common costs like rent, repairs, and salaries,
which are incurred for the benefit of a number of cost unit or centres. Thus
indirect expenditure of any kind is indicated by overhead and in other words,
it is called overhead. Overhead is the aggregate of all indirect materials cost,
indirect labour cost and indirect expenses, including services, which cannot
be conveniently identified to a specific cost centre or cost object or product.
The following are the some of the authoritative definitions of overheads
are reproduced below:

ICMA, London “Overhead is the aggregate of indirect materials,

indirect wages and indirect expenses.”
ICA of India (CAS-3) “Overheads comprise costs of indirect materials,
indirect employees and indirect expenses which
are not directly identifiable or allocable to a
cost object in an economic feasible manner.”
CIMA, London “Expenditure on labour, materials or services
which cannot be economically identified with
a specific saleable cost unit.”
Wheldom “Overhead may be defined as the cost of indi-
rect materials, indirect labour and such other
expenses, including services as cannot be con-
veniently charged directly to specific cost units.
Alternatively, overheads are all expenses other
than direct expenses.”
Blocker and Welter “Overhead costs are the operating costs of a
business enterprise which cannot be traced
­directly to a particular unit of output.”
Harper “Overheads are those costs which do not result
from existence of individual cost units.”

In modern industrial undertakings, overheads are a very large proportion of

the total cost and, therefore, good deal of attention has to be paid to them.
It will be a big mistake to pay attention only to direct cost. The problem
in respect of overheads arises from the facts that the amount of overheads
has to be estimated and that too before the concerned period begins (since
it is only continuous costing that is found useful) and that, the amount has
to be distributed over the various cost units, again on an estimated basis.
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Notes
5.4 Procedure for Accounting and Control of Overheads
Overhead costs are indirect costs which cannot be easily identified and
allocated to a cost centre or object. Therefore, a proper accounting and
control of these costs are of paramount importance for the purpose of
ascertainment of cost and profit. The procedure for accounting and control
of overheads involves the following steps which are described as under:

Figure 5.1: An overview of the overhead apportionment rate

5.5 Classification of Overheads

Classification of overheads refers to the process of grouping the overhead
cost into different classes/groups on the basis of some common charac-
teristics. The classification can be summarized as follows:

5.5.1 Classification of Overheads on the Basis of Function

‹ Production Overheads
This overhead includes all indirect cost which have been incurred in
connection with production of a manufactured commodity. These consist

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 Overhead Cost

of indirect material, indirect labour and indirect expenses incurred from Notes
the stage of procurement of materials till completion of the finished
good. It is also known as, factory overheads, manufacturing overheads,
works overheads, factory cost or works cost etc. They are the expens-
es incurred in maintaining and operating a manufacturing division of
an organization. Unlike direct material and direct labour, production
overheads are an invisible part of the finished product. They consist of:

Indirect Material (i) Cost of consumable stores and supplies

such as cotton waste, lubricating oil etc.
(ii) C ost of stationery, printing, postage used
in the works
Indirect Labour (i) S alary paid to store-keepers, works
manager, departmental superintendents,
­supervisor, clerical staff of the factory etc.
(ii) Overtime wages
(iii) Wages for normal idle time
(iv) C
 ontribution to provident fund, leave
pay, maternity pay of factory employees
Indirect Expenses (i) Rent, rates and taxes of factory building
(ii) Power and fuel
(iii) Cost of training new employees
(iv) L
 ighting and heating charges of the
factory
(v) Factory telephone expenses
(vi) Repairs, insurance, depreciation of fac-
tory building, plant and machinery and
factory furniture
‹ Administration Overheads
These represent all those expenses associated with formulating
the policy, directing the organization and controlling the opera-
tions (including secretarial accounting and financial control) of an
undertaking, which are not related directly to production, selling,
distribution, research or development activity. These costs are of
a general nature and not directly related to other functions namely
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Notes production, sales and distribution. These represent the aggregate of

material cost, labour cost and expenses incurred by administration
department for general management of an organization. These over-
heads are also known as office overheads or general overheads. It
generally consists of the following costs:

Indirect Material (i) C

 ost of printing, postage & stationery
used in Administration department
(ii) Cost of dusters, brushes etc. for cleaning
Indirect Labour (i) Salary paid to office staff
(ii) Salary and allowances or fees of manag-
ing director, whole time director, general
manager, finance manager, accounts man-
ager, secretary and other staff working
in the office
(iii) Remuneration of auditors and legal ­advisors
(iv) Counting house salaries
Indirect Expenses (i) Office rent, rates and taxes
(ii) R
 epairs, insurance & depreciation of
office building, equipment and furniture
(iii) Office lighting, heating and cleaning
(iv) Administration office telephone expenses
(v) Bank charges
(vi) Trade subscription
(vii) Sundry office expenses

‹ Selling Overheads
Selling overheads are the cost of seeking to create and stimulate
demand and of securing orders. It comprises the cost to products
of distributors for soliciting and recurring orders for the articles or
commodities dealt in and of efforts to find and retain customers.
These represent the aggregate of material cost, labour cost and
expenses incurred by sales department for the sales management
to sell the product of an organization. These all costs are in nature
of indirect costs. It consists of the following costs:

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 Overhead Cost

Indirect Material (i) C

 ost of printing, postage and stationery Notes
used in sales department
(ii) Cost of catalogues, price lists etc.
Indirect Labour (i) S alary of sales director, sales manager,
salesmen, sales officer and other staff
working in sales department
(ii) Commission to selling agents
Indirect Expenses (i) Advertising, bad debts and debt collection
charges
(ii) R
 ent, rates, insurance & taxes of sales
office/showroom
(iii) Repairs, insurance & deprecation of sales
office building, equipment and furniture
‹ Distribution Overheads
Distribution overhead is the expenditure incurred in the process
which begins with making the packed product available for dispatch
and ends with making the reconditioned returned empty package,
if any, available for re-use. It includes expenditure incurred in
transporting articles to central or local storage. It also comprises
expenditure incurred in moving articles to and from prospective
customer as in the case of goods on sale or return basis. In other
words, Distribution overheads comprise all expenditures incurred
from the time product is completed in the factory till it reaches its
destination or customer. It represents the aggregate of material cost,
labour cost and expenses incurred in connection with distribution
department. It consists of the following costs:

Indirect Material (i) Cost of packing

(ii) Cost of printing, postage and stationery
used in distribution department
(iii) Cost of oil, grease etc.
Indirect Labour (i) S alary of staff working in distribution
department
(ii) Salary of driver of distribution vehicle

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Notes Indirect Expenses (i) Rent, rates and taxes of distribution office
(ii) R
 epairs, insurance and depreciation of dis-
tribution office building, delivery van etc.
(iii) Freight and carriage outwards
(iv) Running expenses of delivery vans

5.5.2 Classification of Overheads on the Basis of Element

‹ Indirect Materials
Indirect material costs are the cost of materials which cannot con-
veniently be allocated and identified to a particular cost centre or
cost object in an economically feasible way but can be apportioned
to or absorbed by a particular cost centre or cost object. Examples
of indirect material are:
‹ Consumable stores
‹ Stationery
‹ Coal
‹ Lubricants
‹ Tools
‹ Indirect Labour
Indirect labour costs are the cost of labours (wages) which cannot
conveniently be allocated and identified to a particular cost centre or
cost object in an economically feasible way but can be apportioned
to or absorbed by a particular cost centre or cost object. Examples
of indirect labour are:
‹ Salary of General Manager
‹ Salary of Accountants
‹ Salary and commission of Salesmen
‹ Salary and wages of Supervisors, Foremen and Operators
‹ Wages of sweeper
‹ Indirect Expenses
Indirect expenses are the expenses other than of the nature of indirect
material or indirect labour, which cannot conveniently be allocated and

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identified to a particular cost centre or cost object in an economically Notes

feasible way but can be apportioned to or absorbed by a particular
cost centre or cost object. Examples of indirect expenses are:
‹ Power, lighting and heating
‹ Advertising expenses
‹ Rent, rates and insurance
‹ Sundry expenses like legal charges audit fees etc.
‹ Depreciation, repairs and maintenance
‹ Welfare expenses like canteen, medical, recreation service etc.

5.5.3 Classification of Overheads on the Basis of Controllability

‹ Controllable Overheads
Controllable overhead costs are indirect costs which the management
of a manufacturing concern can keep under its control, as they are
influenced by its decisions. Therefore those overheads which can
be influenced by the management decisions are called controllable
overheads. The examples of controllable overheads are indirect
materials, power expenses and lighting expenses.
‹ Uncontrollable Overheads
Uncontrollable overhead costs are indirect cost which are beyond the
control of the management are known as uncontrollable overheads.
The management cannot influence such expenses by its decisions
and implementing proper policies, therefore, they are uncontrollable.
The examples of uncontrollable overheads are managerial salary,
factory rent, office salaries, depreciation, and legal expenses.

5.5.4 Classification of Overheads on the Basis of Normality

‹ Normal Overheads
Normal overheads refer to those overhead costs which are expected to
be incurred at a given level of output. These overheads are unavoidable
and uncontrollable. This cost is a part of cost of production.

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 COST ACCOUNTING

Notes ‹ Abnormal Overheads

Abnormal overheads refer to those overhead costs which are not
expected to be incurred at a given level of output. These overheads
are avoidable and controllable. This cost is not a part of cost of
production. In fact, such costs are charged to costing profit and
loss account. For example, cost of abnormal idle time.

5.5.5 Classification of Overheads on the Basis of Behaviour

‹ Variable Overheads
Variable overhead costs are those costs which vary in direct proportion
to the volume of output i.e. total variable overheads decrease as the
production volume decreases and vice versa. Variable overheads per
unit remain same. Examples are indirect material, indirect labour,
salesmen’s commission, power etc. Variable overhead changes in
total but its incidence on unit cost remains constant.
Suppose, for a manufacturing unit variable overheads per unit is Rs. 20.
It will remain fixed and does not change with the changes in the
volume of output. This can be observed from the following scenario:
Output Total variable overheads Variable Overheads
(in units) (in Rs.) (in Rs. per unit)
A B C = B/A
0 0 0
100 2,000 20
200 4,000 20
300 6,000 20
400 8,000 20
500 10,000 20

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 Overhead Cost

‹ Semi-Variable Overheads Notes

These overhead costs are partly fixed and partly variable. That is
why they are termed as semi-variable overheads because they consist
of both kinds of elements i.e. fixed and variable. They vary with
change in the volume of output nut not in the same proportion as
the change in the volume of output. They are also called Step Costs
as it may remain fixed within a certain activity level, but once
that level is exceeded, they vary without having direct relationship
with volume changes. For example, an expense may not change
if output is upto 40% capacity but may increase by 5% for every
10% increase in output over 40% capacity but upto 60% capacity.
Examples are supervisory salaries, depreciation, telephone charges,
repair and maintenance of buildings, machines and equipment etc.
Suppose, Semi-variable overheads Rs. 5,00,000 are constant upto
55% capacity (5,500 units) but increase by 10% over 55% but upto
85% and then increase by 20% over 85% but upto 100% capacity.

Output Total Semi-Variable Semi-Variable Overheads

Capacity (unit) Overheads (Rs.) per unit (Rs.)
A B C D = C/A
30% 3,000 Rs. 5,00,000 Rs. 166.67
40% 4,000 Rs. 5,00,000 Rs. 125.00
50% 5,000 Rs. 5,00,000 Rs. 100.00
60% 6,000 Rs. 5,50,000 Rs. 91.67
70% 7,000 Rs. 5,50,000 Rs. 78.57
80% 8,000 Rs. 5,50,000 Rs. 68.75
90% 9,000 Rs. 6,60,000 Rs. 73.33
100% 10,000 Rs. 6,60,000 Rs. 66.00

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Notes ‹ FIXED OVERHEADS

Fixed overheads comprise of those expenses which do not change
with the change in the volume of production upto a given range.
Fixed overheads have two characteristics:
 
(i) Total fixed overheads do not vary with the change in the volume
of production upto a given range.
(ii) Fixed overhead cost per unit varies with the change in the
volume of production i.e. fixed overheads per unit decreases
as the production increases and vice versa.
Suppose total fixed overheads are Rs. 5,000. It is fixed and inde-
pendent of change in volume of production. This can be observed
from the following scenario:

Output (in units) Total Fixed Overheads Fixed Overhead

(in Rs.) (in Rs. per unit)
A B C = B/A
0 5,000 0
1000 5,000 5
2000 5,000 2.5
3000 5,000 1.67
4000 5,000 1.25

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 Overhead Cost

Notes
5.6 S
 egregation of Semi-Variable Overheads into Fixed
and Variable Overheads
Semi-variable costs are partly fixed and partly variable. This classification
is important for the management for the purpose of planning, controlling
and decision making. The semi-variable costs need to be split into fixed
and variable components. The following methods can be used for clas-
sifying semi-variable costs into fixed and variable parts:
1. High and Low Points Method: Under this method, semi-variable
costs at the highest and lowest volume of production are considered.
The difference in semi-­variable costs at highest and lowest volume
of production is divided by the difference in highest and lowest
volume of output to calculate variable cost per unit component in
semi-variable cost.
Variable cost per unit
Difference in costs at highest and lowest volume of production
=
Difference between highest and lowest volume of production
Total fixed Cost = Total Semi-variable overheads – Total Variable Cost
Example 1:

Production Semi-Variable Overheads

(Units) (in Rs.)
Highest Production 16,000 10,000
Lowest Production 12,000 8,000
Difference 4,000 2,000
Variable cost per unit
Difference in costs at highest and lowest volume of producction
=
Difference between highest and lowest volume of produuction
2, 000
= = Rs. 0.50 per unit
4, 000

Total Variable cost at highest level = Rs. 0.50 × 16,000 = Rs. 8,000
Hence, Total Fixed Cost = Rs. 10,000 – Rs. 8,000 = Rs. 2,000
Total Variable cost at lowest level = Rs. 0.50 × 12,000 = Rs. 6,000
Hence, Total Fixed Cost = Rs. 8,000 – Rs. 6,000 = Rs. 2,000
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Notes 2. Comparison by Level of Activity Method: Under this method, semi-

variable cost can be divided into variable and fixed by comparing
semi-variable costs at two different level of activity.
Change in amount of semi-variable costs
Variable cost per unit =
Change in level of activity output

Total fixed Cost = Total Semi-variable overheads – Total Variable Cost

Example 2:
Month Production Units Semi-Variable Cost (in Rs.)
April   4,000 10,000
May 15,000 21,000
Difference 11,000 11,000
Change in amount of semi-variable costs
Variable cost per unit =
Change in level of activity
11, 000
= = Re. 1 per unit
11, 000

Total Variable Cost in April = 4,000 × 1 = Rs. 4,000

Total fixed Cost = Total Semi-variable overheads – Total Variable Cost
= Rs. 10,000 – Rs. 4,000
= Rs. 6,000
Total Variable Cost in May = 15,000 × 1 = Rs. 15,000
Total fixed Cost = Total Semi-variable overheads – Total Variable Cost
= Rs. 21,000 – Rs. 15,000
= Rs. 6,000
3. Simultaneous Equation Method: Under this method, overhead
costs are segregated into its fixed and variable cost elements by
means of an equation of straight line. This equation is:
Y = aX + b
Where, Y = Total Semi-Variable Cost
a = Variable cost per unit
X = Volume of output
b = Fixed Cost

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From example 1, we can have to equations: Notes

10,000 = 16,000 a + b……………………….. (i)
8,000 = 12,000 a + b……………………….. (ii)
Subtracting equation (ii) from equation (i), we get
2,000 = 4,000 a
Hence, a = Rs. 0.50
Therefore, Variable cost per unit = Rs. 0.50
Putting the value of ‘a’ in equation (i), we get
10,000 = 16,000 × 0.50 + b
b = Rs. 2,000
Hence, Fixed Cost = Rs. 2,000
4. Analytical Method: Under this method, an attempt is made to
judge empirically the proportion of variable overheads and fixed
overheads. The degree of variability is estimated for each item of
semi-variable expenses. For example, suppose in the last month of
financial year, the total semi-variable cost was Rs. 20,000. If the
degree of variability is assumed to be 40%, the variable element
= 40% of Rs. 20,000 = Rs. 8,000.
Fixed element = Rs. 20,000 – Rs. 8,000 = Rs. 12,000
In future, the fixed element will remain constant, but the variable element
will vary in direct proportion to change in volume of production.
5. Graphical Method (Scatter Diagram Method): Under this method,
variable and fixed element of semi-variable overheads can be ascertained
through graph. Under this method, a good number of observations in
respect of semi-variable costs at different levels of activity or output are
plotted on a graph with the output on the X-axis and their corresponding
costs on the Y-axis. Then a line of semi-variable cost is drawn touching
most of the points but leaving distant points, if any. This line is known
as a line of ‘best fit’ which passes through all or most of the points is
drawn. The point at which the cost line touches the Y-axis is taken to
be the fixed element of cost. From this point a line parallel to X-axis
is drawn to represent fixed cost line. The variable cost, at any level
of output, is derived by deducting this fixed cost element from semi-
variable cost.
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Notes

5.7 Advantages of Classification of Overheads into Fixed

and Variable
The advantages of classification of overheads into fixed and variable are
as follows:
1. Ascertaining Marginal Cost: The segregation of cost into fixed
and variable helps in ascertainment of marginal cost which is the
key requirement of marginal costing. The marginal costing is an
important technique for management planning, controlling and
decision making. Without the segregation cost into fixed and variable,
marginal costing technique cannot be applied.
2. Decision Making: A number of decisions of management depend
upon a comparison of (a) the extra amount that would have to be
spent if an additional activity is undertaken or an alternative course
is adopted, and (b) measurement of the benefits resulting therefrom.
The extra amount that will have to be spent will only be the variable
costs (including materials, labour and variable expenses) and not
fixed expenses. Therefore, a distinction between fixed and variable
expenses is essential.
3. Effective Cost Control: The classification of expenses into fixed and
variable helps in controlling expenses. Fixed overheads are generally
policy costs and mostly uncontrollable. Fixed expenses are controlled
by higher level management and are incurred irrespective of the volume
of production, hence it is more or less non-controllable. Variable
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expenses vary with the volume of activity and the responsibility for Notes
incurring this expenditure is determined in relation to output. Variable
overheads can, however, be controlled at lower level of management.
4. Preparation of Budgets: The classification of overheads into fixed
and variable helps in the preparation of flexible budget. For example,
when flexible budgets are prepared for different levels of production,
fixed cost remains same at all levels of activity, whereas variable
cost varies according to the actual level of activity.
5. Preparation of Break-even Charts: The classification of overheads
into fixed and variable helps in preparation of break-even charts
and also helpful in technique of profit-cost-volume relationship.
6. Absorption of Overheads: The segregation of cost into fixed and
variable helps in easy absorption of overheads. For absorption of fixed
and variable overheads separate rate can be calculated and applied.
The under/over absorption arising out of two types of overheads are
different in nature and needs different managerial action.

5.8 Codification of Overheads

After the classification of overheads, it is always advisable to codify the
overhead expenses. It is found useful to allot a number or symbol or a
combination of both to each group of expenses so that such group is easily
distinguished from that of each other. Such symbols or numbers or a combi-
nation of both are codes for overheads and are called standing order number.
Each standing order number represents a particular type of expenditure and
as when the expenditure is incurred, it is appropriately classified. Generally,
Standing Order Numbers are used to refer to various items of production
overheads and there is another concept of Cost Account Numbers which
are used to refer to various items of administration and selling & distribution
overheads. In the following ways, codification can be done:
Numerical Method: According to this method, numbers are used
(i) 
for codification and allotted to each heading and sub-heading of
expense. For example,
Standing Order Number: 10 for Indirect Material
Standing Order Number: 11 for Indirect Labour
Standing Order Number: 12 for Indirect Expenses
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Notes Alphabetical or Mnemonic Method: According to this method,

(ii) 
alphabets are used for codification of overheads. For example:
SO: Selling Overheads
SOA: Selling Overheads - Advertisement
SOAS: Selling Overheads – Advertisement - South India
Combination of Alphabets and Numbers Method: According
(iii) 
to this method, a combination of alphabets and number is used
for codification of overheads. Here alphabet stands for the main
group and number stands for the sub-group. For example:
D - Depreciation
D1 - Depreciation for plant and machinery
D2 - Depreciation for building
D3 - Depreciation for office equipment

5.9 Collection of Overheads

When classification of overheads on some scientific and consistent basis
is complete, overheads are regularly collected i.e. estimated on the basis
of standing order code numbers allotted to them. For the collection of
overhead, the following are the main sources:-
(i) Stores requisitions
(ii) Job cards or tickets
(iii) Invoices or purchase voucher
(iv) Salary or Pay bills
(v) Cash book
(vi) Subsidiary records
Indirect materials originate in store requisitions. Each store requisitions
note specifies the standing order number and the department for which
the stores are drawn. The departmentalization is done at sources. A
material issue analysis sheet is prepared from store requisitions. At
the end of each month, the total of these items is charged or debited
to Factory Overhead Control Account and credited to Stores Ledger
Control Account.

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Indirect labour is obtained in the first place, from the time cards and pay Notes
rolls. Wages paid to workers against each standing order number can be
obtained from the time tickets or job cards. From the time tickets, the
wages analysis sheet is prepared each month and at the end of the month,
the total is debited to Factory Overhead Control Account and credited
to the Wages account.
Indirect expense can come from several sources such as cash book, factory
journals or vouchers. In the case of cash outlays, the entry may come
from the cash book. Expenses such as depreciation and other adjustment
items which do not result from cash outlays are taken from subsidiary
records. At the end of the period, the total of factory overheads would
be debited to Factory Overhead Control Account and credited to the Cost
Ledger Control Account.
Each item of overheads may be seen and proper estimate of the amount
for the coming period may be prepared. Another way, more expeditious,
is to analyse the total overheads into fixed and variable and then arrive
at the estimate by adjusting the variable amount by the expected change
in output and the fixed amount by such changes as employment of more
people, increments, etc.

5.10 Departmentalization of Overheads

After the collection, classification and codification of overheads, the next
step is allocation and apportionment of overheads. Before the allocation
and apportionment of overheads process start, the first step in this direc-
tion is ‘Departmentalization’ of overhead expenses. Departmentalization
means allocation and apportion of overheads to various departments in
the firm. For efficient working, a factory is sub-divided into a number
of departments, each of which represents a particular area or activity of
the factory. These departments are mainly of two types:
(a) Production Department, and
(b) Service Department
Advantages of Departmentalization:
‹ It helps in calculating the cost of various service departments.
‹ It makes possible the effective control of overhead costs.

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Notes ‹ It ensures effective decision making because of greater accuracy in

cost ascertainment and cost control.
‹ It helps in ascertaining the correct cost of work-in-progress which
is not possible unless overheads are departmentalized.

5.11 Allocation of Overheads

According to the Chartered Institute of Management Accountants, London,
cost allocation is “that part of cost attribution which charges a specific
cost to a cost centre or cost unit”. Allocation of overheads is the process
of charging the full amount of overheads to particular a cost center or
cost unit. Thus, it is a direct process of identifying overheads to the cost
units or cost centers.
For example, electricity charges can be allocated to various departments
if separate meters are installed, indirect materials can be easily allocated
to various departments in which they are incurred.
Statement showing the allocation of overheads
Production Department Service Department
Items of Overhead
A B C D E
Direct Material – – – XXX XXX
Direct Wages – – – XXX XXX
Direct Expenses – – – XXX XXX
Indirect Material XXX XXX XXX XXX XXX
Indirect Wages XXX XXX XXX XXX XXX
Total Overheads
XXX XXX XXX XXX XXX
allocated

5.12 Apportionment of Overheads (Primary Distribution)

Apportionment refers to the distribution of overheads among departments
or cost centres on an equitable basis. In other words, apportionment in-
volves charging a share of the overheads to a cost centre or cost unit.
CIMA, London has defined it as “that part of cost attribution which
shares costs among two or more cost centres or cost units in propor-
tion to the estimated benefit received, using a proxy”. Apportionment is
done in case of those overhead items which cannot be directly allocated

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to a particular department. Wherever possible, the overheads are to be Notes

allocated. However, if it is not possible to charge the overheads to a
particular cost center or cost unit, they are to be apportioned to various
departments on some suitable basis.
For example, if separate meters are installed in every department, the elec-
tricity expenses can be allocated to various departments. However, if separate
meters are not installed, electricity expenses will have to be apportioned to
the departments on some suitable basis like number of light points.
BASIC PRINCIPLES OF APPORTIONMENT OF OVERHEADS:
Overheads are to be apportioned to various production and service depart-
ment on some conventional basis. According to ICAI, (CAS-3), Overheads
are to be apportioned on following two principles:
Cause and Effect - Cause is the process or operation or activity
(i) 
and effect is the occurrence of cost. Hence, apportionment of
overheads should be based on this criterion of cause and effect
relationship which ensures better rationality as it is based on the
relationship between cost object and cost.
Benefits received - Overheads are to be apportioned to the various
(ii) 
cost centres or objects in proportion to the benefits received by them.
In case of facilities created on a ready-to-serve basis, the cost shall
be assigned on the basis of expected benefits instead of actual.
BASIS OF APPORTIONMENT OF OVERHEADS:
Items of Overhead Basis of apportionment
Factory Rent, rates and taxes Floor area occupied
Group insurance, canteen expenses, Super- Number of employees
vision, general welfare expenses, compen- or wages of each
sation and other fringe benefits, etc. department
Insurance and depreciation of plants, Capital values of assets
machinery and equipment.
Insurance of Stock Insured value of Stock
Compensation to workers, Employees’ Direct labour hours
State Insurance contribution, Provident
Funds Contribution, Works manager’s
remuneration, general overtime expenses,
cost of inter-­department transfers etc.

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Notes Lighting and Heating charges Number of light points

Electric power consumption Horse power of machines
or machine hours
Stores overheads/Store Keeping Expenses Value or weight of
direct material
Delivery expenses Weight or tonne-Km
or mile.

For allocation and apportionment of overheads, a statement called as

“Overhead Distribution Summary” is prepared. The format of Overhead
Distribution Summary is given below:
Production Service
Items of Basis of Total
Department Department
Overheads Apportionment (in Rs.)
A B C D E

5.13 R
 e-Apportionment of Service Department Costs
(Secondary Distribution of Overheads)
Once the overheads have been allotted and apportioned to production
and service department, the next step is re-distribution of overheads of
service department to production department on some suitable basis. It
is necessary, as our ultimate goal is to charge the total overhead costs to

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cost unit and no cost unit passes through service departments. Normally Notes
products do not pass through service departments, but service departments
do benefit the manufacture of products. Therefore, it becomes essential to
apportion the overheads of service department to production department.
The process of redistribution of the cost of service departments among
the production departments is known as secondary distribution.
The method of re-apportionment of service department costs is similar
to apportionment of overheads discussed earlier. The following table
suggests common basis of apportionment of service department costs to
production department:

Service Department Basis of Apportionment

Purchase Department Number of Purchase Orders or value of
materials purchased
Employment/personnel Rate of labour turnover or total wages
department or number of employees in each
department
Maintenance department Numbers of hours worked for each
department
Payroll or time department Direct labour hours, machine hours,
number of employees
Stores keeping department Number of material requisitions, ­quantity
or value of materials issued
Welfare department Number of employees in each department
Inspection Inspection Hours or Value of items
inspected
Tool Room Direct Labour Hours or Machine Hours
or Wages
Power house Meter reading, Floor space, H.P. hours
for powers, Number of points for light-
ing and heating
Various methods are used for apportionment of cost of service department
to production department:
‹ RE-APPORTIONMENT TO PRODUCTION DEPARTMENT ONLY
Under this method, the costs of service departments are directly
apportioned to production departments only, without taking into

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Notes consideration any services rendered by one service departments to

another service department. The costs of such service departments
are apportioned in the proportion of service rendered to various
production departments.
‹ RE-APPORTIONMENT TO BOTH PRODUCTION DEPARTMENT
AND SERVICE DEPARTMENT
Under this method, the costs of service departments are not
directly apportioned to production departments because in this
case a service department renders services to not only production
departments but also to other service departments. Here, service
department are not inter-dependent. For example, maintenance
department provides services not only to assets installed in produc-
tion departments but to equipment presents in service departments.
Similarly, power house supplies power and electricity not only
to production departments but also to other service departments
like maintenance, canteen etc. In this case, re-apportionment of
service department costs can be done on Reciprocal Basis or
Non-Reciprocal Basis.
1. Re-apportionment on non-reciprocal basis (step-ladder method):
This method is used when a service department renders services to
the production and other service department but does not receive
services of the services department. The following steps involved
in this method:
The service departments are arranged in descending order on the
(a) 
basis their serviceability to production and service department.
Apportion the cost of first service department which serves the
(b) 
maximum number of services to all the production and other
service departments.
Apportion the cost of next largest service provider department
(c) 
to all the production and other service departments (excluding
the first service department)
This process continues till the cost of last service department
(d) 
is apportioned.
(e) In the end, the cost of last service department is apportioned
only to the production departments.

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2. Re-apportionment on reciprocal basis: Notes

This method recognizes the fact that where two or more service de-
partments render services to each other, each department receiving
such services should be charged for the cost of services rendered
by the other. This means a service department not only provides its
services to other service departments but also receives services of
other service departments. For example, power house provides power
to maintenance department and maintenance department provides ser-
vices power house. Re-apportionment of service ­department costs on
reciprocal basis can be by using any one of the following method:
Simultaneous Equation Method: In this method, total cost of
(a) 
each service department is apportioned to production department
only by forming and solving simultaneous equation.
X = a + bY
Y = a + bX
Where, X denotes the total cost of service department X
Y denote the total cost of service department Y
a denotes cost of a service department before re-apportionment
b denotes share of cost of one service department to be
distributed to other service department
Repeated Distribution Method: Following steps are followed
(b) 
to apportion the cost of service department:
(i) Apportion the cost of first service department to production
department and other service department in given percentages.
After distribution at this level, the account of service
department will be closed.
(ii) Apportion the cost of second service department (plus
apportioned cost received in step 1) to production department
and other service department in given percentages.
(iii) Apportion the cost of next service department (plus apportioned
cost received from previous steps) to production department
and other service departments in given percentages.
(iv) The above procedure should be followed till the value of all
service departments become negligible small. In the end,

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Notes the small figures left should be apportioned to production

department only.
Trial and Error Method: Following steps are followed to
(c) 
apportion the cost of service department:
(i) Apportion the cost of first service department to other
service departments only in given percentages.
(ii) Apportion the cost of Second service department (plus
apportioned cost received in step 1) to other service
departments only in given percentages.
(iii) Apportion the cost of next service department (plus
apportioned cost received from previous steps) to
production department and other service departments
in given percentages.
(iv) Repeat the process till the service department cost is reduced
to negligible amount.
(v) At the last, the total of each service department cost is
distributed to production departments on agreed percentages.

Illustration 1: A company has three production departments and two

service departments. Distribution summary of overheads is as follows:

Production Departments Service Departments

A Rs. 3,000 1 Rs. 234
B Rs. 2,000 2 Rs. 300
C Rs. 1,000
The expenses of service departments are charges on a percentage basis
which as follows:

A B C 1 2
1 20% 40% 30% – 10%
2 40% 20% 20% 20% –
Find out the total overheads of production departments using the fol-
lowing methods:
(a) Simultaneous Equations Method (b) Repeated Distribution Method

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Solution: Notes
(a) Simultaneous Equation Method
Let x denote total overheads of service department 1
y denote total overheads of service department 2
Therefore, x = 234 + 0.2 y ..... (i)
y = 300 + 0.1x ..... (ii)
To solve the equations, rearrange these and multiply by 10 to
eliminate decimals.
10x − 2y = 2,340
−x + 10y = 3,000
Multiplying second equation by 10 and adding
10x − 2y = 2,340
−10x + 100y = 30,000
98y = 32,340
y = 32,340 ÷ 98 = 330
x = 300
Secondary Distribution Summary
Total Production Department
A B C
Rs.
Rs. Rs. Rs.
Total as per primary summary 6,000 3,000 2,000 1,000
Service Dept. 1 (90% of 300) 270 60 120 90
Service Dept. 2 (80% of 330) 264 132 66 66
Total 6,534 3,192 2,186 1,156
(b) Repeated Distribution Method
Production Department Service Department
A B C X Y
Rs. Rs. Rs. Rs. Rs.
Total as per primary 3,000 2,000 1,000 234 300
summary
Service Dept. 1 47 94 70 ( ̶ )234 23
Service Dept. 2 129 65 65 64 ( ̶ )323
Service Dept. 1 14 25 19 ( ̶ )64 6
Service Dept. 2 2 2 2 – –
Total 3,192 2,186 1,156 – –

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Notes Illustration 2: The following account balances and distribution of indirect

charges are taken from the accounts of a manufacturing concern for the
year ending on 31st March, 2015.

Total
Amount Production Departments Service Departments
Items (Rs.) X (Rs.) Y (Rs.) Z (Rs.) A (Rs.) B (Rs.)
Indirect material 1,25,000 20,000 30,000 45,000 25,000 5,000
Indirect labour 2,60,000 45,000 50,000 70,000 60,000 35,000
Superintendent 96,000 – – 96,000 – –
salary
Fuel & heat 15,000
Power 1,80,000
Rent & rates 1,50,000
Insurance 18,000
Meal charges 60,000
Depreciation 2,70,000

The following department data are also available:

Production Departments Service Departments

X Y Z A B
Area (Sq. ft) 4,400 4,000 3,000 2,400 1,200
Capital value of assets 4,00,000 6,00,000 5,00,000 1,00,000 2,00,000
Kilowatt hours 3,500 4,000 3,000 1.500 –
Radiator sections 20 40 60 50 30
No. of employees 60 70 120 30 20

Expenses charged to the service depts. are to be distributed to other

departments in the following percentages:

X Y Z A B
Department A 30 30 20 – 20
Department B 25 40 25 10 –

Prepare an overhead distribution statement to show the total overheads

of production departments after reapportioning service departments’ over-
head by using simultaneous equation method. Show all the calculations
to the nearest rupee.

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 Overhead Cost

Solution: Primary Distribution of Overheads Notes

Items Basis Total Production departments Service
amount departments
(Rs.) X (Rs.) Y (Rs.) Z (Rs.) A (Rs.) B (Rs.)
Indirect Actual 1,25,000 20,000 30,000 45,000 25,000 5,000
material
Indirect labour Actual 2,60,000 45,000 50,000 70,000 60,000 35,000
Superin­tendent Actual 96,000 – – 96,000 – –
salary
Fuel & heat Radiator 15,000 1,500 3,000 4,500 3,750 2,250
sec­tions
(2:4:6:5:3)
Power Kilowatt 1,80,000 52,500 60,000 45,000 22,500 –
hours
(7:8:6:3:0)
Rent & rates Area (sq. Ft.) 1,50,000 44,000 40,000 30,000 24,000 12,000
(22:20:15:12:6)
Insurance Capital 18,000 4,000 6,000 5,000 1,000 2,000
value
of assets
(4:6:5:1:2)
Meal charges No. of 60,000 12,000 14,000 24,000 6,000 4,000
employ­ees
(6:7:12:3:4)
Deprecia­tion Capital val- 2,70,000 60,000 90,000 75,000 15,000 30,000
ue of assets
(4:6:5:1:2)
Total OH 11,74,000 2,39,000 2,93,000 3,94,500 1,57,250 90,250

Redistribution of overheads of service departments A and B

Total overheads of service departments may be distributed using simul-
taneous equation method.
Let, the total overheads of A = a and the total overheads of B = b
a = 1,57,250 + 0.10 b (i)
b = 90,250 + 0.20 (ii)
Multiplying equation (i) by 10 and adding both the equation after rear-
ranging them, we get
10 a – b = 15,72,500
– 0.20 a + b = 90,250
9.8 a = 16,62,750
a = 1,69,668

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Notes Putting the value of a in equation after rearranging them, we get:

b = 90,250 + 0.20 × 1,69,668
b = 1,24,184
Secondary Distribution of Overheads
Production departments
X (Rs.) Y (Rs.) Z (Rs.)
Total overheads as per primary 2,39,000 2,93,000 3,94,500
distribution
Service department A (80% of 50,900 50,900 33,934
1,69,668) in 3:3:2
Service department B (90% of 31,046 49,674 31,046
1,24,184) in 25:40:25
Total 3,20,946 3,93,574 4,59,480

5.14 Absorption of Production Overheads

After allocation and apportionment of overheads to production and ser-
vice department plus re-apportionment of service department costs to
production department, the total overhead cost pertaining to production
department then charged to products, jobs, processes, etc. The pro­cess of
charging overheads from cost centres to products or services by means
of absorption rate for each cost centre is called absorption of overheads.
CIMA defines absorption as, “the process of absorbing all overhead costs
allocated or apportioned over a particular cost center or production de-
partment by the units produced.”
The absorption of overheads involved the following two steps:
Computation of Overhead Absorption Rate: Absorption rate is
(a) 
the rate at which overheads are charged to different products. It is
computed for the purpose of absorption of overheads. This can be
in the form of a percentage of direct material cost, direct labour
cost, prime cost, direct rate per labour hours, rate per machine
hours, rate per production units etc. The formula for computing
overhead absorption rate is:
Total cost of overheads of cost centre
Overhead Absorption Rate =
Total units of base used

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 Overhead Cost

For example: Factory Overheads = Rs. 15,000 Notes

Direct Material = Rs. 60,000
15,000
Overhead Absorption Rate   100
60,000
= 25%
Application of Rates to Cost Units: To calculate cost of each unit,
(b) 
the overhead rate is multiplied to the value of base in cost unit.
Overhead Absorbed = Overhead rate × Number of units in cost unit
For example: In continuation of above example, if direct materials
cost for a particular job is Rs. 2,000, then the overheads absorbed
by the job will be 25% of Rs. 2,000 i.e. Rs. 500.

5.15 Methods of Absorption of Factory Overheads

There are six methods of absorption of factory overheads. They are as follows:

S. No Methods Description
1. Percentage In this method, the cost of direct material
of Direct incurred in producing the product is used
Material as basis for calculating production overhead
Meaning

Cost absorption rate. The rate is calculated in the

following manner:
Production Overhead Rate =
Amount of Production Overheads
× 100
Direct Material Cost
1. I n this method calculations are easy and
simple to understand.
2. I t is suitable when production units are
Advantages

uniform.
3. T
 his method provides more accurate re-
sults in case the prices of materials do not
fluctuate.
4. T
 his method is suitable where one type of
product produced using same type of material.

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Notes S. No Methods Description

1. It ignores the time factor.
2. It does not give satisfactory results where
the prices of materials fluctuate.
3. T
 his method doesn’t provide distinction

Disadvantages
between jobs done by skilled workers and
those done by unskilled workers.
4. O
 verhead costs in no way related to direct
material costs. It seems illogical because
production overheads do not vary with
change in cost material consumed.
5. I t ignores the distinction between jobs done
by machine and manual labour.
For example: Factory Overheads = Rs. 15,000
Direct Material = Rs. 60,000
15,000
Overhead Absorption Rate   100
Example

60,000
= 25%
Thus, if direct materials cost for a particular job
is Rs. 2,000, then the overheads absorbed by
the job will be 25% of Rs. 2,000 i.e. Rs. 500.
2. Percentage In this method, direct labour costs incurred
of Direct in producing the product is used as basis for
Labour calculating production overhead absorption rate.
Meaning

Cost The rate is calculated in the following manner:

Production Overhead Rate =
Amount of Production Overheads
× 100
Direct Labour Cost

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 Overhead Cost

S. No Methods Description Notes

1. In this method calculations are easy and
simple to understand.
2. It takes into account time factor.
Advantages
3. I t gives satisfactory results where wages of
­labour do not fluctuate. Normally wages of
labour fluctuate less as compared to material
prices.
4. This method is more suitable when work-
ers are equally efficient and type of work
performed is equal.
1. It does not give satisfactory results where
labour costs fluctuate.
2. If workers are remunerated on piece wage
Disadvantages

system, this method is not reliable.

3. I t ignores the distinction between jobs done
by machine and manual labour.
4. I t ignores the distinction between jobs done
by skilled workers and those done by un-
skilled workers.
For example: Factory Overheads = Rs. 15,000
Direct Labour = Rs. 30,000
15,000
Overhead Absorption Rate   100
Example

30,000
= 50%
Thus, if direct labour cost for a particular job
is Rs. 2,000, then the overheads absorbed by
the job will be 50% of Rs. 2,000 i.e. Rs. 1,000.
3. Percentage In this method, prime cost incurred in produc-
of Prime ing the product is used as basis for calculating
Cost production overhead absorption rate. The rate
Meaning

is calculated in the following manner:

Production Overhead Rate =
Amount of Production Overheads
× 100
Prime Cost
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Notes S. No Methods Description

1. This method combines the advantages that
direct material costs and direct labour costs

Advantages
methods have.
2. It takes into consideration both direct ma-
terial costs and direct labour costs which
give rise to overhead expenses.
1. It suffers from the same drawbacks from

Disadvantages
which material and labour suffer.
2. T
 he results can be more misleading because
of the chances of cumulative error.

For example: Factory Overheads = Rs. 12,000

Prime Cost = Rs. 1,00,000
12,000
Overhead Absorption Rate   100
Example

1,00,000
= 12%
Thus, if direct labour cost for a particular job
is Rs. 2,000, then the overheads absorbed by
the job will be 12% of Rs. 2,000 i.e. Rs. 240.
4. Rate per In this method, direct labour hour used in
Direct producing the product is used as basis for cal-
Labour culating production overhead absorption rate.
Meaning

Hour The rate is calculated in the following manner:

Production Overhead Rate =
Amount of Production Overheads
Direct Labour Hours
1. It takes into consideration time factor.
2. T
 his method tries to eliminate the limitation
of direct wage method.
Advantages

3. The absorption rate is not affected by the

method of wage payment i.e. time rate of
piece rate method.
4. It is suitable when labour is major part of
factor of production.
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 Overhead Cost

S. No Methods Description Notes

1. It requires additional records of labour.

Disadvantages
2. I t ignores the distinction between jobs done
by machine and manual labour.
3. I t ignores the distinction between jobs done
by skilled workers and those done by un-
skilled workers.
For example: Factory Overheads = Rs. 30,000
Direct Labour Hours = 10,000 hours
30,000
Overhead Absorption Rate =
10,000
Example

= Rs. 3 per hour

Thus, if for a particular job, direct labour hours
required is 2,000 hours, then the overheads
absorbed by the job will be 2,000 hours × Rs.
3 per hour i.e. Rs. 6,000.
5. Machine This method is used when major portion of
Hour Rate production is performed by machinery. In this
method, machine hours used in producing the
product is used as basis for calculating pro-
Meaning

duction overhead absorption rate. The rate is

calculated in the following manner:
Production Overhead Rate =
Amount of Production Overheads
Machine Hours
1. It is more accurate method of absorption
of production overheads.
2. It takes into consideration time factor.
Advantages

3. I t is suitable where work is mainly per-

formed by machines.
4. W
 hen separate rates are calculated for fixed
and variable overheads, the cost of idle
machine can be measured.

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Notes S. No Methods Description

1. I t is quite difficult to estimate machine
hours in advance.

Disadvantages
2. Thus method is suitable only in those de-
partments where majority of the production
is done by machines.
3. This method requires maintenance of de-
tailed records.
4. It is difficult to understand and calculate.
For example: Factory Overheads = Rs. 45,000
Machine Hours = 10,000 hours
40,000
Overhead Absorption Rate =
10,000
Example

= Rs. 4 per hour

Thus, if for a particular job, machine hours
required is 2,000 hours, then the overheads
absorbed by the job will be 2,000 hours × Rs.
4 per hour i.e. Rs. 8,000.
6. Rate per In this method, number of units incurred in
unit of producing the product is used as basis for cal-
Production culating production overhead absorption rate.
Meaning

The rate is calculated in the following manner:

Production Overhead Rate =
Amount of Production Overheads
No. of units of production
1. This method is suitable where units are
Advantages

uniform in size, quality and standard.

2. It is easy to adopt and simple to
understand.

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 Overhead Cost

S. No Methods Description Notes

1. It ignores time factor.

Disadvantages
2. I t ignores the distinction between jobs done
by machine and manual labour.
3. I t ignores the distinction between jobs done
by skilled workers and those done by un-
skilled workers.
For example: Factory Overheads = Rs. 12,000
No. of Units Produced = 10,000 units
12,000
Overhead Absorption Rate =
10,000
Example

= Rs. 1.2 per unit

Thus, if for a particular job, number of units
produced are 2,000 units, then the overheads
absorbed by the job will be 2,000 units × Rs.
1.2 per unit i.e. Rs. 2,400.

5.16 Computation of Machine Hour Rate

The Chartered Institute of Management Accountant (CIMA), England
defines a machine hour rate as, “an actual or predetermined rate of cost
apportionment or overhead absorption, which is calculated by dividing
the cost of apportioned or absorbed by the number of hours for which a
machine or machines are operated or expected to be operated.”
The following steps are taken for computation of machine hour rate:
1. Each machine or group of machines should be treated as a separate
cost centre.
2. The estimated overhead expenses for the period should be determined
for each machine or group of machines.
3. The overheads relating to the machine should be 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 effective machine hours
for the period in order to get the fixed overhead hourly rate. For

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 COST ACCOUNTING

Notes variable charges, an hourly rate is calculated for each item of expenses
separately by dividing the expenses by the effective machine hours.
5. Total of standing charges and variable charges rates will give the
machine hour rate.
FORMAT FOR CALCULATION OF MACHINE HOUR RATE
Per Machine Per Machine
Particulars
(per annum) (per hour)
Standing Charges (Fixed Charges):
Rent and Rates XXXX
Supervisor’s salary XXXX
Heating and Lighting XXXX
Insurance XXXX
Lubricating oil XXXX
Consumable Stores XXXX
Total Standing Charges XXXX
Standing Charges per hour
Total Standing Charges XXXX
=
Effective Machine Hours (WN1)
Variable Expenses:
Depreciation (WN 2) XXXX
Power (WN 3) XXXX
Repair and Maintenance XXXX
Machine Hour Rate XXXX
COMPREHENSIVE (OR COMPOSITE) MACHINE HOUR RATE:
The direct wages are not included in production overheads. Hence, it is
not considered while calculating the machine hour rate. When the direct
wages of machine operators are included in machine hour rate, it is known
as comprehensive machine hour rate. Thus, overheads and direct wages
are absorbed in one single rate in the cost of a product.
Working Notes:
S.No. Item Calculation
= Total working hours expected
Effective
( ̶ ) Unproductive Maintenance hours
WN 1 ­Machine
( ̶ ) Unproductive set up time
Hours
( ̶ ) Overtime Hours
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 Overhead Cost

S.No.Item Calculation Notes

Depreciation
Cost  Installation Charges  Salvage
WN 2 (Straight Line 
Effective Machine Hours
Method)
[Unit consumption per hour  Rate 
(Total working hours  Mainttenance hour 
WN 3 Power
Setup hours during which no power is consumed

Effective Machine Hours
Illustration 3: From the following information compute Machine Hour
Rate in respect of a machine installed in the department:
Cost of the machine Rs. 40,000
Life of the machine 10 years
Working hours per year 2,200 hours
(Including setting up time of 200 hours)
Power consumption 10 units per hour @ Re. 1 p.u.
Annual rent of the department Rs. 20,000
Annual insurance and other expenses Rs. 1,000
of the machine
Salary of the supervisor Rs. 5,000 per month
The machine requires a chemical Solution which is replaced every month
at a cost Rs. 200. The machine occupies ¼ of the total area of the de-
partment. The supervisor devotes 1/6 of his time on the machine. The
setting up time is unproductive but power is consumed during that time.
[B.Com (Hons), Delhi 2016]
Solution:
Particulars Per annum (Rs.) Per hour (Rs.)
Standing charges:
Rent (Rs. 20,000/4) 5,000
Supervisory salary (Rs. 5,000 × 10,000
12 × 1/6)
Insurance etc. 1,000
Chemical (200× 12 months) 2,400
Total 18,400
Standing charges per hour 9.20
(Rs. 18,400/2,000 hrs*)
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 COST ACCOUNTING

Notes Particulars Per annum (Rs.) Per hour (Rs.)

Variable charges:
Depreciation (Rs. 40,000/ 10 years 2.00
× 2,000 hrs)
Power 11.00*
Machine hour rate 22.20

Working notes:
* Working hours per annum are 2,200 less 200 = 2,000 hrs
* Power 10 units @ Rs. 1 = Rs. 10
Power per hour = 2,200 × 10 / 2,000 = Rs. 11
Illustration 4: The following annual charges are incurred in respect of
a machine shop where manual labour is almost nil and where work is
done by means of five machines exactly of similar type and specification:
Rs.
1. Rent and rates (proportional to the floor
space occupied) for the shop 4,800
2. Depreciation on each machine 500
3. Repairs and maintenance for the five machines 1,000
4. Power consumed (as per meter)
@ 5 p. Per unit for the shop 3,000
5. Electric charges for light in the shop 540
6. Attendants: There are two attendants for the five machines and they
are each paid Rs. 60 per month.
7. Supervision:
For the five machines in the shop there is one supervisor whose
emoluments are Rs. 250 p.m.
8. Sundry supplies such as Lubricants, Jute and cotton waste etc. for
the shop is Rs. 450
9. Hire Purchase Installments payable for the machine (including Rs.
300 as interest) is Rs. 1,200
10. 
The Machine uses 10 units of hour per hour. Calculate the machine
hour rate for the machine for the year. [B.Com (Hons) Delhi, 2014]

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 Overhead Cost

Solution: COMPUTATION OF MACHINE HOUR RATE FOR Notes

THE YEAR
Particulars Rs. (p.a.)
Fixed charges per machine:
Rent and rates 4800 ÷ 5 960
Depreciation 500
Repairs and maintenance 200
Electric charges 540 ÷ 5 108
Supervision (250 × 12)/5 600
Sundry supplies 450 ÷ 5 90
Total fixed charges 2,458
Rs. Per hour
Fixed charges per hour (2,458 ÷ 1200 hrs *) 2.05
Variable charges
(60 × 2 × 12)
Attendants wages 0.24
(5 × 1200)
Power (10 units @ 5 paise per unit) 0.50
Machine hour rate 2.79
* Working Notes:
1. Hire purchase installment in a capital item and thus not included
in machine hour rate computation.
2. Each machine runs for 1,200 hours per year. This is computed from
the power cost as under.
10 units @ 5 paise = 50 paise per hour and total cost is Rs. 3,000
Hours per machine = 6,000 ÷ 5 = 1,200
Illustration 5: The cost of a machine is Rs. 66,000 and it has an estimated
scrap value of Rs. 6,000 at the end of its estimated effective life of 10
years. Annually the machine works on all the 365 days at a rate of 8 hours
every day of which 120 hours p.a. are consumed by maintenance. About
1/7th of the total productive time is consumed in setting the machines.
Various costs relating to the working of machines are as follows:
1. Two units of power are consumed every hour at the rate of Rs.
1.40 per unit.
2. Monthly cleaning and oiling expenses for the machines are Rs. 280.

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Notes 3. Annual maintenance of machines amounts to Rs. 2,800

4. Three operators combined together control operation of ten identical
machines and each of them gets a monthly salary of Rs. 2,100.
5. Annual departmental overheads apportioned to the machines are:
Fixed: Rs. 5,480 Variable: Rs. 12,600
Compute machine hour rate in each of the following cases:
1. Setting up time is regarded as productive but power is not consumed
during setting up time.
2. Setting up time is not regarded as productive but power is consumed
during setting up time.
Solution:
1. When setting up time is productive but power is not consumed
during setting up time.
Working hours per year (365 days × 8 hours) 2,920 hrs
Less: Maintenance hours   120 hrs
Effective hours 2,800 hrs
Computation of machine hour rate
Per annum Per hour
Standing charges:
Rs. Rs.
Salary of operators (Rs. 2,100 × 12 months
7,560
× 3/10)
Cleaning and oiling (Rs. 280 × 12 months) 3,360
Departmental overhead 5,480
Depreciation (Rs. 66,000 ̶ 600) 6,000
10 years
Maintenance 2,800
Total 25,200
Standing charges per hour (Rs. 25,200 ÷
9.00
2,800 hrs)
Variable overhead (Rs. 12,600 ÷ 2,800 hrs) 4.50
Power (Rs. 1.40 × 2 units × 2,400 hrs)
2.40
2,800 hrs
Machine hour rate 15.90

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 Overhead Cost

2. When setting up time is not productive but power is consumed Notes

during setting up time.
Set up time 2,800 × 1/7 = 400 hrs
Effective hours = 2,800 hrs ̶ 400 hrs = 2,400 hrs.
Computation of machine hour rate
Per hour (Rs.)
Standing charges (Rs. 25,200 ÷ 2,400 hrs) 10.50
Variable overhead (Rs. 12,600 ÷ 2,400 hrs) 5.25
Power (Rs. 1.40 × 2 units × 2,800 hrs) 3.27
2,400 hrs
Machine hour rate 19.02

5.17 R
 equisites of a Good Method of Absorption
of Production Overheads
A good method of absorption should possess the following characteristics:
1. It should be simple to understand and adopt.
2. It should make a distinction between the work done by skilled
workers and work done by unskilled workers.
3. It should distinguish between the work done by manual labour and
the work done by machine.
4. It should take into consideration the time factor.
5. It should be economical in application.
6. It should follow an equitable base so that it does not result in very
much under/over absorption of overheads.

5.18 Types of Overhead Rates

Overhead absorption rate may be based on actual figures or estimated figures.
1. Actual Overhead Rates vs Pre-determined Overhead Rates
Actual Overhead Rates
This rate is calculated by dividing the actual overhead expenses incurred
during the accounting period by the actual base (i.e. actual output or

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Notes actual labour hours or actual machine hours etc.). This rate can be
calculated after the actual overheads have been incurred. This rate is
determined as follows:
Actual Overhead Expenses for the period
Actual Overhead Rate =
Actual Base for the period
This method suffers from the following limitations:
(i) Actual overhead rate cannot be computed till the end of the
accounting period. The management is always interested in knowing
the cost well in advance for planning, controlling and decision
making purpose.
(ii) Due to Seasonal or cyclical factors, this rate is liable to wide
fluctuations. Therefore, it will be difficult to compare the cost
of one period with another period.
(iii) It cannot be used for cost control purpose. For cost controlling,
the cost must be known in advance.

Pre-Determined Overhead Rates

This rate is calculated by dividing the estimated or budgeted overhead
expenses for the accounting period by the budgeted base for the period.
It is determined in advance of the period in which it is to be used. This
rate is determined as follows:

Budgeted Overhead for the period

Pre-determined Overhead Rate =
Budgeted Base for the period

The advantages of using pre-determined rate is as follows:

(i) The pre-determined rate helps in prompt cost ascertainment because
this rate is computed in advance which can be used for planning,
controlling and decision making.
(ii) Cost controlling is also facilitated by comparing the actual overheads
with the pre-determined overheads recovered.
(iii) The pre-determined rate enables prompt preparation of tenders and
quotations and fixation of selling prices.

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 Overhead Cost

1. Blanket Overhead Rate vs Departmental Overhead Rates Notes

Blanket Overhead Rate
A blanket overhead rate is a single overhead rate for the whole factory
covering all its departments or processes. It is computed as follows:
Total Overheads for the factory
Blanket Overhead Rate =
Total number of units of base for the factory

Applicability: It is applicable for those firms who:

(i) Produce only one product
(ii) Produce two or more products of similar nature and having equal
incidence of overhead costs.

Limitations:
It suffers from the following limitations:
(i) When this rate is used, performance of individual department or
cost centres cannot be properly assessed and exercise of control
becomes difficult.
(ii) It may result in over valuation of work-in-progress if units included
in work-in-progress do not pass through all the departments.
(iii) This method of absorption of overhead is not used when output
is not of uniform nature.

Departmental Overhead Rates/ Multiple Overhead Rates

A departmental overhead rate is a separate rate of overhead absorption
which is computed for each department or cost centre. It is always
advisable to use separate overhead rates for each department to assign
its overhead cost on most equitable basis to the cost of production.
For example, separate rate may be calculated for production depart-
ment, service department, cost centres, products etc. It is computed
as follows:
Total Overheads of the department
Multiple Overhead Rate =
Total number of units of base for that department

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 COST ACCOUNTING

Notes
5.19 Distribution of Administration Overheads
Administrative overheads represent all those expenses associated with for-
mulating the policy, directing the organization and controlling the operations
(including secretarial accounting and financial control) of an undertaking.
These costs are of a general nature and not directly related to other functions
namely production, sales and distribution. These represent the aggregate of
material cost, labour cost and expenses incurred by administration department
for general management of an organization. These overheads are also known
as office overheads or general overheads. As production and sales cannot
function without some sort of administrative control, these overheads serve
the purpose of such a control. For example, office rent, salary of managing
director and general manager, depreciation of office machines etc.
Absorption of Administration Overhead
Office and administration overheads generally constitute a minor portion of
the total cost, so it will not be advisable to follow a complicated method
for their absorption. A blanket rate may be computed for the entire factory.
The rate may be calculated according to any of the following methods:
1. As a percentage of conversion cost: Administrative Overheads can also
be absorbed as a percentage of conversion cost. Conversion cost is the
cost of converting raw material into finished goods. It includes the cost
of direct labour, direct expenses and factory overheads. The formula for
calculating the administration overhead absorption rate is as follows:
Administration Overheads
Administration OH Absorption Rate   100
Conversion Cost
2. As a percentage of works cost: Administrative Overheads are
generally absorbed as a percentage of works cost. The formula for
calculating the administration overhead absorption rate is as follows:
Administration Overheads
Administration OH Absorption Rate   100
Works Cost
3. As a percentage of Sales: Administrative Overheads are sometimes
absorbed as a percentage of Sales. The formula for calculating the
administration overhead absorption rate is as follows:
Administration Overheads
Administration OH Absorption Rate   100
Sales
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 Overhead Cost

4. As a percentage of Factory Overheads: Administrative Overheads Notes

can also be absorbed as a percentage of Factory Overheads. The
formula for calculating the administration overhead absorption rate
is as follows:
Administration Overheads
Administration OH Absorption Rate   100
Factory Overheads

5.20 Distribution of Selling and Distribution Overheads

Selling Overheads
Selling overheads are the cost of seeking to create and stimulate demand
and of securing orders. It comprises the cost to products of distributors
for soliciting and recurring orders for the articles or commodities dealt in
and of efforts to find and retain customers. These represent the aggregate
of material cost, labour cost and expenses incurred by sales department
for the sales management to sell the product of an organization. These
all costs are in nature of indirect costs. For example, travelling cost,
brokerage and commission, cost of free samples etc.
Distribution Overheads
Distribution overhead is the expenditure incurred in the process which
begins with making the packed product available for dispatch and ends
with the making the reconditioned returned empty package, if any, avail-
able for re-use. It includes expenditure incurred in transporting articles to
central or local storage. It also comprises expenditure incurred in moving
articles to and from prospective customer as in the case of goods on
sale or return basis. In other words, Distribution overheads comprise all
expenditures incurred from the time product is completed in the factory
till it reaches its destination or customer. It represents the aggregate of
material cost, labour cost and expenses incurred in connection with dis-
tribution department. For example, salaries of distribution staff, carriage
outwards, secondary packing, warehousing and storage etc.
These two selling and distribution costs are different in nature. Selling
overheads are incurred for increasing the volume of sales and secur-
ing more orders. While distribution overheads are incurred during the
­distribution of finished goods from the factory (or warehouse) to the
ultimate customer (or retailers).
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 COST ACCOUNTING

Notes Absorption of Selling and Distribution Of Overheads

After collection, allocation and apportionment, the following methods are
usually adopted for the absorption of selling and distribution overheads:
1. As a percentage of sales value: Selling and distribution Overheads
can be absorbed as a percentage of sales value. The formula for
calculating the selling and distribution overhead absorption rate is
as follows:
Selling and distribution Overhead Absorption Rate
Selling and distribution Overheads
  100
    Sales Value
2. As a percentage of works cost: Selling and distribution Overheads
can be absorbed as a percentage of works cost. This method is suitable
when a business produces only one product. The formula for calculating
the selling and distribution overhead absorption rate is as follows:
Selling and distribution Overhead Absorption Rate
Selling and distribution Overheads
  100
    Works cost
3. Rate per unit sold: Selling and distribution Overheads can be
absorbed as per rate per unit sold. This method is suitable when a
business selling only one uniform type of product. The formula for
calculating the selling and distribution overhead absorption rate is
as follows:
Selling and distribution Overhead Absorption Rate
Selling and distribution Overheads
  1000
    Number of units sold

5.21 Under-Absorption and Over-Absorption of Overheads

It is already stated, the absorption of overhead can be based on either
actual overhead rate of pre-determined overhead rate. When actual rate is
used, the overheads absorbed are equal to the overhead incurred. There
will be no under-absorption or over-absorption of overheads. But when
pre-determined rate is used for absorption of overheads, in such situation
overhead absorbed may not be equal to the actual overhead incurred. This
will results in either under- absorption or over-absorption of overheads.

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 Overhead Cost

Meaning of If the amount of overheads absorbed in the pro- Notes

Under-absorption duction is less than the actual amount of overhead
incurred, it is called under-absorption of overheads.
The under-absorption has the effect of understating
the cost as the actual overheads costs are not fully
recovered or assigned in the cost of job or process-
es etc. For example, if during April, the overhead
absorbed are Rs. 20,000 and the actual overhead
incurred are Rs. 21,000, there is under-absorption
of overhead to the extent of Rs. 1,000.
Meaning of If the amount of overheads absorbed in the produc-
Over-absorption tion is more than the actual amount of overhead
incurred, it is called over-absorption of overheads.
The over-absorption has the effect of overstating
the cost as the actual overheads costs are already
recovered or assigned in the cost of job or process-
es etc. For example, if during April, the overhead
absorbed are Rs. 21,000 and the actual overhead
incurred are Rs. 20,000, there is over-absorption
of overhead to the extent of Rs. 1,000.
Causes Under/over absorption of overhead arise due to any
one or more of the following causes:
(i) Wrong estimation of overhead costs.
(ii) Wrong estimation of the base i.e. production
units or labour hours or machine hours.
(iii) Wrong estimation of output.
(iv) Unexpected changes in method of production.
(v) Under/over utilization of production capacity.
(vi) S
 easonal fluctuations in the overhead expenses
in certain industries.
Accounting The under/over absorption of overhead may be dis-
Treatment posed off by any one of the following three methods:
(1) Use of Supplementary rate method
(2) Write off to costing profit and loss account
(3) Carry over to next accounting period method
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Notes Use of Sup- This method is used when the amount of under
plementary or over-absorption of overhead is significant or
rate method large and is due to normal reasons like increase in
material prices or labour rates etc. The difference
between absorbed overhead and actual overhead
will be adjusted by calculating a supplementary
rate. Supplementary rate is calculated as follows:
Supplementary Rate =
Actual Overhead − Absorbed Overhead
Actual Base
Disposal of Under/over absorption of overhead

In
�  case of under absorption, the overhead is ad-
justed by a plus rate. The cost of sales, finished
Stock and Work-in-progress are increased by
applying positive supplementary rate.
In
�  case of over absorption, the overhead is ad-
justed by a minus rate. The cost of sales, finished
Stock and Work-in-progress are increased by
applying negative supplementary rate.
Write off This method is used when the amount of under or
to costing over-absorption of overhead is not significant or
profit and not very large and is due to abnormal reasons like
loss account idle capacity, defective planning etc. The difference
between absorbed overhead and actual overhead will
be write off to Costing Profit and Loss Account.
Carry over This method is used when the normal business cycle
to next extends over more than one year and overheads rates
accounting are determined on a long-term basis. The difference
period between absorbed overhead and actual overhead
method is transferred to Overhead Suspense Account and
carried forward to next year.
In
�  case of under absorption, the amount is transferred
to debit of Overhead Reserve/Suspense Account.
In
�  case of over absorption, the amount is transferred
to credit of Overhead Reserve/Suspense Account.

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Illustration 6: A company has budgeted Rs. 5,00,000 for variable over- Notes
heads and Rs. 8,00,000 for fixed overheads for the year. The overheads
are recovered on the basis of the machine hours. The company has bud-
geted for Rs. 1,00,000 machine hours for the year. During the year, the
company used Rs. 95,000 machine hours for the actual output. Actual
costs incurred for the fixed and variable manufacturing overheads were
Rs. 8,00,000 and Rs. 4,70,000 respectively.
Required:
(i) Compute the over or under recovered variable manufacturing
overhead amount.
(ii) Compute the over or under recovered fixed manufacturing overhead
amount.
(iii) Compute the over or under recovered total manufacturing overhead
amount.
 [B.Com (Hons) Delhi, 2014]

Budgeted overheads
Solution: Overhead absorption rates =
Budgeted Hours
For variable overheads = Rs. 5, 00,000/1,00,000 hours = Rs. 5 per hour
For fixed overheads = Rs. 8, 00,000/1,00,000 hours = Rs. 8 per hour
Overheads absorbed = Actual hours × overheads rates
Variable overheads = 95,000 × 5 = Rs. 4,75,000
Fixed overheads = 95,000 × 8 = Rs. 7,60,000
Under/over absorption of overheads = Overheads Absorbed ̶ Actual
Overheads
Variable overheads = Rs. 4,75,000 – Rs. 4,70,000 = Rs. 5,000 (Over
Absorbed)
Fixed overheads = Rs. 7,60,000 – 8,00,000 = Rs. 40,000 (Under Absorbed)
Total under/over absorption of overheads
= Rs. 5,000 (over absorbed) ̶ 40,000 (under absorbed)
= Rs. 35,000 under-absorbed overheads

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Notes Illustration 7: The production department of a factor furnishes the fol-

lowing information for the month of October:
Rs. Rs.
Materials used 54,000
Direct wages 45,000
Labour hours worked 36,000
Hours of machine operation 30,000
Overheads chargeable to the department 36,000
For an order executed by the department during the period, the relevant
information was as under:
Rs. Rs.
Materials used 6,000
Direct wages 3,200
Labour hours worked 3,200
Hours of machine operation 2,400
Calculate the overheads chargeable to the job by the following methods:
(i) Direct material cost percentage rate
(ii) Labour hour rate
(iii) Machine hour rate
Solution:
(i) Direct material cost percentage rate
Overheads 36, 000
  100   100  66.67%
Direct materials 54, 000
Materials used on the job cost = Rs. 6,000
Overheads chargeable to the job (66.67 % of 6,000) = Rs. 4,000
(ii) Labour hour rate
Overheads 36, 000
= = = Re. 1
Labour hours 36, 000
Overheads chargeable to the job (Rs.1 for 3,200 hours) = Rs. 3,200
(iii) Machine hour rate
Overheads 36, 000
= = = Rs. 1.20
Machine hours 30, 000
Overheads chargeable to the job (Rs.1.20 for 2,400 hours) = Rs. 2,880
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 Overhead Cost

Notes
5.22 Meaning and Types of Capacity
Capacity of an undertaking can be defined in terms of ability of plant
or an undertaking to produce by utilizing available resources. It can be
expressed in terms of units of production or services or equivalent ma-
chine or man hours.
1. Installed Capacity: It refers to the maximum possible capacity of
producing goods or services of a plant, according to the manufacturer’s
specifications, which can be achieved only under perfect conditions
i.e. when there is no loss of operating time.
2. Practical Capacity: It refers to the maximum possible capacity
of producing goods or services of a plant less capacity to be lost
due to normal reasons (inevitable interruptions due to time lost for
preventive maintenance, repairs, setups, etc.)
3. Normal Capacity: It refers to the production achieved or achievable
on an average over a period under normal circumstances. Normal
capacity is practical capacity minus the loss of productive capacity
due to external factors like of demand. For example, Practical
capacity is 42,000 hours and Actual capacity during the last 5
years was: I 40,000 hours, II 49,000 hours, III 41,500 hours, IV
42,500 hours, V 36,500 hours. In this situation, Year II being
too high and Year V being too low are to be ignored. Hence,
Normal Capacity = (40,000 + 41,500 + 42,500) / 3 = 41,333
hours (approx.)
4. Idle capacity: It is the difference between installed capacity and
the actual capacity utilization when actual capacity utilization is
less than installed capacity.
5. Actual capacity utilization: Actual capacity utilization is the
volume of production achieved or service provided in a specified
period, expressed as a percentage of installed capacity. Volume can
be expressed in terms of units produced or services provided or
equivalent machine or man hours, as applicable. Actual capacity
utilization is mostly expressed in relation to or as a percentage of
installed capacity.

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 COST ACCOUNTING

Notes IN-TEXT QUESTIONS

1. Overhead refers to:
(a) Direct or Prime Cost
(b) All Indirect costs
(c) Only Factory indirect costs
(d) Only indirect expenses
2. Allotment of whole item of cost to a cost centre or cost unit
is known as:
(a) Cost Apportionment (b) Cost Allocation
(c) Cost Absorption (d) Machine hour rate
3. Service department’s costs should be allocated to:
(a) Only Service departments
(b) Only Production departments
(c) Both Production and service departments
(d) None of the production and service departments
4. In element-wise classification of overheads, which one of the
following is not included?
(a) Fixed overheads (b) Indirect labour
(c) Indirect materials (d) Indirect expenditure.
5. Which of the following is not a possible method of accounting
for administration overheads?
(a) Include as part of production overheads
(b) Apportion to production, selling and distribution functions
(c) Treat administration as a separate entity and treat the costs
as such
(d) Transfer to costing profit and loss account
6. Most suitable basis for apportioning insurance of machine
would be:
(a) Floor Area (b) Value of Machines
(c) No. of Workers (d) No. of Machines

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 Overhead Cost

Notes
7. The process of distribution of overheads allotted to a particular
department or cost center over the units produced is called:
(a) Allocation (b) Apportionment
(c) Absorption (d) Departmentalization
8. If an item of overhead expenditure is charged specifically to
a single department this would be an example of:
(a) Apportionment (b) Allocation
(c) Re-apportionment (d) Absorption
9. Which of the following is not included in functional classification
of overheads?
(a) Repairs and maintenance
(b) Lubricating oil
(c) Consumable stores
(d) Chargeable expenses
10. The process of cost apportionment is carried out so that:
(a) Costs may be controlled
(b) Cost units gather overheads as they pass through cost centres
(c) Whole items of cost can be charged to cost centres
(d) Common costs are shared among cost centres
11. Which of the following methods is used to account for the
under-absorption and over-absorption of overheads?
(a) Use of supplementary rates
(b) Carrying forward of overheads
(c) Writing-off to costing profit and loss account
(d) All of the above
12. Which of the following is not a method of cost absorption?
(a) Percentage of direct material cost
(b) Machine hour rate
(c) Labour hour rate
(d) Repeated distribution method

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 COST ACCOUNTING

Notes
13. Blanket overhead rate is:
(a) One single overhead absorption rate for the whole factory
(b) Rate which is blank or nil rate
(c) Rate in which multiple overhead rates are calculated for
each production department, service department etc.
(d) Always a machine hour rate
14. Overhead expenses can be classified according to:
(a) Functions (b) Elements
(c) Behavior (d) All of the above
15. An overhead absorption rate is used to :
(a) Share out common costs over benefiting cost canters
(b) Find the total overheads for a cost centre
(c) Charge overheads to products
(d) Control overheads
16. Fill in the Blanks:
(a) Overhead is the aggregate of ________ and ________ and
________.
(b) Overheads can be classified according to, ________,
________, ________ and ________.
(c) Under absorption/over absorption of overheads takes place
when ________ rate of absorption is used.
(d) The term used for charging overheads to cost units is
known as ________.
(e) When the amount of under absorbed/over absorbed
overheads is negligible, it is disposed of by transferring
to ________.
(f) The________ rate is computed by dividing the overhead by
the aggregate of the productive hours of direct workers.
(g) Administration overheads are usually absorbed as a percentage
of ________.

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 Overhead Cost

Notes
(h) The difference between the practical capacity and the
capacity based on sales expectancy is known as ________.
(i) When a single overhead absorption rate is used for the
entire factory, it is called as ________.
17. A departmental store has several departments. What bases
would you recommend for apportioning the following items
of expenses to its departments:
(i) Fire Insurance of Building________.
(ii) Rent________.
(iii) Delivery Expenses________.
(iv) Purchase Department Expenses________.
(v) Credit Department Expenses________.
(vi) General Administration Expenses________.
(vii) Advertisement________.
(viii) Sales Assistants Salaries________.
(ix) Personnel Department Expenses________.
(x) Sales Commission________. (I.C.W.A. Inter)
18. Indicate whether the following statements are True or False:
(a) Fixed overhead cost per unit changes inversely with the
increase in output levels.
(b) Semi-fixed overheads are not affected by change in
production volume.
(c) Multiple rates of absorption of overhead should be preferred
over blanket rate.
(d) Variable overheads comprise of those indirect expenses
which vary in direct proportion as the change in the
volume of output.
(e) Factory overhead items of rent, rates and taxes, insurance,
depreciation and repairs of buildings etc. can be apportioned
on floor area occupied basis.

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 COST ACCOUNTING

Notes
5.23 Treatment of Certain Items in Cost Accounts

Bad Debts Bad debts are bound to occur during normal course
of business. Some accountants are of the opinion that
bad debts are financial losses and should be excluded
from cost accounts. It is treated as follows:
‹ Bad debts within normal limits: It is treated as part
of selling overheads.
‹ Bad debts over and above normal limits: It is charged
to costing profit and loss account.
Bonus In India, the Payment of Bonus Act, 1965, makes it oblig-
1
atory to pay a minimum bonus of 8 % to employees
3
irrespective of profit or loss. It is treated as follows:
‹ Minimum Bonus: If it is paid to factory direct labour
then treated as Direct Labour Costs, if it is paid to
factory indirect labour then it is treated as Factory
Overheads, if it is paid to administration staff then
it is treated as Administration Overheads, if it is
paid to sales workers then it is treated as Selling
Overheads and if it is paid to distributors then it
is treated as Distribution Overheads.
‹ Over and above minimum bonus: It is charged to
Costing Profit and Loss Account.
Carriage Carriage expenses incur in the process of inward or
Expenses outward movement of material and goods from one
place to another. It is treated as follows:
‹ Incurred in relation to Direct Material: It is treated
as a part of direct material costs.
‹ Incurred in relation to Indirect Material: It is treated
as a part of production overheads.
‹ Incurred in relation to Distribution of Finished goods:
It is treated as a part of distribution overheads.
‹ Incurred in relation to Direct Material/Indirect
Material/ Distribution of Finished goods: It is charged
to Costing Profit and Loss Account.
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 Overhead Cost

Cash Discount Cash discount is given to customer or received for the Notes
creditors for prompt payment of cash. It is purely a finan-
cial matter and should be excluded from cost accounts.
Cost of tools The treatment is as follows:
‹ Cost of small tools: One of the methods of treatment
of the cost of small tools is to capitalize the cost
of small tools and debited to Small Tools Account.
Depreciation on the same shall be written off.
Depreciation is treated as overheads. If there are any
difficulties in treating this cost as a capital cost due
to difficulty in ascertaining the life of small tools,
the other method can be used is to charge the cost
of small tools as a part of production overheads
and distribute them to other departments on some
suitable basis and finally absorbed by products.
‹ Cost of large tools: The amount of depreciation on
large tools is treated as part of production overheads.
Defectives or It is treated as follows:
Spoiled Work ‹ Arising under normal circumstances: It should be
included in the cost of production as normal loss.
‹ Arising under abnormal circumstances: The net loss
should be charged to Costing Profit and Loss Account.
Depreciation Depreciation is the decrease in the value of a fixed
asset over a period of time due to wear and tear. It is
treated as follows:
‹ Depreciation on Fixed Assets of Production Department:
It is treated as part of production overheads.
‹ Depreciation on Fixed Assets of Administration
Department: It is treated as part of administration
overheads.
‹ Depreciation on Fixed Assets of Selling Department:
It is treated as part of selling overheads.
‹ Depreciation on Fixed Assets of Distribution
Department: It is treated as part of distribution
overheads.

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 COST ACCOUNTING

Notes Drawing and Drawing and design office expenses represent all ex-
Design Office penses incurred in drawing office and in relation to
Costs preparation of design, drawing and plans. It is treated
as follows:
‹ Incurred for a particular job: The entire cost should
be charged to this job as a direct expenses.
‹ Incurred for production in general: It is treated as
part of production overheads and later on apportioned
to different departments on suitable basis.
‹ Enclosed with sales tenders: It is treated as part of
Selling Overheads.
Fringe These are the indirect benefits given to workers in
Benefits addition to basic salary and direct cost-allowances.
These benefits are provided to boost the morale, to
increase loyalty and stability of the employees in the
organization. It is treated as follows:
‹ If the amount is substantial: It may be recovered
as direct charge by means of a supplementary wage
or labour rate.
‹ If the amount is not substantial: It may be treated
as part of production overheads.
Interest on There is controversy whether interest on capital should
Capital be included in the cost or not. The arguments in favour
of inclusion and against inclusion are given below:
For Inclusion:
‹ Interest is a production cost similar to wages. Wages
is the reward for labour, interest is the reward for
capital. True profit cannot be calculated unless
interest is taken into consideration.
‹ True comparison of different jobs with different
requirements of amount if capital or different period
of completion cannot be made unless interest is
included.
‹ To submit tenders for cost plus contracts etc. interest
should be taken into account.
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 Overhead Cost

‹ True carrying cost of maintain stocks cannot be Notes

ascertained unless interest is considered.
‹ The decision of using labour intensive or machine
intensive technique cannot be correctly decided
without taking interest factor into consideration.
‹ The inclusion of interest is of particular importance
where articles of different values are produced and
capital invested in each case varies considerably.
Against Inclusion:
‹ The argument interest is the reward of capital holds
good in economics and not in costing.
‹ Inclusion of interest inflates the value of stocks in
hand which means recognition of unrealized profit.
‹ It is difficult to determine the amount of capital
upon which interest is to be calculated.
‹ Interest is an internal matter of pure finance and
is not connected with the cost of manufacture and
hence should be excluded from cost.
‹ It is difficult to determine the fair rate of interest
to be charged.
Conclusion:
‹ Interest should be excluded from cost accounts, and
‹ Interest should be considered while making cost
comparison for managerial decision making.
Leave Wages Leave wage means the wages for an accrued leave. It
is treated as follows:
‹ When the workers are entitled to leave
‹ Leave wages to factory direct workers: It is treated
as part of direct labour cost.
‹ Leave wages to factory indirect workers: It is treated
as part of production overheads.

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 COST ACCOUNTING

Notes ‹ Leave wages to administration workers: It is treated

as part of administration overheads.
‹ Leave wages to sales workers: It is treated as selling
overheads.
‹ Leave wages to distribution workers: It is treated
as distribution overheads.
‹ When the workers are not entitled to leave: It is
charged to Costing Profit and Loss Account.
Packing It is treated as follows:
Expenses ‹ Primary Packing necessary for handling: It is treated
as part of prime cost.
‹ Fancy Packing to attract customer: It is treated as
part of selling overheads.
‹ Secondary Packing to facilitate distribution: It is
treated as part of distribution expenses.
Research and It is treated as follows:
Development ‹ Research Cost related to manufacturing activities:
Cost It is treated as part of production overheads.
‹ Research Cost related to administration activities:
It is treated as part of administration overheads.
‹ Research Cost related to marketing activities: It is
treated as part of selling and distribution overheads.
‹ Research Cost related to a particular product: It is
charged to a particular product.
‹ Cost of unsuccessful research: It is charged to
Costing Profit and Loss Account.
Royalties and It is treated as follows:
Patent Fees ‹ Expense incurred in relation to Units Produced: It
is as a part of direct expense and hence included
in the prime cost.
‹ Expense incurred in relation to Units sold: It is
treated as selling overheads.

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 Overhead Cost

Notes
5.24 Absorption of Overheads: Activity Based Costing
Approach
When all indirect costs are allocated, apportioned and finally absorbed
in the cost units, this is a traditional method of absorption of overheads.
This traditional method can lead to distortion in correct computation of
costs due to the basis selected for absorption. This method is criticized on
this ground also that it is completely volume based and assign overhead
costs in proportion to production volumes. If production volume doubles
so does the consumption of resource and consequently overhead costs.
Hence, a new concept is developed by Cooper and Kaplan which is known
as Activity Based Costing (ABC). Activity Based Costing is based on
the belief that there are activities which cause costs and therefore better
way to absorb the cost is by creating link between activities and product.
CIMA defines Activity Based Costing as, ‘cost attribution to cost units
on the basis of benefit received from indirect activities, e.g., ordering,
setting up, assuring quality.’
ABC has also been defined by CAM-1 organisation of Arlinton Texas as
“the collection of financial and operation performance information tracing
the significant activities of the firm to product Costs”.
In the words of Cooper and Kaplan, “ABC system calculates the costs
of individual activities and assigns costs to cost objects such as product
and services on the basis of activities undertaken to produce each product
or service.”
Process of activity based costing is summarized below:
1. Identifying Main Activities: The first step is to identify all activities
of an organization which may represent the work performed in an
organization. An activity may be a unit level, batch level, product-
sustaining or facility-sustaining activity. By determining the actual
activities, it can be easily related to customers, products and services
to determine correct cost.
2. Identifying Suitable Activity Cost Driver: According to CIMA, ‘cost
driver is any factor which causes a change in the cost of an activity,
e.g., the quality of parts received by an activity is a determining
factor in the work required by that activity and therefore affects

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 COST ACCOUNTING

Notes the resources required. An activity may have multiple cost drivers
associated with it.’ So it is important to determine an appropriate
cause of occurrence of that particular cost. Thus a cost driver is
termed as an activity which generates cost.
3. Determining the Cost of Each Activity Per Cost Driver: After
determining an appropriate cost driver or cause of occurrence of a
cost, an activity cost driver is calculated in the following manner:
Total cost of activity
Activity cost driver rate =
Number of cost driver
4. Absorbing Cost: Activity costs are finally absorbed by a product
on its consumption of each activity. We can use following formula
for assigning costs to product/jobs/service:
Activity Cost charged to a product = R
 esources Consumption
× Activity Cost Driver Rate

5.25 Answers to In-Text Questions

1. (a) Direct or Prime Cost
2. (b) Cost Allocation
3. (c) Both production and service departments
4. (a) Fixed overheads
5. (a) Include as part of production overheads
6. (b) Value of Machines
7. (c) Absorption
8. (b) Allocation
9. (d) Chargeable expenses
10. (d) Common costs are shared among cost centres
11. (d) All of the above
12. (d) Repeated distribution method
13. (a) One single overhead absorption rate for the whole factory
14. (d) All of the above
15. (c) Charge overheads to products

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 Overhead Cost

Notes
16. (a) Indirect Material, Indirect Labour and Indirect expenses
(b) function, behavior, elements and control
(c) Pre-determined
(d) Absorption of overheads
(e) Costing Profit and Loss Account
(f) Production overhead absorption rate
(g) Works Cost
(h) Actual Capacity
(i) Blanket Rate
17. (i) Floor area
(ii) Floor area
(iii) Volume or weight × Distance
(iv) No. of Purchase Orders or Value of Purchases
(v) Credit Sales Value
(vi) Works Cost
(vii) Sales Value
(viii) Actuals or Time Devoted
(ix) Number of employees
(x) Actual or Sales Value
18. (a) True
(b) False
(c) True
(d) True
(e) True

5.26 Self-Assessment Questions

1. State the distinction between the two terms in each of the following,
giving examples:
(a) Cost allocation and cost apportionment.
(b) Direct cost and indirect cost.
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 COST ACCOUNTING

Notes (c) Fixed cost and variable cost.

(d) Indirect expenses and overheads.
2. What are overheads? How should overheads be classified? To what
extent will you include overhead charges in your valuation of (a)
work-in-progress, and (b) finished goods?
3. Write a detailed note on Collection and Codification of Overheads.
4. Distinguish between Primary and Secondary Distribution of Overheads.
5. What do you understand by Secondary Distribution Summary? What
are the methods of the same?
6. Distinguish between allocation and apportionment of overheads.
7. Discuss the treatment of the following items in cost accounts.
(i) Capacity cost
(ii) Set-up time
(iii) Packing expenses
(iv) Blue print and design
8. Distinguish clearly between direct and indirect materials. Under
what circumstances may direct materials be charged indirectly to
the product?
9. What are meant by ‘actual overheads’ and ‘recovered overheads’?
Under what circumstances overheads stand under-absorbed or over
absorbed? How will you account for the under/over absorption of
overheads?
10. What is meant by absorption of overheads? What factors should be
considered in obtaining a rate for absorption of overheads?
11. Describe the different bases on which factory overheads can be
apportioned.
12. Distinguish between cost allocation, cost apportionment and cost
absorption.
13. Explain how you would treat under-absorbed factory overheads in
cost accounts.

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14. A company has two production departments and two service Notes
departments. The data relating to a period are as under:
Production Departments Service Departments
PD1 PD2 SD1 SD2
Direct material 80,000 40,000 10,000 20,000
Direct wages 95,000 50,000 20,000 10,000
Overheads 80,000 50,000 30,000 20,000
Power requirement at 20,000 35,000 12,500 17,500
normal capacity oper-
ations (kWh)
Actual power consump- 13,000 23,000 10,250 10,000
tion during the period
(kWh)
The power requirements of these departments are met by a power gener-
ation plant. The said plant incurred an expenditure, which is not included
above, of Rs. 1,21,875 out of which a sum of Rs. 84,375 was variable
and the rest fixed.
After appointment of power generation plant costs to the four depart-
ments, the service department overheads are to be distributed on the
following bases:
PD1 PD2 SD1 SD2
SD1 50% 40% – 10%
SD2 60% 20% 20% –
You are required to:
1. Apportion the power generation plant costs to the four departments.
2. Re-apportion service department cost to production departments.
3. Calculate the overhead rates per direct labour hour of production
departments, given that the direct wage rates of PD1 and PD2 are
Rs. 5 and Rs. 4 per hour respectively.
 [B.Com (Hons) Delhi University, 2005]
Answers: Overheads after secondary distribution: Department PD1
Rs. 2,06,490, PD2 Rs. 1,55,385, Overhead rate per hour: Department
PD1 Rs. 10.87, PD2 Rs. 12.43

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 COST ACCOUNTING

Notes 15. Kumaresh Ltd. has three production Departments A, B and C and two
service departments D and E. The following figures are extracted
from the records of the company.
(Rs.)
Rent and rates 5,000
Indirect wages 1,500
Depreciation of machinery 10,000
General lighting 600
Power 1,500
Sundries 10,000
Following further details are available:
Total A B C D E
Floor space 10,000 2,000 2,500 3,000 2,000 500
(sq. meters)
Light points 60 10 15 20 10 5
Direct wages (Rs.) 10,000 3,000 2,000 3,000 1,500 500
H.P. of machines 150 60 30 50 10 –
Value of 2,50,000 60,000 80,000 1,00,000 5,000 5,000
machinery (Rs.)
Apportion the cost to various departments on the most equitable basis by
preparing a Primary Departmental Distribution Summary.
 [B.Com (Hons) Delhi University, 1993]
Answers: Primary Distribution of overheads: Department A Rs. 7,550,
B Rs. 7,200, C Rs. 9650, D Rs. 4,625, E Rs. 1,575
16. A company has 3 production departments A, B and C and two
service departments X and Y. The following data are extracted from
the records of the company for a particular given period.
(a) Rs.
Rent and rates 25,000
General lighting 3,000
Indirect wages 7,500
Power 7,500
Depreciation on machinery 50,000
Sundries 50,000

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 Overhead Cost

Additional Data, Departmental wise

(b)  Notes
DEPARTMENTS
TOTAL
A B C X Y
Direct wages (Rs.) 50,000 15,000 10,000 15,000 7,500 2,500
Horsepower of
150 60 30 50 10 –
Machines used
Cost of machinery 12,50,000 3,00,000 4,00,000 5,00,000 25,000 25,000
Production hours
– 6,226 4,028 4,066 – –
worked
Floor space used
10,000 2,000 2,500 3,000 2,000 500
(Sq. mtr)
Lighting points
60 10 15 20 10 5
(number)

Service Department’s Expenses Allocation

(c) 
Departments A B C X Y
X 20% 30% 40% – 10%
Y 40% 20% 30% 10% –

You are required to:

(i) Compute the overhead rate of production departments using the
repeated distribution method.
(ii) Hence, determine the total cost of a product whose direct material
cost and direct labour cost are respectively Rs. 250 and Rs. 150 and
which would consume 4 hours, 5 hours and 3 hours in departments
A, B and C respectively.
 (ICWA Inter June 1997)
Answers: Overheads after secondary distribution: Department A Rs. 46,697,
B Rs. 45,304, C Rs. 60,999; Overhead rate per hour: Department A Rs.
7.50, B Rs. 11.25, C Rs. 15, Total cost of product Rs. 531.25
17. A machine shop in a factory has five machines of exactly similar
type and specification. One operator is employed on each machine at
Rs. 20 per hour. The factory works a 40 hour week which includes
four hours for set up time for each machine. The operators are
paid fully for 40 hours. Costs are reported for the machine shop
on the basis of thirteen four weekly periods. The following details
applicable to the cost centre/ machine are available.

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 COST ACCOUNTING

Notes 1. Set up time is unproductive and no power is consumed during

the set up time.
2. Original cost of a machine is Rs. 1,30,000
3. Depreciation on machine is to be provided at 10% per annum
on original cost.
4. Maintenance and repairs per week per machine amounts to Rs.
25
5. Consumable stores per week per machine amount to Rs. 27
6. Power consumed is 10 units per hour per machine at 80 paise per
unit.
7. Wages paid to the operators are considered as indirect.
8. Overheads apportioned to the cost centre are:
Rent Rs. 3,000 p.a.
Heat and Light Rs. 4,000 p.a.
Miscellaneous expenses Rs. 6,000 p.a.
You are required to calculate:
(i) Cost of running one machine for a four week period
(ii) The machine hour rate
 [B.Com (Hons) Delhi University, 2005]
Answers: (i) Rs. 1,440 (ii) MHR Rs. 40
18. XYZ Ltd. manufacturers a single product and absorbs the production
overheads at a determined rate of Rs. 10 per machine hour.
At the end of financial year 2014-15, it has been found that actual
production overheads incurred were Rs. 6,00,000. It included Rs.
45,000 on account of ‘written off’ obsolete stores and Rs. 30,000
being the wages paid for the strike period under an award.
The production and sales data for the year 2014-15 is as under:
Production:
Finished goods 20,000 units
Work in Progress (50% complete in all respect) 8,000 units

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 Overhead Cost

Sales: Notes
Finished goods 18,000 units
The actual machine hours worked during the period were 48,000. It
has been found that one third of the under absorption of production
overheads was due to lack of production planning and the rest was
attributable to normal increase in costs.
You are required to:
Calculate the amount of under absorption of production overheads
during the year 2014-15. Show the accounting treatment of under-
absorption of production overheads:  (C.A. Inter Nov. 1999)
Answers: (i) Under absorption Rs. 45,000, (ii) Charged to; (a) cost
of sales Rs. 22,500 (b) WIP Rs. 5,000 (c) Finished Goods Rs 2,500
(d) Costing P&L A/c Rs. 15,000

5.27 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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Cost Accounting B.Com Sem-4_Unit 3 Lesson 5.indd 208 01-Feb-25 4:01:51 PM
 UNIT - IV

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Cost Accounting B.Com Sem-4_Unit 4 Lesson 6.indd 210 01-Feb-25 3:00:17 PM
 L E S S O N

6
Output Costing
Ms. Preeti Singh

STRUCTURE
6.1 Learning Objectives
6.2 Introduction
6.3 Meaning of Unit Costing
6.4 Cost Sheet
6.5 Components of Total Cost
6.6 Preparation of Cost Sheet
6.7 Production Statement
6.8 Production Account
6.9 Treatment of Stock and Scrap
6.10 Items Not Included in Cost Sheet
6.11 Difference Between Cost Sheet and Production Account
6.12 Answers to In-Text Questions
6.13 Self-Assessment Questions
6.14 Suggested Readings

6.1 Learning Objectives

After reading this lesson, the students wil be able to:-
‹ Explain the meaning and applicability of unit or output costing.
‹ Discuss about the various concepts that are prime cost, works cost, cost of production,
cost of goods sold and cost of sales.
‹ Prepare the cost sheet, production statement and production account.
‹ Discuss about the accounting treatment of scrap.
‹ Describe the items not to be included in the cost sheet.

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 COST ACCOUNTING

Notes
6.2 Introduction
In today’s era, different business and industry need different costing systems
to meet their individual requirements. Various methods of ascertaining
costs are available to meet the business need. The choice of a method
of costing particularly depends on the nature of concern business. Unit
costing is one of the most commonly used methods of costing by the
business organization engaged in manufacturing of products with identical
units. Under this method, the cost per unit can be computed by dividing
the total expenditure by the quantity produced. In order to compute total
cost and cost per unit of a product, a statement is prepared on weekly,
fortnightly, monthly or quarterly basis which is known as Cost Sheet. This
cost sheet throws light on every aspect of cost and gives clear picture of
detailed expenditure of the concern business.

6.3 Meaning of Unit Costing

Unit costing, single costing or output costing refers to a method of
costing used by industries engaged in mass production of single prod-
uct, homogeneous or identical product. The basic feature of unit costing
is that the units of production are identical and production is uniform.
Though the production is of a single or identical product but it may be
produced in more than one grade or variant. This is very simple form
of costing. Under this method, to calculate cost per unit, relevant cost
data collected from various records, such as Material Abstract, Wage
Abstract, Time records and Cost Ledgers, are then totaled and divided
by the number of units produced.
Examples of industries in which this method is commonly used with their
unit of cost estimation are given below:
Industries Cost Unit Industries Cost Unit
Petrol/Diesel Per liter Collieries Per tonne of coal
Paper mills Per kg of paper Brick Work Per 1,000 bricks
Sugar Mills Per quintal of sugar Steel Per tonne of steel
Flour mills Per quintal of flour Breweries Per barrel of beer
Cement Per tonne of cement Milk Per gallon of milk
Industries

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 Output Costing

Notes
6.4 Cost Sheet
Meaning An authoritative definition of Cost sheet has been given
by CIMA, London as “a statement which provides for the
assembly of the detailed cost of a cost centre or cost unit”.
Periodicity Cost sheet is a periodical document which is prepared
weekly, fortnightly, monthly, quarterly, half-yearly or yearly.
Uses Cost sheet is prepared for the following purposes:
(a) It helps the management in fixation of selling prices.
(b) It helps the management in comparing the cost of any
two periods.
(c) It helps in providing detailed information in relation to
cost of a product like total cost, different components
of total cost and cost per unit.
(d) It helps in controlling the costs.
(e) It helps in the preparation of estimates for submission
of tenders.
Types Cost sheet may be prepared on the basis of actual data (His-
torical Cost Sheet) or on the basis of estimated data (Estimated
Cost sheet) depending on the technique of costing to be used
and the purpose to be achieved. The details are as follows:
(a) H
 istorical Cost Sheet: When cost sheet is prepared
after the actual costs have been incurred i.e. on the
basis of historical cost figures is called historical cost
sheet. Actual costs are compiled and presented through
such a manner. Cost comparison between periods can
be made by comparing the corresponding cost figures
of the two periods. Accordingly cost control can be
exercised in the next period.
(b) E
 stimated Cost Sheet: When cost sheet is prepared
before the actual commencement of production on the
basis of estimated costs is called estimated cost sheet.
The estimated costs are compared with the actual costs
every time in order to control cost effectively and
variance can be calculated. The required corrective
action can be taken for unfavourable variance.
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 COST ACCOUNTING

Notes
6.5 Components of Total Cost
The various components of total costs are ascertained in the following
manner:

6.6 Preparation of Cost Sheet

A cost sheet is a statement showing various components of total cost of
output of a particular product or service produced during a particular
period. The format is as follows:
Pro forma of Cost Sheet (or Statement of Cost) for the period……
No. of units produced........
Total Cost Cost per unit
Particulars Rs. Rs.
Opening Stock of Raw Material
Add: Purchases
Add: Expenses on Purchases
Less: Purchase Returns
Less: Closing Stock of Raw Material
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 Output Costing

Total Cost Cost per unit Notes

Particulars Rs. Rs.
Less: Net Value of Normal Scrap of
Direct Material
Direct Material Cost XXXX XXXX
Add: Direct Labour Cost (Add/Less:
Outstanding/Prepaid at the end) XXXX XXXX
Add: Direct Expenses XXXX XXXX
Prime Cost XXXX XXXX
Add: Works/Factory Overheads XXXX XXXX
Less: Net Value of Normal Scrap XXXX XXXX
of Indirect Material
Add: Opening stock of Work-in-progress XXXX XXXX
Less: Closing stock of Work-in-progress XXXX XXXX
Works Costs XXXX XXXX
Add: Office and Administration
Overheads XXXX XXXX
Cost of Goods Produced XXXX XXXX
Add: Opening Stock of Finished Goods XXXX XXXX
Less: Closing Stock of Finished Goods XXXX XXXX
Cost of Goods Sold XXXX XXXX
Add: Selling and Distribution
Overheads XXXX XXXX
Cost of Sales XXXX XXXX

6.7 Production Statement

In practice, production statement is used interchangeably with cost sheet.
But production statement is broader or expanded form of cost sheet.
Production statement is a statement which includes:
(a) Different components of total cost
(b) Opening and closing stock of finished goods
(c) Sales
(d) Profit
As production statement includes items of stock of finished goods, sales
and profit in addition to various components of total cost whereas cost
sheet includes only the various components of total costs.

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 COST ACCOUNTING

Notes PRO FORMA OF PRODUCTION STATEMENT

No. of units produced........
Total Cost Cost per unit
Particulars Rs. Rs.
Opening Stock of Raw Material
Add: Purchases
Add: Expenses on Purchases
Less: Purchase Returns
Less: Closing Stock of Raw Material
Less: Net Value of Normal Scrap of
Direct Material
Direct Material Cost XXXX XXXX
Add: Direct Labour Cost (Add/Less:
Outstanding/Prepaid at the end) XXXX XXXX
Direct Expenses XXXX XXXX
Prime Cost XXXX XXXX
Add: Works/Factory Overheads XXXX XXXX
Less: Net Value of Normal Scrap of XXXX XXXX
Indirect Material
Add: Opening stock of Work-in-progress XXXX XXXX
Less: Closing stock of Work-in-progress XXXX XXXX
Works Costs XXXX XXXX
Add: Office and Administration
Overheads XXXX XXXX
Cost of Goods Produced XXXX XXXX
Add: Opening Stock of Finished Goods XXXX XXXX
Less: Closing Stock of Finished Goods1 XXXX XXXX
Cost of Goods Sold XXXX XXXX
Add: Selling and Distribution Overheads XXXX XXXX
Cost of Sales XXXX XXXX
Add: Profit XXXX XXXX
Sales XXXX XXXX

1
Value of Closing Stock of Finished Goods =
Cost of goods produced
= × Closing Stock in units
No. of units produced

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 Output Costing

Notes
6.8 Production Account
When the cost information as shown in the production statement is
presented in the form of an ordinary T-shaped ledger account then it is
known as production account.
PRO FORMA OF PRODUCTION ACCOUNT
For the period…..
Particulars Rs. Particulars Rs.
To Opening stock XXXX By Closing stock of XXXX
of material material
To Direct Material XXXX By Net value of normal XXXX
To Direct Labour XXXX scrap of raw material
To Direct Expenses XXXX By Prime Cost c/d XXXX
XXXX XXXX
To Prime Cost b/d XXXX By Closing Stock XXXX
To Opening stock XXXX of WIP
of WIP By Factory Cost c/d XXXX
To Production XXXX
Overheads
XXXX XXXX
To Factory Cost b/d XXXX By Cost of goods XXXX
To Administration XXXX produced c/d
Overheads
XXXX XXXX
To Opening stock XXXX By Closing stock of XXXX
of finished goods finished goods
To cost of goods XXXX By Cost of goods XXXX
produced b/d sold c/d
XXXX XXXX
To Cost of goods XXXX By Sales XXXX
sold b/d
To Selling and distribu- XXXX
tion OH
XXXX XXXX

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 COST ACCOUNTING

Notes
6.9 Treatment of Stock and Scrap
Stock can be of three types:
(a) Stock of Raw Material
(b) Stock of Work-in-progress
(c) Stock of Finished Goods
The adjustment of the above said types of stock is as follows:
Stock of Raw Material: The value of raw materials consumed is
(a) 
calculated with the help of value of opening stock of raw material
and closing stock of raw material. The value of opening stock
is added and the value of closing stock is subtracted from the
purchases, to arrive at the value of raw material consumed. The
calculation are as follows:
Opening stock of raw materials XXXX
Add: Purchase of raw materials XXXX
Less: Closing stock of raw materials XXXX
Value of raw materials consumed XXXX
Stock of Work-in-Progress: Work-in-progress means those units
(b) 
which not completely converted into finished goods. The cost of
work-in-progress consists of cost of materials consumed, direct
wages and a proportionate part of the factory overheads. Therefore,
while preparing cost sheet, opening and closing stock of work-in-
progress is added and subtracted from the gross works cost and
that is why this done at the stage of factory cost. The calculations
are as follows:
Prime cost XXXX
Add: Factory overheads XXXX
Work-in-progress (beginning) XXXX
Less: Work-in-progress (closing) XXXX
Works cost XXXX
Stock of Finished Goods: This stock is adjusted after the calculation
(c) 
of cost of production. The opening stock of finished goods is
added and the closing stock of finished goods is subtracted from

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the cost of production. The resulting figure will be cost of goods Notes
sold. The current cost is considered while calculating the value of
closing stock of finished goods on the assumption that the stocks
are being disposed off on first in first out basis. Thus the last
year’s stock is over and whatever remains is of the current year’s
lot of production. The calculations are as follows:
Cost of production XXXX
Add: Opening stock of finished goods XXXX
Less: Closing stock of finished goods XXXX
Cost of goods sold XXXX

6.9.1 Treatment of Scrap

During manufacturing process, scrap arises which is the incidental res-
idue in the form of cuttings, trimmings, from paper, metals, timber etc.
Scrap is generally of small quantity and low value. The realizable value
of scarp is deducted from factory overheads or factory costs while pre-
paring cost sheet. In some cases, material found to be defective before
being used and then value of material used should be reduced from the
cost of such material.

IN-TEXT QUESTIONS
1. Closing work in process Inventory of last year:
(a) Is treated as Opening inventory for current year
(b) Is not carried forward to next year
(c) Become expense in the next year
(d) Charge to Profit & Loss account
2. A document which provides for the detailed cost centre and
cost unit is _______.
(a) Tender
(b) Cost sheet
(c) Invoice
(d) Profit statement

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 COST ACCOUNTING

Notes
3. Direct material is a _______.
(a) Fixed cost (b) Variable cost
(c) Semi variable cost (d) Semi fixed cost
4. Which of the following items are purely financial incomes?
(a) Discount on issue of shares
(b) Interest on bank loan
(c) Transfer fees received
(d) Notional interest on capital employed.
5. Cost of production is equal to
(a) Prime costs + other manufacturing costs.
(b) Production costs + Administration expenses.
(c) Prime costs + Manufacturing costs + Opening W.I.P –
Closing W.I.P.
(d) None of the above
6. The cost of goods sold is equal to
(a) Total Purchases − Total Sales
(b) Opening stock + Total Purchase
(c) Opening stock − Total Purchases + Closing Stock + Direct
Costs
(d) Opening stock + Total Purchases − Closing Stock + Direct
Costs
7. Objectives of research and development costs include:
(a) Maintaining present competitive position
(b) Improving enterprise‘s competitive position
(c) Exploring now market/products
(d) All of the above
8. Normal stores losses are:
(a) Part of prime cost

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 Output Costing

Notes
(b) Part of production overheads
(c) Part of selling and distribution overheads
(d) Written-off to costing and profit and loss account
9. Secondary packing expenses are:
(a) Part of prime cost
(b) Part of production overheads
(c) Part of distribution overheads
(d) Written-off to costing profit and loss account
10. Fill in the blanks:
(a) Under unit costing, cost and profit per unit of production
is ascertained by preparing a statement of cost known as
__________.
(b) Unit costing is also known as __________ costing.
(c) Historical cost sheet is prepared on the basis of ___________
cost figures.
(d) Salary paid to factory manager is an item of __________

6.10 Items Not Included in Cost Sheet

The following is the list of items not to be included while preparing
cost sheet:
1. Goodwill written off
2. Cash discount
3. Interest paid
4. Transfer to reserves
5. Donations
6. Income tax paid
7. Dividend paid

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 COST ACCOUNTING

Notes 8. Provision for bad debts

9. Provision for taxation
10. Profit or loss on sale of fixed asset
11. Preliminary expenses written off
12. Damages payable at law etc.

6.11 Difference Between Cost Sheet and Production Account

The following points depict the difference between cost sheet and pro-
duction account:

Cost Sheet Production Account

1. It is prepared as a statement. 1. It is prepared as an account.
2. E xpenses are classified to as- 2. Expenses are not classified.
certain prime cost, factory cost, 3. N
 o figures of previous period are
total cost, etc. provided. Hence no comparison
3. To enable comparison, figures is possible.
of previous period are provided. 4. It is based on actual figures.
4. I t is based on actual and estimated 5. It is prepared for each production
figures of expenses. department.
5. It is prepared for each job and
sometimes for the whole factory

Illustration 1: The Vardhman Ltd. manufactures one product. A summary

of its activities for the year 2016 is given below:

Particulars Units Rupees

Sales 80,000 8,00,000
Material inventory 01.01.16 40,000
Material inventory 31.12.16 32,000
W.I.P. 01.01.16 55,000
W.I.P. 31.12.16 72,000
Finished goods 01.01.16 16,000 64,000
Finished goods 31.12.16 34,000
Material purchases 1,52,000

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 Output Costing

Particulars Units Rupees Notes

Direct labour 1,45,000
Manufacturing overhead 1,08,000
Selling expenses 50,000
General expenses 40,000

Prepare a cost sheet. [B.Com (Hons) Delhi 2003, adapted]

Solution: COST SHEET
Particulars Rs. Rs.
Raw materials – opening stock 40,000
Add: Purchases 1,52,000
Less: Closing stock 32,000 1,92,000
Materials consumed (1,92,000­– 32,000) 1,60,000
Direct labour 1,45,000
Prime cost 3,05,000
Manufacturing overheads 1,08,000
Add: Opening work in Progress 55,000
4,68,000
Less: Closing work in Progress 72,000
Factory cost 3,96,000
General expenses 40,000
Cost of production 4,36,000
Add: Opening stock of finished goods 64,000
5,00,000
Less: Closing stock of finished goods* 1,51,265
Cost of goods sold 3,48,735
Selling expenses 50,000
Total cost 3,98,735
Profit 4,01,265
Sales 8,00,000
Working notes:
1. Value of closing stock = Rs. 4,36,000 × 34,000 units
98,000 units
2. Units Produced = 80,000 + 34,000 – 16,000 = 98,000 units.

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 COST ACCOUNTING

Notes Illustration 2: From the following data prepare a cost and production
statement of Popular Stoves Manufacturing Co. For the year 2016:
Particulars Rs.
Stock of material on 1-1-2016 35,000
Stock of material on 31-12-2016 4,900
Purchase of materials 52,500
Factory wages 95,000
Factory expenses 17,500
Establishment expenses 10,000
Completed stock in hand on 1-1-2016 Nil
Completed stock in hand on 31-12-2016 35,000
Sales 1,89,000
The number of stoves manufactured during the year 2016 was 4,000.
The company wants to quote for a contract for the supply of 1,000 Elec-
tric Stoves during the year 2017. The stoves to be quoted are of uniform
quality and make similar to those manufactured in the previous year, but
cost of materials has increased by 15% and cost of factory labour by 10%.
Prepare a statement showing the price to be quoted to give the same
percentage of net profit on turnover as was realized during the year 2016
assuming that the cost per unit of overhead charges will be the same as
in the previous year.
 [B.Com (Hons) Delhi, 2004 Adapted]
Solution: COST STATEMENT OF STOVES FO THE YEAR 2016
 Output 4,000 stoves
Amount Total Amount per
Particulars (Rs.) unit (Rs.)
Opening stock of materials 35,000
Purchase of materials 52,500
87,500
Less: Closing stock 4,900
Cost of materials consumed 82,600 20.65
Factory Wages 95,000 23.75
Prime cost 1,77,600 44.40
Factory expenses 17,500 4.37

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 Output Costing

Amount Total Amount per Notes

Particulars (Rs.) unit (Rs.)
Works Cost 1,95,000 48.77
Establishment expenses 10,000 2.50
Total cost of production 2,05,100 51.27
Opening completed stock Nil
Total cost of production during
2,05,100
the period
2,05,100
Less: closing completed stock 35,000
Cost of sales 1,70,100
Profit 18,900
Selling price 1,89,000
STATEMENT SHOWING QUOTATION PRICE FOR 1,000 STOVES
Amount total Amount per
Particulars (Rs.) unit (Rs.)
Material consumed 20,650
Add: 15% increase 3,098 23,748 23.748
Factory wages 23,750
Add: 10% increase 2,375 26,125 26.125
Prime Cost 49,873 49.873
Factory expenses 4,375 4.375
Factory cost 54,248 54.248
Establishment expenses 2,500 2.500
Total cost 56,748 56.748
Profit 10% on selling price 6,305 6.305
Selling price 63,053 63.053
Illustration 3: The particulars obtained from the records of M/s. Jeevan
Industries for the year 2015 are given below:
Particulars Rs.
Opening stock
Raw materials 1,40,000
Finished goods 20,000
Purchases 2,10,000

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 COST ACCOUNTING

Notes Particulars Rs.

Factory wages 3,80,000
Factory overheads 70,000
Office overheads 40,000
Selling overheads 9,600
Sales (3,200 units) 9,28,000
Closing stock:
Raw materials 19,600
Finished goods (900 units) 1,64,080
Prepare cost sheet showing prime cost, factory cost, cost of production,
total cost and sales per unit.
During 2016 the industry expects to receive an order for 5,000 units. It
is estimated that:
(i) The prices of raw materials and factory wages will rise by 15%
and 10% respectively.
(ii) There will be no change in the total factory overheads and office
overheads.
(iii) Selling overheads per unit will remain the same.
Prepare an estimated cost sheet. The factory intends to earn the same
rate of profit on cost.
 [B.Com (Hons), Delhi]
Solution: COST SHEET for the Year 2015
Particulars Per Unit (Rs.) Total (Rs.)
Direct material
Opening stock 1,40,000
Add: Purchases 2,10,000
3,50,000
Less: Closing stock 19,600 106.58 3,30,400
Direct/Factory wages 122.58 3,80,000
Prime cost 229.16 7,10,400
Add: Factory Overheads 22.58 70,000
Factory cost 251.74 7,80,400
Add: Office overheads 12.91 40,000

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 Output Costing

Particulars Per Unit (Rs.) Total (Rs.) Notes

Office cost/Cost of 264.65 8,20,400
Production (3,100 units)
Add: opening stock of finished goods 200.00 20,000
(1,000 units) 464.65 8,40,400
Less: Closing stock 182.31 1,64,080
of goods (900 units)
Cost of Production of 282.34 6,76,320
Goods sold (3,100 units)
STATEMENT OF PROFIT
Cost of goods sold Rs. 6,76,320
Add: selling overheads 9,600
Cost of sales 6,85,920
Add: Profit (Balance) 2,42,080
Sales 9,28,000
9,28,000
Sales per unit = = Rs. 290
3,200
2,42,080
Profit as % of cost of sales = × 100
6,85,920
= 35.293%
ESTIMATED COST SHEET FOR 2016 Output Sales 5000 Units
3,30,400 115 6,12,839
Direct Material × 5,000 ×
3,100 100
3,80,000 110 6,74,194
Direct Labour × 5,000 ×
3,100 100
Prime cost 12,87,033
Add: factory overheads 70,000
Works/factory cost 13,57,033
Add: office overheads 40,000
Cost of production 13,97,033
Add: selling overheads 15,000
Cost of sales 14,12,033
Add: profit (35.29% of cost of sales) 4,98,307
Sales 19,10,340

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Notes 19,10,340
Sales per unit = = Rs. 382 per unit
5,000
Illustration 4: A factory’s normal capacity is 12,000 units p.a. The esti-
mated cost of production is as under:
Direct Materials = Rs. 3 p.u.
Direct Labour = Rs. 2 p.u. (subject to a minimum of Rs 1200 pm)
Overheads:
Fixed: Rs. 16,000 per annum
Variable: Rs. 2 per unit
Semi variable: Rs. 6,000 p.a. up to 50% capacity and an additional Rs.
2,000 for every 20% increase in capacity or part thereof.
In the current year the factory worked at 50% capacity for the first three
months but it is expected that it would work at 80% capacity for the
remaining 9 months.
During the first 3 months the selling price per unit was Rs. 20. What
should be the price in the remaining 9 months to earn a total profit of
Rs. 1,23,500 for the whole year?
 [B.Com (Hons) Delhi, 2016]
Solution: COST SHEET
First 3 months Further 9 months
Particulars (Rs.) (Rs.)
Output (12,000 × 50% × 3 ) (12,000 × 80% × 9 )
12 12
1,500 units 7,200 units
Direct material @ Rs. 3 4,500 21,600
Direct Labour @ Rs. 2
3,600 14,400
(Minimum of Rs. 1,200 pm)
Prime cost 8,100 36,000
Overheads: Fixed 4,000 12,000
Variable (@ Rs. 2 p.u.) 3,000 14,400
Semi variable 1,500 7,500
16,600 69,900

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 Output Costing

Rs. Notes
Total cost for full year (Rs. 16,600 + Rs. 69,900) 86,500
Desired Profit 1,23,500
Sales required 2,10,000
Sale in first 3 months 1,500 units @ 20 30,000
Sales required from 7,200 units (Balance) 1,80,000
Rs. 1,80,000
Selling price per unit = = Rs. 25 per unit
7,200 units
Illustration 5: The Fancy Toys Co. Are manufacturers of two types, x and
y. The manufacturing cost for the year ended 31st December, 2016 was:
Rs.
Direct Material 2,00,000
Direct wages 1,12,000
Production Overheads 48,000
3,60,000
There was no work in progress at the beginning or at the end of the
year. It is ascertained that:
(i) Direct materials in type x costs twice as much as direct material
in type y.
(ii) The direct wages for type y were 60% of those for type x.
(iii) Production Overhead was 30 paise, the same per toy of x and y
types.
(iv) Administration Overhead for each grade was 200% of direct labour.
(v) Selling cost was 25 p. per toy for each type of toy.
(vi) Production during the year was:
Type x – 40,000 toys of which 36,000 were sold.
Type y – 1,20,000 toys of which 1,00,000 were sold.
(vii) Selling prices were Rs. 7 per toy for type x and Rs. 5 per toy for
type y.
Prepare a statement showing the total cost per toy for each type of toy
and the profit made on each type of toy. [ICWA Inter, Dec. 1990 Adapted]

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 COST ACCOUNTING

Notes Solution: Fancy Toys Company

STATEMENT OF COST OF PRODUCTION
For the year ended 31st Dec., 2016
Type x Type y
Particulars Production – 40,000 Toys Production – 40,000 Toys
Per Toy Rs. Total Rs. Per Toy Rs. Total Rs.
Direct materials 2.00 80,000 1.00 1,20,000
Direct Wages 1.00 40,000 0.60 72,000
Production 0.30 12,000 0.30 36,000
Overheads
Administrative 2.00 80,000 1.20 1,44,000
Overheads
Cost of 5.30 2,12,000 3.10 3,72,000
production

STATEMENT OF COST OF SALES

Type x Type y
Particulars Per Toy Rs. Total Rs. Per Toy Rs. Total Rs.
Cost of production 5.30 2,12,000 3.10 3,72,000
Less: Cost of 21,200 62,000
closing stock
Cost of goods sold 5.30 1,90,800 3.10 3,10,000
Selling costs 0.25 9,000 0.25 25,000
Cost of sales 5.55 1,99,800 3.35 3,35,000

STATEMENT OF PROFIT

Type x Type y
Particulars Sold 36,000 Toys Sold 1,00,000 Toys
Per Toy Rs. Total Rs. Per Toy Rs. Total Rs.
Cost of sales 5.55 1,99,800 3.35 3,35,000
Profit 1.45 52,200 1.65 1,65,000
Sales 7.00 2,52,000 5.00 5,00,000

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 Output Costing

Notes
6.12 Answers to In-Text Questions
1. (a) Is treated as Opening inventory for current year
2. (b) Cost sheet
3. (b) Variable cost
4. (c) Transfer fees received
5. (d) None of the above
6. (d) Opening stock + Total Purchases – Closing Stock + Direct Costs
7. (d) All of the above
8. (b) Part of production overheads
9. (c) Part of distribution overheads
10. Fill in the Blanks:
(a) Cost sheet
(b) Single/output
(c) Historical
(d) Factory overhead

6.13 Self-Assessment Questions

1. Compute the cost of raw materials consumed from the data given below:
Opening Stock of Raw Materials Rs. 10,000
Closing Stock of Raw Materials Rs. 15,000
Expenses on Purchases Rs. 5,000
Direct Wages Rs. 50,000
Prime Cost Rs. 1,00,000 [Adapted]
Answer: Rs. 50,000
2. Determine the prime cost from the following:
Materials purchased during the year Rs. 60,000
Opening stock of materials Rs. 10,000
Closing stock of materials Rs. 20,000
Direct Wages Rs. 50,000

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Notes Carriage Inwards Rs. 1,500

Carriage Outwards Rs. 2,000
Material returned to supplier Rs. 1,500
Chargeable expenses Rs. 5,000 [Adapted]
Answer: Rs. 1,05,000
3. What is unit or output costing?
4. What is a cost sheet? Explain the purposes served by it.
5. Distinguish between cost sheet and production account.
6. Explain briefly Unit costing method of ascertaining product cost.
7. Draw a pro forma of cost sheet.
8. Describe the objects of cost sheets. Give an example of a cost sheet
indicating clearly the headings and the important items supplying
imaginary figure.
9. Distinguish between the following:
(a) Prime Cost and Conversion Cost
(b) Prime Cost and Factory Cost
(c) Factory Cost and Cost of goods produced
(d) Cost of goods produced and Cost of Goods sold
(e) Cost of Goods sold and Cost of sales
10. Z Ltd. manufactured 15,000 units of a product during the month
of December while only 13,500 units were sold. The selling price
was Rs. 7 per unit. The following figures are obtained from the
costing records of the company:
Direct materials Rs. 52,000
Direct wages Rs. 15,600
Machine hour rate Rs. 4
Machine hours worked 1,100
Office overhead 15% on works cost
Selling overhead 25 paise per unit
Prepare a cost sheet showing cost and profit
for the month. (B.Com. Andhra)
Answer: Profit Rs. 16,605

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 Output Costing

11. From the following particulars: Notes

(i) Prepare a cost sheet showing:
(a) The cost of materials consumed
(b) Prime cost
(c) Production cost
(d) Total cost
(e) Profit
(ii) Calculate:
(a) Percentage of production overheads to direct wages
(b) Percentage of general overheads to production cost
(c) Percentage of profit to sales
Stock of raw materials - 1st Jan, 2012 30,850
Work in progress - 1st Jan, 2012 60,850
Purchase of raw materials 1,43,250
Direct wages 1,78,500
Production overhead 1,42,800
General overhead 1,12,700
Stock of raw materials - 31st Dec. 2012 37,700
Work in progress - 31st Dec. 2012 67,750
Sales for the year 8,60,625
There is no opening or closing stock of
finished goods. (B.Com. Andhra)
Answer: (1) (a) Rs. 1,36,400 (b) Rs. 3,14,900 (c) Rs. 4,50,800 (d)
Rs. 5,63,500 (e) Rs. 2,97,125
(2) (a) 80% (b) 25% (c) 34.50%
12. The following extract of costing information relates to commodity
for the half year ended 30th June 2012:
Particulars Rs.
Purchase of raw materials 1,32,000
Direct wages 1,10,000
Rent, rates, insurance and works on cost 44,000
Carriage inward 1,584

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 COST ACCOUNTING

Notes Stock on 1st January, 2012:

Raw materials 22,000
Finished products (1,600 tonnes) 17,600
Stock on 30th June, 2012:
Raw materials 24,464
Finished products (3,200 tonnes) 35,200
Work in progress:
1st Jan, 2012 5,280
30th June, 2012 17,600
Cost of factory supervision 8,800
Sales of finished production 3,30,000
Advertising and other selling expenses are 75 paise per tonne sold.
25,600 tonnes of the finished products were produced during the year.
Prepare cost sheet and ascertain and ascertain profit.
[BBM Bangalore, B.Com, Delhi, Adapted]
Answer: Total profit: Rs. 48,000
13. From the following particulars you are required to prepare a statement
showing
(a) The cost of materials used;
(b) The works cost;
(c) The total cost;
(d) The percentage of works overhead to productive wages; and
(e) The percentage of office overhead to works cost.
Particulars Rupees
Stock of finished goods, 31-12-2007 56,000
Stock of raw materials, 31-12-2007 25,000
Purchases 5,84,000
Productive wages 3,97,000
Sales of finished goods 11,84,000
Stock of finished goods, 31-12-2008 60,000
Stock of raw materials, 31-12-2008 27,200
Works overhead charges 87,472
Office and general expenses 71,048

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The company is about to send a tender for a large plant. The cost- Notes
ing department estimates that the materials required would cost Rs.
40,000 and the wages to workmen for making the plant would cost
Rs. 24,000. The tender is to be made is to be made at a net profit
of 25% on the selling price. Show what the amount of the tender
would be if based on the above percentage?  (B.Com)
Answers: (a) Rs. 5,82,400 (b) Rs. 10,67,472 (c) Rs. 11,38,520 (d)
22% (e) 6.65% ; Tender price Rs. 98,516
14. The following particulars have been extracted from the books of J.K.
Production Co. Ltd. Kolkata, for the year ended 31st March, 2012.
Stock of materials as on 1st April,2011 47,000
Stock of materials as on 31st May,2012 45,000
Materials purchased 2,08,000
Drawing office salaries 9,600
Counting house salaries 14,000
Carriage inwards 8,200
Carriage outwards 5,100
Donation to relief funds 4,300
Sales 4,87,000
Bad debts written off 4,700
Repairs of plant, machinery tools 8,600
Rent, rates, taxes and insurance (factory) 3,000
Rent, rates, taxes and insurance (office) 1,000
Travelling expenses 3,700
Travelling salaries and commission 7,800
Production wages 1,45,000
Depreciation written off on machinery, 9,100
plant and tools
Depreciation written off on office furniture 600
Director’s fees 6,000
Gas and water charges (factory) 1,000
Gas and water charges (office) 300
General charges 5,000
Manager’s salary 18,000

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 COST ACCOUNTING

Notes Out of 48 working hours in a week,the time devoted by the manager to

the factory and office was on an average 30 hours and 18 hours respec-
tively throughout the accounting year.
Prepare a production statement showing different elements of cost.
(B.Com, Delhi)
Answer: Prime cost Rs. 3,63,200, Factory cost Rs 4,05,750, Cost of
production Rs. 4,25,400, Cost of as sales Rs. 4,60,700, Profit Rs. 26,300

6.14 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 L E S S O N

7
Job Costing
Ms. Preeti Singh

STRUCTURE
7.1 Learning Objectives
7.2 Introduction
7.3 Meaning of Job Order
7.4 Characteristics of Job Costing
7.5 Applicability of Job Costing
7.6 Advantages of Job Costing
7.7 Limitations of Job Costing
7.8 Procedure of Job Cost Accounting
7.9 Job Ticket
7.10 Answers to In-Text Questions
7.11 Self-Assessment Questions
7.12 Suggested Readings

7.1 Learning Objectives

After reading this lesson, the students will be able to:
‹ Define job costing.
‹ Explain objectives, advantages and limitations of job costing.
‹ Discuss the applicability of job costing over other methods of costing.
‹ Prepare job sheet.
‹ Discuss about the concept of job ticket.

7.2 Introduction
Job costing is one of the methods of costing that is used in those industries where the
production is done as per the requirements of the customers, as distinct from continuous
production for stock and sale. Consequently, in Job Order industries, the production is
not on continuous basis, each order can be different from the other one. Method used in
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Notes such type of business organizations is called Job Costing or Job Order
Costing. Under job costing, each job order has its own characteristics and
has to be performed as per the special requirement of the customer. The
objective of this method of costing is to ascertain the cost of each job
by preparing the Job Cost Sheet. In job costing, cost unit is a job and
therefore costs are collected for each job under a separate job or produc-
tion order number. The cost of completed job will be the materials used
for the job, the direct labour employed for the same and the production
overheads and other overheads if any charged to the job.

7.3 Meaning of Job Order

Job costing may be defined as a method of costing in which each element
of cost are accumulated separately for a particular job or work order
undertaken by an organization. Industries which manufacture products
or render services against specific orders use job costing or job order
method of cost accounting. A job can be a product, unit, batch of prod-
ucts, project, contract, a service or any other specific order. The CIMA,
London defines job costing as “that form of specific order costing which
applies where work is undertaken according to customer’s specifications”.

7.4 Characteristics of Job Costing

The following characteristics can be observed for the above discussion
and definition:
(i) It is a specific order costing.
(ii) Each job is unique and distinct from the other.
(iii) Each job is executed as per customer’s satisfaction.
(iv) A separate job cost sheet or job card is used for each job and
is assigned a certain number by which the job is identified.
(v) Job costing enables a business to ascertain the cost of a job
on the basis of which quotation for the job may be given.
(vi) While computing the cost, direct costs are charged to the job
directly as they are traceable to the job.
(vii) Indirect expenses i.e. overheads are charged to the job on the
basis of predetermined absorption rate.
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 Job Costing

(viii) Each job completed may be different from other jobs and hence Notes
it is difficult to have standardization of controls and therefore
more detailed supervision and control is necessary.
(ix) At the end of the accounting period, work in progress may or
may not exist.

7.5 Applicability of Job Costing

Following are the examples of those industries where the goods are
manufactured or services are rendered against specific orders as per
customer’s specific requirements:
(i) Furniture-making Manufacturing
(ii) Engineering Industries
(iii) Construction Industries
(iv) Interior Decoration
(v) Machine Manufacturing
(vi) Automobile Service Industries
(vii) Printing Industries
(viii) Accounting Firms
(ix) Equipment Companies

7.6 Advantages of Job Costing

The following are the main advantages of job costing:
(i) A separate Job Card or Job Cost Sheet is prepared. This helps
in ascertaining profit or loss made on each individual job.
(ii) To know a detailed analysis of costs of materials, labour and
overheads charged to a particular job.
(iii) It helps management to detect those jobs which are more
profitable and those which are unprofitable.
(iv) It provides an estimate of cost for determining the cost of
similar jobs undertaken in future which in turn assists in the
prompt furnishing of price quotations for specific jobs.

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 COST ACCOUNTING

Notes (v) It helps in controlling operational inefficiency by comparing

the actual costs with the estimated costs.
(vi) Job costing is particularly suitable for the contracts where
selling price is determined directly on the basis of costs.

7.7 Limitations of Job Costing

Job costing suffers from the certain limitations which are as follows:
(i) It is said that it is too time consuming and requires detailed
record keeping. This makes the method more expensive.
(ii) Record keeping for different jobs may prove complicated.
(iii) Inefficiencies of the organization may be charged to a job
though it may not be responsible for the same.

7.8 Procedure of Job Cost Accounting

The following steps are taken in job costing:
1. Job Order Number: When an order received by a manufacturing
concern, an individual Job Order Number must be assigned to
each such job. This is used as reference for production as well as
for costing purposes. This step of assigning Job Order Number is
conveniently easy and can be used on various form and documents
for reference.
2. Preparing Production Order: When a job is accepted, the production
control department issues a written order known as Production Order.
It is issued by production department to manufacturing department
to proceed with the job. Its purpose is to give authority for starting
the job work. It also authorizes the store keeper to issue the required
materials and the accounting department to assign the cost to the
job. Several copies of production order are prepared and are passed
on to the following:
(a) Concerned foremen with the job of all departments
(b) Storekeeper to issue material
(c) Tool Room for notification of tools required

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 Job Costing

A specimen pro forma of a production order is given below: Notes

PRODUCTION ORDER
Name of Customer_________ Job No._________________
Date of Commencement________ Date____________________
Date of Completion________ Bill of Material____________
Special Instruction_________ Drawing attached Yes/No____
Quantity Description Machines to be used Tools required

3. Job Cost Sheet: Receipt of production order is the signal for the
cost accountant to prepare a job cost sheet on which he/she will
record all cost incurred in relation to job in terms of material,
labour and overheads applicable to particular job. A job cost sheet
is referred to as a basic document of job costing. It gives complete
break up of different components of the total cost of accomplishing
a job and profit earned thereon.
Job cost sheets are not prepared for specified periods but they are
made out for each job regardless of the time taken for its comple-
tion. The material, labour and overhead to be absorbed into jobs
are collected and recorded in the following way:
(a) Direct Material: Material Requisition Slip, Bill of Material,
Material Abstract or Material Issue Analysis.
(b) Direct Wages: Clock Cards, Job Cards, Time Sheets, Wages
Abstract or Wages Analysis Sheet.
(c) Direct Expenses: Vouchers pertaining to direct expenses.
(d) Overheads: Absorbed on the basis of pre-determined absorption
rates.
The job cost sheet is also known as job card.

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 COST ACCOUNTING

Notes A specimen pro forma of a job cost card or sheet is given below:

JOB COST CARD

Product___________ Job Order No._______________________
Ordered by________ Buyer’s Purchase Order No.___________
Date Started_______________________
Date Completed_____________________
Direct Material Direct Labour Overheads
Date Reference Amount Date Reference Amount Date Amount
(Store Worker’s (based on
Req. No.) Ticket No. predetermined)
SUMMARY OF COST
Direct Material Cost XXXX
Direct Labour Cost XXXX
Overheads XXXX
Total cost of a job XXXX

4. Completion of Job: On completion of Job, the cost is transferred

to cost of sales. The Costing Department prepares cost sheet and
ascertain profit on the job. For controlling purpose, the costing
department can compare the actual cost incurred with estimated cost
and if any unfavourable variance occurs, necessary actions need to
be taken.

7.9 Job Ticket

A job ticket is used to record the time spent on each job, having a spec-
ified work order or job order number. Job cards may be of two types,
one, which is a job cost card, and contains information regarding material
consumption as well as time spent by operators. The other one is, in
effect, a job ticket, which is issued to an operator by the supervisor and
contains only the operation details. When the operator starts the work,
he records the time either manually or through time recording clock on
the card. The finishing time is recorded when the operation is complet-
ed. If there is any break in between, then time ‘out’ and time ‘in’ are
also recorded indicating hours not used on job and shall be considered
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indirect labour hours. When the job is completed, the operator deposits Notes
the card with the supervisor, and collects the next job ticket. At the end
of each day, the time-keeper collects all these cards and records the time
for each job or process or operation. Following are the features of job
ticket/job cost card:
‹ It reduces normal idle time.
‹ It gives clear, logical and suitable information to the costing
department.
‹ It provides a very useful link between the production control and
costing.
‹ Job card gives information about number and particulars of job
accurately.
‹ The entries are made by costing officer in card at the time of
commencement and completion of the job.
IN-TEXT QUESTIONS
1. In process and job costing system, normal spoilage cost is
considered as
(a) Conversion costs
(b) Sunk costs
(c) Inventoriable costs
(d) Non-inventorable costs
2. Cost of abnormal spoilage is not treated as
(a) Conversion costs
(b) Sunk costs
(c) Inventorable costs
(d) Non-inventoriable costs
3. The companies that produce many different products or services
usually use:
(a) Process costing
(b) Job order costing
(c) Both process costing and job order costing
(d) None of the above

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Notes
4. Which of the following costs is recorded on the job cost sheet?
(a) Direct materials cost
(b) Direct labor cost
(c) Manufacturing overhead cost
(d) All of the above
5. In a job order costing system, which of the following costs is
not an example of manufacturing overhead cost?
(a) Indirect labor cost
(b) Fuel used in factory
(c) Salary of production manager
(d) Sales commission
6. Which of the following source documents is used to record
the amount of direct materials on the job cost sheet?
(a) Production order
(b) Bill of materials
(c) Materials requisition form
(d) Materials purchase order
7. Fill in the blanks:
(a) Job costing is that form of specific order costing which applies,
where work is undertaken to customer’s special requirements
and each order is of comparatively_________________.
(b) Labour time on each Job is recorded on a ______ which
is then recorded on the Job Cost Sheet.
(c) _________ costing is applied where work is usually carried
out within a factory or workshop which is short duration.
(d) Job costing act as a tool of cost comparison and control
because actual costs of a job can be compared with the
__________ costs.

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 Job Costing

Notes
7.10 Answers to In-Text Questions
1. (c) Inventoriable costs
2. (d) Non-inventoriable costs
3. (b) Job order costing
4. (d) All of the above
5. (d) Sales commission
6. (c) Materials requisition form
7. Fill in the Blanks:
(a) Short duration
(b) Job Card
(c) Job
(d) Estimated

7.11 Self-Assessment Questions

1. The following information is expected from a job ledger in respect
of Job No. 443:
Materials Rs. 3,500
Wages 80 hours @ Rs. 2.50 per hour
Variable overhead incurred for all jobs Rs. 5,000 for 4,000 labour hours
Find the profit if the job is billed for Rs 4,000. [B.Com]
Answer: Profit - Rs. 200
2. The following information is extracted from the job ledger in respect
of Job 907:
Materials: Rs. 3,400
Wages:
Department A: 80 hours @ Rs. 2.50 per hour
Department B: 60 hours @ Rs. 4 per hour
Variable overheads:
Department A: Rs. 5,000 for 4,000 hours

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Notes
Department B: Rs. 6,000 for 3,000 hours
Fixed overhead: Rs. 7,500 for 10,000 hours of normal working
time of the factory.
Calculate the cost of Job No. 907 and estimate the percentage of
profit if the price quoted is Rs. 4,750. [B.Com]
Answer: Profit - Rs. 585; % of profit on sales 12.32
3. From the following particulars, prepare the cost sheet for Job No.
86 and find out the value of the job:
Materials Rs. 5,000
Productive Wages Rs. 4,600
Direct Expenses Rs. 1,500
Provide 60% on productive wages for works on cost and 12½% on
work cost for office on cost. Profit to be realized on the selling
price is 20%. [B.Com]
Answer: Cost of job Rs. 15,592.50 and Profit Rs. 3,898.13
4. Discuss the nature, purposes and procedures adopted in job order
cost system.
5. Discuss the importance of estimating in job costing.
6. How the different costs are recorded in job costing?
7. What are the main features of job order costing? Describe briefly
the procedure of recording costs under job order costing?
8. What do you understand by Job order costing? Discuss the conditions
suitable for the introduction of the job order cost accounting.
9. What is a job order number? Explain how costs are booked against
job order numbers.
10. “Job order costing is more accurate than process costing”. Comment.
11. Distinguish between job costing and contract costing.
12. Distinguish between job costing and process costing.
13. What are the advantages of job costing?
14. A factory uses a job costing system. The following data are available
from the books at the year ending on 31st March 2007.

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 Job Costing

Particulars Amount Rs. Notes

Direct Materials 18,00,000
Direct Wages 15,00,000
Profit 12,18,000
Selling and Distribution Overheads 10,50,000
Administrative Overheads 8,40,000
Factory Overheads 9,00,000

Required:
(a) Prepare a job cost sheet showing the prime cost, works cost,
production cost, cost of sales and sales value.
(b) In the year 2007-08, the factory has received an order for
a number of jobs. It is estimated that the direct materials
would be Rs. 24,00,000 and direct labor would cost
Rs. 15,00,000. What would be the price for these jobs if
the factory intends to earn the same rate of profit on sales,
assuming that the selling and distribution overheads have
gone up by 15%. The factory recovers factory overhead
as a percentage of direct wages and administrative and
selling and distribution overhead as a percentage of works
cost, based on the cost rates prevalent in the previous
year. [Adapted]
Answer: Sales - Rs. 73,08,000
15. A company has two manufacturing shops. The shop floor supervisor
presented the following cost for Job No. 121 to determine the selling
price.

Particulars Amount Rs. Per Unit

Material 70
Direct wages Department X - 8 hours,
Department Y - 6 hours
= 14 hours @ Rs. 2.50 per hour 35
Chargeable expenses (stores) 5
110
Add: 33.33 % for overheads 37
147

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 COST ACCOUNTING

Notes Analysis of the Profit and Loss A/c shows the following
Dr Profit and Loss AccountCr
Amount Amount
Particulars Rs. Particulars Rs.
To Materials used 1,50,000 By Sales less returns 2,50,000
To Direct wages
Department X 10,000
Department Y 12,000
To Stores expenses 4,000
To Overheads
Department X 5,000
Department Y 9,000
To Gross profit c/d 60,000
2,50,000 2,50,000
It is noted that average hourly rates for the two departments, X
and Y are similar. You are required to:
(a) Draw up a job cost sheet.
(b) Calculate the revised cost using overheads figures as shown in
the profit and loss account as the basis of charging overheads
to department X and Y.
(c) Add 20% of total cost to determine selling price. [Adapted]
Answer:
(a) Job Cost Sheet [Overheads absorption on the basis of Direct
Labor Hour Rate]
Total Cost Rs. 131.25
Value of Job A Rs. 157.50
(b) Job cost sheet [overhead absorption rate based on percentage
of direct wages]
Total Cost Rs. 131.25
Add: Profit 25% on cost Rs. 26.25
Value of job A Rs. 157.50

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 Job Costing

16. The following information relates to the activities of a Production Notes

Department in a factory for the week ending on 31-01-2016:
Material consumed Rs. 6,00,000
Direct wages Rs. 5,00,000
Department Overheads Rs. 4,00,000
Labour Hours worked 20,000
Hours of Machine in operation 16,000
Relevant data for the Job No. 415 carried out in the department
is as under:
Material consumed Rs. 61,000
Direct wages Rs. 44,000
Labour hours worked 1,250
Hours of Machine in operation 800
Prepare a comparative statement of cost of this job, by using the
following three methods of absorption of overheads:
(a) Direct labour hour rate
(b) Direct labour cost rate and
(c) Machine hour rate  [B.Com (Hons), DU 2015]
Answer: Cost of Job
(a) Rs. 1,30,000
(b) Rs. 1,40,200
(c) Rs. 1,25,000
17. The following information relates to the production operations of
a company for the year 2015.
Direct Labour Cost:
Machine Department: Rs. 1,00,000
Assembling Department: Rs. 50,000
Factory overheads traceable to Department:
Machine Department: Rs. 92,000

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 COST ACCOUNTING

Notes Assembling Department: Rs. 53,000

Factory Office: Rs. 41,000
Factory Overheads not traced to Department:
Factory Rent, taxes and insurance Rs. 10,000
Floor space occupied by three departments is in the proportion 6:3:1.
Factory office is a service department and its cost is apportioned to
production departments on the basis of labour cost. The machining
department operates on 40 hours a week. There are five machines
in the department and every machine has remained idle for 280
hours in 2015 for vacations, holidays, repairs, etc.
You are required to:
(a) Calculate overhead absorption rate based on machine hours for
Machining department and the overhead absorption rate based
on direct labour cost for Assembling Department.
(b) Ascertain the factory cost of a job performed in the factory
which has materials cost of Rs. 5,000, labour cost of Rs.
1,000 and the time booked in the machining and assembly
departments was 200 hours and 70 hours respectively.
 [B.Com (Hons) Delhi University, 1984]
Answer:
MHR - Rs. 14; DLCR- 140%
Rs. 10,200

7.12 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 L E S S O N

8
Contract Costing
Ms. Preeti Singh

STRUCTURE
8.1 Learning Objectives
8.2 Introduction
8.3 What is Contract Costing
8.4 Features of Contract Costing
8.5 Distinction Between Job Costing and Contract Costing
8.6 Special Aspects of Contract Costing
8.7 Accounting for Profit on Incomplete Contracts
8.8 Answers to In-Text Questions
8.9 Self-Assessment Questions
8.10 Suggested Readings

8.1 Learning Objectives

After reading this lesson, the students will be able to:
‹ Define contract costing and explain its features
‹ Differentiate between contract costing and job costing
‹ Explain contract costing procedure and treatment of various components of cost
‹ Calculate profit on incomplete contracts
‹ Discuss about the concept of cost-plus contracts
‹ Discuss about the accounting treatment of work-in-progress in contract costing

8.2 Introduction
Contract Costing is a method which is commonly used in construction industry to ascertain
the cost and profit of a particular construction project. The principles of job costing can
be applied on contract costing. In fact Contract Costing can be viewed as an extension of
Job Costing as each contract can be treated as a completed job. Contract Costing is used
by concerns like construction firms, civil engineering contractors, and engineering firms.
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Notes A contract work usually involves huge amount of expenditure and can
be continued for more than one accounting period. Under Contract Cost-
ing, the price paid by the contractee to contractor is termed as Contract
Price. Usually, there is a separate account opened for each contract. Also
the number of contracts undertaken at a time, generally, not being very
large in comparison to Job Order Costing System, the Contract Ledger
can very well be operated as part of the financial books. The contract
account is debited with all direct and indirect expenditure incurred in
relation to the contract. It is credited with the amount of contract price
on completion of the contract. The balance figure represents profit or loss
made on the contract and is transferred to the profit and loss account. In
case, the contract is not completed at the end of the accounting period,
a reasonable amount of profit, out of the total profit made so far on the
incomplete contract, may be transferred to profit and loss account.

8.3 What is Contract Costing

Contract Costing is a special form of job costing under which each con-
tract is treated as cost unit and costs are accumulated and ascertained
separately for each contract. Contract Costing is also known as terminal
costing. Generally, Contract means a big job in which work is done at site
and not in factory premises. ICMA has defined contract costing as “that
form of specific order costing which applies where work is undertaken
to customer’s special requirement and each order is of long duration”.
Contact Costing is applicable in building construction, road construction,
flyover construction, bridge construction, ship building, engineering
projects etc.

8.4 Features of Contract Costing

1. Each contract undertaken is treated as cost unit.
2. A contract generally takes more than one accounting period to complete.
3. Work on contract is carried out at the site and not in the factory
premises.
4. A separate account is prepared for each contract and assigned a
certain number by which the contract is identified.

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5. There are two parties involved in a contact that is the contactor Notes
and the contractee.
6. Direct costs usually constitute a major portion of the total cost of
the contract. On the contrary, indirect costs constitute minor portion
of the total cost of the contract.
7. Material purchased specifically for contract is charged direct from
the supplier’s invoice. Any materials issued from stores are charged
to contract on the basis of material requisition notes.
8. Labour cost is direct and are charged directly to the respective
contract.
9. Most expenses are direct in nature.

8.5 Distinction Between Job Costing and Contract Costing

The following points highlight the difference between job costing and
contract costing:
Job Costing Contract Costing
1. J obs are generally performed 1. Work on contract is usually un-
within the factory premises. dertaken at the site.
2. Size of the job is smaller than 2. Size of the contract is larger than
that of a contract. that of a job.
3. The numbers of jobs are usually 3. The numbers of contract under-
large. taken are usually smaller.
4. J ob work is comparatively of 4. C ontract costing usually takes
short duration of time period. longer time which can be extended
for more one accounting period.
5. U
 nder job costing, pricing is influ- 5. Under contract costing, pricing
enced by individual conditions and is influenced by specific clauses
general policy of the organization. of the contract.
6. Under job costing, the cost is 6. In contract costing, most of the
first allocated to cost centres and expenses are of direct nature,
then to individual jobs. overhead forms only a small
percentage of total expenditure
and it represents expenses like
share of head office expenses,
share of central storage cost etc.
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 COST ACCOUNTING

Notes Job Costing Contract Costing

7. I ndirect costs are higher than 7. Indirect Cost is lower than that
that of contract Costing. of Job Costing.
8. Job costing is suitable for printing 8. Contract Costing is usually em-
work, automobile repair shop, ployed in construction of build-
interior decoration etc. ings, bridges, flyovers, roads etc.

8.6 Special Aspects of Contract Costing

The following is the accounting treatment of the special aspects in con-
tract costing:
1. Material Costs: The following is the accounting treatment of
material costs:

Particulars Accounting Treatment

(i) When material purchased specif- Contract Account is debited
ically for the contract and Supplier’s Account or Cash
­Account is credited.
(ii) When material issued from stores Contract Account is debited and
Stores Control Account is credited.
(iii) When material charged to a con- Stores Control Account is debited
tract are returned to the stores and Contract Account is credited.
(iv) When surplus material is sold Cash/Bank Account is debited
and Contract Account is credited.
(v) When there is abnormal loss of Costing Profit and Loss Account
material is debited and Contract Account
is credited.
(vi) When the contractee himself sup- The value of such material should
plied material for the contract not be charged to Contract Account.
(vii) When material transferred to other Transferee Contract Account is
contracts debited and Transferor Contract
Account is credited on the basis
of Material Transfer Note.

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2. Labour Costs: The following is the accounting treatment of material Notes

costs:
Particulars Accounting Treatment
(i) When wages paid to the workers The amount of such wages and
and salary of the supervisory staff salary of supervisor are directly
engaged on a particular contract charged to Contract Account.
(ii) When wages of the labour and It will be considered as indirect
salary of the supervisor cannot cost and apportioned over the
be identified with a particular contracts concerned on a reason-
contract. able basis.
(iii) Wages paid to workers who move Such wages are distributed over
from one contract to another the contracts on the basis of time
spent by workers on each contract.
3. Direct Expenses: Direct expenses incurred on the contract are
directly charged to the concerned contract.
4. Plant and Machinery: The plant and machinery used on a contract
can be dealt in any of the following ways:
Particulars Accounting Treatment
(i) When a plant and machinery is The Contract Account is ­debited
purchased specifically for a par- with the cost of the plant and
ticular contract machinery at the time of purchase
and is credited with the depreciated
value of the plant and machinery at
the end of the accounting period.
(ii) When a plant and machinery is The Contract Account is debited
issued from store for a short period with the amount of depreciation
for the period of use.
(iii) When a plant and machinery is The Contract Account is debited
taken on hire with the amount of hire charges
paid in this regard.
5. Indirect Expenses: Where a contractor has a number of contracts-
in-process, in this situation some common expenses can occur in
relation to office and staff for all contracts. These indirect expenses
are distributed over different contracts on some suitable basis.
These include cost of special tools, cost of design, electric charge,
insurance etc.
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 COST ACCOUNTING

Notes 6. Sub-Contracts: Work of specialized nature for which facilities are

not internally available, is done by sub-contractor who are responsible
to main contractor. The cost of such sub-contract work is debited
to the concerned Contract Account.
7. Extra Works: Contractee may require some additions or alterations to
be made in the work originally agreed to be done as per agreement.
The contractor charges extra for such extra work. The cost of such
extra work should be debited to Contract Account and the amount
payable for the extra work by the contractee should be added to
the contract price.
8. Escalation Clause: Escalation clause is usually provided in the
contract as a safeguard against any likely changes in the price or
utilization of material and/or labour. This clause provides that in
case, prices and utilization of raw materials, labour etc. specified
in the contract change during the execution of the contract, beyond
a specified limit over the prices prevailing at the time of signing
the agreement, the contract price will be suitably adjusted. The
procedure for calculating such adjustment of prices in order to avoid
all future disputes is mentioned in the contract. The main objective
of this clause is to safeguard the interest of both the contractor
and the contractee in case of fluctuations in the prices of material,
labour etc. This clause is of particular importance where prices of
material and labour are anticipated to increase or where quantity
of material or labour time cannot be accurately determined.
9. Cost Plus Contract: Cost plus contract is a contract in which the
value of the contract is ascertained by adding a certain percentage
of profit over the total cost of the work. This system of costing is
used in cases where it is difficult for the contractor to quote the
contract price because there has been no precedent which can be
taken as basis. The profit to be paid to the contractor may be a
fixed amount or it may be a particular percentage of cost or capital
employed. These types of contracts are undertaken for production of
special articles not usually manufactured and is generally employed,
when Government happens to be a contractee. Generally, in such
contract, contractor and contractee have clear agreement about the
items of cost to be included, type of material to be used, labour

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rates for different grades, normal wastages to be permitted and the Notes
rate or amount of profit.

‹ Advantage of Cost Plus Contract

(i) Cost plus contract ensures that a reasonable profit accrues to the
contractor even in risky projects.
(ii) It simplifies the work offering tenders and quotations.
(iii) It provides escalation clauses and thus covers the contractor from
fluctuations in price and utilization of elements of production.
(iv) The customer is assured of paying only reasonable amount of profit.
(v) The customer has the right to conduct cost audit so that he can
ensure that he is not being cheated by the contractor.

‹ Disadvantages of Cost Plus Contract System

In spite of the advantages mentioned above cost plus contract system has
the following disadvantages:
(i) Since the contractor is assured of profit margin, he may not take
initiative for cost reduction by affecting economies of production
and reducing wastages.
(ii) The ultimate price to be paid by the customer cannot be exactly
ascertained until the work is completed and this creates delay in
preparing purchase budget by the customer.
(iii) The customer has to pay not only the resultant high cost but also
the resultant high profit. Thus, customer has to pay substantially
for lack of proper attitude (towards cost and efficiency) on the
part of contractor.
10. 
P rogress payment, Architects’ certificate, Retention money and
Cash ratio: In case of small contracts, the contractee makes full
payment on the completion of the contract. But in case of large
contracts, completion of contract takes more than one year and the
contractor cannot afford to block a large amount of funds until
the completion of the contract. Therefore, the system of progress
payment is adopted. In this system, the contractee agrees to pay
from time to time on the basis of progress of the contract work.

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Notes The progress will be judged by the contractee’s architect, surveyor

or engineer who will issue a certificate stating the value of work
so far done and approved by him. In this certificate, the architect
will certify the value of the work satisfactorily completed.
The contractee usually does not pay 100% of the value of work
certified by the architect. He/She retains a certain percentage of the
amount certified for payment by the architect as security for any
defective work which may be discovered later within the guarantee
period. This is called retention money. If contractee decides to pay,
say 80% or 90% of work certified, then this 80% or 90% of the work
certified is known as Cash Ratio. The balance is retention money.
Retention Money = Value of Work Certified – Cash Received
11. 
Work Certified: When the contract is not completed till the end
of the accounting period, the progress of the work on the contract
has to be assessed by the architect. The work done on incomplete
contract i.e. work-in-progress can be classified into value of work
certified and cost of work uncertified. Work Certified is that portion
of the work completed which has been certified by the contractee’s
architect. It is valued in terms of contract price.
The value of work certified is calculated as follows:
Cash Received
Value of Work Certified =
Cash received as % of Work Certified
Or
= Contract Price × Work certified as % of Contract Price
The following journal entries shall be passed:-
‹ Contractee’s A/c Dr.
To Contract A/c
(Being the value of work certified)
‹ Bank A/c Dr.
To Contractee’s A/c
The value of work certified is debited to Contractee’s Account or
Work-in-progress Account and is credited to Contract Account. This
value is brought down to the next year on the debit side of Contract
Account at the beginning of the next accounting year. This value
is also shown on the assets side of the balance sheet.
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12. 
Work Uncertified: This is that part of work-in-progress which is Notes
not approved or certified by the architect. It is valued at cost and
thus does not include an element of profit in it. The cost of work
uncertified is calculated as follows:
Value of Work Uncertified
% of work Uncertified
 Total Cost incurred till date 
% of Tootal work done till date
Or
= Cost of work incurred till date – Cost of Work Certified
The cost of work uncertified is credited to Contract Account. This
value is brought down to the next year on the debit side of Contract
Account at the beginning of the next accounting year. The cost of work
uncertified is also shown on the assets side of the balance sheet.
13. 
Notional Profit: It is the difference between the value of work certified
and cost of work certified. It is computed in the following manner.
Notional Profit = Value of work certified – [cost of work till date
– cost of work completed but not certified]
14. 
Estimated Profit: It is the difference between the contract price
and the estimated total cost of the contract.
Estimated Profit = Contract Price – [cost of work till date + cost
of work to be incurred]
15. 
Work-in-Progress: In contract accounts, the value of work-in-
progress includes the amount of the value of work certified and the
cost of work uncertified. The work-in-progress account appears in
the assets side of the balance sheet. The amount of cash received
from the contractee and reserve for contingencies or unrealized
profit is deducted out of this amount.
The work-in-progress account can be presented as follows in two
ways in the balance sheet:

Balance sheet as on............. Balance sheet as on.............

Assets Amount Assets Amount

Work-in-progress: Work-in-Progress:
Balance in contractee’s Account Value of work certified

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Notes Add: Work uncertified Add: Cost of work uncertified

Less: Reserve for unrealized Less: Reserve for unrealized profit
profit Less: Amount received from the
contractee
If the expenditure on uncompleted contracts includes the value of
plant and materials, these items may be shown separately in the
balance sheet. Thus, instead of showing the total expenditure un-
der the heading of work-in-progress, expenditure may split up and
shown separately in the balance sheet, under the headings of plant
at site, material at site, and work-in-progress.

8.7 Accounting for Profit on Incomplete Contracts

At the end of an accounting period it may be found that certain contracts
which have been completed while others are still in process and will be
completed in the coming years. The profit on completed contracts may
be safely taken to the credit of the profit and loss ­account. In the case of
incomplete contracts, there can be unforeseen contingencies which may
lead to heavy fluctuations in costs and profit. At the same time it does not
also seem desirable to consider the profits only on completed contracts and
ignore completely incomplete ones as this may result in heavy fluctuations
in the future for profit from year to year. If a large number of contracts
are completing in a year, contract account will show high figure of profit
in the year of completion and vice versa. Therefore, profits on incomplete
contracts should be considered.
There is no hard and fast rule regarding calculation of the figures for
profit to be taken to the credit of profit and loss account. However, the
following rules may be followed:
(i) Profit should be calculated with respect of work certified and work
uncertified should always be valued at cost.
(ii) No profit should be taken into consideration if the amount of work
certified is less than 1/4th of the contract price because in such
a case it is not possible to foresee the future clearly.
(iii) If work certified is 1/4th or more but less than 1/2 of the contract
price, 1/3rd of the profit disclosed as reduced by the percentage
of cash received from the contractee, should be taken to the profit
and loss account or
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1 Cash Received Notes

Transfer to Profit & Loss A/c   Notional Profit 
3 Work Certified
The balance will be allowed to remain as a reserve.
(iv) If work certified is 1/2 or more of the contract price, but less than
9/10 of the contract price, then profit to be transferred to Profit
& Loss A/c is as follows:
2 Cash Received
Transfer to Profit & Loss A/c   Notional Profit 
3 Work Certified
The balance should be treated as reserve.
(v) In case the contract is very much near to completion, if possible the
total cost of completing the contract should be estimated. The estimated
total profit on the contract then can be calculated by deducting the
estimated cost from the contract price. The profit and loss account
should be credited with that proportion of total estimated profit on
cash basis, which the work certified bears to the total contract price.
Work Certified
Transfer to Profit & Loss A/c  Estimated total Profit 
Contract Price
(vi) The whole of loss, if any, should be transferred to the profit and
loss account. That part of the profit which is not credited to the
profit and loss account is treated as a reserve against contingencies
and is deducted from the amount of work-in-progress for balance
sheet purpose.
Pro forma of contract account Contract Account
For the Accounting Period…..
Particulars Amount Particulars Amount
To Materials issued to site XXXX By Material at site XXXX
To Wages (Paid + Outstanding XXXX By Stores Ledger A/c XXXX
– Prepaid) (Return to store)
To Direct expenses (Paid + XXXX By Bank A/c (Sale) XXXX
Outstanding – Prepaid) By Costing P&L A/c (Loss XXXX
To Depreciation on Plant & XXXX on Sale)
Machinery By Work-in-progress:
To Office & Adm. Exp. XXXX Value of Work Certified XXXX
Incurred (Paid + Outstanding Cost of Work Uncertified XXXX
– Prepaid)
To Costing P&L A/c (Profit XXXX
on Sale)
To Notional Profit c/d XXXX
XXXX XXXX
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Notes Particulars Amount Particulars Amount

To Profit & Loss A/c XXXX By Notional Profit b/d XXXX
To Reserve A/c XXXX
XXXX XXXX
Contract Account
Dr. For 2nd Accounting Period Cr.
Particulars Amount Particulars Amount
To Work-in-progress b/d
Value of Work Certified
Cost of Work Uncertified
Less: Reserve XXXX
Rest format is same as previous
year
Format of balance sheet of a contractor (Extract)
as at Accounting Period
Liabilities Amount Assets Amount
Capital Plant & Machinery
Outstanding Expenses (Depreciated value)
Profit & Loss A/c Building (Depreciated Value)
Materials:
At stores
At site
Work-in-progress:
Value of Work Certified
Cost of Work Uncertified
Less: Cash received from
contractee
Less: Transfer to Reserve
Cash & Bank Balance
Prepaid Expenses
Illustration 1: Thekedar accepted a contract for the construction of a
building for Rs. 10,00,000, the contractee agreeing to pay 90% of work
certified by the architect. During the first year, the amounts spent were:
Particulars Amount
Material 1,20,000
Labour 1,50,000
Machinery 30,000
Other expenses 90,000
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At the end of the year, the machinery was valued at Rs. 20,000 and mate- Notes
rials at site were of the value of Rs. 5,000. Work certified during the year
totaled Rs. 4,00,000. In addition work-in-progress not certified at the end
of the year had cost Rs. 15,000. Prepare Contract Account in the books of
Thekedar. Also show the various figures of profit that can be reasonably
transferred to the Profit and Loss Account. [B.Com, Delhi]
Solution:
Contract Account for the year ending
Particulars Rs. Particulars Rs.
To Materials 1,20,000 By Work-in-progress:
To Labour 1,50,000 Certified 4,00,000
To Machinery 30,000 Uncertified 15,000
To Other expenses 90,000 By Machinery at site 20,000
To Notional Profit c/d 50,000 By Materials at site 5,000
4,40,000 4,40,000
To P&L A/c 15,000 * By Notional Profit c/d 50,000
To Reserve 35,000
50,000 50,000
Working Notes:
Transfer to P&L A/c = 50,000 × 1/3 × 90% = Rs. 15,000
Other figures that may alternatively be transferred to P&L A/c may be
computed as follows:
1. Notional profit × 1/3 = 50,000 × 1/3 = Rs. 16,667
Notional profit  Work certified
2.  Cash ratio
Contract price
50,, 000  4, 00, 000
=  90%
10, 00, 000
 Rs. 18,000
Notional profit  Work certified
3.
Contract price
50, 000  4, 00, 000

10, 00, 000
 Rs. 20,000

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Notes Illustration 2: The BBA Construction Company undertakes large con-

tracts. The following particulars relate to contract No. 125 carried out
during the year ended on 31st March, 2015.
Particulars Amount
Work certified by architect 1,43,000
Wages accrued on 31st March, 2015 1,800
Cost of work not certified 3,400
Direct expenditure 2,400
Plant installed at site 11,300
Materials on hand on 31st March, 2015 1,400
Value of plant on 31st March, 2015 8,200
Materials returned to store 400
Materials sent to site 64,500
Direct expenditure accrued on 31st March, 2015 200
Labour 54,800
Establishment charge 3,250
Contract price 2,00,000
Cash received from contractee 1,30,000
Prepare a Contract Account for the period ending 31st March 2015 and
find out the profit. It was decided to transfer 2/3 of the profit on cash
basis to Profit and Loss Account. [B.B.A., B.I.S. Delhi]
Solution: Contract No. 125 Account for the year ending 31st March, 2015
Particulars Amount Particulars Amount
To Materials sent to site 64,500 By Materials returned 400
To Labour 54,800 By Materials in hand 1,400
To Establishment charge 3,250 By Work-in-Progress:
To Direct expenses 2,400 Certified 1,43,000
To Wages accrued 1,800 Uncertified 3,400
To Direct expenses accrued 200 By Plant at site 8,200
To Plant at site 11,300
To Notional Profit c/d 18,150
1,56,400 1,56,400
To P&L A/c 11,000 By Notional Profit b/d 18,150
To Reserve 7,150
18,150 18,150

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 Contract Costing

Illustration 3: Modern Contractors have undertaken the following two Notes

contracts on 1st January, 2015:
Contract A Contract B
Particulars In Rs. In Rs.
Materials sent to sites 85,349 73,267
Labour engaged on sites 74,375 68,523
Plants installed at sites at cost 15,000 12,500
Direct expenditure 3,167 2,859
Establishment charges 4,126 3,852
Materials returned to store 549 632
Work certified 1,95,000 1,45,000
Cost of work not certified 4,500 3,000
Materials in hand 31st Dec., 2015 1,883 1,736
Wages accrued 31st Dec. 2015 2,400 2,100
Direct expenditure accrued 31st Dec. 2015 240 180
Value on plant 31st Dec. 2015 11,000 9,500
The contract prices have been agreed at Rs. 2,50,000 for contract A and Rs.
2,00,000 for contract B. Cash has been received from the contractee’s as fol-
lows: Contract A Rs. 1,80,000 and Contract B Rs. 1,40,000. Prepare Contract
Accounts, Contractee’s Accounts and show how the work-in-progress shall
appear in the Balance Sheet of the contractor.  [B.Com, Delhi; Bangalore]
Solution: Contract ‘A’ Account for the year ending 31st Dec., 2015
Particulars Amount Particulars Amount
To Materials sent to site 85,349 By Materials 549
To Labour 74,375 (returned to stores) 1,883
To Plant 15,000 By Materials in hand 11,000
To Direct expenditure 3,167 By Plant in hand
To Establishment charges 4,126 By Work-in-progress:
To Wages accrued 2,400 Work certified 1,99,500
To Direct expenses accrued 240 1,95,000
To Notional Profit c/d 28,275 Work uncertified 4,500
2,12,932 2,12,932
To Profit & Loss A/c 17,400 * By Notional Profit b/d 28,275
To Balance c/d (Reserve) 10,875
28,275 28,275

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 COST ACCOUNTING

Notes *Note: Proportion of profit transferred to Profit and Loss Account has
been calculated by the following formula:
2 Cash received
 Notional Profit  
3 Work certified
2 1, 80, 000
 28, 275    Rs. 17,400
3 1, 95, 000

A Contractee’s Account
Particulars Amount Particulars Amount
To Balance c/d 1,80,000 By Cash 1,80,000
1,80,000 1,80,000
Contract ‘B’ Account for the year ending 31st Dec, 2015
Particulars Amount Particulars Amount
To Materials 73,267 By Materials returned to 632
To Labour 68,523 store
To Plant 12,500 By Materials in hand 1,736
To Direct expenditure 2,859 By Plant in hand 9,500
To Establishment charges 3,852 By Work-in-progress:
To Wages accrued 2,100 Work certified 1,45,000
To Direct expenditure 180 Work uncertified 3,000 1,48,000
accrued By Loss transfer to P&L A/c 3,413
1,63,281 1,63,281
B Contractee’s Account
Particulars Amount Particulars Amount
To Balance c/d 1,40,000 By Cash 1,40,000
1,40,000 1,40,000
Balance Sheet as on Dec. 31, 2015
Liabilities Amount Assets Amount
Wages accrued (2,400 + 2,100) 4,500 Plant less Depreciation
Direct expenses accrued (27,500 – 7,000) 20,500
(240 + 180) 420 Materials in hand 3,619
Profit on contract A 17,400 Work-in-progress:
Less: Loss on contract B 3,413 13,987 Contract A
Work certified 1,95,000
Work uncertified 4,500
1,99,500

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 Contract Costing

Liabilities Amount Assets Amount Notes

Less: Profit in reserve 10,875
1,88,625
Less: Cash received 1,80,000 8,625
Contract B
Work certified 1,45,000
Work uncertified 3,000
1,48,000
Less: Cash received 1,40,000 8,000
Illustration 4: An expenditure of Rs. 3,88,000 has been incurred on a
contract up to the end of 31st December 2015. The value of work cer-
tified is Rs. 4,40,000. The cost of work uncertified is Rs. 12,000. It is
estimated that contract will be completed by 31st March 2015 and an
additional expenditure of Rs. 80,000 will have to be incurred to com-
plete the contract. The total estimated expenditure on the contract is to
include a provision of 2.5 per cent for contingencies. The contract price
is Rs. 5,60,000 and Rs. 4,00,000 has been realized in cash up to 31st
December 2015. Calculate the proportion of profit to be taken to Profit
and Loss Account as on 31st December 2015 under different methods.
[B.Com (Hons), Delhi; M.Com, Madras]
Solution: Calculation of Notional Profit
Value of work certified Rs. 4,40,000
Add: Cost of work not certified Rs. 12,000
4,52,000
Less: Cost to date Rs. 3,88,000
Notional Profit Rs. 64,000
Estimated Profit on Full Contract
Contract price Rs. 5,60,000
Less: Cost to date Rs. 3,88,000
Further cost Rs. 80,000
Contingencies Rs. 12,000*
Rs. 4,80,000
Estimated profit Rs. 80,000
*(3,88,000 + 80,000) × 2.5/97.5 = Rs. 12,000 for contingencies.

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 COST ACCOUNTING

Notes Profit to be transferred to Profit and Loss Account

Method (i)
2 2
Notional Profit   64, 000   Rs. 42,667
3 3
Method (ii)
2 Cash received 2 4, 00, 000
Notional Profit    64, 000    Rs. 38,788
3 Work certified 3 4, 40, 000
Method (iii)
Work certified 4, 40, 000
Estimated Profit   80000   Rs. 62,857
Contract Price 5, 60, 000
Method (iv)
Work certified Cash received
Estimated Profit  
Contract Price Work certified
4, 40, 000 4, 00, 000
 80000    Rs. 57,143
5, 60, 000 4, 40, 000

IN-TEXT QUESTIONS
1. Cash received on contract is credited to:
(a) Contract account
(b) Work in progress account
(c) Plant account
(d) Contractee’s account
2. Escalation clause in a contract to prefect the interest of:
(a) Contractor (b) Contractee
(c) Surveyor (d) Contractee’s architect
3. Contract costing usually applicable in:
(a) Construction work (b) Textile Mills
(c) Cement industries (d) Chemical industries
4. Work certified is valued at:
(a) Cost price
(b) Market price

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 Contract Costing

Notes
(c) Cost or market price whichever is less
(d) Estimate price
5. The degree of completion of work is determined by comparing
the work certified with:
(a) Contract price
(b) Work-in-progress
(c) Cash received on contract
(d) Retention money
6. A debit balance on the contractee account should be incorporated
in the balance sheet as:
(a) A current liability
(b) Set of against contract stock valuation
(c) Excess payment on account not set off against contract
stock value
(d) In debtors as “amount recoverable on contracts”
7. Retention monies are best defined as:
(a) Cash withheld by the contractee in order to improve the
cash flow of the contractor
(b) Payment to the contractor, where it is desired to secure
his services for a future contract
(c) Cash return to the contractee if actual profits on a contract
are 10% higher than an agreed figure
(d) Cash withheld by the contractee under the terms of the
value of work certified are being made
8. In contract costing, which of the following provides safeguard
against any fluctuation in the prices of material, labour, etc?
(a) Pricing clause
(b) Exclusion clause
(c) Arbitration clause
(d) Escalation clause

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 COST ACCOUNTING

Notes
9. ‘Contract costing’ is used in which of the following –
(a) Ship building
(b) Textile industry
(c) Paper manufacturing
(d) Nursing homes
10. In contract costing, if the amount of work certified is ½ or
more but not near to completion, profit to be transferred to the
statement of profit and loss can be calculated using the formula-
(a) 1/2 × Notional profit × cash received/ work certified
(b) 1/3 × Notional profit × cash received/ work certified
(c) 2/3 × Notional profit × cash received/ work certified
(d) Estimated profit × cash received/ work certified
11. Most of the expenses are direct in:
(a) Job costing
(b) Batch costing
(c) Contract costing
(d) None of the above.
12. The loss incurred on an incomplete contract is transferred
to __________ account.
(a) Costing profit and loss account
(b) Profit and loss account
(c) Trading account
(d) Deferred to next year
13. Fill in the blanks:
(a) Contracts are undertaken to ________________ requirements
of the customers.
(b) _______ costing is applied for Engineering Projects.
(c) In case of _______ contracts, only portion of the profit is
taken to the Profit and Loss account depending on the
extent of work completed on the contract.

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 Contract Costing

Notes
8.8 Answers to In-Text Questions

1. (d) Contractee’s account

2. (b) Contractee
3. (a) Construction work
4. (a) Cost price
5. (a) Contract price
6. (d) In debtors as “amount recoverable on contracts”
7. (d) C
 ash withheld by the contractee under the terms of the value
of work certified are being made
8. (d) Escalation clause
9. (a) Ship building
10. (c) 2/3 × Notional profit × cash received/work certified
11. (c) Contract costing
12. (b) Profit and loss account
13. Fill in the Blanks:
(a) Special
(b) Contract
(c) Incomplete

8.9 Self-Assessment Questions

1. How much of profit, if any, you would consider in the following
case:
Contract price Rs. 20,00,000
Cost incurred Rs. 11,20,000
Cash received Rs. 10,80,000
Work not certified Rs. 1,20,000
Deduction from bills by way of security deposit is 10%. [Adapted]
Answer: Rs. 1,20,000

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 COST ACCOUNTING

Notes 2. In contract cost accounts, it may be necessary to make a charge for

the use of a plant of machinery. Explain briefly two methods of
dealing with the charge and state in what circumstances you would
adopt each method.
3. What is a cost-plus-contract. Discuss this from the point of view of
(a) manufacturer and
(b) buyer.
4. Explain the methods of computing the profits in case of an incomplete
contract.
5. What do you understand by ‘Escalation Clause’? Explain in detail.
6. Discuss the nature of contract costing and explain how costs are
recorded in contracts.
7. Indicate how you would deal with the following items in contract account:
Plant and machinery specially purchased for a contract
(a) Loss of materials stolen or destroyed
(b) Sub-contracting
(c) Progress payment
8. How does contract costing differ from job costing? Mention the
special features of contract costing.
9. What is meant by retention money in context of contract costing?
What are its objectives?
10. Discuss the methods of calculating profits in respect of incomplete
contracts where:
(a) The work on the contract has not reasonably advanced
(b) The work on the contract has reasonably advanced
(c) The work is nearer completion
11. The following expenditure was incurred on a contract of Rs. 12,00,000
for the year ending 31-12-2015.
Materials Rs. 2,40,000
Wages Rs. 3,28,000
Plant Rs. 40,000
Overheads Rs. 17,200
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 Contract Costing

Cash received on account of the contract to 31st Dec, 2015 was Rs. Notes
4,80,000, being 80% of the work certified. The value of materials
in hand was Rs. 20,000. The plant had undergone 20% depreciation.
Prepare Contract Account. [B.Com, Madurai]
Answer: Notional Profit is Rs. 26,800
12. Deluxe Ltd. undertook a contract for Rs. 5,00,000 as on 1st July 2006.
On 30th June 2007, when the accounts were closed, the following
details about the contract were gathered:

Particulars Amount Rs. ’000s

Materials purchased 100
Wages paid 45
General expenses 10
Plant purchased 50
Materials on hand on 30th June 2007 25
Wages accrued on 30th June 2007 5
Work certified 200
Cash received 150
Work uncertified 15
Depreciation of plant 5
The above contract contained an escalation clause which read as
follows.
‘In the event of materials and rates of wages increase by more than
5% the contract price would be increased accordingly by 25% of the
rise in the cost of materials and wages beyond 5% in each case’.
It was found that since the date of signing the agreement, the prices
of materials and wage rates increased by 25%. The value of work
certified does not take into account the effects of the above clause.
Prepare Contract Account. Working should form part of your answer.
 [Adapted]
Answer: Amount transferred to Profit and Loss Account- Rs. 20,000
Amount transferred to Reserve Account- Rs. 60,000

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 COST ACCOUNTING

Notes 13. Construction Ltd. is engaged in two contracts, A and B during the
year. Following information is available at the year- end.

Contract A Contract B
Particulars
Rs. Rs.
Date of commencement April 1st September 1st
Contract price 6,00,000 5,00,000
Materials delivered direct to site 1,20,000 50,000
Materials issued from store 40,000 10,000
Materials returned to store 4,000 2,000
Material on site on December 31st 22,000 8,000
Direct labor payments 1,40,000 35,000
Direct expenses 60,000 30,000
Architect’s fees 2,000 1,000
Establishment charges 25,000 7,000
Plant installed at cost 80,000 70,000
Value of plant on 31st December 65,000 64,000
Accrued wages 31st December 10,000 7,000
Accrued expenses 31st December 6,000 5,000
Cost of contract not certified by architect 23,000 10,000
Value of contract certified by architect 4,20,000 1,35,000
Cash received from contractor 3,78,000 1,25,000

During the period, materials amounting to Rs. 9,000 have been

transferred from contract A to contract B. You are required to show,
(a) Contract A/c, Contractee A/c and
(b) Extract from the Balance Sheet as on 31st December showing
the calculation of WIP
 [Adapted]
Answer:
Contract A Account
Amount transferred to Profit and Loss Account- Rs. 36,000 (Profit)
Amount transferred to Reserve Account- Rs. 24,000
Contractee A/c
Balance c/d- Rs. 42,000

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 Contract Costing

Contract B Account Notes

Amount transferred to profit and Loss Account- Rs. 5,000 (Loss)
Contractee A/c
Balance c/d- Rs. 10,000
14. The following balances were extracted from the books of a building
contract on 31st March, 2014 regarding Contract No. 123:
Materials issued to site Rs. 6,27,200
Wages Paid Rs. 7,34,550
Wages outstanding on 31.3.2014 Rs. 7,200
Plant issued to site Rs. 60,000
Direct charges paid Rs. 25,150
Direct charges outstanding on 31.3.2014 Rs. 2,100
Establishment charges Rs. 56,500
Stock of materials at site on 31.3.2014 Rs. 12,000
Value of work certified on 31.3.2014 Rs. 16,50,000
Cost of work not yet certified Rs. 35,000
Cash received on account of architect’s certificate after deduction
by customer of 5 percent retention money is Rs. 14,10,750.
The work was commenced on April 1, 2013 and the contract price
agreed at Rs. 24,50,000.
Prepare contract account for the year providing for depreciation of
plant of 25 per cent. Calculate the Profit or Loss in the contract
to date and make such provision in the contract account as you
consider desirable. Set out also contractor’s balance sheet so far
as it relates to the contract.
Answer: Notional Profit Rs. 2,29,300

8.10 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 L E S S O N

9
Process Costing
Ms. Preeti Singh

STRUCTURE
9.1 Learning Objectives
9.2 Introduction
9.3 Meaning of Process Costing
9.4 Features of Process Costing
9.5 Distinction Between Job Costing and Process Costing
9.6 Procedure of Process Costing
9.7 Process Losses and Wastage
9.8 Treatment of Partly Sold Output and Partly Transferred to Next Process
9.9 Work-in-Progress
9.10 Meaning and Computation of Equivalent Production Units
9.11 Steps Involved in the Preparation of Process Account When There is
Work-in-Progress
9.12 By-Products and Joint Products
9.13 Accounting Treatment of By-Products
9.14 Accounting Treatment of Joint Products
9.15 Answers to In-Text Questions
9.16 Self-Assessment Questions
9.17 Suggested Readings

9.1 Learning Objectives

After reading this lesson, you will be able to:
‹ Define process costing and its features
‹ Explain the difference between process costing and job costing

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 Process Costing

‹ Explain the applicability of process costing Notes

‹ Discuss the procedure being followed under this costing method
‹ Explain about the accounting treatment of process losses and wastages
‹ Explain the concept of equivalent production and valuation method
of work-in-progress.

9.2 Introduction
In one of the previous chapters we have discussed some of the methods
of costing like, Job, Batch, and Contract costing. The job costing and
contract costing are used for calculating the cost and profit for individual
jobs or contracts. These methods are used when work is performed as per
the specific requirements of the customer. These methods are not suitable
for ascertaining the cost where mass production of goods is involved. In
fact, these methods are also not suitable when the production is carried out
in sequence of different operations or processes. Where goods or services
result from a sequence of continuous processes, then the process costing
method is employed. Process Costing is a method of costing which is
used in those industries where the production is in continuous flow, i.e.
the output of one process becomes the input of another process and so
on. Examples of such industries are paint works, chemical plants, food
manufacturing, oil refining, paper mill, textile mills, sugar factories, fruit
canning, dairy and so on. In such industries, the input is put in the first
process and the output of each process becomes the input of the subse-
quent process till the final product emerges from the last process. Thus
it is not possible to compute the cost of say, 300 kg of sugar or 400 kg
of cement produced as thousands of kg of sugar or thousands of kg of
cement is manufactured at the same time. We can get the cost per unit
by dividing the total cost by the total production produced during that
period. The features and intricacies of process costing are discussed in
the subsequent paragraphs.

9.3 Meaning of Process Costing

Process costing refers to a method of costing under which all costs are
accumulated at each stage of production or process and the cost per unit
of product is also determined at each stage of production by dividing the
total cost of each process by the normal output of that process.
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 COST ACCOUNTING

Notes The Chartered Institute of Management Accountants, London, defines

process costing as “that form of operation costing which applies where
standardized goods are produced”.

9.4 Features of Process Costing

The features of process costing are as follows:
(i) Process costing is applicable in those industries where production
is done in continuous flow.
(ii) The product is homogeneous and process is standardized.
(iii) The individual units lose their identity as production is in continuous
flow.
(iv) The output of one process becomes raw material of another process
(v) The output of the last process is transferred to finished stock
(vi) All the cost of material, labour, direct expenses and overheads
are accumulated and ascertained process-wise.
(vii) The total cost of each process is divided by the total production of
the process and average cost per unit for the period is obtained.
(viii) The sequence of operations or processes is specific and pre-determined.
(ix) Some loss of materials in processes is unavoidable.

9.5 Distinction Between Job Costing and Process Costing

The type of cost accumulation is determined by the type of manufacturing
operations. The differences between the two methods centre mainly around
how costing is accomplished. The product cost under both methods is
ascertained by averaging process, size of denominator being different in
both the cases. In job costing, costs are applied to specific jobs consist-
ing of a single or joint units, while in process costing, cost is applied
to a large number of units. The main points of distinction between job
costing and process costing may be summarized below:
Job Costing Process Costing
Job costing is applied where goods Process costing is applied where
are manufactured only against spe- production is (of like units) in con-
cific orders. tinuous flow.
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Costs are accumulated and applied Costs are accumulated and applied Notes
to specific jobs. process-wise or department-wise.
Costs are computed after every job Costs are computed after the expiry
is completed. of a particular cost period.
Job costs are calculated only when Process costs are calculated at the
a job is completed. end of each period.
Products are normally not transferredCosts are normally transferred from
from one job to another except in one process to another. Generally
the case of surplus work or excess the finished product of the process
production. becomes the raw material of the
next process until the goods are
completely manufactured.
From the point of view of managerial Because of the standard, mass and
control, more attention is needed continuous production, managerial
because production is not in contin- control is easier.
uous flow and each job is different.
Every job may or may not have Where the production is continuous,
opening or closing work-in-progress. there is always an opening and
closing balance of work-in-progress.
Greater degree of control and su- Comparatively lesser control is re-
pervision is required over the cost quired as the work is continuous and
of each job. involves standardized manufacturing
process.

9.6 Procedure of Process Costing

Under process costing method, a separate account is prepared for each
process in the following manner:
1. All production activities are divided into a number of processes
and a separate account is maintained for each process.
2. Each process account is debited with cost of material consumed,
cost of labour, direct expenses, cost of rectification of Normal
Defectives and overheads allocated or apportioned to the process.
3. Each process account is credited with scrap value of normal loss,
cost of abnormal loss and cost of output to be transferred to the
next process.

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 COST ACCOUNTING

Notes 4. The output of a process is transferred to the next process and this
will be shown on the debit side of the next process as cost of input.
5. The output of the last process is transferred to Finished Stock
Account.
The format of the process account is as follows:
Process I Account
Particulars Units Amount Particulars Units Amount
To Basic material XXXX XXXX By Normal Loss (1) XXXX XXXX
To Direct Material XXXX XXXX By Abnormal Loss (2) XXXX XXXX
To Direct labour XXXX XXXX By Process II (Output
To Direct Expenses XXXX XXXX transferred to next
To Production overhead XXXX XXXX processes) (3) XXXX XXXX
To Cost of rectification By Process I stock
of defective material XXXX XXXX Account (output trans-
To Abnormal gains (6) XXXX XXXX ferred to process I XXXX XXXX
Stock A/c) (4)
By P&L A/c (output
sold) (5) XXXX XXXX
Working Notes:
1. Normal Loss:
No. of units of expected normal loss = Input × Expected % of
Normal Loss
Realizable Value of units of Normal Scrap = Units of Normal Scrap
× Scrap Value per unit
2. Abnormal Loss:
No. of Units of Abnormal Loss = Expected Output (Input-Normal
Loss) – Actual Output
Cost of Abnormal Loss =
Total cost incurred  Scrap Value of Normal Loss

Input  Units of Normal Loss
Abnormal Loss units
3. Process II A/c (Output transfer to next process):
Cost of Output t/f to next process =
Total cost incurred  Scrap Value of N L

Input  Units of Normaal Loss
 Units of Output t/f to next process A/c
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 Process Costing

4. Process I stock Account (output transferred to process I Stock A/c): Notes

Cost of Output t/f to Process I Stock Account =
Total cost incurred  Scrap Value of N L

Input  Units of Normaal Loss
 Units of Output t/f to Process Stock A/c
5. P&L A/c (output sold):
Cost of Output Sold =
Total cost incurred  Scrap Value of Normal Loss

Input  Units of Normal Loss
 Units of Output sold
6. Abnormal Gain:
Cost of Abnormal Gain =
Total cost incurred  Scrap Value of Normal Loss

Input  Units of Normal Loss
 Units of Abnormal Gain

9.7 Process Losses and Wastage

In most of the manufacturing industries where process costing is em-
ployed, a certain amount of loss occurs at various stages of production.
Consequently the output from a process is generally less than the input.
The difference is termed as a process loss.
Process loss can be classified as (a) Normal Loss and (b) Abnormal Loss
9.7.1 Normal Loss in Process
Normal loss is an unavoidable loss which occurs due to the inherent na-
ture of the material and production process under normal conditions. It
is caused by factors, like chemical change, evaporation, withdrawals for
tests or sampling and unavoidable spoiled quantities. This loss can be in
the form of Normal Waste, Normal Scarp, Normal Spoilage and Normal
Defectives. It may occur in the beginning of the process or during a
process. Normal loss units are generally determined as:
Normal Loss (as % of current input) = Units Introduced × Normal Loss %

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Notes Or
Normal Loss (as % of Total input) = (Opening WIP + Units Introduced)
× Normal Loss %
Or
Normal Loss (as % of Production/Units processed) = (Opening WIP +
Units Introduced ̶ Closing WIP) × Normal Loss %
The loss due to normal wastages should be charged to the effectives, i.e.
the good units arising out of the process. Thus, the cost of spoiled and
lost units is absorbed as an additional cost of good units produced by
the process. Hence, the cost per unit is calculated, where the total cost
should be divided by the number of good units. However, if the wastage
has some realizable value, the same should be credited to the process
account and deducted from the total cost of process.
Cost per good unit can be calculated by using the following formula:
Total cost incurred  Scrap Value of Normal Loss
Cost per good unit 
Input  Units of Normal Loss

Specimen of
Normal Loss Account
Dr.Cr.
Particulars Units Amount Particulars Units Amount
To Process A/c XXXX XXXX By Bank A/c XXXX XXXX
By Abnormal XXXX XXXX
Gain A/c

9.7.2 Abnormal Loss in Process

Abnormal loss is an avoidable loss which occurs due to abnormal rea-
sons like accidents, carelessness, machine breakdown, use of defective
materials, inefficiency etc. This loss is in excess of the normal process
loss. Such losses cannot be estimated in advance. Thus, abnormal losses
arise when actual losses are more than expected losses. The number of
units of Abnormal Loss is calculated in the following manner:
Number of units of Abnormal Loss = Input – Normal Loss – Actual Output

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These losses are controllable and can be avoided by taking care of Notes
the factor responsible for such losses. The cost of abnormal loss is
not treated as part of the cost of production as well as not absorbed
by the good units produced. Hence, it is charged to Costing Profit &
Loss Account.
The real problem arises in ascertaining the cost of abnormal process
loss. The guiding principle in this regard is to treat the abnormal loss as
equivalent to the loss of good units of output. Cost of Abnormal losses
in calculated as per under given formula which will be shown of credit
side of Process Account:
Cost of Abnormal Loss
Total cost incurred  Scrap Value of Normal Loss
  Units of Abnormal Loss
Input  Units of Normal Loss

Specimen of
Abnormal Loss Account
Dr.Cr.
Particulars Units Amount Particulars Units Amount
To Process XXXX XXXX By Bank A/c XXXX XXXX
A/c By Costing P&L A/c XXXX XXXX

ABNORMAL GAIN (OR ABNORMAL EFFECTIVES) IN PROCESS

In case of actual production is more than the expected production or
actual losses are less than the expected normal losses. The lesser loss or
more production may be either because of over estimation of normal loss
or other abnormal circumstances like unexpected supply of better quali-
ty of material, extra-ordinary supervision or maintenance of machinery,
extraordinary efficiency achieved by workmen.
Number of units of Abnormal Gain = Actual Output – (Input – Normal
Loss)
The presence of this abnormal gain or effectiveness should not affect
the normal cost per unit of normal output. The abnormal gain is not
treated as recovery of cost of production and cost of good units are not
reduced by the cost of abnormal gains. Hence the value of abnormal gain
is credited to Costing P&L A/c.

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Notes The formula used for abnormal gain is as follows:

Cost of Abnormal Gain
Total cost incurred  Scrap Value of Normal Loss

Input  Units of Normal Loss
 Units of Abnormal Gain

Since, the normal loss is shown in the process account on the basis of
pre-determined rate and not on the actual basis. That is the reason of
transferring the sales values of abnormal gain units to Normal Loss Ac-
count since it arrives out of the savings of Normal Loss. The balancing
figure is transferred to Costing P&L A/c as a Real gain.
Specimen of
Abnormal Gain Account
Dr.Cr.
Particulars Units Amount Particulars Units Amount
To Normal Loss A/c XXXX XXXX By Process A/c XXXX XXXX
To Costing P&L A/c XXXX XXXX

9.8 T
 reatment of Partly Sold Output and Partly Transferred
to Next Process
When the output of a process may be partly sold and partly transferred
to the next process for further processing. That part of the output so sold
will contain an element of profit or loss which will be revealed in the
Process Account. But when a part of the output is sent to warehouse for
sale, it is recorded at cost in the Process Account and does not contain
an element of profit or loss.

9.9 Work-In-Progress
Process costing mainly deals with those industries that are involved in
continuous production. At the end of the accounting period, there is
generally some incomplete production in this type manufacturing units.
Incomplete production units represent those units on which percentage of
completion with regard to all elements of cost (i.e. material, labour and

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overhead) is not 100%. Such incomplete or semi-finished production units Notes

are known as work-in-progress. For the purpose of valuation of work-
in-progress, the incomplete units have to be converted into equivalent
completed production units.

9.10 M
 eaning and Computation of Equivalent
Production Units
Equivalent production units represent incomplete production units expressed
in terms of equivalent completed units. For example, if there are 100 units
in work-in-progress and these are estimated to be 70% complete, then
their equivalent production is 100 units × 70% = 70 units. Equivalent
units should be calculated separately with regard to each element of cost
i.e. material, labour and overheads because the percentage of completion
with regard to different elements of cost may be different.
Equivalent units of work-in-progress = Completed Units + (Number of
units of WIP × Degree of completion in %)

9.11 S
 teps Involved in the Preparation of Process
Account When There is Work-In-Progress
The following steps need to be followed when there is work-in-progress
while preparing Process Account:
Step 1: Prepare Statement of Equivalent Production:
FORMAT OF STATEMENT OF EQUIVALENT PRODUCTION
Input Output Equivalent Production
Material Labour Overheads
Particu- Particu- % % %
lars Units lars Units Comple­tion Units Completion Units Completion Units
Opening XX Units in- XXX XXX XXX XXX XXX XXX XXX
Stock troduced
& com-
pleted
Units XX Normal XXX XXX XXX XXX XXX XXX XXX
intro- Loss
duced
Abnormal XXX XXX XXX XXX XXX XXX XXX
Loss
Equiva- XXX XXX XXX XXX XXX XXX XXX
lent units

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Notes Step 2: Prepare Statement of Cost (per unit)

FORMAT OF STATEMENT OF COST PER EQUIVALENT UNITS
Elements of Cost in Equivalent Cost per equivalent
Cost Rs. Units Units in Rs.
Material Cost XXXX XXXX XXXX
Labour Cost XXXX XXXX XXXX
Overhead Cost XXXX XXXX XXXX
Step 3: Prepare Statement of Evaluation
Format of Statement of Evaluation
Cost per Total
Element Equivalent equivalent Cost Cost
Particulars of Cost Units units in Rs. in Rs. in Rs.
Units In- Material XXX XXX XXX XXX
troduced & Labour XXX XXX XXX XXX
Completed Overhead XXX XXX XXX XXX
Material XXX XXX XXX XXX
Closing WIP Labour XXX XXX XXX XXX
Overhead XXX XXX XXX XXX
Material XXX XXX XXX XXX
Finished
Labour XXX XXX XXX XXX
Goods
Overhead XXX XXX XXX XXX
Step 4: Prepare Process Account
The Process Account is prepared in the usual way and all values com-
puted under evaluation statement are entered in it.
The calculation of equivalent production will be done in different manner
according to the following four situations:
1. When there is no opening work-in-progress and no process loss
In this case, there is only closing work-in-progress and existence
of process loss is ignored. Closing work-in-progress is converted
into equivalent production units in respect of degree of completion
of materials, labour and production overhead. Afterwards, the cost
per equivalent unit is calculated and the same is used to value the
finished output transferred and the closing work-in-progress

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2. When there is no opening work-in-progress but there is process loss Notes

In this case, there is closing stock and process losses also. The
treatment of process loss is same as already discussed in this
chapter. In case of normal loss, it should not be considered while
calculating equivalent production. If normal loss has any reliable
value, the amount should be deducted from the cost of materials in
the cost statement before dividing by equivalent production units.
If abnormal loss is there, it should be treated as 100% complete
as regard to each element of cost and considered as good units
completed during the period. Abnormal gain in terms of units is
deducted to obtain equivalent production.
3. When there is opening as well as closing work-in progress with
or without process loss
When there is opening as well as closing work-in-progress, the
valuation of both closing work-in-progress and the actual output
transferred to next process depend on the method of apportionment
of cost followed viz, FIFO and Average cost Method. Let us discuss
these two methods:
(a) FIFO Method: The FIFO method of costing is based on the
assumption of that first all opening work-in-progress units
will be completed and the cost of finishing these units will
be equal to the sum of the cost of opening WIP and the cost
incurred during the period for their completion. Equivalent
production units of opening work-in-progress can be calculated
in the following manner:
Equivalent Production units = Units of Opening WIP × Per-
centage of work needed to finish the units
(b) Average Cost Method: This method is useful when degree
of completion of the opening WIP stock is not given and
the overall cost of opening WIP is given but the degree of
completion and the individual cost of various elements is
not mentioned. The closing valuation of work-in-progress of
the previous year is added to the cost of current year and an
average rate obtained. In calculating the equivalent production
units, opening WIP units will not be shown separately. In fact
it is included in the units completed and transferred.
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Notes Illustration 1: Roy & Johnson (P) Ltd. gives the following particulars
relating to process A in its plant for the month of December 2012:
Work in progress Rs.
(opening balance) on 01.12.2012 - 500 units: Materials 4,800
Labour 3,200
Overheads 6,400
14,400
Units introduced during the month – 19,500
Processing costs incurred during the month:
Materials Rs. 1,86,200
Labour 72,000
Overheads 1,06,400 Rs. 3,64,600
Output: Units transferred to Process B 18,200
Units scrapped (completely processed) 1,400
Work in process (closing balance) 400
(Degree of completion: Materials: 100% Labour and overheads: 50%)
Normal loss in processing is 5% of total input and normal scrapped units
fetch Rs. 1 each.
Prepare the following statements for Process A for December 2012:
(a) Statement of equivalent production;
(b) Statement of cost
(c) Statement of evaluation
(d) Process ‘A’ Account (ICWA Inter)
Solution: Average method is used here.
Statement of Production
Labour and
Input Output Material Overheads
Units Particulars units % Units % Units
500 Opening WIP
19,500 Units introduced
Units completed 18,200 100% 18,200 100% 18,200
Normal Loss 1,000

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Labour and Notes

Input Output Material Overheads
Units Particulars units % Units % Units
Abnormal Loss 400 100% 400 100% 400
Closing WIP 400 100% 400 50% 200
20,000 20,000
Equivalent units 19,000 18,800
Statement of Cost per unit
Cost per unit
Materials Cost Rs. (A) Units (B) Rs. (A + B)
Opening work in progress 4,800
Add: Materials consumed 1,86,200
1,91,000
Less: Sale from normal loss 1,000
1,90,000 19,000 10
Labour: Opening work in 3,200
progress
Add: Cost incurred 72,000
75,200 18,800 4
Overhead: Opening WIP 6,400
Add: Cost incurred 1,06,400
1,12,800 18,800 6
Total 20
Statement of Evaluation
Rs.
Output completed 18,200 units @ 20 3,64,000
Abnormal loss 400 units @ 20 8,000
Work in progress (closing)
Material 400 units @ Rs 10 4,000
Labour and overheads 200 units @ Rs. 10 2,000 6,000
Process ‘A’ Account
Units Rs. Units Rs.
To Opening WIP 500 14,400 By Transfer To Process B 18,200 3,64,000
To Units Introduced 19,500 1,86,200 By Normal loss 1,000 1,000
To Labour 72,000 By Abnormal loss 400 8,000

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 COST ACCOUNTING

Notes Units Rs. Units Rs.

To overhead 1,06,000 By Closing WIP 400 6,000
20,000 3,79,000 20,000 3,79,000

Illustration 2: The product of a manufacturing concern passes through

two processes A and B. The normal losses and abnormal losses are defec-
tive units having a scrap value of Rs. 2 and Rs. 5 per unit in processes
A and B respectively. The following information relates to the month
ending 31-3-2016:
Process A Process B
Raw material issued @ Rs. 5 3000 units –
Normal Loss 10% of input 5% of input
Output 2,800 units 2,600 units
Additional components Rs. 1,000 Rs. 780
Direct wages Rs. 4,000 Rs. 3,000
Direct Expenses Rs. 10,000 Rs. 14,000
Production Overhead (as a percentage 75% 125%
of direct wages)
There was no opening or closing work in progress but opening and closing
stocks of finished goods were Rs. 20,000 and Rs. 23,000 respectively.
Prepare Process Account, Finished Stock A/c, Normal Loss A/c, Abnormal
Loss A/c and Abnormal Gain A/c. [B.Com (Hons) Delhi, 2016]
Solution: Process A Account
Particulars Units Amount Particulars Units Amount
To Raw Material 3,000 15,000 By Normal Loss 300 600
(10% of input)
To Additional 1,000 By Transfer to 2,800 33,600
Components Process B (@
Rs. 12 per unit)
To Direct wages 4,000
To Direct Expenses 10,000
To Production 3,000
Overheads (75%
of Direct Wages)
To Abnormal Gain 100 1,200
(WN 1)
3,100 34,200 3,100 34,200

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Process B Account Notes

Particulars Units Amount Particulars Units Amount
To Transfer from 2,800 33,600 By Normal Loss 140 700
Process A (5% of input)
To Additional 780 By Abnormal Loss 60 1,227
Components
To Direct wages 3,000 By finished Goods 2,600 53,203
(stock A/c @ Rs.
20.463 per unit)
To Direct Expenses 14,000
To Production Over- 3,750
heads (125% of Direct
Wages)
2,800 55,130 2,800 55,130
Finished Goods Stock Account
Particulars Amount Particulars Amount
To Opening Stock 20,000 By Cost of Finished 50,203
goods sold
To Transfer From 53,203 By Closing stock 23,000
Process B
73,203 73,203
Normal Loss Account
Particulars Units Amount Particulars Units Amount
To Process A 300 600 By Sale Proceeds 200 400
By Abnormal 100 200
Gain A/c
300 600 300 600
Abnormal Loss Account
Particulars Units Amount Particulars Units Amount
To Process B 60 1,227 By Sales Proceeds 60 300
By Costing P& L A/c 927
60 1,227 60 1,227
Abnormal Gain Account
Particulars Units Amount Particulars Units Amount
To Normal Loss A/c 100 200 By Process A 100 1,200
To Costing P& L A/c 1,000
100 1,200 100 1,200

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Notes Working Notes:

  Normal Cost  
1. Normal Cost of Abnormal Gain = × Abnormal Gain
Normal Output
= 32,400 × 100 = Rs 1,200
2,700
54,430
2. Normal Cost of Abnormal Loss = × 60 = Rs. 1,227
2,660
Illustration 3: ABX Company Ltd. provides the following information
relating to Process B:
(i) Opening work in progress - Nil
(ii) Units Introduced - 45,000 units @ Rs. 10 per unit
(iii) Expenses debited to the process:
Direct Material - Rs. 65,500
Labour - Rs. 90,800
Overhead - Rs. 1,80,700
(iv) Normal loss in the process - 2% of Input
(v) Work in progress - 1,800 units
Degree of completion
Materials - 100%
Labour - 50%
Overhead - 40%
(vi) Finished Output - 42,000 units
(vii) Degree of completion of abnormal loss:
Materials - 100%
Labour - 80%
Overhead - 60%
Units scrapped as normal loss were sold at Rs. 5 per unit.
All the units of abnormal loss were sold at Rs. 2 per unit.
You are required to prepare:
(a) Statement of equivalent production
(b) Statement showing the cost of finished goods, abnormal loss and
closing balances of work-in-progress
(c) Process B account and abnormal loss account.
 [CA IPC, May, 2013]
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Solution: (a) STATEMENT OF EQUIVALENT PRODUCTION Notes

Equivalent production
Input Material Labour Overhead
details Units Output Units % Units % Units % Units
Units 45,000 Finished 42,000 100 42,000 100 42,000 100 42,000
produced output
Normal 900 - - - - - -
loss (2%
of 45000)
Abnormal 300 100 300 80 240 60 180
loss
Closing 1,800 100 1,800 50 900 40 720
WIP
45,000 45,000 44,100 43,140 42,900

(b) STATEMENT OF COST

S. No Particulars Units Rate Amount Amount
(1) Finished goods 42,000 17.9042 7,51,976.40
(2) Abnormal loss
Material 300 11.5873 3,476.19
Labour 240 2.1048 505.15
Overhead 180 4.2121 758.18 4,739.52
(3) Closing WIP
Material 1,800 11.5873 20,857.14
Labour 900 2.1048 1,894.32
Overhead 720 4.2121 3,032.71 25,784.17

Working Notes: COMPUTATION OF COST PER UNIT

S no Particulars Amount Units Per Unit
(1) Direct Material:
Units introduced 4,50,000
Add: Material 65,500
5,15,500
Less: Value of normal loss (4,500)
(900 units × Rs. 5)
5,11,000 44,100 11.5873
(2) Labour 90,800 43,140 2.1048
(3) Overhead 1,80,700 42,900 4.2121
17.9042

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Notes (c) (i) PROCESS B ACCOUNT

Particulars Units Amount Particulars Units Amount
To Input 45,000 4,50,000 By Normal loss 900 4,500
To Direct Material 65,500 By Abnormal loss 300 4,740
To Labour 90,800 By Finished goods 42,000 7,51,976
To Overhead 1,80,700 By closing WIP 1,800 25,784
45,000 7,87,000 45,000 7,87,000

(ii) ABNORMAL LOSS ACCOUNT

Particulars Units Amount Particulars Units Amount
To Process - B 300 4,740 By Cost ledger control A/c 300 600
A/c or Bank A/c
By Costing Profit & loss A/c - 4,140
300 4,740 300 4,740

Illustration 4: The following data relate to Process Q:

(i) Opening work in progress 4,000 units
(ii) Degree of completion:
Materials 100% Rs. 24,000
Labour 60% Rs. 14,400
Overheads 60% Rs. 7,200
(iii) Received during the month of April, 2016 from Process P:
40000 units Rs, 1,71,000
(iv) Expenses incurred in Process Q during the month:
Materials Rs. 79,000
Labour Rs. 1,38,230
Overheads Rs. 69,120
(v) Closing work-in-progress 3,000 units
Degree of completion:
Materials 100%
Labour & Overheads 50%
(vi) Units scrapped 4,000 units
Degree of completion
Materials 100%
Labour & Overheads 80%
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(vii) Normal loss: 5% of current input Notes

(viii) Spoiled goods realized Rs. 1.50 each on sale
(ix) Completed units are transferred to warehouse.
Prepare:
(i) Equivalent units statement
(ii) Statement of cost per equivalent unit and total costs
(iii) Process Q Account
(iv) Any other account necessary.
 [CA Inter, May 1998; B.Com. (Hons.), Delhi 2008, adapted]
Solution:
(i) STATEMENT OF EQUIVALENT PRODUCTION (using FIFO
method)
Equivalent production
Input Output Material Labour Overhead
Units Particulars Units % Units % Units % Units
4000 Opening work-in-prog- 4000 - - 40 1600 40 1600
ress (units completed and
transferred to warehouse)
Units completed and trans- 33000 100 33000 100 33000 100 33000
ferred to warehouse
Closing work-in-progress 3000 100 3000 50 1500 50 1500
Normal loss 2000 - - - - - -
Abnormal loss 2000 100 2000 80 1600 80 1600
44000 38000 37700 37700

(ii) STATEMENT OF COST PER EQUIVALENT UNIT AND TOTAL

COST
Material I Material II Labour
Particulars (Process P) (Process Q) (Process Q)
Cost (Rs.) 1,71,000 79,000 2,07,350
Less: Recovery from sale of scrapped - 3,000 -
2,000 units at Rs. 1.50 per unit being
normal loss
1,71,000 76,000 2,07,350
Equivalent production 38,000 38,000 37,700
Cost per unit Rs. 4.50 Rs. 2 Rs. 5.50

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Notes Material I Material II Labour

Particulars (Process P) (Process Q) (Process Q)
Cost of completed units:
Opening stock 4,000 units 45,600
Cost incurred to complete Opening stock 8,800
into finished products (1,600 × 5.50)
54,400
Cost of 33000 completed units (33,000 3,96,000
units × 12)
Total cost of 37000 completed units (Rs.) 4,50,400
Cost of 3,000 Closing WIP units (Rs.) 27,750
(3,000 units × Rs. 6.50) = Rs. 19,500 and
(1,500 units × Rs. 5.50) = Rs. 8,250
Cost of 2000 Abnormal units (Rs.) 21,800
(2,000 units × Rs. 6.50) = Rs. 13,000 and
(1,600 units × Rs. 5.50) = Rs. 8,800
4,99,950

(iii)       PROCESS Q ACCOUNT

Particulars Units Amount Particulars Units Amount
To Opening WIP 4,000 45,600 By Normal loss 2,000 3,000
To Units received 40,000 1,71,000 By Completed units 37,000 4,50,400
(transferred to ware-
house)
To Costs incurred: By Closing WIP 3,000 27,750
Materials 79,000 By Abnormal loss 2,000 21,800
Labour 1,38,230
Overheads 69,120
44,000 5,02,950 44,000 5,02,950

(iv)       ABNORMAL LOSS ACCOUNT

Particulars Units Amount Particulars Units Amount
To Process Q A/c 2,000 21,800 By Sale proceeds 2,000   3,000
By Profit & loss A/c (Loss) 18,800

2,000 21,800 2,000 21,800

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Notes
9.12 By-Products and Joint Products

9.12.1 Introduction
In most of the industries where the production is carried in a sequence,
two or more products emerge from the same manufacturing process or
same raw material. These products are sometimes produced intentionally
while in some cases they emerge out of the main manufacturing process.
Such products are known as either joint products or by-products. These
two or more products may be either of comparatively equal importance
or some may be of equal importance and others of lesser importance.
Though sometimes these terms are used interchangeably, there is a major
difference between the two and therefore it is necessary to understand
clearly the difference between them. Similarly there is a difference be-
tween the accounting of the two and hence it is essential to define clearly
the concepts of joint products and by-products.

9.12.2 Meaning of By-Product and Joint Product

By-products are products of relatively small saleable or usable value
which are incidentally produced in addition to the main product. They
are simultaneously or incidentally produced with the main products.
By-products mean secondary or subsidiary products arising in the course
of manufacturing the main product(s). They are relatively of lesser eco-
nomic importance when compared to main products. In the process of
producing the main product it frequently occurs that materials or other
products emerge which are of smaller value. These are the by-products
and even if subsequent processing enhances their value, the resulting profit
will be less than that from the main product; otherwise, of course the
by-product would become the main product and vice-versa. For example,
in sugar industry, the main product is sugar and by-products are bagasse
and molasses. In coal industry, the main product is coal and by-products
are benzoyl, sulphate and ammonia etc.
Joint-products represent two or more products separated in the course
of a manufacturing process or operations, usually requiring further pro-
cessing, each product being in such proportion that no single product

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Notes can be designated as a major product. There are certain industries where
two or more products of equal importance are simultaneously produced
such products are regarded as joint products. The Chartered Institute of
Management Accountants has defined the joint products as “two or more
products separated in processing, each having a sufficiently high saleable
value to merit recognition as a main product.”
So joint products imply the following:
(i) Joint products are produced from the same raw material in natural
proportion.
(ii) They are comparatively of almost equal importance.
(iii) They are produced simultaneously from a single manufacturing
process.
(iv) They may have saleable value after the point of separation.

9.13 Accounting Treatment of By-Products

Accounting for by-products may be classified as follows:
1. Non-cost or Sales Value Methods:
(i) Treatment of by-product as other income: In this method the
sales value of by-products is credited to profit and loss account,
treating it as other miscellaneous income.
(ii) Sales value of by-products deducted from total cost: Under
this method the sale proceeds of the by-products are treated
as deductions from total joint costs.
(iii) By-product sales added to the main product sales: In this case
all costs incurred on main and by products are deducted from
the combined sales of the main product and by-products.
(iv) Crediting sales value after deducting administration, selling
and distribution expenses: In this method, a portion of the
administration, selling and distribution overhead incurred for
disposing of the by-product is deducted from the sale value
for credit to process account.
(v) Crediting sales value after deducting the costs incurred on
by-products after split off point: In certain cases it becomes

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necessary to perform some further operations on by-products Notes

after the split off point, in order to make it saleable. Credit
is given to the process account for sale value less the cost
after split off point.
(vi) Reverse cost method: Under this method, an estimated profit
from the sale of by-products, selling and distribution expenses
and further processing cost, after the split off points are
deducted from the sale value of a by-product.
Cost
2. Cost Methods:
(i) Opportunity or replacement cost method: This method is adopted
where by-products are utilized by the factory itself as input
material for some other process and the by-product may be
valued at the opportunity or replacement cost.
(ii) Standard cost method: A standard cost is set on the basis of
technical assessment for each by-product and credit is given
to the process account on this basis. Because of the stability
of this method, effective control would be exercised on the
cost of the main product.
(iii) Apportionment on suitable basis: Where by-products are of
major significance, cost should be apportioned on the most
suitable basis, i.e. physical measurement, market value etc.

9.14 Accounting Treatment of Joint Products

Joint products are not identifiable as separate products until a certain
point or stage of production is complete. This stage is known as split
off point. Cost incurred prior to the split off point is referred to as joint
costs. Costs incurred after this stage are referred to as separate or sub-
sequent costs. Accounting of joint products implies the assignment of a
portion of the joint cost to each of the joint product. Unless the joint
costs are properly and reasonably apportioned to different joint products
produced, the cost of joint products will vary considerably and this will
affect valuation of inventory, pricing of products and profit or loss on
sale of different products. The commonly used methods for apportioning

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Notes total process costs up to the point of separation over the joint products
are as follows:
(i) Physical unit method
(ii) Average unit cost method
(iii) Survey method
(iv) Market value method
(i) Physical Unit Method
Under this method, joint costs are apportioned on the basis of some
physical base, such as weight or measure expressed in gallons,
tonnes etc. In other words, the basis used for apportioning joint
costs over the joint products is the physical volume of materi-
als present in the joint products at the point of separation. This
method is suitable when the physical units of output for all the
products are similar. If physical units of the two joint products are
not similar then this method cannot ascertain the cost correctly.
(ii) Average Unit Cost Method
Under this method, total process costs (upto the point of sepa-
ration) are divided by total units of joint products produced by
which average cost per unit of production is obtained. This average
cost per unit will be uniform for all products. Under this method
customers of high quality items are benefited as they have to pay
less price on their purchases.
(iii) Survey Method
This method is based on technical evaluation of various factors
involved in the production and distribution of products. Under
this method joint costs are apportioned over the joint products,
on the basis of percentage/point values, assigned to the products
according to their relative importance. This method is considered
to be more equitable them other methods.
(iv) Market Value Method
This is the most common method employed because it makes
use of a realistic basis for apportioning joint costs. Under this
method, the products are made to bear a proportion of the joint
costs on the basis of their ability to absorb the same.

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Market value means weighted market value i.e. units produced x price Notes
of a unit of joint product.
(a) Market value at the point of separation or relative market value
method:
The adoption of this method involves the following steps: The
physical output of each product is multiplied with the market price
at the split off point. The resultant market value of all products is
then added. The percentage of the market value of each product
to the total of the market values is found out. These percentages
are used to allocate the total input cost among the joint products.
(b) Market value after further processing:
Here the basis of apportionment of joint costs is the total sales
value of finished products and involves the same principle as
stated in (i) above.

IN-TEXT QUESTIONS
1. Cost of abnormal wastage is:
(a) Charged to the product cost
(b) Charged to the profit & loss account
(c) Charged partly to the product and partly profit & loss account
(d) Not charged at all
2. In process costing, if an abnormal loss arises, the process
account is generally
(a) Debited with the scrap value of the abnormal loss units
(b) Debited with the full production cost of the abnormal loss
units
(c) Credited with the scrap value of the abnormal loss units
(d) Credited with the full production cost of the abnormal loss
units
3. In process costing, a joint product is
(a) A product which is later divided into many parts
(b) A product which is produced simultaneously with other
products and is of similar value to at least one of the
other products.
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Notes
(c) A product which is produced simultaneously with other
products but which is of a greater value than any of the
other products.
(d) A product produced jointly with another organization.
4. Total costs incur in a production process, is divided by total
number of output units to calculate the
(a) Cost of indirect labor
(b) Cost of direct labor
(c) Cost of direct material
(d) Unit costs
5. Process costing is suitable for___________.
(a) Hospital
(b) Oil refining firms
(c) Transport firms.
(d) Brick laying firms.
6. Which of the following is considered as normal loss of material?
(a) Pilferage
(b) Loss due to accident
(c) Loss due to careless handling of material
(d) None of the above.
7. Fill in the blanks:
(a) Cost of ___________ is not borne by good units.
(b) Under process costing, the output of each process is
transferred as an _________ to the next process.
(c) A process may involve simultaneous production of more than
one product, classified as joint-products and ______________.
(d) Equivalent production represents the production during a
particular period in terms of ____________ units with
regard to each element of cost.

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Notes
8. State whether the following statements are True or False:
(a) Process costing is not suitable for Industries manufacturing
televisions and washing machines.
(b) Normal process loss does not increase the per unit cost
of production.
(c) Cost of abnormal loss is included in the cost of each
process.
(d) In process costing when degree of completion of the opening
WIP stock is not given then FIFO method of valuation
is used.
(e) Under process costing cost of a product is ascertained at
each stage or process of manufacturing.

9.15 Answers to In-Text Questions

1. (b) Charged to the profit & loss account
2. (d) Credited with the full production cost of the abnormal loss units
3. (b) A product which is produced simultaneously with other products
and is of similar value to at least one of the other products.
4. (d) Unit costs
5. (b) Oil refining firms
6. (c) Loss due to careless handling of material
7. Fill-in the Blanks:
(a) Abnormal Loss
(b) Input
(c) By-product
(d) completed
8. True/False
(a) True
(b) False

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Notes
(c) False
(d) False
(e) True

9.16 Self-Assessment Questions

1. Define process costing. State any four features of process costing.
2. Explain the fundamental difference between Process Costing and
Job Costing?
3. What do you mean by normal loss? How is it treated in process
cost accounts?
4. What do you mean by abnormal loss? How is it treated in process
cost accounts?
5. Distinguish between normal loss and abnormal loss.
6. What do you mean by abnormal effective? How is it treated in
process cost accounts?
7. What do you mean by inter process profit? What purpose does it
serve?
8. What do you mean be equivalent production? State the method of
calculating equivalent units.
9. Name any four industries in which process costing is applicable?
10. “The value of scarp generated in a process should be credited to
process account.” Do you agree with this statement? Give reasons.
11. Distinguish between joint product and by-product.
12. Explain:
(a) Split Off Point
(b) Equivalent Units
(c) Equivalent production
(d) Accounting for by-products
(e) Inter-process profits
13. Define Joint-products and By-products and cite an example on each.

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Explain the various bases available for apportionment of joint costs Notes
to joint products.
14. How are the units of output transferred to next process under the
following methods:
(a) FIFO Method
(b) Average Method
15. Prepare a Process Account and Abnormal Loss Account from the
following information.
Input of Raw material 1000 units @ Rs. 20 per Unit
Direct Material Rs. 4,200/-
Direct Wages Rs. 6,000/-
Production Overheads Rs. 6,000/-
Actual output transferred to process II 900 units
Normal Loss 5%
Value of Scrap per unit Rs. 8/- [Adapted]
Answer: Amount transferred to Process II Account- Rs. 39,916
Balancing figure of Abnormal Loss Account transferred to Costing
Profit & Loss Account- Rs. 1,484
16. A product is manufactured by passing through three processes A,
B and C. In process C a by-product is also produced which is then
transferred to process D where it is completed. For the first week
in January, the actual data included:
Processes
Particulars A B C D
Normal loss of input (%) 5 10 5 10
Scrap value (Rs. per unit) 1.50 2.00 4.00 2.00
Estimated sales value of by- - - 8.00 -
product (Rs. per unit)

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 COST ACCOUNTING

Notes Processes
Particulars A B C D
Output (units) 5,760 5,100 4,370 –
Output of by-products (units) - - 510 450
Direct materials (6000 units) (Rs.) 12,000 - - -
Direct materials added in 5,000 9,000 4,000 220
process (Rs.)
Direct wages (Rs.) 4,000 6,000 2,000 200
Direct expenses (Rs.) 800 1,680 2,260 151
Budgeted production overhead (based on direct wages) for the week
is Rs. 30,500.
Budgeted direct wages for the week is Rs. 12,200.
You are required to prepare:
(i) Accounts for processes A, B, C and D.
(ii) Abnormal loss and abnormal gain accounts. [Adapted]
Answer: Cost of Finished Goods- Rs. 4,950
Abnormal Loss Account: Costing Profit and Loss A/c - Rs. 921
Abnormal Gain Account: Costing Profit and Loss A/c - Rs. 660
17. Prepare a statement of equivalent production, statement of cost,
process account from the following information using average
costing method.
Opening Stock 50,000 Units
Material Rs. 25,000
Labour Rs. 10,000
Overheads Rs. 25,000
Units Introduced 2,00,000 Units
Material Rs. 1,00,000
Wages Rs. 75,000
Overheads Rs. 70,000
During the period 1,50,000 units were completed and transferred
to Process II.

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 Process Costing

Closing stock 1,00,000 units. Notes

Degree of completion:
Material 100 %
Labour 50 %
Overheads 40 % [Adapted]
Answer: Equivalent Units of Material- 2,50,000, Labour- 2,00,000,
Overheads- 1,90,000
Cost per unit of Material- Rs. 0.50, Labour- Rs. 0.425, Overhead-
Rs. 0.50
Units completed- Rs. 2,13,750
18. During the month of July 2013 in Industry 2,000 units were introduced
into Process I. The cost of the 2,000 units was Rs. 11,600. At the
end of the month 1,500 units had been produced and transferred
to Process II; 360 units were still in process; and 140 units had
been scrapped. A normal loss of 5% on input is allowed. It was
estimated that the incomplete units (i.e. the work-in-progress) had
reached a stage in production as follows:
Material 75% completed
Labour 50% completed
Production overhead 50% completed
The total cost incurred was (in addition to the 2,000 units):
Direct materials introduced during the process Rs. 3,080
Direct wages Rs. 6,880
Production overheads Rs. 3,440
Units scrapped realized Rs. 2 each
The units scrapped had passed through the process, so were 100%
completed as regards material, labour and overhead.
Prepare the Process Account and Abnormal Loss Account.
[Adapted]
Answer: Equivalent units of material- 1,810, labour- 1,720, over-
heads- 1,720

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Notes Cost per unit of material- Rs. 8, labour- Rs. 4, Overhead- Rs. 2
Amount transferred to Process II Account- Rs. 21,000
Abnormal Loss Account- Balance transferred to Costing P & L
A/c- Rs. 480
19. Opening work-in-process - 1,000 units (60% complete) Cost Rs. 1,100
Units introduced during the period 10,000 units; Cost Rs. 19,300
Transferred to next process - 9,000 units
Closing work-in-process - 800 units (75% complete)
Normal loss estimated at 10% of total input including units in
process at the beginning.
Scrap realized Re. 1.00 per unit
Scrapped units are 100% complete
Compute equivalent production and cost per equivalent unit accord-
ing to FIFO and average cost method. Also evaluate the output.
 [Adapted]
Answer:
FIFO Method:
Equivalent unit- 9,100
Cost of completely processed units- Rs. 16,000
Average Cost Method:
Equivalent unit- 9,700
Cost of goods transferred to next process- Rs. 17,910
20. XYZ Ltd. is engaged in process industry. During the month August
2000, 2000 Units were introduced in process ‘X’. The normal loss
was estimated at 5% of input. At the end of the month 1,400 units
had been produced and transferred to process ‘Y’. 460 units were
incomplete and 140 units, after passing through fully the entire
process had to be scrapped. The incomplete units had reached the
following state of completion:
Materials 75% Completed
Labour 50% Completed

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 Process Costing

Overheads 50% Completed Notes

Following are the further information on the process ‘X’:
Cost of the 2000 units Rs. 58,000
Additional Direct materials Rs. 14,400
Direct Labour Rs. 33,400
Direct Overheads Rs. 16,700
Units scrapped realized Rs. 10 each
Prepare statement of equivalent production, statement of cost, state-
ment of evaluation and process ‘X’ account.
 [M.Com, March 2005]
Answer: Equivalent Units of Material: 1,785, Labour: 1,670, Over-
heads: 1,670

9.17 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 L E S S O N

10
Operating Costing
Ms. Preeti Singh

STRUCTURE
10.1 Learning Objectives
10.2 Introduction
10.3 Meaning of Operating Costing
10.4 Features of Operating Costing
10.5 Cost Unit
10.6 Transport Costing
10.7 Classification of Costs and Preparations of Operating Cost Sheet
10.8 Calculation of Cost Units
10.9 Answers to In-Text Questions
10.10 Self-Assessment Questions
10.11 Suggested Readings

10.1 Learning Objectives

After reading this lesson, you will be able to:
‹ Understand the meaning of operating costing and its applicability
‹ Learn about types of cost unit
‹ Explain the transport costing procedure
‹ Prepare transport operating cost sheet
‹ Understand about the concept of Joint Products and By-Products

10.2 Introduction
Operating Costing or Service Costing is a method of ascertaining the cost used by those
undertakings which are engaged in producing or monitoring a service rather than in
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 Operating Costing

manufacturing activities. For example, transport industries, railways, wa- Notes

ter supply industries, airways etc. It is normally used in service sector.
This method of costing is employed to find out the cost of rendering the
service internally or externally. This method of computing operating cost
is very simple. Service costs are collected periodically like process cost.
The operating costs are collected for a particular period and are related
to quantum of services rendered during the particular period to arrive at
cost per unit of service rendered. In this costing method, we can estimate
cost for a future period on the basis of estimated service units and the
estimated costs as we do in the unit costing method. This operating cost-
ing method is just a variant of output costing. This will help in fixing
the price to be charged for the service units on the basis of the estimated
cost. Thus, the basic method of calculating cost is in operating costing
is as same as under unit costing but they differ in the manner in which
costing information have to be collected and allocated to cost units.
Operating Costing should not be confused with operation costing. While
operating costing is a method of computation of cost used in various
service providing organizations, operation costing is a refinement and
more detailed application of process costing.

10.3 Meaning of Operating Costing

Operating costing is a method of ascertaining the cost of providing or render-
ing a service. It is also known as Service costing. The Chartered Institute of
Management Accountants, London, defines Operating Costing as “that form
of operation costing which applies where standardized services are rendered
either by an undertaking or by a service cost center within an undertaking”.
Operating costing is very useful in determining the cost of providing
services and is applicable in the following industries:
‹ Hospitals
‹ Road Transport Companies
‹ Rail Transport Companies
‹ Air Transport Companies
‹ Electricity Supply Companies
‹ Cinemas
‹ Canteen and hotels
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 COST ACCOUNTING

Notes ‹ Hotels
‹ Water Supply Companies
‹ Canteen
‹ Gas Supply Companies
‹ Shipping companies

10.4 Features of Operating Costing

The basic features of operating costing are as follows:
1. The organizations which adopt operating costing do not manufacture
tangible goods. In fact they render unique services to their
customers.
2. Services are of standardized nature.
3. Operating costing can be used for the service performed internally
or externally.
4. The operating cost is collected for a particular period and divided
by the number of service units to obtain cost per unit of service.
5. The cost units vary from industry to industry.
6. The cost unit may be simple or composite.
7. The operating cost is broadly divided into fixed and variable costs.
8. A large portion of capital is invested in fixed assets and comparatively
less working capital is required.
9. Major portion is of fixed costs as compared to variable costs.
Per unit cost of service is affected by the economies and scale of
operations. Cost per unit will decrease if more units of service are
rendered and vice versa.

10.5 Cost Unit

Determining the suitable cost unit (which is to be used for cost ascertain-
ment) is a major problem in operating costing. The selection of proper
cost unit is a difficult task and depends on the nature of work. The unit
for which the operating cost is to be computed should be decided after

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considering all the technical and other factors affecting the operating Notes
cost. The cost unit can be of following two types:
1. Simple Cost Units: A cost unit is said to be simple cost unit when
only one unit of cost is used. Some examples of simple cost unit
are as follows:

Undertaking Simple Cost unit

Transport Per Km or Per mile
Canteen Per meal
Hospitals Per operation
Water Supply Per 1,000 litre
School Per child
Road Maintenance Per km

2. Composite Cost Units: A cost unit is said to be composite cost

unit when two units of cost is used. Some examples of composite
cost unit are as follows:

Undertaking Composite Cost unit

Transport Per passenger-kilometer
Electricity Board Per Kilowatt-hour
Hotels Per guest-day
Cinema Hall Per seat-show
Hospital Per bed-day
Goods Transport Per tonne-km

10.6 Transport Costing

10.6.1 Meaning
Transport costing is a form of service costing used to ascertain cost by
those undertakings involved in providing transport services. The trans-
port undertakings may include goods transport or passenger transport.
As these business units are dealing with goods or passengers, then cost
unit is ascertained that will be either in tonne-km or passenger-km. This
includes air, water, road and railways; motor transport includes private
cars, carriers for owners, buses, taxies, carrier Lorries etc.

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Notes 10.6.2 Objectives

The main objectives of transport costing:
1. To determine the cost of running and operating a vehicle per
kilometer.
2. To fix the rates of carriage of goods or passengers on the basis of
operating costs.
3. To determine hire charges where vehicles are given in hire.
4. To compare cost of running own vehicles with hired or other forms
of transport.
5. To determine cost of idle vehicles and lost running time.
6. To determine what should be charged to different departments
involved in rendering services.
10.6.3 Transport Costing Procedure
Transport costing procedure includes the following steps:
1. Data Collection
2. Classification of costs and preparations of Operating Cost Sheet
3. Calculation of Cost Unit

Data Collection
Accumulation and control of costs in transport costing are achieved by
preparing a daily log sheet. A log sheet is prepared and maintained for
each vehicle and filled in by the drivers to record the details of trips,
running time, cost of petrol/diesel, distance covered etc. This is a doc-
ument which contains information regarding each journey. These details
enable the management team to make suitable allocation of vehicles, to
avoid waste or idle running capacity and to guard against unnecessary
duplication of trips. A specimen of a log sheet is given below:

Daily Log Book

Vehicle No. :…………. Date :………………..
Date of Purchase :…………. Driver :………………
Make and Specification :…………. Time Left :……………

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Notes
Registration No. :………….  Time Returned :……………
License No. :…………........
Particular of Trips
Trip Packages Distance Time
From To Distance Remarks
No. Out Collected Km Out In

Total

Supplies Worker’s Time Abnormal Delays

Petrol/Diesel…….. Driver…………….. Loading/Unloading………
Oil………………. Conductor………… Traffic Delays…………...
Grease…………... Cleaner……………. Accidents………………..

10.7 C
 lassification of Costs and Preparations of Operating
Cost Sheet
All costs incurred during a particular period are collected and classified
into two categories in the following ways:
(i) Standing or Fixed Charges: These are constant cost independent
on usage of a vehicle. Whether the vehicle is in operation or
not such costs shall have to be incurred. Examples of these
costs are rent of the garage, Insurance, Road tax, License fee,
Interest on capital, Wages of drivers and conductors, Depreciation
etc. Total standing and fixed charges are divided by number
of transport service units to get the cost per service unit of
standing charges.
(ii) Running and Maintenance Charges or Variable Charges: These
costs are those which vary in direct proportion to mileage run. For
example, Petrol or diesel, Oil, Grease, Repairs and maintenance,
Cost of tyres, tubes, batteries etc. The cost of these is calculated
separately on per service unit basis.

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 COST ACCOUNTING

Notes The specimen pro forma of the operating cost sheet is given below:
Operating Cost Sheet
(For the month of …….)
Vehicle No. :………………..
Particulars Total Per Unit
A. Standing Charges (Fixed Charges):
Garage Rent XXXX
License Fee XXXX
Road Tax XXXX
Driver’s Wages XXXX
Conductor’s Wages XXXX
Depreciation, if related to effluxion of time XXXX
Interest on Capital XXXX
Office and administration Overheads XXXX
Insurance XXXX
Total (A) XXXX XXXX
B. Running and Maintenance Charges:
Petrol/Diesel XXXX
Repairs and maintenance XXXX
Oil/Grease XXXX
Tyres and Tubes XXXX
Depreciation, if related to operation XXXX
Total (B) XXXX
C. Total Operating Cost Total (A+B) XXXX

10.8 Calculation of Cost Units

A proper calculation of cost unit is important. In transport undertak-
ings, the cost unit is normally the tonne-km or passenger-km; but
according to the nature of the undertakings, the organization may
vary the cost unit.

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 Operating Costing

Composite cost units under operating costing may be computed in the Notes
following two ways:
(a) Absolute Tonne-km: In this method, the cost units between two
stations is calculated separately in tonne-km and then totaled up.
Absolute tonne-km = Various distance × respective load quanti-
ties carried
(b) Commercial Tonne-km: In this method, the trip is considered as
whole and it is arrived at by multiplying the total distance in km
by average load quantity.
Commercial tonne-km = Total distance × Average load quantity
carried
Illustration 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 sta-
tion R. It reaches back directly to station P after getting reloaded with
8 tonnes of goods at station R. The distances between P and Q, Q to
R and then from R to P are 40 Kms, 60 Kms and 80 Kms respectively.
Compute ‘Absolute tonne-kms’ and ‘Commercial tonne-kms’.
[B.com (Hons), Delhi 1998 and 2010]
Solution:
Absolute Tonne-Kms = 10 tonnes × 40 Kms + 6 tonnes × 60 Kms
+ 8 tonnes × 80 Kms
= 1,400 tonne-kms
Commercial Tonne-Kms = Average Load × Total Kms travelled
= [(10 + 6 + 8)/3] tonnes × 180 kms
=1,440 tonne-kms
Illustration 2: Gurpal Singh owns a taxi, a bus and a truck. The bus is
50 seater. The maximum capacity of the truck is 10 tonnes. The taxi runs
on an average 3,000 kms in a month out of which 20% is normal running
without fare. Variable cost of running the taxi is Rs. 8 per kilometer.
The bus and the truck run between Delhi and Jaipur, on way distance
being 300 kms. The bus makes 25 round trips in a month and is generally
90% occupied. Variable cost of running a bus is Rs. 13.50 per kilometer.
The truck makes 20 round trips in a month and is fully loaded on ­outward

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 COST ACCOUNTING

Notes journey but only 90% loaded on return. Variable cost of running a truck
is Rs. 9.50 per kilometer.
You are required to calculate:
(a) Total variable cost per month and variable cost per effective
kilometer for the taxi;
(b) Total variable cost per month and variable cost per effective
passenger-kilometer for the bus; and
(c) Total variable cost per month and variable cost per effective ton-
kilometer for the truck.  [B.Com(Hons), Delhi 2005]
Solution:
(a) Total variable cost per month and variable cost per effective
kilometer for the taxi
Total variable cost per month (3,000 hours × Rs. 8) = Rs. 24,000
Since 20% is the normal running wihtout fare, hence 80% is
effective running
Calculation of effective km = 3,000 × 0.80 = 2,400 km
Cost per effective km = 24,000/2,400 = Rs. 10
(b) Total variable cost per month and variable cost per effective
passengers-kilometer for the bus
Total variable cost per month = 300 km × 2 × 25 × Rs. 13.50
= Rs. 2,02,500
Effective passenger-km = 300 km × 2 × 25 × (50 × 0.90) =
6,75,000
Coat per effective passenger-km = 2,02,500/6,75,000 = Rs. 0.30
(c) Total variable cost per month and variable cost per effective ton-
kilometer for the truck
Total variable cost per month = 300 km × 2 × 20 × Rs. 9.50 =
Rs. 1,14,000
Effective ton-km:
Outward journey = 300 km × 20 × 10 tons = 60,000
Return journey = 300 km × 20 × 9 tons = 54,000
= 1,14,000
Cost per effective ton-km = 1,14,000/1,14,000 = Rs. 1.00
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 Operating Costing

Illustration 3: A transport company has been given a 20 km long route Notes

to run a bus. The bus costs Rs. 50,000 and has been insured @ 6% p.a.
while annual taxes amount to Rs. 2,000, garage rent is Rs. 100 pm.
Yearly repairs will be Rs. 2,000 and the bus is likely to last for 5 years.
The driver’s salary will be Rs. 3,000 pa and that of conductor’s Rs. 1,800
pa. In addition they are also entitled to 10% of the takings as commission
(to be shared by them equally). Cost of stationery will be Rs. 600 pa,
manager’s salary is Rs. 400 pm who also looks after accounts.
Diesel and oil will be Rs. 25 per 100 km. The bus will make 3 trips
carrying on an average 40 passengers on each trip. Assuming 25% profit
on takings, calculate the bus fare to be charged from each passenger. The
bus runs on an average 25 days in a month.
 [B.Com (Hons), Delhi University, 2008]

Solution:

STATEMENT OF OPERATING COST

Cost Per Per month
Particulars Annum (Rs.) (Rs.)
Standing Charges:
Taxes 2,000
Insurance (50,000 × 0.06) 3,000
Garage Rent (100 × 12) 1,200
Repairs 2,000
Salary of Driver 3,000
Salary of Conductor 1,800
Stationery 600
Salary of Manager (400 × 12) 4,800
Total 18,400
Monthly Standing Charges: (18,400/12) 1,533.33
Depreciation [(50,000/50/12] 833.33
Diesel and oil [(3 × 2 × 20 × 25) × 0.25] 750.00
Total cost before commission 3,116.67
Commission 479.49
Total cost 3,596.16
Profit 1,198.72
Total takings 4,794.88

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 COST ACCOUNTING

Notes Total passenger-km = 3 × 2 × 20 × 25 × 40 = 1,20,000 passenger km

Hence, Fare per passenger-km = 4,794.88/ 1,20,000 = Rs. 0.40
Working Note:
Calculation of Commission and Profit:
Let total takings = Rs. x
Commission = 0.10 x
Profit = 0.25 x
Takings = Cost before commission and profit + commission + profit
Therefore, x = 3,116.67 + 0.10 x + 0.25 x
x = Rs. 4,794.88
Commission = 0.10 × Rs. 4,794.88 = Rs. 479.49
Profit = 0.25 × Rs. 4,794.88 = Rs. 1,198.72

IN-TEXT QUESTIONS
1. Which of the following organizations should not be advised to
use service costing?
(a) Distribution service
(b) Hospital
(c) Maintenance division of a manufacturing company
(d) A light engineering company
2. Operating costing is suitable for ___________.
(a) Job order business
(b) Contractors
(c) Sugar industries
(d) Service industries
3. Which of the following is generally used as cost unit in cement
industry ?
(a) Per tone
(b) Per kilolitre
(c) Per kilogram
(d) Per gallon

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 Operating Costing

Notes
4. Describe the method of costing to be applied in case of Nursing
Home:
(a) Operating Costing
(b) Process Costing
(c) Contract Costing
(d) Job Costing
5. Which one is not an example of single cost unit:
(a) Per-Km
(b) Per-meal
(c) Per-seat-per-show
(d) Per-mile
6. In cinema halls, composite cost unit is ______________
(a) A seat per show
(b) Cost of screening
(c) Salary of staff
(d) Rent of cinema hall
7. A transport company is running five buses between two towns,
which are 50 kms apart. Seating capacity of each bus is 50
passengers. Actually passengers carried by each bus were 75%
of seating capacity. All buses ran on all days of the month.
Each bus made one round trip per day. Passenger kms are:
(a) 2,81,250
(b) 1,87,500
(c) 5,62,500
(d) None of the above
8. Fill in the blanks:
(a) In hospital the cost unit is__________.
(b) Operating costing is applicable in ________ sector but not
in _______ sector.
(c) Operating cost is just a variant of __________.

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 COST ACCOUNTING

Notes
(d) In operating costing, services provided to customers are
of _________ type.
(e) ___________ costing may be applicable in passenger
transport or goods transport.
9. State whether the following statements are True or False:
(a) Operation Costing and Operating Costing are interchangeably
used for the same technique of costing.
(b) Transport costing is form of service costing.
(c) The operating costs are related to the quantum of services
provided.

10.9 Answers to In-Text Questions

1. (d) A light engineering company

2. (d) Service industries
3. (a) Per tone
4. (a) Operating Costing
5. (c) Per-seat-per-show
6. (a) A seat per show
7. (c) 5,62,500
8. Fill in the Blanks
(a) Per bed
(b) Service, manufacturing
(c) Output or unit costing
(d) Standardized
(e) Transport
9. True/False
(a) False
(b) True
(c) True
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 Operating Costing

Notes
10.10 Self-Assessment Questions
1. What is ‘operating costing’? Explain the important features of
Operating costing.
2. Define the concept ‘operating costing’. Mention at least ten activities
where operating costing is applicable.
3. Describe the process of cost classification involved in operating costing.
4. What do you understand by composite unit in service costing?
5. “The more kilometers you travel with your own vehicle, the cheaper
it becomes”. Comment briefly on this statement.
6. The under given data is supplied by Fair deal travel services, from
the following information calculate fare for passenger Km.
The cost of the Bus Rs. 4,50,000
Insurance charges 3 % p.a.
Annual tax Rs. 4500
Garage rent Rs. 500 p.m.
Annual repairs Rs. 4800
Expected life of the bus 5 years
Value of scrap at the end of 5 years Rs. 30,000
Route distance 20 km long
Driver’s salary Rs. 550 p.m.
Conductor’s Salary Rs. 500 p.m.
Commission to Driver & conductor (shared equally) 10 % of the
takings
Stationary Rs. 250 p.m.
Manager-cum-accountant’s Salary Rs. 1750 p.m.
Diesel and Oil (for 100 kms) 125
The bus will make 3 rounds trips for carrying on the average 40
passenger’s in each trip. Assume 15 % profit on takings. The bus
will work on the average 25 days in a month. [Adapted]
Answer: Total time taking: 2,04,200
Passenger Km: 14,40,000
Fare for passengers km: Rs. 0.14180
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 COST ACCOUNTING

Notes 7. Union Transport Company supplies the following details in respect

of a truck of 5 tonne capacity:
Cost of truck Rs. 4,50,000
Estimated life 10 years
Diesel, oil, grease Rs. 150 per trip each way
Repairs and maintenance 5,000 per month
Drivers’ wages 5,000 per month
Cleaners’ wages 2,500 per month
Insurance 4,800 per year
Tax 2,400 per year
General supervision charges 4,800 per year
The truck carries goods to and from the city covering a distance
of 50 km. each way.
In outward trip, freight is available to the extent of full capacity
and on return 20% of capacity. Assuming that the truck runs on an
average of 25 days a month, work out:
(a) Operating cost per tonne-km.
(b) Rate per tonne per trip that the company should charges if a
profit of 50% on freight is to be earned.
Answer: Cost per tonne-km: Rs. 3.30
Profit per tonne-km: Rs. 3.30
8. HP unit is required to drive a pump for watering an agricultural
farm. Two plans A and B for supplying are under consideration:
Particulars Plan A Plan B
Purchase and installation Rs. 10,000 Rs. 4,000
Life in years 4 4
Salvage value Rs. 1,000 -
Interest on capital 10% 10%
Maintenance per year Rs. 3,000 -
Maintenance per hour - 0.50
Operating wages per hour Rs. 0.20 Rs. 0.60
Power per hour 1.00 -
Fuel and oil per hour - 2.00

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 Operating Costing

Assuming that 3 million litres of water is to be pumped in a year Notes

and that the pump will pump 1,000 litres in an hour, find out the
cost per 1,000 litres of water under both the plans and find out the
number of hours for which the operating costs of both the machines
will be even. [Adapted]
Answer:
Cost per 1,000 litres of water under Plan A: Rs. 3.28
Cost per 1,000 litres of water under Plan B: Rs. 3.57
The number of hours for which the operating costs of both the
machines will be even: 2,553 hours
9. A transport company is running five buses between Delhi and Tilliar (a
picnic spot in Haryana), covering a distance of 125 kms. The seating
capacity of each bus is 50 passengers. The following particulars are
obtained from its books for the month of October, 2014:
Details Amount
Wages of drivers, conductor 1,60,000
Salaries of office staff    70,000
Honorarium of accountant    25,000
Diesel, oil etc. 7,50,000
Repairs and maintenance    32,500
Road Tax and Insurance    50,000
Depreciation 1,50,000
Interest and other charges 1,12,500
Actual passengers carried were 80% of the seating capacity. All
the buses ran for 30 days. Each bus made one round trip per day.
Find out the fare the company should charge per passenger/km if
it wants a profit of 25% on the takings. [B.Com (Hons), 2015]
Answer: Cost per passenger km Rs. 0.90, Fare Rs. 1.20 per pas-
senger km.

10.11 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.

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 COST ACCOUNTING

Notes ‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 UNIT - V

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Cost Accounting B.Com Sem-4_Unit 5 Lesson 11.indd 328 01-Feb-25 4:06:43 PM
 L E S S O N

11
Integral and Non-Integral
Accounting System
Ms. Preeti Singh

STRUCTURE
11.1 Learning Objectives
11.2 Introduction
11.3 Non-Integrated Accounts
11.4 Ledgers To Be Maintained
11.5 Control Accounts
11.6 Principal Control Accounts
11.7 Accounting Entries Under Non-Integral System
11.8 Limitations of Non-Integrated Accounting
11.9 Integrated Accounts
11.10 Accounting Entries Under Non-Integral System
11.11 Answers to In-Text Questions
11.12 Self-Assessment Questions
11.13 Suggested Readings

11.1 Learning Objectives

After reading this lesson, students will be able to:
‹ Describe the meaning integral and non-integral system of accounting book keeping
‹ Discuss about the ledgers and cost control accounts maintained under non-integral
accounting system
‹ Analysis & compare about the accounting entries involved in both integral and non-
integral accounting system
‹ Prepare ledger and trial balance under both the systems.
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 COST ACCOUNTING

Notes
11.2 Introduction
In cost accounting, the cost books are basically maintained under the
following two systems.
1. Non Integrated accounts (non integral system)
2. Integrated accounts (Integral system)
Where cost accounting and financial accounting books are maintained in a
combined way, this system is called as integrated while if the records are
maintained separately, this system is called as non-integrated system of
maintaining books of accounts. Under the non-integrated system, separate
ledgers are maintained for financial transactions while the cost accounts
department is responsible for maintaining cost accounts. Whereas, under
integrated accounting system, financial and cost accounts are merged and
a single set of books of accounts are maintained. This system is discussed
in the following paragraphs in detail.

11.3 Non-Integrated Accounts

Non-integrated is that system of accounting in which two separate set of
books of accounts are maintained that is one for recording cost transaction
and other for recording financial transactions. Like financial accounts, cost
accounting records also can be maintained on the basis of double entry
book keeping system. This system will help in checking the accuracy of
the postings made. Non-integrated system of accounting is also known
as cost ledger accounting or interlocking accounting system.
Chartered Institute of Management Accounting, London defines it as, “a
system in which the cost accounts are distinct from financial accounts,
the two sets of accounts being kept continuously in agreement by the
use of control accounts or made readily reconcilable by other means.”
In financial accounting books, following three types of accounts are
maintained:
(i) Personal Accounts: For example, Capital A/c, Bank A/c, Debtors
A/c, Creditors A/c etc.
(ii) Real Accounts: For example, Cash A/c, Stock A/c, Fixed Assets A/c
etc.

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 Integral and Non-Integral Accounting System

(iii) Nominal Accounts: For example, Purchases A/c, Wages A/c, Rent Notes
A/c, Depreciation A/c etc.
But in cost accounting books, following types of accounts are maintained:
(i) Impersonal Accounts(Real and Nominal Accounts): For example,
Store Ledger Control A/c, Work-in-progress Ledger Control A/c,
Finished Goods Ledger Control A/c etc.
(ii) Various Ledgers: One principal ledger i.e. Cost Ledgers and various
subsidiary ledgers are maintained.

11.4 Ledgers To Be Maintained

The following four important ledgers are maintained in the cost books
under non-integral sys­tem:
(i) Cost Ledger: This ledger maintains the accounts relating to income
and expenditure. The following accounts are maintained in this
ledger.
A. Cost Control Accounts: These accounts are maintained to
exercise control over the subsidiary ledgers and also to complete
the double entry in cost accounts. The important cost control
accounts are as follows.
(I) Stores ledger control a/c
(II) Work-in-progress ledger control a/c
(III) Finished goods ledger control a/c
(IV) General ledger adjustment a/c
B. Other Accounts: They include all other impersonal accounts
[real as well as nominal] which effect costs, e.g. wages control
account, factory overhead accounts, administration overhead
account, selling and distribution overhead account, cost of sales
account etc. Depending upon the requirement, the following
additional accounts may also be main­tained.
(I) Overhead suspense account
(II) Capital orders account
(III) Service orders account.

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 COST ACCOUNTING

Notes (ii) Stores Ledger: This ledger maintains a separate account for each
item of store that deals with material transactions (i.e. raw-materials,
components, consumable stores etc.). Each such account is debited
with stores received and is credited with stores issued/returned to
vendor.
(iii) Work-in-Progress Ledger: This ledger maintains a separate account
for each job/work in progress. Each such job account is debited
with the material costs, direct labour costs and factory overheads
and credited with factory cost of job completed. The closing balance
will represent the factory cost of work which is still in progress.
(iv) Finished Goods Ledger: This ledger maintains a separate account
for each job/work completed. Each such account is debited with the
cost of finished goods and the amount of administration overheads
absorbed and credited with the cost of goods sold. The balance of
this account represents the cost of unsold finished goods.

11.5 Control Accounts

Control accounts are the total/summary accounts in the cost ledger. In
these accounts, entries are made once in each accounting period on the
basis of the periodical total of transactions in the respective subsidiary
ledgers. Control accounts are maintained in the cost ledger to complete
the double entry and making the cost ledger self-balancing.
A control account is debited with the total of items which have been
debited in various individual accounts in the respective subsidiary ledger
and is credited with the total of items which have been credited in various
individual accounts in the respective subsidiary ledger. The balance in
a control account represents the total of balances in various individual
accounts in the respective subsidiary ledger.
The main advantages of maintaining control accounts are:
(i) Control accounts provide summary of transactions of various subsidiary
ledgers.
(ii) It facilitates prompt preparation of financial statements at the end
of each accounting period.

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 Integral and Non-Integral Accounting System

(iii) It helps in prompt reconciliation of cost and financial accounts. Notes

(iv) It provides internal check leads to greater accuracy and control of
records.

11.6 Principal Control Accounts

(i) Stores Ledger Control Account: The opening balance of this account
shows the opening stock of all items of raw material, consumable
stores and spares. It is debited with stores received on the basis
of Goods Received Notes, Material Returned Notes and is credited
with issues of material. Closing balance of this account shows all
material items at the end.
(ii) Wages Control Account: This account records wage transactions in
aggregate. It is debited with gross wages (paid and accrued) and
is closed by transferring direct wages to Work-in-progress Account
and indirect wages to respective overhead control account.
(iii) Factory Overheads Control Account: This account deals with factory
overheads in aggregate. It is debited with the indirect material cost,
indirect labour cost and indirect expenses incurred in production
and credited with the overheads absorbed by work-in-progress.
The balance in this account represents under or over absorption of
overheads. And this amount is transferred to Overheads Adjustment
Account or Costing Profit and Loss Account.
(iv) Work-in-progress Control Account: This account starts with opening
balance of Work-in-progress and is debited with all the direct
material, direct labour, direct expenses, and production overhead
incurred. It is credited with total cost of finished goods produced
which is transferred to Finished Goods Control Account. The closing
balance of this account represents the value of unfinished jobs.
(v) Finished Goods Stock Ledger Control Account: This account
represents all finished goods transactions in aggregate. It is debited
with the cost of finished goods produced transferred from Work-in-
progress Ledger Control Account and the amount of administration
overheads absorbed transferred from Administration Overheads
Control Account. It is credited with the total cost of goods sold

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 COST ACCOUNTING

Notes which is transferred to Cost of Sales Account. The closing balance

of this account represents the cost of goods remaining unsold.
(vi) Administration Overheads Control Account: This account is
debited with administration overheads incurred and credited with
overheads absorbed by finished goods produced which are transferred
to Finished Stock Ledger Control account. The closing balance is
this account represents under or over-absorbed overheads which is
transferred to either Overheads Adjustment Account or to Costing
Profit or Loss Account.
(vii) Cost of Sales Account: This account is debited with cost of goods
sold transferred from finished Stock Ledger Control Account. It is
also debited with the amount of selling and distribution overheads
absorbed transferred from Selling and Distribution Overhead Control
Account. It is credited with the Cost of Sales Account which is
transferred to Costing Profit and Loss Account.
(viii) Selling and Distribution Overhead Control Account: This account
is debited with selling and distribution overheads incurred and is
credited with overheads absorbed by cost of sales. The closing
balance in this account represents under or over-absorbed overheads
which is transferred to Overheads Adjustment Account or to Costing
Profit or Loss Account.
(ix) Overhead Adjustment Account: This account is debited with under-
absorbed overheads for factory, administration and selling and
distribution overheads and is credited with over-absorbed overheads.
The closing balance in this account represents the net amount of
under or over absorbed overheads which are transferred to Costing
Profit & Loss Account.
(x) Costing Profit and Loss Account: This account is debited with the
cost of sales, abnormal/losses and under-absorbed overheads. It is
credited with sale value of goods sold, abnormal gains and over-
absorbed overheads. The closing balance in this account represents
costing profit or loss which is further transferred to cost ledger
control account.
(xi) Cost Ledger Control Account: This account is also known as General
Ledger Adjustment Account or Financial Ledger Control Account. The

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 Integral and Non-Integral Accounting System

objective of this account is to complete the double entry and make Notes
the cost ledger self-balancing. As no personal accounts are kept in
cost books, in order to complete the double entry, all transactions
of nominal nature which originates in financial accounts are entered
in this account, for ultimate transfer to some control account.

11.7 Accounting Entries Under Non-Integral System

(1) Materials purchased for stock
Stores Ledger Control account Dr.
To General Ledger Adjustment a/c
(2) Material purchased for a special job
Work in Progress Control a/c Dr.
To General Ledger Adjustment a/c
(3) For issue of direct materials to production department
Work-in-progress Control a/c Dr.
To Stores Ledger Control account
(4) For issue of indirect materials to production departments
Overhead Control a/c Dr.
To Stores Ledger Control a/c
(5) For returning materials to supplier
General Ledger Adjustment a/c Dr.
To Stores Ledger Control a/c
(6) For materials returned from production department
Stores Ledger Control a/c Dr.
To Work in Progress Control a/c
(7) For materials transferred from job to job
No entry in Control A/c but the following Entry is passed in work
in progress ledger
Transferee Job a/c Dr.
To Transferor Job a/c

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 COST ACCOUNTING

Notes (8) Loss of material

(a) Abnormal
Costing P&L A/c Dr.
To Stores Ledger Control A/c
(b) Normal
Production Overheads Control A/c Dr.
To Stores Ledger Control A/c
(9) On payment of wages

Wages Control a/c Dr.
To General Ledger Adjustment a/c
(10) For allocation of direct and indirect labour
Work in Progress Control a/c Dr.
Overhead Control a/c Dr.
To Wages Control a/c
(11) For recording direct expenses
Work in Progress Control a/c Dr.
To General Ledger Adjustment a/c
(12) For recording overhead incurred and accrued
Overhead Control a/c Dr.
To General Ledger Adjustment a/c
(13) For adjusting under or over absorption overheads
The overhead control account is closed by transferring to overhead
suspense account.
(14) For recording finished stock produced
Finished Goods Stock Ledger Control a/c Dr.
To Work in Progress Control a/c
(15) When finished goods are sold at cost
Cost of Sales a/c Dr.
To Finished Goods Stock Ledger Control a/c

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 Integral and Non-Integral Accounting System

(16) When finished goods are sold at total sales value Notes
General Ledger Adjustment a/c Dr.
To Costing Profit and Loss a/c
(17) For recording sales returns
Costing Profit and Loss a/c Dr.
To General Ledger Adjustment a/c
(18) For recording total cost to make and sell

Cost of Sales a/c Dr.
To Costing Profit and Loss a/c
(19) For recording under absorption of overheads which is not yet adjusted
Costing Profit and Loss a/c Dr.
To Overhead Suspense a/c
(20) For recording over absorption of overheads which is not yet adjusted

Overhead Suspense a/c Dr.
To Costing Profit and Loss a/c
(21) For recording profit
Costing Profit and Loss a/c Dr.
To General Ledger Adjustment a/c

11.8 Limitations of Non-Integrated Accounting

The non-integrated system of accounting suffers from the following
limitations:
1. The Financial transactions other than cost are not recorded in the
system.
2. Transactions involving payment other than that of cost are not
included in the system for example, loss on fixed assets.
3. There is always a difference between the profits reported as per the
Cost Accounting System and the Financial Accounting System.

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 COST ACCOUNTING

Notes
11.9 Integrated Accounts

11.9.1 Meaning
The term “Integral or Integrated Accounting” means integration or merger
of financial and cost accounts. It is a system of accounting under which
single set of books of accounts is maintained to record both the cost and
financial transactions. This enables a firm to eliminate separate Profit &
Loss Accounts under financial accounting and cost accounting systems &
only one Profit & Loss Accounts is prepared. There is no Cost Ledger
Control A/c is prepared in this system. In other words, it refers to that
system of accounting which is prepared in such a way that full information
required for costing and financial accounting purpose can be obtained
from one set of books.

11.9.2 Distinctive Features

The following are the essential features of an integral an accounting system:
1. In Integral system of accounting, there is no need to open cost
ledger control account because these are maintained in the financial
accounts.
2. Under this system, various subsidiary ledgers are maintained that is
stores ledger, work-in-progress ledger and finished goods ledger are
maintained as maintained in non-integrated accounting. In addition
to these, sales ledger (contains separate personal account for each
customer), purchases ledger (contains separate personal accounts
for each supplier) and overhead ledger (contain separate accounts
for factory, administration and selling and distribution overheads).
3. A control account is prepared for each subsidiary ledger in the
general ledger. The following control accounts is prepared:
(a) Store Ledger Control Account
(b) Wages Control Account
(c) Work-in-progress Control Account

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 Integral and Non-Integral Accounting System

(d) Finished Goods Control Account Notes

(e) Factory Overheads Control Account
(f) Administration Overheads Control Account
(g) Selling And Distribution Control Account
(h) Sales Ledger Control Account
(i) Purchase Ledger Control Account
4. The balances of overheads control accounts which represent under/
over absorption of overheads are transferred to profit and loss
account.
5. The balance in profit and loss account is transferred to profit and
loss appropriation account.

11.9.3 Advantages
Integrated system of accounting offers the following advantages:
1. No Need for Cost Ledger: There is no need for cost ledger because
all control accounts are maintained in the financial ledger.
2. No Need for Reconciliation: There is no need for reconciliation
because this system maintains only one set of records and it will
show only one figure of profit or loss.
3. Centralization of Accounting Works: Maintenance of one set of
accounts leads to centralization of accounting work under one
department. This leads to improved efficiency and better control
in accounting function.
4. Information Available Without Delay: There is no delay in the
availability of information because it is provided directly from the
books of original entry.
5. Simple and Economical: This system of accounting is simple
and economical as it eliminates the duplication of recording the
transactions in two separate sets of books.
6. Better Co-ordination: This system helps in better co-ordination in
the activities of cost accounting and financial accounting staff.

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 COST ACCOUNTING

Notes 11.9.4 Disadvantages

Integrated System of accounting suffers from the following limitations:
1. The integrated system of accounting is not suitable for large firms
because only one system cannot handle all the accounting work.
Large firms require cost and financial information on continuous
basis.
2. The integrated system sometimes become cumbersome and complicated
and cannot meet the requirement of providing timely and prompt
cost information.

11.10 Accounting Entries Under Non-Integral System

(1) Materials purchased for stock
Stores Ledger Control account Dr.
To Cash/Creditor’s a/c
(2) Material purchased for a special job
Work-in-progress Control a/c Dr.
To Cash/Creditor’s a/c
(3) For issue of direct materials to production department
Work-in-progress Control a/c Dr.
To Stores Ledger Control account
(4) For issue of indirect materials to production departments
Factory Overhead Control a/c Dr.
To Stores Ledger Control a/c
(5) For returning materials to supplier

Creditor’s a/c Dr.
To Stores Ledger Control a/c
(6) For materials returned from production department
Stores Ledger Control a/c Dr.
To Work in Progress Control a/c

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 Integral and Non-Integral Accounting System

(7) For materials transferred from job to job Notes

No entry in Control A/c but the following Entry is passed in work
in progress ledger
Transferee Job a/c Dr.
To Transferor Job a/c
(8) Loss of material
1. Abnormal

Profit &Loss A/c Dr.
To Stores Ledger Control A/c
2. Normal
Factory/Production Overheads Control A/c Dr.
To Stores Ledger Control A/c
(9) On payment of wages

Wages Control a/c Dr.
To Cash/Bank a/c
(10) For allocation of direct and indirect labour
Work-in-progress Ledger Control a/c Dr.
Respective Overhead Control a/c Dr.
To Wages Control a/c
(11) For recording direct expenses
Work-in-progress Control a/c Dr.
To Cash/Creditor’s a/c
(12) For recording overhead incurred and accrued
Overhead Control a/c Dr.
To Cash/Creditor’s a/c
(13) On absorption of different overheads
1. Of Production Overheads
Work-in-progress Ledger Control A/c Dr.
To Production Overheads Control A/c

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 COST ACCOUNTING

Notes 2. Of Administration Overheads

Finished Stock Ledger Control A/c Dr.
To Adm. Overhead Control A/c
3. Of Selling and Distribution Overheads

Cost of Sales A/c Dr.
To Selling and Distribution Overheads Control A/c
(14) Over-absorption of Overheads

Respective Overhead Control A/c Dr.
To Overhead Adjustment A/c/ P&L A/c
(15) Under-absorption of Overheads
Overhead Adjustment A/c/ P&L A/c Dr.
To Respective Overhead Control A/c
(16) For recording finished stock produced
Finished Goods Stock Ledger Control a/c Dr.
To Work-in-progress Control a/c
(17) When finished goods are sold at cost
Cost of Sales a/c Dr.
To Finished Goods Stock Ledger Control a/c
(18) For recording transfer of cost of sales

Profit & Loss A/c Dr.
To Cost of Sales A/c
(19) For recording Sales

Cash/Bank/Debtor’s A/c Dr.
To Profit & Loss A/c
(20) For recording profit

Profit and Loss a/c Dr.
To Profit & Loss Appropriation a/c

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 Integral and Non-Integral Accounting System

IN-TEXT QUESTIONS Notes

1. Cost control accounts are prepared on the basis of double entry

system. (True/False)
2. Store ledger control account is a summary account which summaries
all the material transactions in aggregate. (True/False)
3. A system in which the cost accounts and financial accounts
are distinct from each other, that is known as integral system.
(True/False)
4. General Ledger Adjustment Account is used to make the cost
ledger self-balancing. (True/False)
5. The closing balance of work-in-progress ledger control account
indicates opening work-in-progress in the starting of the period.
(True/False)
Illustration 1: Pass Journal Entries in the Cost Books [non-integrated
systems] for the following transactions.
(a) Materials worth Rs. 50,000 returned to stores from job
(b) Gross total wages paid Rs. 96,000
(c) Employer’s contribution to PF and State Insurance amount to
Rs. 4000
(d) Wages analysis book detailed Rs. 40,000 direct labour
(e) Rs. 24,000 towards indirect factory labour
(f) Rs. 20, 000 towards salaries to office staff and Rs. 16,000 for salaries
to selling and distribution staff. [Adapted, EP-CMA]
Solution:
COST JOURNAL
Dr. Cr.
(Amount (Amount
Particulars in Rs.) in Rs.)
Stores Ledger Control A/c Dr 50,000
To Work-in-progress Control A/c 50,000
[Being material returned from stores]

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 COST ACCOUNTING

Notes Dr. Cr.

(Amount (Amount
Particulars in Rs.) in Rs.)
Wages Control A/c Dr 1,00,000
To General Ledger Adjustment A/c 96,000
To Provident Funds and Employees State 4,000
Insurance A/c
[Being gross total wages paid]
Work-in-progress Control A/c Dr 40,000
Factory Overheads Control A/c Dr 24,000
Office Overheads Control A/c Dr 20,000
Selling Overheads Control A/c Dr 16,000
To Wages Control A/c 1,00,000
[Being wages allocated]
Illustration 2: The following figures have been ascertained from the
costing records. You are required to pass the necessary entries in the cost
journal. Assume that a system of maintaining control accounts prevails
in the organization:
In Rs.
(1) Purchases 3,90,000
(2) Carriage inwards 5,850
(3) Stores issued 3,58,800
(4) Productive wages 3,46,320
(5) Unproductive wages 1,21,680
(6) Works on cost 2,48,400
(7) Materials used in repairs 3,120
(8) Cost of completed jobs 12,80,630[Adapted, EP-CMA]

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 Integral and Non-Integral Accounting System

Solution: Notes
COST JOURNAL
Dr. Cr.
(Amount (Amount
Particulars in Rs.) in Rs.)
Stores ledger control a/c Dr. 3,90,000
To General Ledger Adjustment a/c 3,90,000
(Being the entry for purchase of materials)
Stores Ledger Control a/c Dr. 5,850
To General Ledger Adjustment a/c 5,850
(Being carriage inward treated as part of the cost
of materials purchased)
Work-in-progress Ledger Control a/c Dr. 3,58,800
To Stores Ledger Control a/c 3,58,800
(Being stores issued to production)
Wages Control a/c Dr. 3,46,320
To General Ledger Adjustment a/c 3,46,320
(Being Payment of Wages)
Work-in-progress Ledger Control a/c Dr. 3,46,320
To Wages Control a/c 3,46,320
(Being amount of direct wages allocated to jobs)
Factory Overhead Control a/c Dr. 1,21,680
To General Ledger Adjustment a/c 1,21,680
(Being indirect wages incurred)
Factory Overhead Control a/c Dr. 2,48,400
To General Ledger Adjustment a/c 2,48,400
(Being works overhead other than indirect wages)
Factory Overhead Control a/c Dr. 3,120
To Stores Ledger Control a/c 3,120
(Being materials used in repairs)
Finished Stock Ledger Control a/c Dr. 12,80,630
To Work-in-progress Ledger Control a/c 12,80,630
(Being completed production transferred to finished
stock)

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 COST ACCOUNTING

Notes Illustration 3: As at 31st March 2014, the following balances existed in

a company’s cost ledger
Dr. Cr.
Stores Ledger Control a/c 6,02,870
Work-in-progress Ledger Control a/c 2,44,730
Finished Stock Ledger Control a/c 5,03,890
Manufacturing Overhead Control a/c 21,050
Cost Ledger Control a/c 13,30,440
13,51,490 13,51,490
During the next three months the following items arose:
in Rs.
(1) Raw materials purchased 2,46,000
(2) Materials returned to suppliers 5,800
(3) Materials issued to production  2,54,630
(4) Factory wages 
1,01,060
(5) Manufacturing overhead incurred  1,83,020
(6) Indirect labour 43,330
(7) Manufacturing overhead charged to production  1,54,400
(8) Cost of sales 
3,71,780
(9) Sales returns at cost  10,760
(10) Finished product at cost  4,21,670
Pass the necessary entries, open ledger accounts and prepare trial balance.
 [Adapted, EP-CMA]
Solution:
JOURNAL ENTRIES
Dr. Cr.
(Amount (Amount
Particulars in Rs.) in Rs.)
Stores Ledger Control a/c Dr. 2,46,000
To General Ledger Adjustment a/c 2,46,000
(Being materials purchased)

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 Integral and Non-Integral Accounting System

Dr. Cr. Notes

(Amount (Amount
Particulars in Rs.) in Rs.)
General ledger Adjustment a/c Dr. 5,800
To Stores Ledger Control a/c 5,800
(Entry for materials returned to suppliers)
Work-in-progress Ledger Control a/c Dr. 2,54,630
To Stores Ledger Control a/c 2,54,630
(Entry for issue of materials to production)
Wages Control a/c Dr. 1,01,060
To General Ledger Adjustment a/c 1,01,060
(Entry for direct wages incurred)
Work-in-progress Ledger Control a/c Dr. 1,01,060
To Wages Control a/c 1,01,060
(Entry for direct wages charged to production)
Works Overhead Control a/c Dr. 1,83,020
To General Ledger Adjustment a/c 1,83,020
(Entry for works overhead incurred)
Works overhead control a/c Dr. 43,330
To General Ledger Adjustment a/c 43,330
(Entry for indirect wages incurred)
Work-in-progress Ledger Control a/c Dr. 1,54,400
To Works Overhead Control a/c 1,54,400
(Entry for overhead charged to production)
General Ledger Adjustment a/c Dr. 3,71,780
To Finished Stock Ledger Control a/c 3,71,780
(Entry for cost of sales)
Finished Stock Ledger Control a/c Dr. 10,760
To General Ledger Adjustment a/c 10,760
(Entry for sales return)
Finished Stock Ledger Control a/c Dr. 4,21,670
To Work-in-progress Ledger Control a/c 4,21,670
(Entry for finished goods transferred)

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 COST ACCOUNTING

Notes GENERAL LEDGER ADJUSTMENT ACCOUNT

Particulars Amount Particulars Amount
To Stores Ledger
Control a/c 5,800 By balance b/d 13,30,440
To Finished Stock By Stores Ledger Control a/c 2,46,000
Ledger Control a/c 3,71,780 By Wages Control a/c 1,01,060
To balance c/d 15,37,030 By Works Overhead Control a/c 1,83,020
By Works Overhead Control a/c 43,330
By Finished Stock Ledger
Control a/c 10,760
19,14,610 19,14,610
Stores Ledger Control Account
Particulars Amount Particulars Amount
To balance b/d 6,02,870 By General Ledger Control 5,800
To General Ledger By Work-in-progress Ledger
Adjustment a/c 2,46,000 Control a/c 2,54,630
By balance c/d 5,88,440
8,48,870 8,48,870
WORKS (MANUFACTURING) OVERHEAD
CONTROL ACCOUNT
Particulars Amount Particulars Amount
To General Ledger By balance b/d 21,050
Control a/c 1,83,020 By Work-in-progress
To General Ledger Ledger Control a/c 1,54,400
Control a/c 43,330 By balance c/d 50,900
2,26,350 2,26,350
Work-In-Progress Ledger Control Account
Particulars Amount Particulars Amount
To balance b/d 2,44,730 By Finished Stock Ledger
To Stores Ledger Control a/c 4,21,670
Control a/c 2,54,630 By balance c/d 3,33,150
To Wages Control
a/c 1,01,060
To Works Overhead
Control a/c 1,54,400
7,54,820 7,54,820

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 Integral and Non-Integral Accounting System

Finished Stock Ledger Control Account Notes

Particulars Amount Particulars Amount
To balance b/d 5,03,890 By Cost Ledger Control a/c 3,71,780
To Work-in-progress By balance c/d 5,64,540
Ledger Control a/c 4,21,670
To General Ledger
Adjustment a/c 10,760
9,36,320 9,36,320
Trial Balance
Particulars Dr. Cr.
Stores Ledger Control a/c 5,88,440
Work-in-progress Ledger Control a/c 3,33,150
Finished Stock Ledger Control a/c 5,64,540
Manufacturing Overhead Control a/c 50,900
Cost Ledger Control a/c 15,37,030
15,37,030 15,37,030

11.11 Answers to In-Text Questions

1. True 2. False 3. False 4. True 5. True

11.12 Self-Assessment Questions

1. What is meant by Non-Integral system? State its basic features.
2. Explain the important ledgers maintained under Non-Integral system.
3. Write short notes on ‘Integrated Accounts’.
4. State the essential pre-requisites of integrated accounting system.
5. List three main advantages of integrated accounts.
6. What are the main ledgers have been maintained under non-integral
accounting system?
7. Explain the meaning, objective and advantages of control accounts.
8. As of 31st March, 2008 the following balances existed in a firm’s
cost ledger, which is maintained separately on a double entry basis:

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 COST ACCOUNTING

Notes Particulars Debit Credit

Stores Ledger Control A/c. 3,00,000
Work-in-Progress Control A/c. 1,50,000
Finished Goods Control A/c. 2,50,000
Manufacturing overheads Control A/c. 15,000
Cost Ledger Control 6,85,000
During the next quarter, the following items arose: Rs.
Finished product (at cost) 2,25,000
Manufacturing overhead incurred 85,000

Raw material purchased 1,25,000

Factory wages 40,000

Indirect Labour 20,000

Cost of sales 1,75,000
Materials issued to production 1,35,000
Sales returned (at cost) 9,000
Materials returned to suppliers 13,000
Manufacturing overhead charged to production 85,000
You are required to prepare the cost ledger control A/c, Stores
Ledger Control A/c, Work-in-Progress Control A/c, Finished Stock
Ledger Control A/c, Manufacturing Overheads Control A/c, Wages
Control A/c, Cost of Sales A/c and the Trial Balance at the end of
the quarter. [C.A., PCE]
Answer: Cost of sales is Rs. 1,66,000
9. Following transactions took place in Willu & Co. during the month
of March, 2013 :
Rs.
1. Raw material purchased on credit 40,000
2. Direct material issued to production 30,000
3. Wage paid (30% indirect) 24,000
4. Manufacturing expenses incurred (cash) 16,800

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 Integral and Non-Integral Accounting System

5. Manufacturing overhead charged to production 16,000 Notes

6. Selling and distribution cost (cash) 4,000
7. Finished goods at cost 40,000
8. Sales 58,000
9. Receipts from debtors 13,800
10. Payments to creditors 22,000
You are required to journalise the above transactions presuming
that integrated system of accounting is followed by Willu & Co.
[Adapted]

11.13 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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 L E S S O N

12
Reconciliation of Cost and
Financial Accounts
Ms. Preeti Singh

STRUCTURE
12.1 Learning Objectives
12.2 Need for Reconciliation
12.3 Causes of Differences
12.4 Preparation of Reconciliation Statement or Memorandum Reconciliation Account
12.5 Answers to In-Text Questions
12.6 Self-Assessment Questions
12.7 Suggested Readings

12.1 Learning Objectives

After reading this lesson, you will be able to:
‹ Understand the need for reconciliation of cost and financial accounts.
‹ Learn the causes of difference in profit shown under two sets of accounting books.
‹ Prepare Reconciliation Statement.
‹ Prepare memorandum Reconciliation Statement.

12.2 Need for Reconciliation

In non-integrated accounting system, separate set of books of accounts are maintained
that is one for recording cost transaction and other for recording financial transactions.
Like financial accounts, cost accounting records also can be maintained on the basis of
double entry book keeping system. As financial accounts are concerned mainly with the
ascertainment of profit or loss for the whole operation of the organization for a relatively

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 Reconciliation of Cost and Financial Accounts

long period usually a year, not much concerned about cost computation, Notes
on the other hand, cost accounts are prepared for ascertaining the profit
or loss made by manufacturing or product divisions/products for cost
comparison and use this information for preparing cost statements.
Because of this difference in approaches or principles, the profit shown
by one set of books may not agree with that of other set of books. It
may also be noted that when financial accounts and cost accounts are
prepared on a computer system, may show accurate and precise result
but even in this case also profit shown by one set of books may differ
from the profit shown under other set of books. The difference in profit
establishes the need for a reconciliation of profit between cost accounts
and financial accounts.
Thus, reconciliation between the results of the two sets of books is
necessary due to the following reasons:
(i) To identify the reasons for the difference in the profit or loss in
cost and financial accounts.
(ii) To ensures the arithmetic accuracy and reliability of cost accounts
in order to have cost ascertainment, cost control and to have a
check on the financial accounts.
(iii) To contributes to the standardization of policies regarding stock
valuation, depreciation and overheads.
(iv) To promotes more coordination and better co-operation, between the
activities of financial and cost sections of the accounting department.
(v) Reconciliation places management in better position to acquaint
itself with the reasons for the variation in profits paying the way
for more effective internal control.

12.3 Causes of Differences

Difference in profit or loss between cost and financial accounts may arise
due to the following causes:
1. Items Included Only in Financial Accounts
The following are items which are included in financial accounts
but find no place in cost accounts. These may be items of purely
financial charges, purely financial incomes and appropriation of
profit. The items are classified as under:
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 COST ACCOUNTING

Notes (a) Purely Financial Charges:

(i) Loss on sale of capital assets
(ii) Loss in investments
(iii) Discount on issue of bonds, shares and debentures
(iv) Interest on bank loan, mortgages, debentures etc.
(v) Expenses of the company’s transfer office
(vi) Damages payable
(vii) Penalties and fine
(viii) Losses due to scrapping of machinery
(ix) Remuneration paid to the proprietor in excess of a fair
reward for services rendered
(b) Purely Financial Income:
(i) Rent receivable, (when rent is receivable from subletting
part of business premises - then it can also be included
in cost accounts)
(ii) Interest received on bank deposits
(iii) Profit made on sale of investments, fixed assets etc.
(iv) Transfer fees received
(v) Interest, dividends etc. received on investments
(vi) Brokerage received
(vii) Discount, commission etc. received
(c) Appropriation of Profits:
(i) Donations and charities paid
(ii) Taxes on income and profits
(iii) Dividend paid
(iv) Transfer to special reserves and sinking fund
(v) Additional provision for depreciation of building, plant
etc. and for bad debts
(vii) Capital expenditure, specifically charged to revenue
(d) Writing Off Intangible and Fictitious Assets:
(i) Goodwill
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 Reconciliation of Cost and Financial Accounts

(ii) Preliminary expenses Notes

(iii) Underwriting commission
(iv) Patents and copyrights
2. Items Included Only in Cost Accounts
There are certain items which are excluded from financial accounts
but are included in cost accounts:
(i) Notional Interest on Capital: Interest on capital employed
in production is included in cost books in order to show the
nominal (notional) cost of employing the capital rather than
investing it outside the business.
(ii) Notional Rent: Charge in lieu of rent where premises are
owned.
(iii) Notional Depreciation on the fully depreciated asset.
(iv) Notional salary of the proprietor where he works but does not
charge salary.
3. Over or Under Absorption of Overheads
In cost accounts, absorption of overheads is done on the basis of
an estimate or pre-determined overhead rate e.g. percentage on
prime cost, percentage on sales etc. which may be more or less
than the actual amount incurred. In financial accounting the actual
expenses of overheads are recorded. If overheads are not fully
absorbed i.e. the amount in cost accounts is less than the actual
amount, the difference is called under absorption of overheads. If
the amount of overheads is more in cost accounts as compared to
financial accounts, then the difference is called as over absorption
of overheads. The under recovery or over recovery of overheads
may be carried forward to the next period or may be charged by a
supplementary rate (positive or negative) or transferred to costing
profit and loss account. In case, the under recovery or over recovery
of overheads has been carried forward to the next period, the profit
as shown by the cost accounts will be different from the profits as
shown by the financial books and adjustments will have to be made
on this account. Some cases, selling and distribution expenses are
ignored in cost accounts and as such costing profit will be higher
and thus requiring reconciliation.
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 COST ACCOUNTING

Notes 4. Adoption of Different Basis of Valuation of Stock

(a) Raw Material: In financial accounts, stock of raw material
is valued at cost or market price whichever is less, while in
cost accounts, stock can be valued on the basis of FIFO or
LIFO or any other method. Thus the value of stock may be
different in both the books.
(b) Work-in-progress: Difference may also exist regarding the
mode of valuation of work-in-progress. It may be valued at
prime cost or factory cost or cost of production. The most
appropriate mode of valuing is at factory cost in cost accounts.
In financial accounts, work-in-progress may be valued after
considering a part of administrative expenses also.
(c) Finished Goods: In financial accounts stock of finished goods
is valued at cost or market price whichever is lower. In cost
accounts, finished goods are generally valued at total cost of
production.
Thus the method of valuation of stock gives rise to different
results in the sets of books.
5. Different Methods of Charging Depreciation
The methods of charging depreciation may be different in cost books
as well as in financial books. The method of providing depreciation
under financial accounting is totally governed by the Companies Act or
tax provisions so that diminishing balance method or fixed installment
method is generally followed. However in cost accounts machine hour
rate or production hour or unit method may have been followed.
6. Abnormal Gains and Losses
Abnormal gains or losses may completely be excluded from cost
accounts or may be taken to costing profit and loss account. If it is
not considered, there will be difference in profit under cost accounts
and financial accounts and adjustment will be required. In case, if
these are transferred to costing profit and loss account, the profit
or loss shown by cost accounts will agree with the profit or loss of
financial accounts. In such a case no adjustment will be required.
Examples of such abnormal gains and losses are, abnormal wastage
of materials, e.g. by theft, fire etc., cost of abnormal idle time, cost
of abnormal idle facilities, exceptional bad debts, abnormal gain in
manufacturing through processes etc.
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 Reconciliation of Cost and Financial Accounts

Notes
12.4 P
 reparation of Reconciliation Statement or
Memorandum Reconciliation Account
A Reconciliation Statement or a Memorandum Reconciliation Account
should be drawn up for reconciling profits shown by two set of books.
Results shown by any set of books may be taken as the base and necessary
adjustments should be made to arrive at the results shown by the other
set of books. The technique of preparing a reconciliation statement as
well as a memorandum reconciliation account is as under:
PRO FORMA OF RECONCILIATION STATEMENT
Amount Amount
Particulars in Rs. in Rs.
Profit as per Cost Accounts
Add: 1. Over absorption of overheads in cost accounts
2. Over-valuation of Opening Stocks in cost accounts
3. Under-valuation of Closing Stocks in cost accounts
4. Financial incomes not recorded in cost accounts
5. Items charged only in cost accounts
Less: 1. Under absorption of overheads in cost accounts
2. Under-valuation of Opening Stocks in cost accounts
3. Over-valuation of Closing Stocks in cost accounts
4. Purely financial charges
Profit as per Financial Accounts

PRO FORMA OF MEMORANDUM

RECONCILIATION ACCOUNT
Dr.Cr.
Particulars Amount Particulars Amount
To Loss as per Cost Accounts To Profit as per Cost Accounts
To Financial Expenses To Financial Incomes
To Under absorption of To Over absorption of
overheads in cost accounts overheads in cost accounts
To Under-valuation of Opening To Over-valuation of Opening
Stocks in cost accounts Stocks in cost accounts
To Over-valuation of Closing To Under-valuation of Closing
Stocks in cost accounts Stocks in cost accounts
To Profit as per Financial To Loss as per Financial
Accounts Accounts
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 COST ACCOUNTING

Notes IN-TEXT QUESTIONS

1. Interest on own capital is a:
(a) Cash cost (b) Notional cost
(c) Sunk cost (d) Part of prime cost
2. In Reconciliations Statements Expenses shown only in cost
accounts are:
(a) Added to financial profit
(b) Deducted from financial profit
(c) Ignored
(d) Deducted from costing profit.
3. Which of the following items is not included in preparation of
Cost Sheet?
(a) Carriage inward
(b) Purchase returns
(c) Sales commission
(d) Interest paid
4. State whether the following statements are ‘True’ or ‘False’:
(a) Need for Reconciliation arise in case of integrated system
of accounts.
(b) The reconciliation of two sets of accounts helps in
establishing the accuracy of cost accounts.
(c) Reconciliation can be done in the form of a ledger account
called ‘Memorandum Reconciliation A/c’.
(d) Salary of owner cum manager allowed in cost accounts
but not actually paid is included in cost accounts.
(e) Notional rent of own building is not included in cost
accounts.
Illustration 1: During the year ending 31 October 2012, the profit of
ABC Ltd. as per financial P & L A/c was Rs. 33,248, as shown below.
Prepare a Reconciliation Statement and arrive at the profit as per Cost
Accounts using the additional information given.

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 Reconciliation of Cost and Financial Accounts

Profit and Loss Account Notes

For the Year Ending 31 October 2021
Rs. Rs.
To opening stock 4,94,358 By sales 6,93,000
To purchases 1,64,308 By Sundry income 632
6,58,666
Less: Closing stock 1,50,242
5,08,424
To direct wages 46,266
To factory overheads 41,652
To Adm. Overheads 19,690
To selling expenses 44,352
To Net Profit 33,248
6,93,632 6,93,632
Costing records show the following information:
(i) Closing stock Rs. 1,54,892
(ii) Direct wage absorbed Rs. 48,382
(iii) Factory overhead absorbed Rs. 38,138
(iv) Administrative expenses calculated at 3% of sales
(v) Selling expenses absorbed @ 5% of sales (ICWA Inter)
Solution:
RECONCILIATION STATEMENT
Rs. Rs.
Profit as Per Financial Accounts 33,248
Add: 1. Difference in stock valuation
(1,54,892 – 1,50,242) 4,650
2. Under absorbed factory overheads
(41,652 – 38,138) 3,514
3. Under absorbed selling expenses
(44,352 – 34,650) 9,702

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 COST ACCOUNTING

Notes Rs. Rs.

51,114
Less: 1. Over absorbed direct wages
(48,382 – 46,266) 2,116
2. Over absorbed administration expenses
(20,790 – 19,690) 1,100
3. Sundry income excluded from cost
accounts 632 3,848
Profit as Per Cost Accounts 47,266
Illustration 2: The profit as per cost accounts is Rs. 1,50,000. The
following details are ascertained on comparison of cost and financial
accounts.
Cost Financial
Accounts Accounts
Rs. Rs.
(a) Opening stock
Materials 10,000 15,000
Finished goods 18,000 16,000
(b) Closing stock
Materials 12,000 13,000
Finished goods 20,000 17,000
(c) Interest charged but not paid Rs. 10,000
(d) Write off: Preliminary expenses Rs. 500; Goodwill Rs. 1,500
(e) Dividend on Unit Trust of India received Rs. 1,000
(f) Indirect expenses charged in financial accounts Rs. 80,000 but
Rs. 75,000 recovered in cost accounts.
Find out the financial profit by preparing a Memorandum Reconciliation
Account. [B.Com (Hons), Delhi]

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 Reconciliation of Cost and Financial Accounts

Solution: Notes
MEMORANDUM RECONCILIATION ACCOUNT
Particulars Rs. Particulars Rs.
Opening stock of materials 5,000 Profit as per cost accounts 1,50,000
(undervalued in cost accounts)
Closing stock of finished 3,000 Opening stock of finished 2,000
goods (overvalued in cost goods (overvalued in cost
accounts) accounts)
Preliminary expenses written 500 Closing stock of materials 1,000
off (undervalued in cost
accounts)
Goodwill written off 1,500 Interest charged only in cost 10,000
accounts
Overheads under recovered 4,500 Dividend received 1,000
Profit as per financial 1,49,500
accounts
1,64,000 1,64,000

Illustration 3:Ashoka Engineering Co. Manufactures two sizes of machine

components, Size A and B. The following data refer to the year ended
31 December 2012:
Size A Size B
Production 125 units 400 units
Sales 120 units 360 units
Wages per unit Rs. 40 Rs. 30
Material cost per unit Rs. 15 Rs. 12
Sale price per unit Rs. 125 Rs. 90
All expenses other than wages and materials are analyzed under ‘works
overheads’ which during the year amounted to Rs. 9,000 and ‘office
overheads’ which amounted to Rs. 10,000. In fixing the selling price, it
was estimated that works overheads to be taken at 50% on wages and
office overhead expenses at 331/3 % on works cost.
You are required to compute:
(a) The total cost of each unit on the basis of the above overheads
percentages;
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 COST ACCOUNTING

Notes (b) The net profit for the year shown by financial accounts, valuing
unsolved stocks at actual material and wages cost plus works
overheads at 50% on wages and
(c) The reconciliation of net profit in above (b) with estimated total
net profit, based on cost figures. [B.Com (Hons) Delhi]
Solution:
Statement of Cost and Profit
For the Year Ending 31 December 2012
Size ‘A’ Size ‘B’
(125 units) (400 units)
Per Per
unit Total unit Total Total A + B
Rs. Rs. Rs. Rs. Rs.
Materials 15 1,875 12 4,800 6,675
Wages 40 5,000 30 12,000 17,000
Prime cost 55 6,875 42 16,800 23,675
Works on cost (50%
20 2,500 15 6,000 8,500
on wages)
Works cost 75 9,375 57 22,800 32,175
Office on cost 33.33
25 3,125 19 7,600 10,735
% on works cost
Cost of production 100 12,500 76 30,400 42,900
Less: Closing stock 500 3,040 3,540
Cost of goods sold 100 12,000 76 27,360 39,360
Profit 25 3,000 14 5,040 8,040
Sales 125 15,000 90 32,400 47,400
Profit as per cost books = Rs. 8,040
Note: In cost accounts, closing stock has been valued at cost of production
as under:
A - 5 units @ Rs. 100 = Rs. 500
B - 40 units @ Rs. 76 = Rs. 3,040

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 Reconciliation of Cost and Financial Accounts

Profit and Loss Account Notes

For Year Ending 31 December 2012
Particular Rs. Particular Rs.
To materials By sales
A 1,875 A 15,000
B 4,800 6,675 B 32,400 47,400
To wages By closing stock
A 5,000 A (5 units @ Rs. 75) 375
B 12,000 17,000 B (40 units @ Rs. 57) 2,280 2,655
To works expenses 9,000
To office expenses 10,000
To net profit 7,380
50,055 50,055
RECONCILIATION STATEMENT
Rs. Rs.
Profit as Per Cost Accounts 8,040
Add: over absorbed office overheads (10,725 ̶ 10,000) 725
8,765
Less: Under absorbed works overheads (9,000 ̶ 8,500) 500
Over valuation of closing stock in costing 885 1,385
Profit as Per Financial Accounts 7,380
Illustration 4: The following is the Trading and Profit and Loss account
of Time and Tide Limited for the year ended 31 December 2012:
Particular Rs. ’000 Particular Rs. ’000
To Materials consumed 7,08,000 By Sales - 30,000 units 15,00,000
To Direct wages 3,71,000 By Finished Stock - 1,000 units 40,000
To Works overheads 2,13,000 By Work in progress:
Materials17,000
Wages 8,000

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 COST ACCOUNTING

Notes Particular Rs. ’000 Particular Rs. ’000

To Administration 95,500 Works Overheads 5,000 30,000
overheads
To Selling and 1,13,500
Distribution Overheads
To Net profit 69,000
15,70,000 15,70,000

Manufacturing a standard unit, the company’s cost records show that:

(i) Works overheads have been charged to work in progress at 20% on
prime cost; (ii) Administration overheads have been recovered at Rs 3 per
finished unit; (iii) Selling and distribution overheads have been recovered
at Rs. 4 per unit sold; (iv) The under absorbed or over absorbed overheads
have not been adjusted into costing P & L A/c.
Prepare:
(i) Costing Profit and Loss Account indicating net profit;
(ii) A statement reconciling the profit; A statement reconciling the profit
as disclosed by cost accounts and that shown in financial accounts.
 (ICWA Inter)
Solution:
Costing Profit and Loss Account
For the Year Ended 31 December 2012
Particular Rs. Particular Rs.
Materials consumed 7,08,000 Sales (30,000 units) 15,00,000
Direct wages 3,71,000
Prime cost 10,79,000
Works overheads @ 20% on prime 2,15,800
cost
12,94,800
Less: work in progress:
Materials 17,000
Wages 8,000
Work overheads 5,000 30,000
Works cost 12,64,800

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 Reconciliation of Cost and Financial Accounts

Particular Rs. Particular Rs. Notes

Administrative overheads @ 93,000
Rs. 3 per unit (31,000 units)
Cost of production 13,57,800
Less: Finished stocks* @ 43,800
Rs. 43.80 per unit
Cost of goods sold 13,14,000
Selling and dist. Overheads @ 1,20,000
Rs. 4 per unit sold
Cost of sales 14,34,000
Net profit 66,000
15,00,000 15,00,000
* Cost per unit = Rs. 13,57,800 ÷ 31,000 units produced = Rs. 43.80 per unit.
RECONCILIATION STATEMENT
Rs. Rs.
Profit as per cost accounts 66,000
Add: Over absorption of works overheads 2,800
Over absorption of selling and distribution overheads 6,500 9,300
75,300
Less: Under absorption of administrative overheads 2,500
Over valuation of closing stock in cost books 3,800 6,300
Profit as per financial accounts 69,000
Illustration 5: The following information is available from the financial
books of company having a normal production capacity of 60,000 units
for the year ended 31st March 2012:
(i) Sales Rs. 10,00,000 (50,000 units).
(ii) There was no opening and closing stock of finished units.
(iii) Direct materials and direct wages cost were Rs. 5,00,000 and Rs.
2,50,000 respectively.
(iv) Actual factory expenses were Rs. 1,50,000 of which 60% are fixed.
(v) Actual administration expenses were Rs. 45,000 which is completely
fixed.

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 COST ACCOUNTING

Notes (vi) Actual selling and distribution expenses were Rs. 30,000 of which
40% are fixed.
(vii) Interest and dividends received Rs. 15,000.
You are required to:
(a) Find out the profit as per financial books for the year ended 31st
March 2012;
(b) Prepare the cost sheet and ascertain the profit as per cost accounts
for the year ended 31st March 2012, assuring that the indirect
expenses are absorbed on the basis of normal production capacity;
and
(c) Prepare a statement reconciling profit shown by financial and cost
books. (CA inter)
Solution:
Financial Profit and Loss Account
For the Year Ending 31 March 2012
Rs. Rs.
To Direct materials 5,00,000 By Sales (50,000 units) 10,00,000
To Direct Wages 2,50,000 By Interest and dividend 15,000
To Factory expenses 1,50,000
To Adm. Expenses 45,000
To Selling and dist. Exp. 30,000
To Profit 40,000
10,15,000 10,15,000
Cost Sheet for the Year Ending 31 March 2012
Rs.
Direct material 5,00,000
Direct wages 2,50,000
Prime Cost 7,50,000
Factory expenses – Variable 60,000
Fixed (90,000 × 5/6)* 75,000 1,35,000
Works cost 8,85,000

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 Reconciliation of Cost and Financial Accounts

Rs. Notes
Adm. Expenses (45,000 × 5/6)* 37,500
Cost of production 9,22,500
Selling and Distribution Expenses – Variable 18,000
Fixed (12,000 × 5/6)* 10,000 28,000
Total Cost 9,50,500
Profit 49,500
Sales 10,00,000
* Note: Normal production capacity is 60,000 while actual production is 50,000. This
means only 5/6 of fixed overheads are absorbed in cost.
RECONCILIATION STATEMENT
Profit as per cost accounts 49,500
Add: Interest and Dividends 15,000
64,500
Less: Under absorbed overhead:
Factory expenses (1,50,000 – 1,35,000) 15,000
Adm. Expenses ( 45,000 – 37,500) 7,500
Selling and Distribution Expenses (30,000 – 28,000) 2,000 24,500
Profit as per financial accounts 40,000

12.5 Answers to In-Text Questions

1. (b) Notional cost
2. (b) Deducted from financial profit
3. (d) Interest paid
4. True/False

(a) False (b) True (c) False (d) True (e) False

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 COST ACCOUNTING

Notes
12.6 Self-Assessment Questions
1. Explain the reasons for the disagreement of profit between cost books
& financial books.
2. Explain the reasons why it is necessary for the cost and financial
accounts of an organization to be reconciled.
3. Examine the reasons for the difference between cost and financial
accounts maintained by an organization.
4. List financial expenses which are not included in cost.
5. Prepare a Reconciliation Statement from the following particulars:
Particulars  Amount Rs.
Profit as per cost accounts  2,91,000
Works overheads under-recovered  19,000
Administration overheads under-recovered  45,500
Selling overheads over-recovered  39,000
Overvaluation of opening stock in cost accounts  30,000
Overvaluation of closing stock in cost accounts  15,000
Interest earned during the year  7,500
Rent received during the year  54,000
Bad debts written off during the year  18,000
Preliminary expenses written off during the year  36,000
Profit as per financial accounts  2,88,000
[Adapted]
6. The following information is available from the financial books of
a company having a normal production capacity of 60,000 units for
the year ended 31st March, 2007.
(a) Sales Rs. 10,00,000 [50,000 units]
(b) There was no opening and closing of finished units.
(c) Direct material and direct wages cost were Rs. 5,00,000 and
Rs. 2,50,000 respectively

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 Reconciliation of Cost and Financial Accounts

(d) Actual factory expenses were Rs. 1,50,000 of which 60% are Notes
fixed
(e) Actual administration expenses were Rs. 45,000, which are
completely fixed.
(f) Actual selling and distribution expenses were Rs. 30,000 out
of which, 40% are fixed.
(g) Interest and dividends received Rs. 15,000.
You are required to:
(1) Find out profits as per financial books for the year ended 31st
March 2007.
(2) Prepare cost sheet and ascertain the profit as per the cost
accounts for the year ended 31st March 2007.
(3) Prepare a statement reconciling profits shown by financial and
cost books. [Adapted]
Answers:
(1) Profits as per financial books - Rs. 40,000
(2) Cost of sales - Rs. 9,50,500
Profit - Rs. 49,500
7. The Profit and Loss A/c of XYZ Ltd. for the year ended 31st March,
2007 was as follows:
Profit and Loss A/c for the Year Ended 31st March 2007
Amount Amount
Particulars Rs. Particulars Rs.
To Materials 4,80,000 By Sales 9,60,000
To Wages 3,60,000 By Work-in-progress
To Direct Expenses 2,40,000 Materials 30,000
To Gross Profit 1,20,000 Wages 18,000
Direct Expenses 12,000
By Closing Stock 1,80,000
Total 12,00,000 Total 12,00,000
To Administration Expenses 60,000 By Gross Profit 1,20,000
To Net Profit 66,000 By Dividends Received 6,000
Total 1,26,000 Total 1,26,000

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 COST ACCOUNTING

Notes As per the cost records, the direct expenses have been estimated at a
cost of Rs. 30 per kg and administration expenses at Rs. 15 per kg.
During the year production was 6,000 kg and sales were 4,800 kg.
Prepare a statement of Costing Profit and Loss A/c and reconcile the
profit with financial profit.  [Adapted]
Answer: Profit as per cost accounts: Rs. 1,10,400

12.7 Suggested Readings

‹ Arora, M.N. (2021). Cost Accounting - Principles and Practice.
Delhi, India: Vikas Publishing House.
‹ Maheshwari, S.N., & Mittal, S.N. (2020). Cost Accounting Theory
and Problems. Delhi, India: Shri Mahaveer Book Depot.
‹ Tulsian, P.C. (2020). Cost Accounting. Delhi, India: S. Chand.

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212-Cost Accounting [BCH-DSC10-S4-CC4-DU] Cover Jan25.pdf - February 8, 2025