==

SUBJECT: - Cost Accounting

NATURE AND CHARACTERISTICS OF COST ACCOUNTING

1. Cost accounting is a special branch of accounting having its own specific significance based
on double entry system.
2. It ascertains cost of products and services through the process of accumulation, classification,
analysis and recording.
3. It determines the cost of incomplete work or job.
4. The extensive use of this system involves application of statistical data, control methods &
techniques and determining profitability.
5. This system provides measures for control and guidance for various levels of management.
6. Helpful in decision making process.
SCOPE OF COST ACCOUNTING
1. Analysis of the profitability of product, service, job or activities.
2. Analysis of profitability of various departments of segments of the organization.
3. Analysis of the type and nature of cost.
4. Explanation of the causes of variances between actual cost and standard cost.
5. Helpful in determination of selling price.
6. Analysis of the change in profit as per the change in level of production.
7. Analysis of the profit or loss of the organization.
8. Assist in management information system.
9. Provides basis for the application of techniques of management accounting.
10. Helpful for manufacturing and service rendering organization.

Difference between cost accounting and financial accounting

S.No. Cost Accounting Financial Accounting
1. Kept by business engaged either in Kept by all types of business houses, big or
manufacturing either in manufacturing or small, whether engaged in trading,
in rendering services where the cost per manufacturing or non-profit making
unit is to be ascertained. associations.
2. Maintain full and detailed records
pertaining to all the three elements of cost, Records all types of expenses and incomes and
viz., materials, labour and expenses. also items of profit appropriation. However,
3. Provide data and reports to management they do not keep detailed records of elements of
for cost-ascertainment, planning, control cost. Provide general information to
and decision-making. management and outside parties in the form of
4. Ascertain the cost of each product, job or Profit & Loss A/c and
order and then show profit/loss made on Balance Sheet of the business as a whole.
5. each. Do not show profit/loss on each product, job or
Provide information to management as order individually.
and when desired, daily, weekly, monthly, Provide operating net result and
6. quarterly, etc. financial position at the end of
To calculate the cost, the indirect financial year.
7. expenses include there in are based on
estimates. Show historical costs, i.e., they include expenses
Greater control is exercised on materials having actually been incurred in the financial
and stores, labour and overhead costs by year.
8. budgetary control and standard costing. Greater emphasis is laid on cash and financial
No emphasis is given to cash-in-hand and position. They do not attach that importance to
9. Bank transactions. control of materials, labor and overheads.
As the cost is available, it is easier to fix

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SUBJECT: - Cost Accounting

selling price and quote for tenders No correct tender prices can be quoted.
10. The production costs of a period can be
compared with previous corresponding Such comparison of costs of individual
11. period and the difference analysed. production is not easy.
Provide information on the relative
12. efficiencies of plant, machinery, labour The relative efficiency of workmen, plants, etc.,
and departments. cannot be easily judged.
13. Stocks are valued at costs. Stocks are valued at cost price or market price,
These accounts are for internal whichever is lower.
transactions and do not form the basis of They form basis for external transactions also,
receipts and payments to outside parties. and record receipts, payments and credit
The companies Act has made it obligatory transactions.
for certain industries to maintain Cost It is almost necessary to maintain this
accounting to run business. To meet the
requirements of

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SUBJECT: - Cost Accounting

14 Accounting, otherwise it is voluntary to Companies Act, and Income-tax Act, it is

maintain cost them. obligatory to keep them.
Charts, graphs, diagrams, statements, etc. Not much use is made of such presentation in this
are much used in this system for system.
informatory reports to management.

FUNDAMENTAL PRINCIPLES OF COSTING

1. Cost is related to its cause.
2. Cost is charged after it is incurred.
3. Abnormal costs are excluded from costing.
4. Past costs are not charged to future periods.
5. The concept of conservatism has no place in costing.
6. Accounting for cost is based on Double-entry Principle.

OBJECTS AND FUNCTIONS OF COST ACCOUNTING

i. To ascertain the cost per unit of the different products manufactured by a business concern.
ii. To advise management on future expansion policies and proposed capital projects.
iii. To organize the internal audit system to ensure effective working of different departments.
iv. To help in supervising the working of punched card accounting or data processing through
computers.
v. Provide useful data to the management for taking decisions.
vi. To find out costing profit or loss by identifying with revenues the cost of those products or
services To provide specialized services of cost audit in order to prevent the errors and
frauds and to facilitate prompt and reliable information to the management.
vii. To organize cost reduction programmes with the help of different departmental managers.
viii. To provide requisite data and serves as a guide to price fixing of products manufactured or
services rendered.
ix. To help in the preparation of budgets and implementation of budgetary control.
x. To guide management in the formulation and implementation of incentive bonus plans based
on productivity and cost savings.
xi. To supply useful data to the management to take various financial decisions such as
introduction of new products, replacement of labour by machine etc.
xii. To organize an effective information system so that different levels of management may get
required information at the right time in right form for carrying out their individual
responsibilities in an efficient manner.

TECHNIQUES AND METHODS OF COSTING

1. Historical Costing. “The ascertainment of costs after they have been incurred.” Under this
method all the expenses incurred on the production are first incurred and then the costs are
ascertained.
2. Standard costing. “The preparation and use of standard costs, their comparison with actual
costs and the analysis of variances to their causes and points of incidence.”
3. Marginal Costing. “The ascertainment of marginal costs and of the effect on profit of
changes in volume or type of output by differentiating between fixed costs and variable
costs.”
4. Direct Costing. “The practice of charging all direct costs to operations, processes or products,
leaving all the indirect costs to be written off against profits in the period in which they
arise.”

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SUBJECT: - Cost Accounting

5. Absorption Costing. “The practice of charging all costs, both variable and fixed, to
operations, processes or products.”
6. Uniform Costing. “The use by several undertakings of the same costing principles and/or
practices.”

Methods of Costing
1. Job costing. 2. Contract Costing. 3. Batch Costing. 4. Target Costing. 5. Process Costing. 6. Single
or Output Costing. 7. Operation Costing.8.Departmental Costing. 9. Composite or Multiple Costing.

ANALYSIS AND CLASSIFICATION

OF COST MATERIALS COST
Material cost is of two types, viz., (i) Direct Materials Cost, and (ii) Indirect Material cost.
i. Direct Materials Cost. Is one which can be identified with and allocated to cost centres or
cost units.” E.g., timber in furniture-making; clay in brick-making; cement, stones, etc., in
building.
ii. Indirect Materials Cost. Which cannot be allocated but which can be apportioned to or
absorbed by, cost centres or cost units. For example, power, fuel, repair and maintenance etc.

LABOUR COST
“The Labour Cost is the cost of remuneration (wages, salaries, commissions, bonus, etc.) of the
employees of an undertaking.”
i. Direct Labour Cost. Direct Labour Cost are the cost which can be identified with and
allocated to cost centres or cost units.
ii. Indirect Labour Cost. is one which cannot be allocated but which can be apportioned to, or
absorbed by, cost centres or cost units.”e.g. Wages of indirect labour; Wages of idle time.

OVERHEADS
Overheads are the aggregate of the cost of indirect material, indirect labour and such other expenses,
which cannot be conveniently charged direct to specific cost centre or cost units.

ANALYSIS OF TOTAL COST

1. Prime Cost.- The aggregate of Direct material Cost, direct Labour Cost and Variable Direct
expenses (or chargeable expenses) is the prime Cost.
2. Factory Cost.- Factory Cost is the total of Prime Cost + Factory Overheads,
3. Cost of Production.- The total Factory Cost and Office and Administration Overheads is the
office Cost or Cost of Production.
4. Total Cost.= Cost of Production + Selling & Distribution Overheads.

CLASSIFICATION OF COST AND COST CONCEPT

The cost-classification is the process of grouping costs according to their characteristics.
1. According to Elements. The cost is classified into (i) Direct cost, and (ii) Indirect cost
according to elements, viz., materials, Labour and Expenses.
2. According to Functions. The cost is classified into the following:
i. Production Cost, or Manufacturing Cost, or Factory Cost,
ii. Administration Cost,
iii. Selling Cost, and
iv. Distribution Cost.
3. According to Nature. The cost is classified into the following:
i. Fixed Cost is “a cost which tends to be unaffected by variations in volume of output.
ii. Variable Cost is “a cost which tends to vary directly with volume of output.

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SUBJECT: - Cost Accounting

iii. Semi-fixed or Semi-variable Cost is ‘a cost which is partly variable.’

4. According to Controllability.
i. Controllable cost. This is a cost which can be influenced by the action of a specified member
of an undertaking.
ii. Uncontrollable Cost. It is the cost which cannot be influenced by the action of a specified
member of an undertaking, such as fixed costs.
5. According to Normality. The cost is classified into (i) Normal cost, and (ii) Abnormal cost.
i. Normal cost. It is the cost at a given level of output in the condition at which that level of
output is normally attained.
ii. Abnormal cost. It is a cost which is beyond normal cost.
6. According to Relevance to Decision-making and Control.
i. Shut-down Cost. A cost which will is required to be incurred even though a plant is closed
or shut-down for a temporary period, e.g., the cost of rent, rates, depreciation, maintenance
expenses etc.
ii. Sunk cost. A cost which has been incurred in the past or sunk in the past and is not relevant
to the particular decision-making. E.g. written down book value of the plant.
iii. Opportunity Cost. The costs which are related to the sacrifice made or the benefits foregone
are opportunity costs.
iv. Imputed Cost. It is a hypothetical cost required to be considered to make costs comparable.
Interest on one’s own capital.
v. Out-of-Pocket cost. A cost which will have to be paid to outsiders as against costs such as
depreciation, which do not require any cash payment.
vi. Replacement Cost. It is the cost of replacing a material or assets, by purchase from the
current market.
vii. Marginal Cost. Marginal cost refers to the increase or decrease in total cost caused due to
increase or decrease in output by one single unit.
viii. Differential Cost. The change in total cost due to the change in method or technique of
production or charged in level of production is called differential cost.
ix. Standard Cost. Standard cost is a predetermined cost or estimate which is compared with the
actual cost in order to determine variance and carry out an analysis of variance for cost
control.
x. Relevant Cost. The relevant costs are those cost which aids to makes specific management
decisions.
7. Product Cost & Period Cost

The product cost is the total of cost that is associated with a unit of product. The cost in forming the
product viz., direct material, direct labor, factory overhead constitute the product cost.
Period cost, on the other hand, are costs that tends to be unaffected by changes in level of activity
during as given specific time period. E.g., Selling & distribution cost

SIGNIFICANCE OF COST ACCOUNTING

i. It discloses the profitable and unprofitable activities in a concern and hence necessary
adjustments are done.
ii. It enables the concern to measure its efficiency and then maintain or improve.
iii. It is helpful to the consumer by ensuring lower prices.
iv. It is useful to the government in the form of duties paid.
v. It discloses the relative efficiency of different workers in a concern.
vi. Through it the exact causes of decrease or an increase in profit or loss can be detected.
vii. It provided information upon which estimates and tenders are based.
viii. It guides future production policies.

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SUBJECT: - Cost Accounting

ix. It helps in increasing profits by disclosing the sources of loss or waste and by suggesting
such controls so that the same may not be repeated.
x. It enables a periodical determination of profits or losses without restoring to stock taking.

ADVANTAGES OF COST ACCOUNTING

To the Management
1. Action against unprofitable Activities 2. Facilities Decision Making 3. Inventory Control
4. Budgetary Control 5.Facilitations cost control 6. Prevents Fraud 7.Tool of Management Control
8. Measuring rods 9.Future Prospects
B. To the Employees
1. Sound Wage Policy
2. Security of Job
3. Distinction between Efficient and Inefficient Workers
C. To the Creditors
Bankers, creditors, investors etc., can have a better understanding of the firm as regard the
process and prosperity, before they offer financial leading.
D. To the Government
1. For government wage tribunals, for deciding the state subsidy to industry.
2. In the preparation of national plans, economic development etc.
3. Cost audit is important and industries have to keep books of accounts to show the utilization
of materials, labour and other costs.
E. To the Public
1. Removes all types of wastages and inefficiencies.
2. Facilities the customers to pay fair price.
3. Development and prosperity of industries will create employment opportunities.

CHARACERTISTICS OF A GOOD COSTING SYSTEM

1. Accuracy 6. Promptness
2. Equity 7. Observation and Resulting
3. Simplicity 8. Periodical Result
4. Elasticity 9. Reconciliation with Financial Accounts
5. Comparabilit
y

Material Costing
Material or inventory cost control is defined as a systematic control and regulation of purchase,
storage and usage of materials in such a way as to maintain an even flow of production at proper times
and valued at right prices at the same time avoiding excessive investment in inventories.

Objectives of Material control

i. No under stocking or over stocking
ii. Economy in purchasing
iii. Proper Quality
iv. Minimum wastage
v. Information about material availability

Principles or Essentials of Material Control

i. Proper co-ordination and Co-operation between various departments- Purchase, Stores,
Inspection, Accounting etc.
ii. Proper classification and codification of materials
iii. Proper scheduling of material requirements.

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SUBJECT: - Cost Accounting

iv. Perpetual inventory system should be operated

v. Various stock levels to be fixed
vi. Proper system of internal check to be introduced for adequate safeguards and supervision
vii. Regular reporting to management regarding purchase, issues and stock of materials.
viii. Proper storage and usage of materials to avoid theft and wastages.

Functions of purchasing department:

i. Determination of quality to be purchased
ii. Determination of ordering point.
iii. Determination of price at which to be purchased.

7
 SUBJECT: - Cost Accounting

Purchase Procedure: -
i. Initiating the purchase
ii. Receiving of the purchase requisitions.
iii. Deciding important factors relating to purchase.
iv. Inviting tenders and selecting suppliers.
v. Preparation and execution of purchase orders
vi. Receipt of materials
vii. Inspection and testing of materials received
viii. Debit note upon the supplier in respect of rejected materials.
ix. Passing invoices for payment.

Stores Organization and control

Objectives
i. Receive materials, check them and place them properly
ii. To issues the materials to jobs on the basis of store requisitions
iii. To enter all the receipts and issues in the bin card and show the balance
iv. Avoiding overstocking and under stocking by checking the ordering points of different
materials.
v. Maintain, preserve and protect the materials during storage
vi. Maintain up-to-date stores records
vii. To report on obsolete and slow moving materials, waste, scrap, etc.
viii. Requisitioning further supplies from purchasing department.

Stores Records
i. Perpetual Inventory Records are those which show movement of stores, i.e. receipt and
issues.
Eg. Bin Card and stores ledger
ii. Documents are those which authorize movement of materials into or out of stores e.g. Goods
received Note, Bill of materials, material requisition note, materials return note, etc.

Techniques of Inventory Control

1. ABC Technique: - It is a value based system of material control where materials are classified
according to their value, A, B and C, so that costly and valuable materials are given greater
attention and care.
‘A’ items are high value items which consist of only a small percentage of total items
handled and hence require tight control.
‘B’ items are medium value materials which should be under normal control
procedures ‘C’ items are low value materials which represent a large number of items
and require economical control procedures, and least attention.
2. Stock Levels: - To avoid under stocking and overstocking, maximum, minimum and reorder
levels are fixed.

Factors which influence stock levels are

a. Anticipated rate of consumption
b. Account of capital available
c. Availability of storage space
d. Storage/ warehousing cost
e. Procurement cost
f. Reliability of suppliers
g. Minimum order quantities imposed by suppliers
h. Risk of loss due to obsolescence, deterioration, evaporation and fall in market prices

8
 SUBJECT: - Cost Accounting

i. Maximum Level: - It indicates the maximum quantity of inventory item which can be
stored at any given time
Maximum Level = Minimum Stock + Economic Order quantity

9
 SUBJECT: - Cost Accounting

Or
= Reorder Point + Reorder quantity –
[Minimum Consumption x Minimum reorder Period]
ii. Minimum Level: - It indicates the minimum quantity of stock that should always be
maintained so that there is no risk of stoppage of production.
Minimum Level = Reorder Point – [Average Consumption x Average
re-order period]
iii. Re-order Level or Re-order Point: - This is that level of material at which purchase
requisition is initiated for fresh supplies.
Re-order Level = Maximum consumption x Maximum Re-order period
iv. Danger Level: - It is that level at which normal issued are stopped and materials are issued
for important jobs only.
Danger Level = Normal consumption x Maximum re-order period under emergency condition
v. Average stock Level:=1 × [ Minimum Level + Maximum Level]
2 Or
Minimum Level + ½ x [EOQ or re-order quantity]
3. EOQ [Economic or order quantity] or Re-order quantity: - EOCs is that size of the order which
gives maximum economy in purchasing any material and ultimately contributes towards
maintaining the material at optimum level and at minimum cost. While setting EOQ, two types
of costs are considered
i. Ordering cost: - Cost of placing orders.
ii. Carrying Cost: - Cost of holding stock in storage

EOQ = 2 AO
, where A= annual consumption in units, O = ordering cost per order,
C
C = storage or carrying cost as a percentage of inventory.

Control Ratios
4. Inventory turnover Ratios: - This tells us how many times in a year is are used up and replaced.
The greater the stock turnover, the more efficient is the stock policy. It indicates the rate of
consumption, i.e. whether materials are moving fast or slowly. A high stock turnover ratio
indicates fast moving materials and a low ratio indicates slow moving materials.
i. Stock Turnover Ratio = Cost of Materials consumed during the period
Average stock of materials during the period
Value of Finished Stock sold in the period
ii. Finished Stock Turnover Ratio
Value of Average stock held during the period
=
iii. Inventory Turnover in terms of days = Days of the period
Stock Turnover Rate

Or
Value of Average x Days of the
period Material consumed
iv. Input – Output Ratio: - This is the ratio of raw material put into manufacture and standard
raw material content of the actual output. The formula is
Input Units
O u tp u ×t 100
uni t s
5. Perpetual Inven to r y s y s t e m and system of store verification: - Perpetual
Inventory aims at

10
 SUBJECT: - Cost Accounting

devising the system of records by which the receipts and issues of material stores may be
recorded immediately at the time of each transaction and the balance may be brought out so as
to show the up-to-date position. This system is operated by: -
i. Reconciliation of stock bin cards and stores ledger accounts

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 SUBJECT: - Cost Accounting

ii. Physical stock verification which is of two types: -

a) Periodic stock verification & (b) continuous stock verification

Advantages of Perpetual Inventory System

i. Records are updated
ii. Materials are within Minimum and Maximum Limits
iii. Purchases are requisitioned at appropriate time
iv. Facilitates preparation of interim P & L Account and Balance Sheet.
v. Acts as moral check on staff of stores Department.
vi. A system of internal check remains in operation all the time.
vii. Discrepancies are readily discovered and rectified.
viii. Slow moving, dormant and obsolete materials are readily notified to purchase department
ix. A detailed and reliable check on stores is obtained.

6. Budgetary Techniques for Inventory standards:-

i. Fixation of material cost planning
ii. Preparation of material budget

Pricing of Materials Issued

1. Cost Price Methods: -
i. First-in-First-Out Methods – FIFO
ii. Last in first Out Method – LIFO
iii. Highest in First Out Method – HIFO
iv. Base stock Method
v. Specific Price Method.
2. Average rate Method: -
i. Simple Average Method
ii. Weighted Average Method
3. Market Price Method: -
i. Replacement Price Method.
ii. Realizable Price Method.
4. National Price Method: -
i. Standard Price Method.
ii. Inflated Price Method.

Treatment of material Wastage/ Losses

1. Material Losses may be normal as well as Abnormal.
Normal Loss: - Which has to be incurred and is unavoidable e.g., evaporation in case of liquid
materials, loss due to loading and unloading of materials, etc.
Abnormal Loss: - which arises due to inefficiency in operations or mischief, e.g., theft,
pilferage, breakage, fire etc.
Accounting Treatment: - In order to absorb normal material losses in cost, the rates of usable
materials in stock are inflated so that such losses are covered. Normal material loss is
transferred to factory overhead.
Abnormal material losses are charged to Costing profit and loss account.
2. Waste: - It is that part of basic raw material which is lost in processing and has no recovery
value Accounting: - If it is normal, the cost will be absorbed by the good production and if it is
abnormal, then it is transferred to Costing profit and loss account.
Formulae
1. Economic Order Quantity (EOQ)
EOQ =√ 2 𝐴𝐵

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 SUBJECT: - Cost Accounting

𝐶𝐶

13
 SUBJECT: - Cost Accounting

Where, A = Annual consumption

B = Ordering cost / Procurement cost/ buying cost/ set up

𝑅𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑐𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡

cost CC = Carrying cost / Holding cost/ Storage cost
CC =100
Cost per unit x
 Economic Order Quantity (EOQ)
EOQ =√ 2 𝐴𝐵 x =√ 𝑃
𝐶𝐶 𝑃−𝐷
Where, D = Demand of item or Consumption
P = Production of item or Procurement rate

2 𝐴𝐵 𝐶𝐶+𝐶𝑆
 Economic Order Quantity (EOQ)
EOQ =√ 𝐶𝐶 x =√ 𝐶𝑠
Where, CS = Cost of storage
 Ordering Cost – Per order
 Carrying cost – Per unit per year
 Shortage cost – Per unit per year

2. Total Cost
Total Cost = Total Ordering Cost + Total Carrying Cost + Total Purchase Cost
a. Total Ordering Cost = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑈𝑠𝑎𝑔𝑒 x Ordering Cost per unit
𝐸𝑂𝑄
b. Total Carrying Cost = 𝐸𝑂𝑄 x Carrying Cost per unit
2
c. Total Purchase Cost = Annual Usage x Ordering Cost per unit

3. Variable Cost
Variable cost = Ordering Cost + Carrying Cost

4. Number of Orders
𝐴𝑛𝑛𝑢𝑎𝑙 𝑈𝑠𝑎𝑔𝑒
𝐸𝑂𝑄
Number of orders =
Number of orders cannot come in Decimal
5. Time Between Placing Order
𝑁𝑜 .𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠
𝑁𝑜 .𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠
Time between placing order =

𝑁𝑜 .𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠

6. Cycling Time

Cycling Time = 𝑁𝑜 .𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠

7. Run Time
𝐸𝑂𝑄
𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑖𝑛 𝑎 𝑑𝑎𝑦
Run Time =
Note –
o If Discount is given in question then, cost per units will be changed in all cases.
o If information is given in months then, all items are converted into months.
o Carrying cost is changed when % of carrying cost is given on cost.

8. Re-order Level
Reorder Level = Maximum usage Rate x Maximum Reorder Period/Lead time
OR
(Lead Time x Average Daily Consumption) + Safety Stock

9. Minimum Level
Minimum Level = Reorder Level – (Average Daily Consumption x Average order Period)
10. Maximum Level

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 SUBJECT: - Cost Accounting

Maximum level = Reorder level + Reorder Quantity – (Minimum consumption x

Minimum Reordering Period)
OR
Demand (Review Period x Lead Time) + Safety Stock
11. Average Stock Level
Average Stock Level = Minimum Stock Level + ½ of Reorder Quantity
12. Danger Level
Danger level = Average consumption x Maximum Reorder Period for emergency purchases
13. Inventory Turnover Ratio
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙
𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑
Inventory Turnover Ratio =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙
o Material Consumed = Opening Stock of Raw material + Purchases – Closing Stock of

𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘 +𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘

Raw Material

𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
o
2 Average Raw Material =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
Inventory Velocity
o =

ACCOUNTING FOR LABOUR

Labour cost, representing the human contribution to production is an important factor of cost which
requires constant control, measurement and analysis.

Classification of Labour Cost

i. Direct Labour: - It is the cost of that labour that is directly engaged in production work and can
be conveniently identified or attributed wholly to a particular job, process or cost unit.
ii. Indirect Labour: - It is the cost paid to those workers who are not directly engaged in
converting raw materials into finished product and cannot be conveniently identified with a
particular job, product or cost unit. E.g. supervisors, cleaners’ instructors, peons etc.

Labour Cost Control Factors

i. Production Planning
ii. Setting up of standards
iii. Use of Labour Budgets
iv. Study of the effectiveness of wage policy
v. Labour performance Reports.

Organization for Accounting and control of Labour cost

i. Personnel Department
ii. Engineering and work study Department
iii. Time Keeping Department
iv. Payroll Department
v. Cost Accounting Department

Labour turnover
The rate of change in the composition of the labour force in an organization during a specified period is
called Labour turnover.

Causes of Labour Turnover

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 SUBJECT: - Cost Accounting

i. Low wages and allowances

ii. Ill health and bad working conditions

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 SUBJECT: - Cost Accounting

iii. Lack of safety measures, medical facilities, transport facility, etc.

iv. Dissatisfaction due to various causes like working hours, improper placement, unfair method
of promotion, bad relationship with fellow workers, bad training facilities etc.
v. Inadequate job security and retirement benefits
vi. Marriage in case of female workers
vii. Change of job for better opportunities
viii. Death or retirement.
ix. Seasonal character of the Industry

Reduction and Control of Labour turnover

1. Devising a suitable and satisfactory wage policy.
2. Providing working conditions conducive to health and efficiency.
3. Impartial and sympathetic attitude of personnel management
4. Introducing financial and non financial incentive plans
5. Providing promotional opportunities.
6. Encouraging labour participation in management
7. Introduction of effective grievance procedure
8. Strengthening the welfare measures

Methods of Measurement of labour turnover: -

i. Separation Method: No. of Workers left during a period
-
Labour Turnover rate = x 100
Average No. of workers during the period

ii. Replacement Method:

Labour Turnover Rate No. of workers replaced during the
pxe1r0io0d Average No. of Workers during
=
the period

iii. Flux Method: -

Labour Turnover Rate No. of workers left + No. of workers
= rexp1la0c0ed Average No. of
workers

Idle Time:
Idle time is time lost by workers who are paid on time basis. Idle time represents the time for
which they are paid but no production is obtained. For example time lost between factory gate and the
department, time when production is interrupted due to break down, tea breaks etc.
Causes – Idle time may occur owing to productive, administrative or economic causes.

Over Time – the time worked over and above the normal hour is termed as overtime. The remuneration
usually paid for the overtime work is at double the normal rate.
Need of overtime
1. Increase in demand for the products where the production during the normal hours falls short to
meet it;
2. Shortage of workers due to absence or non-availability and so it is decided to give overtime
work to the existing staff;
3. Utilization of perishable raw material by working overtime;
4. Execution of urgent orders, to complete the work on the same day.

17
 SUBJECT: - Cost Accounting

5. Shortage of equipments, machines, or space for the completion of jobs.

6. Lack of administrative control on workers, on account of which the production during normal
hours remains less than the standard output and overtime work has to be done by the workers.

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 SUBJECT: - Cost Accounting

Disadvantages of overtime working:-

1. Work efficiency is reduced. It is too much to expect of a tired worker to work as efficiently
during overtime as in normal hours;
2. Worker’s health is adversely affected;
3. The quality of the output is affected; and
4. The cost of production rises due to increased labour cost.

Methods of Remuneration
1. Time Rate system: - Under this system workers are paid according to the time for which they
work. Payment may be on hourly basis, daily basis, weekly or monthly.
Suitability of this method
a. Where quality of work is more important than quantity
b. Where output cannot be measured in quantitative terms
c. Where output is beyond the control of the worker
d. Where work is done on a small scale so that close supervision is possible
e. Where the worker is a learner or an apprentice.
2. Piece Rate system: - Here wages = Rate per unit x No. of units produced.
Suitability of this method: -
a. Where production is standardized and repetitive in nature
b. When the aim is continuous maximum production
c. Where output can be measured
d. Where workers continue at the same job for long periods
e. Where standard time required completing a job can be measured accurately.

Various Incentive Schemes

1. Halsey Premium Plan: - In this system, a standard time is fixed for each job. Wages are paid
for actual time spent on the job and bonus or premium is paid in a fixed proportion to time
saved, i.e. 50% or 40%
Total earnings = Time Rate x Time Taken + 50% of [time saved x Time Rate]
2. Halsey Weir Plan: - Same as above except that the bonus is equal to 30% the time saved.
3. Rowan Plan: -
Total earnings = [Time Rate x Time Taken] +
Bonus Bonus = [Time Rate x Time Taken x
Time saved
Time Allowed

4. Taylor’s different Piece Rate Plan: - In this system

i. Day wages are not guaranteed
ii. Standard time is set for each job
iii. Two piece rates are fixed for each job – Higher and Lower rate
The lower piece rate is payable where a worker takes longer time than the standard time and
higher rate is payable where a worker completed the work within the standards time.

Merricks differential Piece Rate system: - This plan lays down three rates
Percentage of standard Output Piece rate
Up to 83% normal Piece rate
83% to 100% 110% of Normal Piece Rate
Above 100% 120% of Normal Piece Rate

5. Emerson’s Efficiency Plan: - Here the standard of efficiency is start 66 2/3% . A worker gets

19
 SUBJECT: - Cost Accounting

guaranteed time wages for efficiency up to the standard. Bonus is payable as follows: -
Efficiency Bonus
Below 662/3% Time wages (No bonus)

20
 SUBJECT: - Cost Accounting

662/3% to 100% Bonus increases in steps and rises to 20%

at 100% efficiency
Over 100% 20% bonus plus 1% bonus for each increase
of 1% inefficiency

6. Gantt’s Task and bonus Plan: - In this plan,

a. Day wages on time basis are guaranteed
b. A standard is set and remuneration is calculated as follows: -
i. When output is below standard – payment at time rate
ii. When output is at standard – payment at time rate plus 20% bonus
iii. When output is above standard: - payment at higher piece rate

8. Bedeaux Point Premium Plan: - In this plan standard time of each job is determined in minutes
known as Bedeaux points or B’s. One B unit represents the amount of work which an average
worker can do in one minute.
No. of B’s x Hourly rate 75
Total Earnings = Time rate x Time
Saved 100
Taken + x
60
Group bonus Plans
These may be adopted in the following circumstances:-
a. Where it is not possible to measure the performance of each individual worker
b. Where the workers constituting a group possess the same or equal efficiency and skill.
c. Where the number of workers constituting a group is not very large
d. Where production is dependent on collective effort of a group of workers as a whole.

Types of group Bonus Plans

1. Priestman’s Output Bonus Plan
2. Cost Bonus Scheme
i. Nunn-Bush Scheme
ii. Scanlan Scheme
iii. Rucker Acheme
iv. Towne Gain Scheme

Co-Partnership and Profit sharing

Co-Partnership is a scheme whereby employees are given an opportunity to share in the capital of the
business and to receive a part of the profit that accrues to their share of ownership.
Under the profit sharing schemes, the workers are paid in addition to wages a predetermined share of
the profits of the undertaking.

Formulae
Measurement of Labour Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑜 .𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠
𝑁𝑜 .𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡𝑕𝑒 𝑝𝑟𝑖𝑜𝑑
1. Separation Method

𝑙𝑒𝑓𝑡 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡𝑕𝑒

𝑝𝑒𝑟𝑖𝑜𝑑
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑜 .𝑜𝑓 𝑁𝑜 .𝑜𝑓 𝑠𝑒𝑝𝑎𝑟𝑎𝑡𝑖𝑜𝑛 +𝑁𝑜.𝑜𝑓
3. Flux Method

𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡

𝑡𝑕𝑒 𝑝𝑟𝑖𝑜𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑜 .𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠
=
𝑑𝑢𝑟𝑖𝑛𝑔 𝑡𝑕𝑒 𝑝𝑟𝑖𝑜𝑑
𝑁𝑜 .𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠
2. Replacement Method

𝑟𝑒𝑝𝑙𝑎𝑐𝑒 𝑖𝑛 𝑡𝑕𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

4. Average Number of Employees
=

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 SUBJECT: - Cost Accounting

x 100 x 100

𝑁𝑜 .𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 𝑎𝑡 𝑡𝑕𝑒

x 100

𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 +𝑁𝑜.𝑜𝑓
𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 𝑎𝑡
=

𝑡𝑕𝑒 𝑒𝑛𝑑 2

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 SUBJECT: - Cost Accounting

Incentive Schemes
1. Halsey Plan
Guaranteed wages = Time taken x Rate per hour
Actual Wage = Guaranteed Wage + Bonus (Time x Rate per hour x Percentage of
bonus) [Assume % of Bonus = 50% (if nothing is given)]
2. Rowan Plan
Guaranteed wages = Time taken x Rate per
hour Actual Wage = Guaranteed Wage +
Bonus
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑇𝑖𝑚𝑒
o Bonus = Time x Rate x Rate per hour x 𝑇𝑖𝑚𝑒 𝑠𝑎𝑣𝑒𝑑
3. Taylor’s Differentiate Price Rate Plan
Actual Salary = under standard x Low piece Rate
OR
Actual Salary = Standard or more than standard x High Piece Rate
4. Gantt Bonus System
o (Below Standard)
Guaranteed wage = Standard Time x Standard Rate per hour
o (Up to Standard)
Guaranteed wage = Standard Time x Standard Rate per hour
Actual Wage = Guaranteed Wages + Bonus Of guaranteed
Wage
o (Above standard)
Actual Wage = No. of Units x High Piece Rate
5. Merrick Differentiate/ Multiple Rate Method
Guaranteed Wage = Actual no. of units x Normal Piece Rate

Actual Wage according to % of efficiency

a.(Up-to 83%) Guaranteed wage = Actual Wage
b.(Above 83% and up-to 100%)
Actual Wage = Guaranteed Wage + 10% of Bonus of Guaranteed Wage
c. (Beyond 100%)
𝑁𝑜 .𝑜𝑓
Guarantees Wages + 20% of Bonus of Guaranteed Wage
𝑢𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑
o Percentage of efficiency = x 100 [Case I – Units
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑇𝑖𝑚𝑒
𝑆𝑡𝑎𝑛𝑑𝑎
given) OR
𝑟𝑑 𝑇𝑖𝑚𝑒 x 100 [Case II – Time given]
𝑇𝑖𝑚𝑒
𝑇𝑎𝑘𝑒𝑛
6. Emerson Efficiency Plan
Guaranteed Wages = Actual Time x Standard Rate per hour
OR
Guaranteed Wage = Standard no. of Units x Normal Piece Rate

Actual Wage according to % of efficiency

a. (Up-to 66.66%) Guaranteed wage = Actual Wage
b. (Above 67 and up-to 100%)
Actual Wage = Guaranteed Wage + Mentioned or 20% of Bonus of Guaranteed Wage
c. (Beyond 100%)
Actual Wage = Guarantees Wages + + Mentioned or 20% of Bonus of Guaranteed Wage +
Each 1% increase in efficiency beyond 100%

23
 SUBJECT: - Cost Accounting

7. Bedeaus Point Premium Plan

Guaranteed wage = Time Taken x Rate per hour
Actual Wage = Guaranteed wage + Bonus (Time saved x Rate per hour x Percentage of
bonus) [Assumed Bonus % = 75% (if nothing is given)]

24
 SUBJECT: - Cost Accounting

Wages = √𝑆𝑡𝑎𝑛𝑑𝑑𝑎𝑟𝑑 𝑡𝑖𝑚𝑒 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑡𝑖𝑚𝑒 𝑥 𝑅𝑎𝑡𝑒

8. Barth Method

9. Time Wage/Rate system

Actual Wage = Actual Time x Rate per hour
10. Piece Rate Wage
Actual Wage = No. of piece or standard time x Rate per piece of Rate per hour

Note – Dearness allowance always calculated on actual time. (D.A. = Actual time x D.A. Per hour)

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 SUBJECT: - Cost Accounting

UNIT-II
UNIT
COSTING

“Single or Output Cost System is used in business where a standard product is turned out and it is
desired to find out the cost of basic unit of Production.” - J.R. Batliboi
Unit or output costing is used in those industries or organization where standard products are produced
from a common process and all the units produced are more or less similar to each other. This method
is also known as single costing method.

Definition of Unit or Output costing

Herold J. Wheldon – “Production cost accounting or unit cost accounting is such a method of cost
ascertainment which is based on production unit. It is applicable where the production work is done
continuously and the units are of same types of manufactured identical.”

From the analysis of the above definition it is clear that generally this method is used in those
industries, where following characteristics are found-
1. Production should be uniform or homogeneous and a continuous affair;
2. The units of production should be identical
3. The cost units should be physical and natural
4. Per unit cost has to be determined, for example per, ton metre, per kg, etc.

Objectives of unit or Output costing

The following are the main objectives for its application
1. To know the total cost of production and per unit cost within specific period.
2. To classify cost under related categories such as Prime Cost, works cost, cost of Production,
etc. and having its detailed analysis in order to determined per unit cost.
3. To determined the effect of each element of cost on total cost so as to have control over cost.
4. To compare the cost during two or more periods and to make efforts for cost control on the
basis of comparative analysis.
5. To determine proposed setting price to earn desired profit
6. To determined tender price on the basis of cost data and future prospects
In this method there is no need of apportionment of cost because all the expenses are made on a
similar type of production. But where production is done for a various grades or for various size, their
expenses have to be apportioned on the basis of size or grades in detail.

Elements of Cost under unit or output costing

In output costing in order to determined total cost and per unit, collection of various elements of
cost is done as follows –
Material – the quantity and value of material consumed is determined by preparing a Material
Abstract. The materials which are issued from stock are valued on an appropriate basis.
Labour – As required. Wages Analysis Sheet is prepared so that direct and indirect labour cost cab be
determined.
Direct Expenses – In addition to material and labour, there are certain other expenses incurred which
are termed as direct expenses.
Overheads – the overheads are debited to production for the period for which the cost us being
determined. These overheads expenses’ are taken from the financial records. There are certain
expenses which cannot be determined before the end of the accounting period.

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 SUBJECT: - Cost Accounting

Methods of determining unit cost

In those industries where production is carried out on mass scale and on a continuous basis and
standards products are manufactured, the total cost and per unit cost can e determined by the use of
following methods –

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 SUBJECT: - Cost Accounting

1. Cost Sheet
2. Statement of Cost

Cost Sheet
Meaning of Cost Sheet
Coat sheet is a statement which is used to determined the total cost of goods produced or units in a
specific period and in which total cost, per unit cost and incurred at various stages from manufacturing
a products to the stage of making it saleable are shown. In this way, it can be said that cost sheet is a
statement in which the cost of production is presented in an analytical way.
Definition of Cost Sheet
ICMA, Landon – ‘Cost sheet is a document which provides for the assemble of the detailed cost of a
cost centre or cost unit.”
W.W. Bigg – “the expenditure which has been incurred upon production for a period is extracted from
the financial books and the records set out in a memorandum statement.

Characteristics and objects of cost Sheet

1. The cost sheets are produced under Unit costing methods of costing because its object is to
determined per unit cost.
2. The cost sheet is a periodic document which may be prepared weekly, fortnightly, montly or
quarterly.
3. The object of preparing a cost sheet is to ascertain the total cost and the burden of each
individual cost on the cost per unit of production for the period.

Difference between Cost Account and Cost Sheet

S.No. Base Cost Accounts Cost Sheet
1 Nature Cost Account is based on double entry Cost sheet is not based on double
principle and has Dr. and Cr. sides. entry principle.
2 Period Cost Account shows the costs but only Cost sheet are prepared during the
after the end of the year or period continuity of production
when they are closed
3 Comparativ The cost account are not helpful to Cost sheet are helpful to know
e Study know comparative costs comparative costs.
4 Reconciliation The cost accounts are useful in The cost sheet are not reconcile.
reconciling the profits of financial
books with cost books
5 Cost per unit Cost accounts do not show cost per Cost sheet ascertain cost per unit
unit in a detailed
6 Record are Cost accounts are prepared in the Cost sheets are prepared in form of
prepared form of accounts statement

Indirect Expenses
These are classified into three groups i.e., factory overheads, administration overheads, selling and
distribution overheads. They are usually charged at a predetermined rate.

Administration (Office) overheads may include

 Office  Audit fees
expenses  General expenses
 Legal expenses  Printing and stationary
 Rent and taxes  Bank charges postage and stamp etc.
 Directors fees

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 SUBJECT: - Cost Accounting

Factory overheads includes –

 Factory expenses  Laboratory expenses
 Motive power  Supervision charges
 Heritage  Repair
 Factory light and heat  Fuel and power
 Factory rent and rates  Wages and Foreman
 Losses tools written off  Light and water
 Unproductive wages  Fuel and gas
 Technical directors salary  consumable stores
 Depreciation on plants etc.  Factory lighting
 Stores overheads  Oil and water.
 Municipal tax

Selling and distribution overheads includes

–  Expenses of demonstration
 Selling expenses  Salaries of commission of salesman
 Unkeep of delivery vans  Sales office expenses
 Commission on sales  Cost of free gifts, samples
 Warehouse expenses  Salary of warehouse staff
 Bad debts  Expenses of warehouse
 Advertisement expenses  Van trucks etc.
 Carriage outwards
 Travelling expenses

It will be proper to know the important basic formula to arrive the cost of material consumed is –

Cost of material consumed – value of opening stock of raw material + purchase value of raw material –
value of costing stock of raw material.

Below is given a list of typical cost units used in different

industries – Industry Cost unit
Colliery Per tone of coal
Sugar Per quintal
Cotton textiles yarn Per pound
Cloth Per meter
Paper Per kg
Steel Per tonne
Automobile Per automobile i.e., number
Power Per kilo watt hour

Items not included in cost –

 Income tax 1. Cost Sheet
 Dividend paid 2. Cost Statement
 Donation
 Cash discount
 Interest on debenture

Methods for finding up unit costing

Following methods are used for finding up unit’s
soting –

29
 SUBJECT: - Cost Accounting

 Interest on capital
 Goodwill, preliminary expenses written off
 Obsolescence loss from machinery

30
 SUBJECT: - Cost Accounting

3. Production Account
4. Trading and profit & loss account and manufacturing account

Cost Sheet
Output……
Particulars Amount
Opening stock of Direct -----
Material (+) Purchase of Raw -----
material (+) Carriage on -----
Purchases
-----
(-) Closing stock of raw -----
-----
material (-) Sale of Raw
material -----
(-) Abnormal Wastage -----
-----
Material Consumed
(+) Direct Wages -----
(+) Direct -----
Expenses
-----
Prime Cost -----
(+) Factory/work overheads -----

Gross Factory -----

Cost -----
(+) Opening stock of work in -----
progress (-) Closing stock of work in -----
progress -----
-----
Factory Cost/ Work
Cost -----
(+) Office overhead -----

Cost of Production -----

(+) Opening stock of finished -----
goods (+) Purchase of Finished
-----
Goods
(-)Goods stock of Finished goods

Cost of Goods sold

(+) Selling & Distribution Overheads

Total Cost
(+) Profit

Sales

Calculation of Tender Price

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 SUBJECT: - Cost Accounting

The price at which the supplier offers his goods for sale, is known as Quotation or
Tender – The tender price should be calculated carefully in the following way –
1. The cost sheet of the produce being for sale, gives the cost of production. If there is a change
in the price of material and cost of labour should be taken into account while quoting a price.
s
2. The cost price per unit should be carefully examined.
3. Where quotation is given for a job, the actual material and direct labour costs can be
ascertained and overheads are charged by a percentage selected base.
4. All possible changes in costs over the previous period should be taken in view preparing the
statement.

32
 SUBJECT: - Cost Accounting

Instructions for calculation the tender price –

1. First prepare cost sheet
2. Determine cost per unit
3. In absence of information the percentage is Calculated for factory overhead on direct labour
and office overhead on works cost.
4. Percentage of profit is calculated either on cost or on selling price.
5. The tender price is easily calculated when the percentage of profit and cost per unit is
determined.

OVERHEAD COSTING
Accounting for overheads
Overheads are those indirect, operating costs of a business enterprise which cannot be traced directly
to any specific product, job, or process because they cannot be directly attached or marked to any
specific activity or cost centre.

Overhead Accounting involves: -

A. Classification, Codification & Collection of overheads
B. Allocation, Appointment and absorption of overheads.
A. Classification of Overheads
1. Elements wise Overheads
i. Indirect Material – e.g. Consumable stores, loose tools, etc.
ii. Indirect Labour – e.g. Salary of foremen, store-keeper, supervisors, etc.
iii. Indirect Expenses – e.g. Factory rent lighting, heating, insurance, administration, and
selling & distribution expenses.
2. Function-wise Classification
i. Production or Manufacturing Overheads: - E.g. Indirect material Indirect labour &
indirect expenses
ii. Administration overheads: - Audit fees, postage and telephone
iii. Selling & distribution overheads: e.g. Advertising, showroom expenses, traveling
expenses, etc.
3. Classification According to Behaviour or Variability
i. Fixed Overheads are those which tends to be unaffected by variation in the volume of
output.
E.g. rent and rates, managerial salaries.
ii. Variable Overheads are those which tends to vary in direct proportion to changes in the
volume of output. E.g. indirect material, indirect labour.
iii. Semi Variable overheads are those which are partly fixed and partly variable? E.g.
depreciation, repairs & maintenance, telephone etc.
4. Classification According to controllability
i. Controllable Cost: - Which Can be controlled by the action of a specified members of the
department e.g. variable cost
ii. Uncontrollable Costs: - Which cannot be controlled by the action of specified members
of the undertaking. E.g. fixed cost.

Departmentalization of overheads: -This is the problem of (allocation and apportionment of

overheads to production and service department)
Cost allocation: - The allotment of whole items of cost to cost centers or cost units is called cost
allocation.
Apportionment of cost: - Where the expense is common and related to various cost centers or units,

33
 SUBJECT: - Cost Accounting

then it is to be allotted to different cost centers on an appropriate basis. This process is called
Apportionment.

34
 SUBJECT: - Cost Accounting

Primary distribution of overheads: - This is the process of allocation and apportionment of different
items of overheads to all the departments.
Secondary distribution of overheads: - This is the process of re-distribution of the overheads cost of
service department among the production department.

Methods: -
i. Direct Redistribution
ii. Simultaneous equation method
iii. Step ladder method
iv. Repeated Distribution method

Objectives of Departmentalization
1. Ensures greater accuracy in cost ascertainment.
2. Control of overhead cost
3. Use of different methods of absorption
4. Valuation of work-in-progress
5. Cost of service departments can be ascertained
6. Accurate forecasting and estimation and decision making.

Common Bases of Apportionment of Overheads

Direct Allocation Consumable stores, specific expenses
Floor Area of Department Rent and other building expenses, lighting & heating,
Direct Labour hours or Direct Supervision, Administration Compensation to workers, Holiday
wages or No. of workers Pay, ESI & PF contribution, fringe Benefits. Labour welfare
expenses, Time Keeping, canteen Expenses.
Capital values of building or Depreciation, insurance charges, rent, repairs & maintenance
plant:- etc.
Light Points Lightning expenses
Kilowatt hours/ Electric power
Machine hours
Wight or volume of material or Material handling, stores overheads
value of materials
Technical estimates Power, light, internal transport, managerial salaries etc.

Absorption of overheads
Absorption means distribution of overhead expenses allotted to a particular department over the units
produced in that department. So charging of overheads to cost units is called absorption of overheads.

Determination of overhead rates

1. Actual Rate
Actual overhead 2. Predetermined BRautdeg–eted Overheads
– Actual Base Budgeted Base

3. Standard
Standard
Overhead Rate – Total overheads for the factory
Standard Base 4. Blanket Rate
– Total quantity of the entire factory

Under Absorption and over Absorption of overheads

Under Absorption: - If the amount absorbed on predetermined rates is less than the overheads
actually incurred, it is called under absorption or under recovery.

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 SUBJECT: - Cost Accounting

Over Absorption: - If the amount absorbed is more than the actual overheads, it is known as over
absorption or over-recovery.

36
 SUBJECT: - Cost Accounting

Causes of Under/Over Absorption of overheads

i. Error in estimating overheads
ii. Error in estimating quantum of production
iii. Actual hours worked may be more or less than those anticipated.
iv. The basis upon which factory overheads are recovered from production may no longer be
correct on account of changes in prices of materials or wage rates.
v. WIP may not have been charged with its share of overhead cost accounts.
vi. Seasonal fluctuations in overheads from time to time.
vii. Unanticipated changes in methods of production and production capacity.

According Treatment of Under/Over Absorption

i. Writing off to costing P & L A/c: - This is used when account of under or over absorption
is quite negligible or when under absorption is due to abnormal factors like idle capacity,
defective planning, etc.
ii. Absorption in the subsequent year: - Here the under or over absorption amount is
transferred to Overhead Reserve Account or Suspense Account for carry over to the next
accounting year.
iii. Application of supplementary Rates: - Where the amount of under or over absorption is
significant, a supplementary overhead absorption rate is calculated by dividing the under or
over absorbed amount by the actual base. Adjustment is made in the cost of :
a. Work in progress b. Finished stock c. Cost of sales
In case of under absorption, the over head is adjusted by a positive rate, since the amount is to be
added. Over absorption is adjusted by a negative rate, since the amount is to be deducted.

Methods of Absorption of overheads

i. Direct Material Cost Method ii. Direct Labour Cost Method iii. Direct Labour Hour Method
iv. Prime Cost Method v. Machine Hour Rate Method vi. Production Units Method or Rate Per Unit
of Output.

MACHINE HOUR RATE

Machine hour rate is cost of running a machine for one hour. It is different for different types
of machine.
An actual or pre-determined rate of cost apportionment or overhead absorption which is
calculated by dividing the cost to be apportioned or absorbed by the number of hours for which a
machine or machines are operated or expected to be operated.
Comprehensive machine hour rate – when the direct wages of machine operators are
included in machine hour rate, it is known as comprehensive machine hour rate.

Bases of apportionment of different overhead to machines

S.No. Expenses Basis
Fixed Charges
1. Rent and Rates Floor area occupied by each machine including the surrounding
space.
2. Heating and The number of points used plus cost of special lighting or heating
for any individual machine, alternatively according to floor area
lighting occupied by each machine.
3. Estimated time devoted by the supervisory staff to each
4 machine. On basis of past experience
. Supervision
5.

37
 SUBJECT: - Cost Accounting

6. Lubricating oil and Insurable value of each machine

consumable stores Equitable basis depending on
Insurance facts
Miscellaneous expenses

38
 SUBJECT: - Cost Accounting

Variable
1. Expenses Cost of machine less residual value spread over its working
2. Depreciation life. Actual consumption as per meter reading
3. Power Cost of repairs spread over its working life.
Repairs

Advantages
1. It helps in analyzing the comparative efficiency of machine and comparing the overheads
charges in various departments.
2. It expresses the quantitative analysis of time and cost of operating of each machine.
3. Managerial decision making is facilitated regarding use of manual labour in place of machines.
4. This is the most scientifically correct way of analyzing production overheads.
5. The cost analysis prepared here is more reliable for management to make decisions.
6. This method provides necessary information for estimating cost of production, laying down
standards and estimating selling price of output.
7. This method can be very effective in valuing the cost of in operational machinery if the costs
are bifurcated into fixed and variable.

Disadvantages
1. Those costs are not at all considered which are not in consideration with hours of operation
of machinery.
2. If manual labor is also equally important part of cost then the results of cost estimation will
be misleading.
3. Because of calculating the hours of operation separately for this method the whole
process seems to be costly.
4. If the production programmes is not pre-decided then estimation of operating hours
becomes difficult.
5. Blanket overhead rates cannot be used here therefore this method becomes more expensive.

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 SUBJECT: - Cost Accounting

UNIT-III
CONTRACT
COSTING

It is one of the methods of cost accounting. This method is used in such industries where work is
performed on contract basis. Contact costing is a part of specific order costing method where work is
performed as per requirement or specification of the customer or contractee. Contract costing is also
known as “terminal costing” or construction costing. It is used in civil engineering works such as
road making, building construction, dam construction, bridge construction etc. Here the work is not
done within the four walls of the factory, but outside the factory which is called site.

Terminology used in contract costing:

1. Contractor and contractee – the person under the terms of agreement, promises to complete
a particular work is called contractor. The person whom such promise is given is called
contractee.
2. Contract price – it is the consideration given to contractor for the construction work.
Normally contract price of every contract is based on the cost involved in the contract.
3. Work in progress – Entire work done before the stage of completion of contract is work-in-
progress. In other words when the contract is not completed till the end of accounting year
the architect is required to value the work in progress. Such work in progress is classified into
two parts – (a) Work certified (b) Work uncertified.
1. Work certified – that part of work-in-progress which has been approved or certified
or authenticated and valued by the expert called certifier or a valuer, is known as
work certified.
2. Work uncertified - it is that part of work-in-progress which has not been approved
by the expert.
4. Retention money and cash ratio – payment by the contractee is always linked to the value
of the work certified. Generally the monthly, quarterly or annual payments are a percentage
of work certified, e.g. 70 or 90 percent or any other percentage agreed upon between the
contractor and the contractee. At the completion of contract the entire balance amount is paid
to the contractor. Some contractees pay interest on retention money. Retention money serves
as a security with the contractee. It may be adjusted against the defective work found later.
5. Escalation, de-escalation or reserve clause - This clause is generally provided in long term
contracts with a view to protecting both the contract and the contractee against fluctuations in
the prices of inputs to the contract mainly material and labour.
6. Cost plus contracts – cost plus contact is a contract in which the contract price is not fixed
at the time of entering into the contract. The contract price is determined by adding a
specified amount of percentage of profit to the cost allowed in the contract.

40
 SUBJECT: - Cost Accounting

Contract A/c

Date Particulars Amount Date Particulars Amount

To Material purchased ------------ By Material/Plant transferred to -------------
other contract -
To Material issued from -------------
By material/plant returned to -
stores ------------ stores -------------
By cash a/c [material or plant -
To plant issued ------------ sold]
To plant purchased ------------- By P&L a/c Material/plant
- stolen or destroyed
To Direct Labour ------------- By material/Plant in hand or at -------------
- -
To Indirect labour ------------- site -------------
- (If contract is completed) -
To Direct Expenses ------------- By Contractee’s
- A/c By P & L A/c
To Indirect Expenses ------------- (Loss)
- (If contract is incomplete)
To Supervision Charges ------------- -------------
- By W.I.P. -
To Sub contract cost ------------- A/c W.C.
-
To cost of extra work -------------
-
done ------------- -------------
- -
To P & L A/c (Profit on
sale)

(If contract is -------------

-
completed)
………A/c
WORK – IN – PROGRESS
To P & L A/c (Profit) ------------- W.U.C -------------
(If contract is
- -
------------- ………
- -------------
completed) ------------- By P & L A/c (Loss) -
-
To Balance c/d (Total
Profit)
CONTRACTEE’s A/c

To P & L A/c
To W.I.P. A/c (Reserve)
By Balance b/d

Da Particular Amount Date Particular Amount

te
To Contract A/c By Contract A/c (Reserve) ………
W.C. ……… By Bal. C/d ………

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 SUBJECT: - Cost Accounting

W.U.C ……… ………

Date Particular Amount Date Particular Amount

1st To Balance c/d ……… 1st By Cash ………
yr yr
Dec. ……… Dec ………
31 To Contract . 31 By Bal.
………
2nd 2nd b/d By
yr A/c yr
Jun Jan. Cash
e 30 01

42
 SUBJECT: - Cost Accounting

June
30
……… ………

BALANCE SHEET
As on 31st December x x x 1
By W.I.P. A/c ------
- Cash Received ------ -----------

Rules regarding Transfer of profit – to Profit & Loss A/c

(A) If contract is completed -
The whole amount of Profit or Loss will be transferred to P & L A/c

(B) If contract is incomplete

(i) In case of Loss: The whole amount of Loss will be Trans to P & L A/c
(ii) In case of Profit:-
(a) If the value of W.C. is less than 1/4th of the contract price - Nil
(b) If the value of W.C. is 1/4th or more than it but less ½ of the contract price

= Total Profit × 1/3 × Cash Received / W.C.

C) If the value of W.C. is ½ of the contract price or more than it

= Total Profit × 2/3 × Cash Received / W.C.

In Case of Loss
The excess of debit over the credit items of the contract account is the loss. This loss is to be
transferred to Profit & Loss A/c

Important Points while Preparing Contract A/c

1. The expenses incurred on contract are written on the debit side of contract A/c for
e.g., Material, Labour, Direct expenses, Indirect expenses, Subcontract cost etc.
2. If any material loss or theft in a contract, it should be recorded in the credit side of Contract
A/c as in the name of Profit & Loss A/c.
3. If any material and plant sold in the contract the sales price is written on the credit side of
Contract A/c and then calculated the profit of loss and it is transferred to P & L A/c. If
profit is there, it should be appeared on the debit side of P & L A/c, and loss should be
appeared on the credit side of P & L A/c
4. Material at site, plant at site, stores at site should be written on the credit side of Contract A/c
5. If only depreciation of plant is given in the sum, then depreciation is written on the debit side
of Contract A/c
6. If work certified amount is not given in the sum, then, following formula is used for

𝐶𝑎𝑠 𝑕 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 𝑥 100

calculating work certified amount –
Work Certified % = 𝑜𝑓 𝑐𝑎𝑠 𝑕 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑
7. Depreciation is calculated by following formula when rate of depreciation is not

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 SUBJECT: - Cost Accounting

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑙𝑎𝑛𝑡
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑙𝑖𝑓𝑒 𝑜𝑓 𝑝𝑙𝑎𝑛𝑡
given – Per hour Rate =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑙 𝑎𝑛𝑡 −𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒
Per hour Rate =𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑙𝑖𝑓𝑒 𝑜𝑓 𝑝𝑙𝑎𝑛𝑡

44
 SUBJECT: - Cost Accounting

Job Costing
Job costing is that part of cost accounting which finds cost of material, produced under a specific
order. There goods are produced for immediate delivery for each job costing, the cost is calculated
separately for each job order because every work order differs from person to person.

Thus, job costing is that method of cost accounting where cost is determined according to quantity
of product, special material equipment, labour and expenses required to fulfill the order.

Job accounting has the following features

1. It differs order to order.
2. It is based on intermittent production and not continuous.
3. In job costing method, each job is treated as a separate cost unit.
4. In job cost, the final cost of production Is ascertained after the completion of the job.

Objects of Job Costing

1. Job costing helps to find out the profit or loss job wise.
2. Job costing helps to management to recognise profitable or non profitable job work.
3. Costing of old job helps to ascertain the cost of same type of new job work.
4. actual cost is compared to standard cost in job costing method which helps to control the cost
in case of repeat job order.

PROCEDURE OF JOB COSTING

The following procedure is adopted in case of job costing method –
1. Job Number - First of all each job is given a separate number for its identification.
2. Production order - Production order is a written order given to for men to start the job. In
this order job number, quantity to be produced design, specific requirement time etc. are
mentioned.
3. Job Cost Sheet— A separate job cost sheet is prepared for each job. This job cost sheet
carries the details of expenditure incurred on that particular job.
4. Completion Certificate - After completion the job. The production department sends the job
completion certificate and a copy of job cost sheet to costing department.

Difference between Contract Costing and Job Costing

The difference between these two may be cleared as follows-
S.N Bases of Contrac Job
o Difference t Costing
1 Nature or work It is related to contraction It is related to production process.
generally
2 Amount Contract is having huge Job is related for shorter period
and Time amount and longer period and small amount.
3 Sub contractor In case of contract work The subcontractor may be contracted
and their cost will be part of
contract costing.
4 Industry Contract costing method is used It is applied in industries which
in contraction industry e.g., Road manufacture products or provide
services against specific orders such as
printing press, furniture makers
general engineering concerns etc.
5 Work site In the contract work is done out Here works is completed in

45
 SUBJECT: - Cost Accounting

the work shop generally. Place the workshop only

of

46
 SUBJECT: - Cost Accounting

contraction is the work site/work

shop.
6 Determination In this method profit or loss is also In this method profit or loss is
of profit or determined on incomplete calculated after the completion of
loss contract job
7 Nature Most of the expenses under In Job costing expenses may be
of contract costing are direct direct and indirect both.
Expenses in
nature.

Batch
Costing
Meaning
There are some such products whose cost of production can be calculated unit wise (for an
individual unit). For example bolts nuts, pins, screw bread, biscuits, etc. In such a case firms which
are producing these products, use the batch costing method in batch costing each batch of
production is treated as an separate job work and cost is determined accordingly.

Procedure of Costing
Batch costing does not differ from job costing in respect of accounting procedure. Like job costing
each batch is given a separate number and cost sheet is prepares. The overheads are distributed by a
proper method.

In this method cost of plant and its setting is treated as fixed overheads and it is distributed among
the batched by the proper methods.

Economic Batch Quantity

In this method that quantity of product is calculated which make the cost of batch economical or
least? Thus, economic batch quality is that best possible size of output which gives that minimum
cost and maximum product.

To calculate the economic batch quantity the following two types of cost are considered –
1. Setting cost of plant.
2. Cost of shortage – Rent of warehouse, insurance expenses, interest on borrowing

Economic Batch Quantity = √ 2 𝑥 𝑈 𝑥 𝑆

𝐶
U = No. of units to be produced in a year
S = Set up cost per batch
C = Carrying costs per units

OPERATING COSTING
Meaning of Operating Costing –
Operating costing is adopted by those businesses which operate services. These service
organizations render services instead of producing & their main feature. The service may be sold by
the enterprises to consumers, e.g. Bus companies, tramways, railways, airways & shipping
companies, hotels, banking finance and consultancy firms, electricity boards, gas, water and other
utility undertakings. The service may also be used within the enterprise e.g. cafeteria, boiler house
etc. Operating costing is a method of cost accounting designed to determine the cost of services, and

47
 SUBJECT: - Cost Accounting

hence justifiably also called services costing.

According to CIMA England “Operating costing applies where standardized services are provided
either by an undertaking or by a cost centre within an undertaking”.

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 SUBJECT: - Cost Accounting

Normally, operating costs are period costs. Expenses accumulated for a period say, quarterly or
monthly are related to the quantum of services rendered during the period. In some cases, however,
operating costs could also be sold as terminal costs. When a plane is chartered for a specific trip, its
cost would be calculated as if it is an independent job.

Characteristics –
The following characteristics are usually found in industries where operating cost is used –
i) Services rendered to customers are of unique type.
ii) A large proportion of the total capital is invested in fixed assets & comparatively less
working capital is required.
iii) The distinction between fixed cost and variable cost is of particular importance because the
economics & scale of operations considerably affect the cost per unit of service rendered. For
example, fixed cost per passenger will be lower if buses in Transport Company run capacity
packs.

This method of costing can be used in the following service undertakings –

i) Transport services – Bus, truck companies, Tramways, Railway, Airlines.
ii) Supply services – Gas Company, water supply, electricity, boiler House etc.
iii) Welfare services – Hospital, Canteen, Hotel, and Public Library.
iv) Public services – Road maintenance, Road lights & other public utility services etc.

Cost unit – The selection of suitable cost unit may sometimes prove difficult. The cost units may be
of the following two types –
i) Simple cost unit.
ii) Composite cost unit.

Simple cost unit – The unit may be simple as under unit costing as per bed in case of hospital, per
1000, liters in case of water works, per child in one of the schools, per cup of tea or per dish in case
of canteen services etc.

Composite cost unit – In this type more than one unit are combined together as per passenger km in
case of bus companies.

S.No Undertaking/Business Cost

. Units
1 Transport Business, Tram, Railways, Roadways Per-passenger-km, per seat-km.
2 Trucks and other loading vehicles. Per-tone or quintal-km.
3 Hospital – Indoor Per bed-day
- Outdoor Per patient-day
4 Electricity supply Per Kwt-hour
5 Water supply Per Gallon-hour, per 1000-litres
6 Canteen Meals per-person, per cup-tea etc.
7 Boiler House Per cub centimeter gas or steam
8 Hotel Per-room-day, per-passenger-day
9 Cinema, Theater etc. Per-person per show
10 Road Maintenance Per-km.

Build-up of Costs –
After determining the unit of cost to which the total expenditure is to be apportioned, the process of
collecting the necessary data about costs of operating the service is carried over. The data after

49
 SUBJECT: - Cost Accounting

collection are classified under two heads –

i) Fixed or standing charges ii) Variable charges.

50
 SUBJECT: - Cost Accounting

This is done so that greater control can be exercised over new costs. In whatever quantum the service
is rendered, fixed cost or standing cost shall not change and the management should concentrate over
such costs.

The expenses which vary according to a change in the operating level are grouped separately and
sometimes such expenses are placed in sub-groups like (i) Maintenance charges (ii) Running
Expenses. This is done to have a better idea about the cost structure. Costing in some specified
undertaking has been explained in detail.
Transport Costing –
Transport is one of the service performed by air, water, railways, tramways roadways, goods carries,
etc. such businesses naturally take to the method of operating costing, with a view to finding the
total cost of each vehicle and then applying it to the unit cost. The cost information helps not only in
charging for the service against departments and outsider customers, but in making comparison
between vehicles inter se and alternative modes of transport.

To calculate the operating expenses following work should be done –

i) Collection of service expenses for specified period.
ii) Division of collected expenses between fixed & variable expenses.
iii) Calculation of units for service rendered.
iv) Calculation of per unit cost by dividing total expenses with units.
v) Adding the profit in per unit cost and take the decision as for fixing rates per passenger
per kilometer or per ton km. etc.

Collection of operating cost –

For each vehicle or for generator or pumping set etc. a log book is maintained to record various
details during a given period of time. Particulars regarding capital, maintenance and running costs,
trips made, fuel & oil supplied; worker’s time spent and exceptional delays are invaluable for
working out the cost services. These enable the management to make suitable allocation of vehicles
and thus avoid unnecessary or duplicate trips and waste or idle running capacity.

From following specimen given it will be seen clearly –

Vehicle No. : Operating Stationed at:
Cost
Statement
Carrying capacity : January 2009 Route No. :
Budget Actual
Particular Total Per ton Km. Total Per ton Km.
A. Standing Charges: Rs. Rs. Rs. Rs.
1. License fee
2. Insurance
3. Road tax
4. Administration
5. Depreciation, if charged on time basis
6. Interest
Total
B. Maintenance Rs. Rs. Rs. Rs.
Charges:
1. Garage expenses
2. Repairs & overhauling

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 SUBJECT: - Cost Accounting

3. Oiling & servicing

4. Spare parts & components
Total

52
 SUBJECT: - Cost Accounting

C. Running Charges:
1. Petrol or diesel
2. Oil & greases
3. Running staff salaries
4. Wear & tear of tyres, tubes
5. Insurance of transit goods
6. Vehicle depreciation if charges on
mileage run basis
Total
D. Total Operating Cost
(A+B+C)
E. Total Ton-kms. or passenger-km.
F. Cost per ton-km or passenger-km.
G. Revenue Earned
H. Net Profit
Remarks if Cost Accounting
any
Classification of Expenses Accumulated
Operating expenses for a specified period are classified into two parts –
i) Fixed charges, & (ii) Variable charges.

i) Fixed charges – License fee, insurance, road tax, garage rent, salary of the supervisory and
office staff, director’s fees, interest on capital, wages of the driver, conductor and cleaner etc.
(if paid on time basis).
ii) Variable charges – Depreciation of vehicle, cost of petrol, diesel, mobile oil, grease and
other lubricants, wages of drivers and cleaners (if paid on mileage run-basis), Repairs and
overhauling expenses. Oiling and servicing charges, wear and tear of tyres and tubes, Gas
and electricity charges, Insurance on transit goods.

Some authors have allocated these expenses in three parts as under –

i) Standing Charges (Fixed) – License fee, insurance, road tax, interest on capital,
depreciation of vehicles, and salary of the supervisory and office administration staff.
ii) Maintenance charges (Semi Variable) – Repairs and renewals, Garage and terminal office
rent, rates etc. staff salaries of garage and terminal office, spare parts, oiling and servicing
charges (routine).
iii) Running Charges (Variable) – Cost of petrol, diesel, mobile oil, grease and other
lubricants, depreciation of tyres, tubes and battery, Insurance of transit goods, wages of
drivers and cleaners (if paid on mileages run basis).

Calculation of Ton Kilometers or per Passenger Kilometers

In transport business before calculation of running expenses. It is necessary to know the meaning of
the words ton kilometer or passenger kilometer. There meaning is being explained here under –
a. Ton Kilometer – It refers to the calculation of cost of carrying one tone load to one
kilometer.
b. Passenger Kilometer – It refers to the estimation of cost incurred on carrying a passenger
one kilometer.

Calculation of Operational Cost

Before calculating operation cost fixed and variable expenses are added. Thereafter following
formula is used for its estimation –

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 SUBJECT: - Cost Accounting

𝑇𝑜𝑡𝑎𝑙 𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑎𝑛𝑑 𝑅𝑢𝑛𝑛𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠

a. In relation to a transport company carrying passengers –

𝐾𝑖𝑙𝑜𝑚𝑒𝑡𝑒𝑟
1. Operating Cost per Km =

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 SUBJECT: - Cost Accounting

𝑇𝑜𝑡𝑎𝑙 𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑎𝑛𝑑 𝑅𝑢𝑛𝑛𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠

2. Operating cost per passenger Km = 𝑇𝑜𝑡𝑎𝑙 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟 𝑘𝑚
b. In relation to a goods carrier transport company –
1. Operating Cost per Km = 𝑇𝑜𝑡𝑎𝑙 𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑎𝑛𝑑 𝑅𝑢𝑛𝑛𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑡𝑜𝑛 𝑘𝑚

2. Operating cost per ton Km = 𝑇𝑜𝑡𝑎𝑙 𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑎𝑛𝑑 𝑅𝑢𝑛𝑛𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠

𝑇𝑜𝑡𝑎𝑙 𝑡𝑜𝑛 𝑘𝑚

55
 SUBJECT: - Cost Accounting

UNIT-IV
PROCESS
Definition:
COSTING
Some important definitions of process costing are as under –
“Process cost accounts are applied to concerns which produce a commodity that has to go through
several processes and which requires to know the cost of each process”.
–
Sharles. “Process costing is used to ascertain the cost of each stage of manufacture where material is
passed through various operations to obtain a final product to result, with by products in many cases
at different stages.
- Lunt and Ripley

Application of process costing –

Process costing is employed in the following types of industries –
1) Food processes industries, e.g., flour mills, meat products, milk diary, confectionaries, fruits
and vegetables processing etc.
2) Other industries involving a sequence of processes, e.g., paper mills, cement works, coke
works, canning factory, textile manufacture, cartoon making, etc.
3) Metallurgical industries, e.g., iron and steel, aluminum, wire drawing and netting and
polishing, alloy production etc.
4) Chemical industries, e.g., drugs and pharmaceuticals, paints soap making, production of
sugar, molasses and alcohol, breweries, distilleries, oil refining, etc.

Salient features/essential characteristics of process costing –

1) The cost per unit produced is the average cost which is calculates by dividing the total
process cost by the number of units produced.
2) Some loss of materials in processes (due to chemical reaction, evaporation, etc.) is unavoidable.
3) The production is continuous and the final product is the result of a sequence of processes.
4) Processing of raw materials may give rise to the production of several products. These
several products produced from the same raw material may be termed as joint products or by-
products.
5) The products are standardized and homogeneous.
6) Costs are accumulated process-wise.
7) The sequence of operations or processes is specific and pre-determined.
8) The finished product of each but last process becomes the raw material for the next process
in sequence and that of the last process is transferred to the finished goods stock.

Advantages / uses/ need of process costing –

Main uses of process costing are as follows –
1) System of standard costing can be applied with ease in case of process accounts.
2) Valuation of inventory of work-in-process of different processes and finished products is
facilitated by process accounts.
3) Cost of individual processes as well as of finished products can be ascertained at short intervals.
4) Make or buy decisions for different processes can be taken in the light of costs at different
processes. For example, in case of textile manufacture if the cost at weaving process is higher
than the price at which plain cloth can be purchased from outside, the company may decide
to buy plain cloth from outside and perform the process of printing only. If weaving costs are
lower, the weaving process is also performed.
5) Effectiveness at each process is determined on the basis of costs incurred at individual process.
6) Since output at each process in homogeneous, average cost per unit can be easily calculated.

56
 SUBJECT: - Cost Accounting

7) Separate cost ascertainment for each process has motivational impact. Employees at the
process resulting in cost economies can be rewarded, and those not performing up to the
mark can be reprimanded.
8) Cost control is facilitated as it is ascertained as to where excessive cost has been incurred and
where wastages and scraps are high.

Limitations of process costing –

Major limitations of process costing are –
1) Process costs throw light on efficiency level of entire group of people working at a process,
not on the efficiently of individuals.
2) Determination of cost at processes is by itself not sufficient for cost control, make or buy
decisions or for motivational measures.
3) In case production at a process is not homogeneous as in the case of foundries making
casting of different sizes, shapes and of different qualities involving different alloys, the
average per unit cost based on total output and total cost at a process will be misleading.
4) Process costs are historical costs and suffer from all weaknesses of such costs.
5) Valuation of inventories where there is work-in-progress at processes, involves lot of
estimation.
6) Determination of cost of by-products and joint-products is also a mere estimation.

Principles of process costing –

The following principles should be followed for ascertaining costs at processes –
1) Output of one process is transferred to the next process and that of final process is transferred
to finished goods account.
2) Cost per unit at processes is ascertained at the end of each specified period, e.g., on monthly
or quarterly basis.
3) All normal losses should be charged to the output at the processes. However, cost per unit
must never be influenced by abnormal gains and losses.
4) Each processes is taken as a cost centre, i.e., all direct and indirect costs are assigned to
processes on appropriate basis.
5) In case of by-products and joint-products, their share is joint costs should be carefully
estimated and credited to the main process.
6) In case there are incomplete units at the process at the beginning and at the end of the period,
equivalence of incomplete units is determined.

Normal and Abnormal losses:

Normal Process Loss: That amount of loss which cannot be avoided because of the nature of
material or process is normal process loss. Such a loss is quite expected under normal conditions. It
is caused by factor like chemical change, evaporation withdrawals for tests or sampling, unavoidable
spoiled quantities etc.
Abnormal Process Loss: This type of loss consists of loss due to carelessness, machine break down,
accident, use of defective material etc. Thus in cases due to abnormal factors it represents a loss
which is over and above the normal loss.

Accounting Treatment of normal loss:

It is a fundamental costing principle that the cost of normal losses should be borne by the good
production. Normal loss is generally determined as a percentage of input. Sometimes such a loss is
due to cost of weight, say due to evaporation a chemical action. Since such a wastage is not
physically present, obviously it cannot have any value.

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 SUBJECT: - Cost Accounting

However when normal loss is physically present in the form of scrap it may have some value,
i.e. it may be sold at some price. Whenever scrapped material has any value, it is credited to the
process account. This illustrated below.

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 SUBJECT: - Cost Accounting

Accounting Treatment of Abnormal Process Loss

It is been stated earlier that abnormal loss is due to carelessness, accidents, machine,
breakdown and other abnormal reasons. Unlike normal loss, abnormal loss is not absorbed by good
production, rather it is transferred to costing P & L a/c. This is because if the cost of abnormal loss
were to fall upon the good production the cost there will fluctuate and the information provided
would be misleading. In order to overcome this and also to disclose the cost of abnormal loss, the
following procedure may be adopted :
(a) Allow for normal loss in the manner described earlier.
(b) After considering normal loss, find out the cost per unit that process. This is done by the
following formula process.
Total cost – value of normal loss
Cost per unit = Units introduced – normal loss
units

(c) Multiply the cost per unit (calculated as above) by the number of units of abnormal loss. This
gives the total value of abnormal loss.
(d) Credit the relevant process account with the quantity and value of abnormal loss.
(e) The balance figure in the process account is the cost of good units produced in the process.
This can also be found by multiplying cost per unit with the number of good units produced.
(f) Open Abnormal loss account and debit it with the quantity and value of abnormal loss shown
in the process account sale proceed from abnormal loss are credited to abnormal loss
account. Any balance lift in this account is net loss and transferred costing P & L a/c.
Fifty units are introduced into a process at a cost of rupee one each. The total additional
expenditure incurred by the process is Rs. 30 of the units introduced 10% are normally
spoiled in the spoiled in the course of manufactures these possess a scrap value of Rs. 0.25
each. Owing to an accident, only 40 units are produced. You are required to propose (i)
Process a/c and (ii) abnormal loss a/c.

Abnormal Gain or Effectiveness –

The normal process loss represents the loss that would be expected under normal conditions. It is an
estimated figure. The actual loss may be greater or less than the normal loss. If the actual loss is
greater than normal loss, it is known as abnormal loss. But if actual loss is less than normal loss, a
gain is obtained which is termed as abnormal gain or effectiveness. The value of abnormal gain is
calculated in a manner similar to abnormal loss. It is shown on the debit side of the Process Account
and credit side of the Abnormal Gain Account. Like abnormal loss, it is ultimately transferred to
Costing Profit and Loss Account.

Joint and By Products

Joint products: The term joint products are used for two or more products of almost equal economic
value which are simultaneously produced from the same manufacturing process and the same raw
material. Joint products thus represent two or more products separated in the course of processing
each product being in such proportion as the main product.
Characteristics:
(a) Joint products are produced from the same raw material by natural proportion.
(b) They are produced simultaneously by a common process.
(c) They are comparatively of almost equal value.
(d) Joint products may be saleable after separations or may be further processed by
incurring additional costs to make them stable or an improved product.

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 SUBJECT: - Cost Accounting

A classic example of joint products as given above is found in oil refining, where items like
petrol diesel, naphtha, kerosene etc. are produced from the crude oil. Other example are in
flour mill where joint products are hides, canned meat, fertilizers etc. The joint product is
also used

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to describe various qualities of the same product, as for example many grades of coal
which may be produced in coal mining.
Examples of Joint Products
Industry Joint Products
1. Oil Refining Petrol, Diesel, Kerosene grase lubricating
oils.
2. Dairy Skimmed Milk, butter
3. Meat processing Meat, Hides
4. Mining Several metals from the same or example
copper, silver, zinc etc.

By Product:
By products are products of relatively small value which are incidentally and unavoidably
produced in the course of incidentally and unavoidably produced in the course of manufacturing the
main product. For example in sugar mills the main products is sugar. But bagasses and molasses of
comparatively smaller value are incidentally produced and thus are by products, other examples of
by products are oil cake produced in the extraction of edible oil, cotton seed produced cotton textile
industry etc. These by products are unavoidably produced and are of secondary value. The sales
value of these by products is much less as compared to the main product is much loss as compared to
the main product. For example sales value of byproducts bagasse and molasses is much less than that
of the main products sugar.
By Products may be :
(a) Those sold in their original form without further processing.
(b) Those which require further
processing Distinctions between Joint Products By
Products.
A product may be treated as a joint product in one business & the same product may be
treated as byproduct is another business. However the following factors should be considered to
determine if a product is a joint product as a byproduct.
(a) Relative sales value: If the sales value of all the products all more or less equal
they all treated as joint products. If however there are wide differences in the
relative sales values of products, the product with the greater sales value is treated
as the main products & the products of lower value are treated as by products.
(b) Objective of manufacture : If the objective of manufacturing is product A, they
unwanted products B & C be treated by products.
(c) Policy of Management : The management may decide to treat a particular product
as the main product & the other product as by products. Alternatively it may
choose to treat all product as joint products.

Examples of By Products:
Industry Joint Products
1. Sugar Bagasse Molasses
2. Butter textile Cotton seed
3. Edible oil Oil cake
4. Meat Bones
5. Rice mills Husk.

Distinction between Joint Product and By Product –

The pint of distinction of Joint products and by products is a question of commercial importance,
business objectives, profit pattern, certainty of market, necessity of further process etc.

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 SUBJECT: - Cost Accounting

The important features distinguishing Joint Products and by products are –

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 SUBJECT: - Cost Accounting

1) Joint products are the products of equal economic importance, while by products are of lesser
economic importance.
2) Joint products are produced from same input and process where as by products are produced
from wastage, scarp and discarded material of the main process.
3) Joint products are not produced incidentally but by products emerge incidentally also.
4) Joint products have significant impact on total cost at the point of separation, whereas by
products have little impact on total cost.
5) Joint products require further processing, while the byproduct generally do not require to be
processed any further.

Joint Expenses –
There are certain industries where products are simultaneously produced and the same are referred to
joint products. Expenses incurred are also joint in this case.
Joint in this case means that the products from the same basic raw material. Examples may include oil
industry, gasoline, fuel oil, lubricants, crude oil etc.
The aim of analyzing joint expenses is to –
i) Correct collection, compilation and classification of process cost.
ii) Determine profit or loss on each line of manufacture.
iii) Determine the pattern of production and the most profitable product mix.
iv) Study the effect on cost and profits due to increase or decrease in production of joint products
in order to fix prices.
v) Determine the profitability of selling joint products and by-products as they come out at the
split off point and maximize profit through marginal contribution analysis.
When accounting for joint products, the products are not identifiable as different individual products
until a certain stage of production known as the split off point. All costs incurred before the split off
point are called joint products costs. Joint costs should be shared properly otherwise valuation will
be difficult.

Average Unit Cost Method –

In this method, the total costs are assessed, yielding an average unit cost with one net profit for the
total operation. It is applicable where processes are common and inseparable for joint products and
where the resultant products can be expressed in some common unit.

Physical Unit Method –

A physical base such as raw material weight, linear measure volume etc. is applied in apportioning
pre- separation point costs to joint products. For example, if there is 40@ beef in product X and 60%
beef in product Y, 2/10 of the cost upto separation point will be charged to X and 6/10 to Y. It is not
a good method in areas for instance one product is a gas and another is liquid.

Survey Method –
In this method all the important factors e.g. volume, selling price, technical side, marketing process
etc. affecting costing are ascertained by means of extensive survey. Point values or percentage are
given to individual products according to their relative importance and costs are apportioned on the
basis of total points. These ratios should be revised from time to time depending on the factors
affecting production and sales.

Contribution (Gross Margin) Method –

In this method the marginal cost of the joint cost is apportioned on the basis of weight or quantity or
each product and fixed cost on the basis of marginal contribution made by each of the products. The

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method provides useful information for taking decision on maximization of profits by rearrangement
of products and sales mix.

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 SUBJECT: - Cost Accounting

Market Value Method –

This is the most popular method of apportioning expenses that are joint. The joint costs are split into
the ratio of selling price of each individual products and the costs are based on these ratios.

Oil Crushing, Refining and Finishing Process –

1. Crushing process
2. Refining process
3. Finishing process

Crushing Process –
In this process raw material i.e. oil seeds or coconut or copra or kernels etc. are used. Other expenses
of the process are debited, sale of bags or sacks is credited. Oil cakes or oil residue are sold as a by-
product is also credited. The output is crude oil transferred as input in the next process. There are
may be loss in weight in the process.

Refining Process –
Crude oil from crushing process is debited, other materials, wages and overheads of the process are
debited. Loss weight if any, is credited. The output is refined oil. Fats and residual oil may be
obtained as by products which are credited. The output being refined oil is transferred to the next
process i.e. finishing process.

Finishing Process –
Refined oil obtained from refining process is debited. Other materials, wages and overheads of the
process are debited. Sale of by product and loss in weight are credited. Sundry sales of finished oil
are also credited. The balance of this process is credited as cost of production of refined oil. Cost of
drums or barrels or tins for storage of refined oil is also debited to find out cost of stored finished oil.
If sale of finished oil is given in the question, then finished Stock A/c should be opened after
finishing process A/c and in such a case cost of goods transferred from Finishing Process A/c, Cost
of Packing material and sale of Finished oil are shown in Finished Stock A/c and the profit or loss is
transferred to Profit & Loss A/c.

Inter-Process Profit –
Generally, the output of one process is transferred to another on cost basis. Similarly, goods
manufactured in the final process are also transferred at cost to Finished Stock A/c. But sometimes it
is desirable by a manufacturing concern to value goods processed by each process at a price
corresponding to the market price of comparable goods. Thus profit or loss made by each process is
revealed and the efficiency of a process is not affected by the efficiency or inefficiency of a previous
process. The market price of the goods processed being generally higher than the cost of the process,
each process account will show some profit. This profit is termed as inter-process profit.

Advantages of Inter Process Profit –

1. Introducing of Working Efficiency of Process – In this case, a process is doing well
maintaining profits or loss is utilized by this method. It knows that process is working at loss
and to remove default of this process and default gets by attempts of remove difficulties of that
process, finished stock is treated as cheaper rate from markets and finished production of that
process.
2. Compare to other Process – Transfer of cost including profits and compare to different process,
cost is deficit by trying cost less product by that working efficiency increased.

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3. Confidential of Real Profits – Cost transfer with profit to next process. Profits are confident in
every cost plus profit in process.
4. Decision to do Work by Self – Trader may acknowledge of any cost of production of process
transfer to contractor which production will be effected in surplus or deficit.

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 SUBJECT: - Cost Accounting

Limitations of Inter Process Profit –

1. Imaging Profit – We cannot tell real profits to inter process profits, this is only imaginary
profits. Its main reason that is not sale in fact to transfer of goods in inter process.
2. Difficulty in Calculation of Real Profit – In this method, unrealized profits is calculated for the
calculation of real profits become its calculation is very difficult.
3. Unrealised Profit – Opening stock and closing stock is taking to all the method, unrealized
profit is included in that process in which book profits and real profits is not a acknowledge.

Computation of Inter-Process Profit –

Under this method, the output of first process after charging certain profit is transferred to second
process and the output of second process after charging certain profit is again transferred to third
process. But in every process there remains certain stock which includes the part of profit of
previous process. Thus profit included in the stock by previous process, is known as unrealized
profit. Therefore, at the end of year the amount of profit included in the closing stock should be
computed and the provision for unrealized profit should be made from the amount of total profit.

It is essential for calculation of unrealized profit for reserve –

1. In this first method, closing stock is not make of reserve of unrealized profit.
2. Calculation of profit of transfer of goods by an cost of ¼ or 20/80 or 25%.
3. Calculation of reserve of unrealized profit by method for closing stock difference of its called
unrealized profit –
Unrealised profit = Value of closing stock – Cost of closing stock
𝑆𝑡𝑜𝑐𝑘 𝑥 𝐶𝑜𝑠𝑡 𝐴𝑚𝑜𝑢𝑛𝑡
OR
𝑇𝑜𝑡𝑎𝑙 𝐴𝑚𝑜𝑢𝑛𝑡
Cost of closing stock =

RECONCILIATION
Reconciliation of cost accounting and financial accounting Profit
A statement prepared to reconcile the difference between the profits as shown by cost book and
financial books for a particular accounting period is called “reconciliation statement”.

Reconciliation of these cost and financial accounts means tallying the profits revealed by the two sets of
books. Reconciliation is aimed to find out the reasons for disagreement of two profits.

Reasons for Disagreement in Profit –

A number of reasons may be attributed to the disagreement between the costing and financial profit.
The chief ones may include –
1. Items shown only in Financial Accounts
2. Items shown only in Cost Accounts
3. Estimation of Indirect Expenses
4. Differences due to different basis of Stock Valuation and Depreciation
5. Abnormal Losses and Gains

Methods of reconciliation
Reconciliation can be done by any one of the following two methods –
1. By preparing reconciliation statement.
2. By Preparing memorandum reconciliation statement.
1. By preparing reconciliation statement – as bank reconciliation statement is prepared to
reconcile the difference in cash book and pass book. Similarly on the same ground a reconciliation

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 SUBJECT: - Cost Accounting

statement is prepared to reconcile the difference between the profit as shown by financial books and
cost books.

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 SUBJECT: - Cost Accounting

SPECIMEN OF RECONCILIATION STATEMENT

Profit as per Cost books ………………
…..
Add:
(i) Expenses overcharged in cost books ……………
……..
(ii) Incomes not included in cost books ……………
……..
(iii) Under valuation of closing stock in cost books ……………
……..
(iv) Over valuation of opening stock in cost books …………… ………………
…….. …..
Less:
(i) Expenses undercharged in cost books ……………
……..
(ii) Expenses and losses shown in financial books but ……………
not in cost books ……..
(iii) Over valuation of closing stock in cost books ……………
……..
(iv) Under valuation of opening stock in cost books …………… ………………
…….. …..
Profit as per Financial Books ………………
…..

Note: If profit as per financial account is taken as the base, then items added should be deducted and
those deducted should be added –

Reconciliation statement - at a glance

In which
column the
Particular amount of
Effec
t difference to be
recorded?
On On Cost Fin.
closing Financial Books Books
Profit Profit * *
Stage I: Profit/Loss as per Profit
cost/Financial books (+) Loss (-)

stage II: To record the amount of the items

of difference in 'plus' or 'minus' columns:
1 overheads overcharged in cot books or Decrease Incereased
under charged in financial books d (-) (+) (+) (-)
2 overheads uncharged in cost books Incereased
or overcharged in financial books (+) Decreased (-) (-) (+)
3 depreciation overcharged in cost books Decrease Incereased
or undercharged in financial books d (-) (+) (+) (-)
4 depreciation undercharged in cost books Incereased
Decreased (-) (-) (+)

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 SUBJECT: - Cost Accounting

or overcharged in financial books (+)

5 Opening stock overvalued in cost books Decrease Incereased
or undervalued in financial books. d (-) (+) (+) (-)
6 Opening stock undervalued in cost books Incereased
or overvalued in financial books. (+) Decreased (-) (-) (+)
7 Closing stock undervalued in cost books Decrease Incereased
or overvalued in financial books. d (-) (+) (+) (-)
8 Closing stock overvalued in cost books Incereased
or undervalued in financial books. (+) Decreased (-) (-) (+)

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 SUBJECT: - Cost Accounting

9 Purely financial expenses/losses: e.g.

goodwill, preliminary exp., underwriting
commission, discount on issue of shares/
debentures written off, interest on
debentures, provision for bad debts, Incereased
treansfer to reserves, loss on sale of fixed (+) Decreased (-) (-) (+)
asset,
abnormal losses, cash discount etc.
10
Purely financial incomes/ gains:e.g. income
from investments, bank interest and transfer
fees received, dividend received, capital Decrease Incereased
gain, d (-) (+) (+) (-)
casual incomes, profit on sale of fixed
assets, commission/cash discount received
etc.
11
purely costing item i.e.
notional/imagnary/opportunity cost e.g. Decrease Incereased
interest on own capital, rent of own building d (-) (+) (+) (-)
used in business, owner's remuneration etc.

2. By Preparing memorandum reconciliation statement – reconciliation statement can be

prepared in the form of “memorandum account” as well. Preparation of this account is
very simple and easy. Items of “plus” column will be credited and the items of “minus”
column are debited. The difference of both the sides represent the profit/loss as per other
set of books.
3. Memorandum Reconciliation Account
To Loss as per books …………… By Profit as per books ……………
To Direct expenses … By Direct expenses …
undercharged overcharged in cost books
in cost books …………… By overheads overcharged or ……………
To overheads undercharged … over …
in cost books recovered in cost books
To expenses or losses not …………… By expenses or losses ……………
included … included only in cost …
in cost books books
To Items of profit/gain/or …………… By Items of profit/gain/or ……………
income … income …
shown or included only in not shown or recorded in
cost books cost books
To over valuation of closing …………… By over valuation of opening ……………
stock … stock …
in cost books in cost books
To Over valuation of closing …………… By Under valuation of ……………
stock … closing stock in cost …
in cost books books
To profit as per financial …………… By Loss as per financial ……………
… …

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 SUBJECT: - Cost Accounting

books (Bal. Fig) books (Bal. Fig)

…………… ……………
… …

Difference between reconciliation statement memorandum reconciliation statement

Basis Reconciliation statement Memorandum reconciliation statement
Nature It is statement It is an account
Sides There are two sides plus and minus There are two sides debit and credit

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 SUBJECT: - Cost Accounting

Items to be They are recorded in plus column They are debited to the account
added
Items to be They are recorded in minus column They are credited to the account
deducted
Total Total of both sides are recorded Only higher total is recorded
Difference of It is recorded below the total It is recorded above the total
total
Side of The difference is recorded in the The difference is recorded in the column of
difference column of higher total. lower total.
Popularity It is more popular. It is less popular

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