cost accountancy assignment

Advanced Cost Accountancy

INDEX

SR. No. PARTICULARS PAGE NO.

1.

Part - I

02

2. Part - II

10

3. Part – III (Group – C)

Question 1

Question 2

Question 3

Question 4

18

4. Reference / Bibliography 39


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Part I

QUESTION

PART - I

“There is no universal method of costing which is applicable for all cost units. The

methods differ as the cost units.” Through statement with the help of atleast four cost units

and costing methods relevant to them.

Solution:-

We know that costing is the system of calculating the cost. In the system of costing, we use

different methods of costing. Any method of costing can be used in any business according to

the need. Following are the main methods of costing.

1. Job Costing

In job costing, we calculate and collect the expenses for each work. This work is done on the

basis of order. So, this is the part of specific order costing. A job card is made for each work

or job. This method of costing is used in the factories which produce the machine tool and

other engineering products, furniture projects, hardware and interior decoration. This method

of costing is also called a piece of work costing or terminal costing.

The objective under this method of costing is to ascertain the cost of each job order. A job

card is prepared for each job to accumulate costs. The cost of the job is determined by adding

all costs against the job it is incurred.

This method of costing is used in printing press, foundries and general engineering workshop,

advertising etc.

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When continuous production is not carried out but production depends on specific order

received from customer, then in such case technique of Job costing is adopted for cost &

profit calculation. Each order represent separate Job and we have to prepare Job cost sheet.

The technique of Job costing is applied for preparation of Tender or Quotation.

In Absence of Information following points should be considered for preparing Job cost

sheet.

[1] First a fall prepare cost sheet of running business or transaction took place in previous

period.

[2] Calculate per unit cost of direct material, Direct labour, Direct Expenses and Selling &

Distribution Overheads. Any Increase or Decrease will be adjusted to such per unit cost. The

Revise per unit cost will be multiplied by Quantity of the Job order and we will get respective

cost per job cost sheet.

[3] Calculate % of Factory overheads to Direct labour, using Data of previous period

transactions.

[4] Apply this % on Direct Labour of Job cost sheet & we will get Factory overheads for

Job cost sheet.

[5] Normally in Job Cost Sheet there will be no opening and closing WIP & Finished

Goods. Even sale of scrape will not be taken place.

[6] Calculate % of office overheads to Works Cost using data of previous period. Apply

this % to works cost of job cost sheet, & we will get office overheads for job cost sheet.

[7] Calculate % of Profit to cost of sale using data of previous period. Apply this % to cost

of sale of Job Cost sheet & we will get the profit for job cost sheet.


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Following are its features

a) Cost of Each unit of production is calculated separately.

b) A cost sheet is made for each job.

2. Batch Costing

Batch costing is just the extension of job costing. In batch costing, we do not calculate and

collect the cost of each unit of production but we calculate the cost of each group or batch.

Each group will be one unit of production under batch costing. For example, we are

calculating the cost of 1000 bricks. It is one unit and under batch cost, we will calculate the

material cost, labour cost and overhead cost of producing 1000 bricks. Except this example,

we can take the example of ready-made garments batch, biscuit batch of 10 units in one

packet etc.

Output costing is also called Unit Costing (or) Single Costing. This method of costing is

applicable where a concern undertakes mass and continuous production of single unit or two

or three types of similar products or different grades of the same products. Under this method

cost per unit is measured by dividing the total cost by number of units produced. Process

Costing is used in industries like Cement, Cigarettes, Pencils, Quarries etc.

Batch Costing is used in drug industries, ready-made garments industries, electronic

components manufacturing, T V Sets, etc.


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We have to prepare cost sheet for particular Batch size. The Overall amount of fixed cost will

not change according to Batch size but per unit fixed cost will be change according to Batch

size.

3. Contract Costing

Under this method, costs are collected according to each contract work. Contract costing is

also termed as Terminal Costing. The principles of job costing are applicable to contract

costing and are used by such concerns of builders, public works contractors, constructional

and mechanical engineering firms and ship builders etc. who undertake work on a contract

basis.

Here, the cost of each contract is ascertained separately. It is suitable for firms engaged in the

construction of bridges, roads, buildings, etc.

Features Of Contract Costing

Following are the distinctive features of contract costing:

1. A separate contract account is maintained for each contract

2. Each contract is considered as a cost unit.

3. A major portion of contract work is done at the contract site.

4. Expenses incurred at the contract site are considered to be direct expenses.

5. Establishment expenses like head office, central store department are treated as overhead

expenses. These overheads are recovered either based on the material consumption ratio,

labor cost ratio, labor hour ratio or the value of material or labor consumption ratio.


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6. Number of contract works with a contractor may not be very large.

When the form of work will be big, at that time, we will use contract costing. We keep

different contract account for each contract. Contract costing is used in building

construction, machine construction contract. Actually like job costing, we will calculate the

cost of material, cost of labour and cost of overhead of each contract. Suppose, we have to

construct the 40 foot by 40 foot shopping mall. This one contract will be the cost unit. Our

contract price is just like our sale value. After deducting our all expenses, we will calculate

our profit from contract. If any contract goes more than one year, we will calculate the notion

profit on the basis of completed work of contract.

4. Process Costing

Process costing is used where production process will active all the time. Every production in

one process will be the raw material of other process. Because produced product will become

at the end of process, we will not only calculate the cost of each process but we will calculate

the unit cost. For every process, we will open process account. We will show all the expenses

relating to process in it. We will use the process costing in oil industry, chemical industry,

paper industry etc.

This kind of costing is used for the products which go through different processes. For

example, manufacturing cloths goes through different process. Fist process is spinning. The

output of spinning is yarn. It is a finished product which can be sold in the market to the

weavers as well as use as a raw material for weaving in the same manufacturing unit. For the

purpose of finding out the cost of yarn, the cost of spinning process is to be ascertained. The

second step is the weaving process. The output of weaving process is cloth which also can be

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sold as a finished product in the market. In such case, the cost of cloth needs to be evaluated.

The third process is converting cloth in to finished product such as shirt or trouser etc. Each

process is to be evaluated separately as the output of each process can be treated as a finished

good as well as consumed as a raw material for the next process. In such industries process

costing is used to ascertaining the cost at each stage of production.

5. Unit Costing

Unit costing is also called single or output costing. This method of costing is used for

products which can be expressed in identical quantitative units and is suitable for products

which are manufactured by continuous manufacturing activity. Costs are ascertained for

convenient units of output.

In cement industry, we can see the example of unit costing. Every bag of cement is

important. We will calculate its production cost when we have to decide its sale price. When

we produce the many units, we calculate unit cost by dividing total cost with total units of

product.

6. Operating Costing

When any company provides the service instead of production of goods, this method of

costing is used. For example, transport carriers, electricity distributing company, municipal

committee, hospitals and hotels.

Operating Costing method is normally used in service sector. When the service is not

completely standardized, it is the cost of producing and monitoring a service. It is a method


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of costing applied to undertakings which provide service rather than production of

commodities. Service may be performed internally and externally. Services are termed as

internal when they have to be performed on inter-departmental basis in factory itself e.g.

Power house services, canteen service etc.

We have to Calculate Cost & Quantity for Period of Operation.

It is concerned with the determination of the cost of each operation rather than process. It

offers scope for computation of unit operation cost at the end of each operation by dividing

the total operation cost by total output of units.

This method of costing is suitable for concerns rendering services.

Cost Unit:

Determining the suitable cost unit to be used for cost ascertainment is a major problem in

service costing. Selection of a proper cost unit is a difficult task. A proper unit of cost must

be related with reference to nature of world and the cost objectives.

The cost unit related must be simple i.e. per bed in a hospital, per cup of tea sold in a canteen

and per child in a school. In a certain cases a composite unit is used i.e. Passenger –

Kilometer in a transport company.

The following are some of example of cost units used in different organizations


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Different Organizations Cost Units

Enterprises Cost per unit

Passenger transport Kilometer

Goods transport Ton – Kilometer

Hotel Per room per day

Hospital Per bed per day

Canteen Per item, per meal

Water supply Per 1000 liters

Electricity Per kilowatt


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PART – II

“Costing techniques plays significant role in decision making, cost control and cost

reduction.” Through the statement with the help of following Costing techniques.

a) Marginal Costing

b) Standard Costing

c) Budgetary Costing.

Solution:-

1. Marginal Costing

Marginal costing is not a system of costing. It is a technique used by the management to

measure the profitability of the undertaking by considering the behaviour of costs. On the

other hand, it is a technique that applies the existing methods in a particular way to bring out

the relationship between profit and volume of output. It is the establishment of marginal cost

to decide the relationship between profit and volume of output.

Marginal cost is synonymous with variable costs, prime costs plus variable overheads in the

short run but, in a way, would also include fixed cost in the planning production activities

over a long period of time involving an increase in the productive capacity of business.

Theoretically marginal cost and differential cost are the same. If there is no change in fixed

cost then both these cost will be same. Thus marginal cost does not include fixed cost at all

whereas differential cost may include an element of fixed cost as well if fixed cost changes

due to a decision.


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1.1 Decision Making

It is a simple technique in decision making. Since fixed overheads are not included in

the cost of production there is no need for complicated and expensive method of

finding out overheads recovery rate, its modifications from time to time and allocating

overheads. Thus, this technique is free from complications and confusion.

Management can easily understand the income statement prepared by allocating fixed

expenses and variable expenses separately. Moreover, stock valuation becomes easier

since it is valued at marginal cost which remains constant.

The main utility of marginal costing lies in the fact that this technique helps the

management in taking various important managerial decisions—particularly in

dealing with problems that require-short-term decision.

1.2 Cost Control

Marginal Costing is essentially a managerial tool for cost control, cost analysis and

cost presentation. It presents the data in a manner which helps the various levels of

management for controlling costs. It is also an important tool for cost reduction. Since

this technique recognises only variable costs, which are always controllable, it

becomes easier to fix the responsibility for these costs and to effect control over them.

On the other hand, fixed costs can be controlled effectively because they are treated as

a whole in the determination of profit. This technique contributes significantly to the

area of price policy and price determination. If the organisation faces the problem of

fixing optimum price, minimum price, dumping price or price under recession, correct

and sound decision may be taken on the basis of information revealed by technique of

marginal costing.


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1.3 Cost Reduction

Marginal Costing helps the management in the area of Cost Reduction and Profit

planning. Break-even Analysis and Margin of Safety are the tools for profit planning.

It also facilitates the analysis of cost profit-volume relationship. The contribution ratio

of marginal ratio which is the ratio of marginal contribution to sales indicates the

relative profitability of the different sectors of business organisation whenever there is

a change in variable cost, fixed costs, sale price or product mix. The technique of

Marginal Costing serves as a tool of cost reduction and profitability appraisals. The

different departments have revenue earning potentialities. The performance of each

department or segment can be measured or evaluated by means of marginal cost

analysis and thus the cost is controlled.

2. Standard Costing

Standard costing is the technique of using standard costs for the purposes of cost control. It is

a system of cost accounting which is designed to find out how much the cost of a product

under defined conditions should be. Standard costing is a management control technique for

every activity. The actual cost can be ascertained only when production is undertaken. The

predetermined cost is compared to the actual cost and a variance between the two enables the

management to take necessary corrective measures.

It is not only useful for cost control purposes but is also helpful in production planning and

policy formulation. It allows management by exception.

It enables the management to evaluate performance of various cost centers by comparing

actual costs with standard costs. The performance variances are determined by comparing

actual costs with standard costs. Management is able to spot out the place of inefficiencies. It


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can fix responsibility for deviation in performance. It is possible to take corrective measures

at the earliest. A regular check on various expenditures is also ensured by standard cost

system.

2.1 Decision Making

The most important benefit which may be derived from a standard costing system is

the atmosphere of cost consciousness which is fostered among executives and

foremen. Each individual is aware that the costs and output for which he is

responsible are being measured, and that he will be called on to take whatever action

is necessary should large variances occur. As we concluded earlier, if the philosophy

of top management is positive and supportive, standard costing may act as an

incentive to individuals to act in the best interest of the firm. Moreover, a standard

costing system which allows subordinates to participate in setting the standards

fosters a knowledge of costing down to shop floor level, and assists in decision

making at all levels. Thus, if there should occur spoilt work necessitating a decision

from the foreman in charge on whether to scrap or rectify the part involved, a

knowledge of costs will enable him to make the best decision.

2.2 Cost Control

Standard costing is a useful method of control in a number of ways. First, the process

of evaluating performance by determining how efficiently current operations are

being carried out may be facilitated by the process of management by exception. Very

often the problem facing management is the time lost in sifting large masses of

feedback information and in deciding what information is significant and relevant to

the control problem. Management by exception overcomes this problem by


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highlighting only the important control information that is the variances between the

standard set and the actual result. This process allows management to focus attention

on important problems so that maximum energy may be devoted to correcting

situations which are falling out of control.

2.3 Cost Reduction

A standard costing system may lead to cost reductions. The installation of such a

system demands a re-appraisal of current production methods as it necessitates the

standardization of practices. This examination often leads to an improvement in the

methods employed which is reflected in a reduction of the costs of the product. One

example of cost reductions through increased efficiency may be seen in the

simplication of the clerical procedures relating to inventory control. All similar items

of inventory may be recorded in the accounts at a uniform price; this eliminates the

need which arises under historical costing for re-calculating a new unit price

whenever a purchase of inventory is made at a different price.

3. Budgetary Costing

Budgetary control is very important in the management of an organisation because it helps in

achieving organizational goals. Once the final budget is agreed to, it becomes a plan against

which the actual cost, revenue and performance are periodically reviewed and compared

with.

Budgetary control is exercised by line management for control over cost through continuous

appraisal of actual expenditures, using as a guide the planned costs as expressed in the

budget. The principle is also applied to the various types of income and to items that affect

the balance sheet, such as receivables inventories, cash, fixed assets, etc.


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Budgetary control is the preparation of targets or budgets for agreed areas of business. An

area may be a functional management area e.g. sales, purchases or production it may be an

agreed cost centre area, e.g. machinery assembly, planning which may consist of a machine,

group of machines or a group of employees.

3.1 Decision Making

Budgeting and budgetary control has been viewed as a tool to management decision.

Budget fulfills both planning and control purpose. Though, during strategic and

tactical planning, some limitations may be imposed which are capable of hindering

the planning process. These are known as limiting factors which are market demand

for the products, the number of skilled employees available, the availability of

materials supplies; and the amount of each credit facilities available to finance the

business. Some of these limitations may be due to natural causes which will

eventually be modified and most of them can be overcome or avoided by planning

decisions. The result in the decision making is derived at by going through the correct

channels budgeting process and stages to reach a decision.

3.2 Cost Control

Budgetary control, as such, controls nothing. Management has a control “yardstick”

and when the actual results are compared with the budget figure management should

be prompted into action. The information can assist in controlling operations and

improving decision making budgetary control of it will control nothing.

It is the importance of budgetary control that with this, we can use the forecasting

techniques. Three departments work hard for calculating best estimation of future.

Accounting department provides old data. Statistical department provides the tools


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and techniques of forecasting like probability, time series other sampling methods.

Management department uses both department services to estimate the expenditures

and revenue of business under the normal conditions of business. So, no departments

say anything wrong in making of budget. So, it is necessary for business to use

budgetary control techniques.

3.3 Cost Reduction:

As time passes, the actual performance of an operation can be compared against the

planned targets. This provides prompt feedback to employees about their

performance. If necessary, employees can use such feedback to adjust their activities

in the future and reduce the cost respectively.

Feedback received in the form of budget report from the responsibility centre. This

report is helpful to know the performance of the concerned unit and reducing cost to

achieve desired results.

Any unexpected changes into the conditions which were prevailing at the time of

preparing budget are taken into account and budgets are revised to show true

performance yardstick.


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PART – III - A

Question No. 01

DISCUSS THE NATURE AND APPLICATION OF PROCESS COSTING

Solution : -

Meaning of Process Costing

Process Costing is a method of costing used in industries where the material has to pass

through two or more processes for being converted into a final product. It is defined as “a

method of Cost Accounting whereby costs are charged to processes or operations and

averaged over units produced”. A separate account for each process is opened and all

expenditure pertaining to a process is charged to that process account. Such type of costing

method is useful in the manufacturing of products like steel, paper, medicines soap,

chemicals, rubber, vegetable oil, paints, varnish etc. where the production process is

continuous and the output of one process becomes the input of the following process till

completion.


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The processes in this industry are-

Cane Shredding

The cane is broken/cut into small pieces to enable easier movement through the

milling machine.

Milling

The shredded cane is passed through rollers which crush them to extract cane juice.

[Similarly, to the cane juice extracted by the vendors who sell you sugar cane juice.]

Heating and Adding lime

The extracted juice is then heated to make it a concentrate and lime is added to the

heated juice.

Clarification

Muddy substance is removed from the concentrate through this process.

Evaporation

Water is removed from the juice by evaporation.

Crystallization and Separation

Sugar crystals are grown from the dry juice concentrate in this process.

Spinning

Molasses are separated from sugar using Centrifugals in this process.

Drying

Sugar is obtained by drying the wet raw sugar obtained in the spinning process.

Following general principles are followed for cost determination under Process

Costing—

(a) The production activities of the factory are classified by processes or departments.


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Each process or department includes a number of operations, none of which is separately

measurable and each of which completes a distinct stage in the manufacture of the product.

The boundaries of the process are determined by

(i) Jurisdiction or supervision,

(ii) Similarity of work performed, and

(iii) Physical location of men and machines in the plant.

(b) All direct and indirect cost of a particular period is classified by processes.

Each process account is debited with the amount of direct material, and labour and with a

proportionate part of overhead expenses.

(c) Production in terms of physical quantities is recorded in respective process accounts.

(d) The total cost of each process is divided by the total production of the process and

average cost per unit for the period is obtained.

(e) When products are processed in more than one department, costs of one department are

transferred to the next department as initial costs. The total cost and cost per unit is thus

determined by cumulating costs of different departments.

(f) In case of loss or spoilage of units in a department, the loss is borne by the units produced

in that department. Thus the average cost per unit is increased.

Basic features / Applications:

Industries, where process costing can be applied, have normally one or more of the following

features:

1. Each plant or factory is divided into a number of processes, cost centres or

departments, and each such division is a stage of production or a process.


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2. Manufacturing activity is carried on continuously by means of one or more

process run sequentially, selectively or simultaneously.

3. The output of one process becomes the input of another process.

4. The end product usually is of like units not distinguishable from one another.

5. It is not possible to trace the identity of any particular lot of output to any lot of

input materials. For example, in the sugar industry, it is impossible to trace any lot

of sugar bags to a particular lot of sugarcane fed or vice versa.

6. Production of a product may give rise to Joint and/or By-Products.

2. Costing Procedure:

The Cost of each process comprises the cost of :

(i) Materials

(ii) Labour

(iii) Direct expenses, and

(iv) Overheads of production.

Materials –

Materials and supplies which are required for each process are drawn against material

requisitions from stores. Each process for which the above drawn materials will be

used should be debited with the cost of materials consumed on the basis of the

information received from the Cost Accounting department. The finished product of

first process general y become the raw materials of second process; under such a

situation the account of second process, be debited with the cost of transfer from the


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first process and the cost of any additional material required under this second

process.

Labour –

Each process account should be debited with the labour cost or wages paid to labour

for carrying out the processing activities. Sometimes the wages paid are apportioned

over the different processes after selecting appropriate basis.

Direct expenses –

Each process account should be debited with direct expenses like depreciation,

repairs, maintenance, insurance etc. associated with it.

Overheads of production –

Expenses like rent, power expenses, lighting bills, gas and water bills etc. are known

as production overheads. These expenses cannot be allocated to a process. The

suitable way-out to recover them is to apportion them over different processes by

using suitable basis. Usually, these expenses are estimated in advance and the

processes debited with these expenses on a pre-determined basis.


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Question No. 02

DISCUSS THE CONCEPT OF NORMAL PROCESS LOSS, ABNORMAL

PROCESS LOSS AND ABNORMAL GAIN IN THE PROCESS OF

ASCERTAINING COST OF FINISHED PRODUCT.

Solution: -

Treatment of Normal Process Loss, Abnormal Process Loss and Abnormal Gain

Loss of material is inherent during processing operation. The loss of material under different

processes arises due to reasons like evaporation or a change in the moisture content etc.

Process loss is defined as the loss of material arising during the course of a processing

operation and is equal to the difference between the input quantity of the material and its

output.

There are two types of material losses viz. (i) Normal loss and (ii) Abnormal loss.

(i) Normal Process Loss:

It is defined as the loss of material which is inherent in the nature of work. Such a

loss can be reasonably anticipated from the nature of the material, nature of operation,

the experience and technical data. It is unavoidable because of nature of the material

or the process. It also includes units withdrawn from the process for test or sampling.

This means the usual percentage of wastage arising in a particular process or

operation.

The loss due to normal wastage should be charged to the effectives, i.e. the good units

arising out of the process. Thus, cost of spoiled and lost units is absorbed as an


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additional cost of good units produced by the process. In this connection the following

points must not be lost sight of:

(a) In some cases the defective or scrapped units possess some value. This amount

should be credited to the process concerned.

(b) In case the scrap is of very small value, it will be inexpedient to credit each

process with the amount which the scrap can realise. It will be better to credit the

total proceeds of the scrap in such a case to Works Overheads Account. In any

case loss in weight or volume must be shown in the Process Account.

(c) In some processes a proportion of the output must be re-worked either in the same

process or an earlier one. The value of such output is not more than the value of

crude materials to which it corresponds. The relevant process should be credited

with the value of such crude material and should be charged to the process to

which such material is relegated.

Treatment in Cost Accounts:

The cost of normal process loss in practice is absorbed by good units produced under

the process. The amount realized by the sale of normal process loss units should be

credited to the process account.

(ii) Abnormal Process Loss:

It is defined as the loss in excess of the pre-determined loss (Normal process loss).

This type of loss may occur due to the carelessness of workers, a bad plant design or

operation, sabotage etc. Such a loss cannot obviously be estimated in advance. But it

can be kept under control by taking suitable measures.


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It consists of loss in excess of the normal process loss. This loss is due to carelessness,

bad plant design or operation, sabotage etc. The management must keep a close watch

on this loss to find out the exact point in the production process at which the units are

lost and take steps to check it at the earliest.

Abnormal wastage should not be allowed to affect the cost of good units otherwise

cost of production per unit will unnecessary fluctuate and costing itself will give

misleading results. At the same time it is necessary to show the amount of abnormal

loss in cost accounts. It will be easy for students to follow the following procedure:

(a) Find out the quantum of Normal Loss. This is to be shown as discussed before.

(b) Find out the cost of production per unit of the relevant process (after considering

normal loss) assuming that there is no abnormal loss.

(c) Multiply the lost abnormal units with the cost per unit [computed as per (b)]. This

will give you the total value of abnormal wastage.

(d) Debit ‘Abnormal Wastage Account’ and credit the relevant Process Account with

the amount and quantity of abnormal wastage.

(e) The balance now in the Process Account is the cost of good units produced by the

process.

(f) Credit the Abnormal Wastage Account with any saleable value of abnormal loss

units.

(g) “Abnormal Wastage Account” will be closed by transferring it to the Costing

Profit and Loss Account.



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The cost of an abnormal process loss unit is equal to the cost of a good unit. The total

cost of abnormal process loss is credited to the process account from which it arises.

Cost of abnormal process loss is not treated as a part of the cost of the product. In fact,

the total cost of abnormal process loss is debited to costing profit and loss account.

(iii) Abnormal Process Gains:

Sometimes, loss under a process is less than the anticipated normal figure. In other

words, the actual production exceeds the expected figures. Under such a situation the

difference between actual and expected loss and actual and expected production is

known as abnormal gain. So abnormal gain may be defined as unexpected gain in

production under normal conditions.

The Abnormal Gain is also known as Abnormal Effectiveness. In case the actual

production of a process is more than the expected production, the excess is known as

abnormal effectiveness. The presence of abnormal effectiveness should not affect the

cost of good units in the normal circumstances. They, therefore, shall be valued at the

rate at which the good units would have been valued had there been wastage at the

normal rate. The amount shall be debited to the relevant Process Account and credited

to “Abnormal Effectives Account” which will be closed by transferring to the Costing

Profit and Loss Account.


The process account under which abnormal gain arises is debited with the abnormal

gain and credited to Abnormal gain account which will be closed by transferring to


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the Costing Profit and loss account. The cost of abnormal gain is computed on the

basis of normal production.

HOW TO VALUE ABNORMAL GAIN OR ABNORMAL LOSS OR TRANSFER TO

OTHER PROCESS.

Rate per unit =

Total Input cost-Scrap value of normal loss & By product

Total units introduced-Normal loss units.& by-product units


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Question No. 03

DISCUSS THE CONCEPT OF EQUIVALENT PRODUCTION AND ITS

APPLICATION IN PROCESS COSTING UNDER FIFO METHOD AND

WEIGHTED AVERAGE METHOD.

Solution: -

COSTING OF EQUIVALENT PRODUCTION UNITS

Manufacturing products is a continuous process. At the end of the accounting period

generally in all manufacturing firms there is some work-in-progress. The cost of such work is

determined by calculating Equivalent or Effective Production.

Accounting Procedure:

The following procedure is followed when there is Work-in- Progress

(1) Find out equivalent production after taking into account of the process losses, degree of

completion of opening and / or closing stock.

(2) Find out net process cost according to elements of costs i.e. material, labour and overheads.

(3) Ascertain cost per unit of equivalent production of each element of cost separately by

dividing each element of costs by respective equivalent production units.

(4) Evaluate the cost of output finished and transferred work in Progress.

The total cost per unit of equivalent units will be equal to the total cost divided by effective

units and cost of work-in progress will be equal to the equivalent units of work-in progress

multiply by the cost per unit of effective production.


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In short the following from steps an involved.

Step 1 – prepare statement of Equivalent production

Step 2 – Prepare statement of cost per Equivalent unit

Step 3 – Prepare of Evaluation

Step 4 – Prepare process account

Equivalent or Effective Production

Equivalent or effective production implies production of a process in a terms of completed

units. For example, if 60 units are incomplete in process A, and they have been estimated at

75% complete, the stock at the end of the accounting period be taken as equivalent to 45%

complete units. A correct estimates regarding the degree of completion is very necessary

because erroneous valuation of these units will affect the valuation of stock in final accounts.

In the case of process type of industries, it is possible to determine the average cost per unit

by dividing the total cost incurred during a given period of time by the total number of units

produced during the same period. But this is hardly the case in most of the process type

industries where manufacturing is a continuous activity. The reason is that the cost incurred

in such industries represents the cost of work carried on opening work-in-progress, closing

working-progress and completed units. Thus to ascertain the cost of each completed unit it is


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necessary to ascertain the cost of work-in-progress in the beginning and at the end of the

process.

FORMAT FOR CALCULATING EQUIVALENT PRODUCTION


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The valuation of work-in-progress presents a good deal of difficulty because it has units

under different stages of completion from those in which work has just begun to those which

are only a step short of completion. Work-in-progress can be valued on actual basis, i.e.,

materials used on the unfinished units and the actual amount of labour expenses involved.

However, the degree of accuracy in such a case cannot be satisfactory. An alternative method

is based on converting partly finished units into equivalent finished units.

Equivalent production means converting the incomplete production units into their

equivalent completed units. Under each process, an estimate is made of the percentage

completion of work-in-progress with regard to different elements of costs, viz., material,

labour and overheads. It is important that the estimate of percentage of completion should be

as accurate as possible. The formula for computing equivalent completed units is:


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Equivalent completed units =

{Actual number of units in the process of manufacture} × {Percentage of work completed}

For instance, if 25% of work has been done on the average of units still under process, then

200 such units will be equal to 50 completed units and the cost of work-in-progress will be

equal to the cost of 50 finished units.

Manufacturing products is a continuous process. At the end of the accounting period

generally in all manufacturing firms there is some work-in-progress. The cost of such work is

determined by calculating Equivalent or Effective Production.

EQUIVALENT UNITS OF PRODUCTION – WEIGHTED AVERAGE METHOD:

At the end of most accounting periods, there is a balance in work-in-process

inventory. This means incomplete units are still in process and must be assigned costs

to in proportion to how complete they are with respect to each of direct materials,

direct labor and manufacturing overhead.

To simplify the calculations, partially completed units are converted into equivalent

whole units for each type of cost. Units completed and transferred out are always

100% complete for all types of costs.

Cost of Finished Goods


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EQUIVALENT UNITS OF PRODUCTION - FIFO METHOD

In the weighted average method opening inventory values are added to current costs to

provide an overall average cost per unit. With FIFO, opening WIP units are distinguished

from those units added in the period.

Unlike the weighted-average method, the FIFO method does not combine beginning

inventory costs with current costs when computing equivalent unit costs. The FIFO method

considers the beginning inventory as a batch of goods separate from the goods started and

completed within the same period. The costs from each period are treated separately. We

follow the same five steps as in the weighted-average method, however, in determining

product costs.

With FIFO it is assumed that the opening WIP units are completed first.

This means that the process costs in the period must be allocated between:

TOTAL COSTS

Cost of opening

WIP brought forward

Cost of Closing

WIP carried forward

Period Costs

Cost of Finished Goods

http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Materials%20costs.aspx?mode=none


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opening WIP units

units started and completed in the period (fully-worked units)

Closing WIP units.

This also means that if opening WIP units are 75% complete with respect to materials and

40% complete with respect to labour, only 25% 'more work' will need to be carried out with

respect to materials and 60% with respect to labour.


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COMPARISON OF WEIGHTED-AVERAGE AND FIFO METHODS

The key difference between the weighted-average and FIFO methods is the handling of

partially completed beginning work-in-process inventory units.

The FIFO method separates the units in the beginning inventory from the units started and

completed during the period. In contrast, the weighted-average method makes no separate

treatment of the units in the beginning work-in-process inventory.

The FIFO method separates costs of the beginning work-in-process inventory from the

current period costs, and it uses only the current period costs and work effort to calculate

equivalent unit costs. As a result, the FIFO method separately calculates costs for units in the

beginning inventory and units that were started during the period.

Current period costs

Cost of Finished

Opening WIP

Cost of Finished Output

Cost of units started and

finished

Cost of units started but not finished

Cost of Closing WIP

carried forward

Costs of Opening WIP

brought forward


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In contrast, the weighted-average method uses the calculated average unit cost for all units

completed during the period, including both the beginning work-in-process inventory and the

units started and completed during the period.

The weighted-average method generally is easier to use because the calculations are simpler.

This method is most appropriate when work-in-process is relatively small, or direct materials

prices, conversion costs, and inventory levels are stable. The FIFO method is most

appropriate when direct materials prices, conversion costs, or inventory levels fluctuate.

Some firms prefer the FIFO method over the weighted-average method for purposes of cost

control and performance evaluation because the cost per equivalent unit under FIFO

represents the cost for the current period’s efforts only. Firms often evaluate department

managers’ performance on only current period costs without mixing in the effects of

performance during different periods.

Under the weighted-average method, the costs of the prior period and the current period are

mixed, and deviations in performance in the current period could be concealed by inter period

variations in unit costs.


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Question No. 04

DISCUSS THE CONCEPT OF INTER PROCESS PROFIT AND ITS

APPLICATION IN PROCESS COSTING.

Solution: -

MEANING OF INTER-PROCESS PROFIT

The profit associated with the transfer of goods from one process to another process is called

inter-process profit. Normally, finished goods are transferred to the immediate next process at

the cost of production basis. In some process industries, finished goods are transfer to the

immediate next process by including a nominal amount of profit. The profit so incorporated

is called inter-process profit. The price fixed by adding the nominal amount of profit for the

transfer of finished goods to the next process is known as transfer price. Adding profit on the

goods transferred is termed as mark-up price.

Transfer Price = Cost of output+ Profit

Sometimes it is considered desirably 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 one 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 to the process, each process account will show

some profit. This profit is termed as inter-process profit.


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The system of accounting for inter-process profits has the following advantages:

1. It is very helpful for those businesses where there is a possibility of getting certain process

performed outside the factory. If the market price of similar processed goods is less than the

cost of manufacturing the goods in the factory, it will be beneficial for the business to buy

partly processed materials rather than carrying the processing work internally.

2. The efficiency and economy of each process can be judged independently as the

economies effected one process due to its efficiency are not transferred to the next process.

Objectives Of Inter-Process Profit

The output of a particular process is transfer to the next process by adding a nominal amount

of profit for the following objectives:

* To assess the performance of the process operation.

* To examine whether the output can compete with the MARKET or not.

* To decide whether the output should be sold without further processing or putting for

further processing

ADJUSTMENTS FOR INTER-PROCESS PROFITS

It is a sound financial principle that stock for balance sheet purposes should be valued at cost

or market price whichever less is. Cost here means ‘Cost’ to the business as a whole. Thus, it

is necessary to eliminate the inter-process profits included in the value of inventory in each

http://accountlearning.blogspot.in/2010/10/inter-process-profit-and-its-objectives.html


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process and the stock of finished goods at the end of the accounting period. A business

cannot earn profit by trading with itself and, therefore, suitable adjustments are made in the

value of closing inventory of each process and stock of finished goods by creating a Stock

Reserve for an appropriate amount. Besides that value of stock of inventories fluctuates from

year to year and, therefore, the Stock Reserve will have to be increased or decreased

according to the circumstances.

This profit on closing stock can be calculated with following formula :

http://1.bp.blogspot.com/_DJEIRrK4tl4/TOKEJe9h_BI/AAAAAAAAGHw/VFG7brZ9wJQ/s1600/profit+on+closing+stock.PNG


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REFERENCE/ BIBILOGRAPHY

http://dosen.narotama.ac.id/

http://info.smithersrapra.com/

http://www.cimaglobal.com/

http://www.fao.org/

http://www.accountingtools.com/

http://www.svtuition.org/

http://accountlearning.blogspot.in/

http://iamsam.hubpages.com/

www.icai.org

SEARCH ENGINE:

https://www.google.co.in/

http://dosen.narotama.ac.id/

http://info.smithersrapra.com/

http://www.cimaglobal.com/

http://www.fao.org/

http://www.accountingtools.com/

http://www.svtuition.org/

http://accountlearning.blogspot.in/

http://iamsam.hubpages.com/

https://www.google.co.in/