cost accounting book of 3rd sem mba @ bec doms

8/2/2019 Cost Accounting Book of 3rd Sem Mba @ Bec Doms

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Cost Accounting

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Contents

Lesson: 1 Introduction of Cost Accounting

Definition – Cost Concepts – Element of Cost – Installation of Costing SystemLesson: 2 Material Cost

Nature – Purchasing Functions – Stores Control – Stock Levels – EOQ – Pricing or Material Issues –

ABC-Analysis – Material houses.

Lesson: 3 Labour Cost

Nature – Wage Policy – Wage Payment methods – Incentive schemes, Leson turnmen.

Lesson: 4 Overhead Cost

Nature - Classification – Allocation – Apportionment of overhead cost – Absorption of overhead:

methods, Machine Hom Rate method.

Lesson: 5 Job Costing and Batch Costing

Nature – features – Cost Sheet preparation – Utilities – Limitations.

Lesson: 6 Contract Costing

Features – Types or Contract

Lesson: 7 Process Costing

Simple Process Costing – Process with Normal and abnormal causes – Inter process profitLesson: 8 Standard Costing and Variance Analysis

Definition – Uses and Limitations – Material Cost Variance – Labour Cost Variance – Overhead Cost

Variance and Sales Variance

Lesson: 9 Cost Ledger Accounting

Nature – Control Accounts and its Uses – Preparation of Cost Ledger Account

Lesson: 10 Integral Accounting

Nature – Uses – Preparation of Integral Accounts

Lesson: 11 Reconciliation of Cost and Financial Accounts – Need for Reconciliation – Steps in reconciliation –

Preparation of Reconciliation Statement.

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Lesson: 1

INTRODUCTION OF COST ACCOUNTING

Cost Accountancy

“It is the application of costing and cost accounting principle, method and techniques to the

science, art and practice of cost control and the ascertainment of profitability. It includes the

presentation of information derived there from for the purpose of managerial decision – making”.

The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-

control and Profitability – ascertainment. It serves as an essential tool of the management for decision –

making.

Cost Accounting

“The process of accounting for cost from the point at which expenditure is incurred or

committed to the establishment of its ultimate relationship with cost centres and cost units. In its widest

usage it embraces the preparation of statistical data, the application of cost control methods and the

ascertainment of the profitability of activities carried out or planned” Cost accounting means such

as analysis of accounting and other information as to enable management to know the cost involved ineach activity together with its significant constituent elements in order to arrive at proper decisions.Cost

accounting provides management with cost data relating to products, processes, jobs and different

operations in order to control the costs and maximize the earnings. It play a vital role in all the business

activities.

Definition of Cost Accounting

The application of costing and cost accounting principles, methods and techniques to the

science, art and practice of cost control and the ascertainment of profitability. It includes the

presentation of information derived these from for the purpose of managerial decision making.

Objects of Cost Accounting

1. To serve as a guide to price fixing of products.

2. To disclose sources to wastage in various operations of manufacture.

3. To reveal sources of economy in production process.

4. To provide for an effective system of stores and material.

5. To measure the degree of efficiency of the various departments or units of production.

6. To provide suitable means and information to the top management to control and guide the operations

of the business organisation.

7. To exercise effective control on the costs, time and efforts of labour, machines and other factors of production.

8. To compare actual costs with the standard costs and analyse the causes of variation.

9. To provide necessary information to develop cost standards and to introduce the system of budgetary

control.

10. It enables the management to know where to economize on costs, how to fix prices, how to maximize profit and so on.

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TECHNIQUES AND METHOD OF COSTING

The types and techniques of costing are as follows:

1. Historial Costing:

‘The ascertainment of costs after they have been incurred’ Historical costs are, therefore, ‘postmortem’

costs as under this method all the expenses incurred on the production are first incurred and them the costs areascertained.

2. Standard Costing:

‘The preparation and use of standard costs, their comparison with actual costs and the analysis of variance to their causes and points of incidence’.

Here the standards are first set and then they are compared with actual performances. The difference

between the standard and the actual is known as the variance. The variances are analyzed to find out their causes

and also the points or locations at which they occur.

3. Marginal Costing:

‘The ascertainment of marginal costs and of the effects on profit of changes in volumes or type of

output by differentiating between fixed costs and variable costs’.

The fixed costs are those which do not change but remain the same, with the increase or decrease in the

quantum of production. The variables costs are those which do change proportionately with the change in

quantum of production.

The marginal costing takes into account only the variable costs to find out ‘marginal costs’. The

difference between Sales and Marginal costs is known as ‘Contribution’ and contribution is an aggregate of

Fixed costs and Profit/Loss. So the fixed costs are deducted from the contribution to find out the profits.

Marginal costing is a technique to ascertain the effect on profits. Marginal costing is a technique to ascertain the

effect on profit by the change in the volume of output or by the change in the type of output.

4. Direct Costing:

The practice of charging all direct cost to operations, process or products, leaving all the indirect costs to be

written off against profits in the period in which they arise

5. Absorption Costing

‘The practice of charging all costs, both variables and fixed, to operations, processes or products.

This is the traditional technique as opposed to Marginal or Direct costing techniques. Here both the fixed

and variables cost are charged in the same manner.

Methods of Costing

The methods of costing can be divided into three main groups:

1. Job Costing;

2. Process Costing; and

3. Farm Costing.

1. Job Costing: The job costing methods are applicable where the unit of manufacture is one and

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complete in itself. They include printers, job foundries, tool manufactures, contractors, etc. the followingmethods are included in Job Costing:

(i) Contract Costing: This method if applied in undertakings erecting buildings or carrying out

constructional works, e.g., House buildings, ship building, Civil Engineering contracts. Here the cost

unit is one and completed in itself. The cost unit is a contract which may continue for over more than a

year. It is also known as the Terminal Costing, since the works are to be completed within a specified

period as per terms of contract or agreement executed by the contractor and contractee.

Contracts can be differentiated from fobs in as much as the contracts jobs are carried out outsidethe factory and generally are of a long-term while jobs are carried out inside the factory and are

of a short duration. If an order complete in itself and meant only for the person who has placed

the order, this job-order is executed inside the press and the completion of the order takes a

short time as against the contract which may take years.

(ii) Batch Costing: In this method, a batch of similar or identical products is treated as a job. Here the unit

of cost is a batch of group of products, costs are collected and analyzed according to batch numbers and the

costs are ascertained batch wise. This method is applied in pharmaceutical industries where medicines or

injections are manufactures batch wise or in general engineering factories producing components in convenient

batches.

1. Process Costing: Process costing method is applicable to those industries manufacturing an number of units of output requiring processing. Here an article has to undergo two or more processes for reaching the stage

of finished goods and succeeding process till completion.

Classification of Cost

The cost-classification is the process of grouping costs according to their characteristics. The cost can

be classified into the following:

1. According to elements;

2. According to Functions or Operations;

3. According to Nature or Behaviour,

4. Accounting to Controllability,

5. According to Normality,

6. According to Relevance to decision-making and Control.

• According to Elements: The cost is classified into i) Direct Cost, and ii) Indirect Cost according to

elements, viz., Materials, Labour and Expenses, the description of which occurs in the earlier pages of this

chapter.

• According to Functions: the cost is classified into the following:

i) Production Cost or Manufacturing Cost,

ii) Administration Cost,

iii) Selling Cost, and

iv) Distribution Cost,

A brief description of each these items are given below:

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the benefit of services of the department. Suppose, the cost of Power departments is shared by the MachineDepartment, the cost of this share is uncontrollable as it has no control over the cost of the other department,

viz., the Power Department.

• 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.

• According to relevance to decision-making and Control:

The costs classified on this basis are the following

i) Shut-down Cost: A cost which will still be 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 etc., is known as shut-down

cost.

ii) Shun Cost: A cost which has been incurred in the past or sunk in the past and is not relevant to the

particular decision-making is a sunk cost. If it is decided to replace the existing plant; the written down book value of the plant less the sale value of the existing plant, is a Sunk a Irrevocable cost.

iii) Opportunity Cost: “The net selling price, rental value or transfer value which could be obtained at a point in time if a particular asset or group of assets were to be sold, hired, or put to some alternative use

available to the owner at that time” is the opportunity cost. The cost which are related to the sacrifice made or

the benefits foregone are opportunity costs. to take an example, if a part of the factory building has been let out

on rent and now we want to use that portion for installing a plant, we would naturally lose the rent that we usedto get. So the loss of rent is the opportunity which would arise due to putting the part of that factory building to

an alternative use available to the owner, and this cost should be kept in view while installing the plant.

iv) Imputed cost: it is hypothetical cost required to be considered to make costs comparable. If the owner of

the factory charges rent of the factory to the cost of production to make cost comparable with that of those

undertakings which run production in rented factories, it is an Imputed cost as the rent has actually not been

paid. Some is the case with charging Interest on one’s own capital.

COST-CENTRE AND COST-UNIT

Cost are ascertained according to Cost Centres or Cost Units.

Cost-centre

A Cost-Centre is a very wide term and includes the Productions. Department Processes, Work orders, Service

Department, Operations, Machine Centers, Area or regions of sales, Warehouses, Persons, etc., of which the

cost is to be ascertained.A Cost-Centre can be classified into the following four types:

1. Impersonal, 2. Personal, 3. Operation, 4. Process.

For manufacturing operations, the cost centres may be Production cost centers, i.e., the Production Departments

engaged in producing, or the Service cost-centres, i.e., the Service Departments which help the production work

e.g., Store, Power Dept. Internal Transport Dept., Repairs and Maintenance Dept., etc.,

For sales operations, the cost-centres, all the machine or the persons operating those machines are brought

together under one cost-centre for determination and control of costs. where the work is carried on through

processes, each process is a cost centre. A machine or a group of machines can also be cost-centre. The Cost

Centres are very useful for analysis, ascertainment and control of costs.

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Cost Unit

A Cost Unit is a unit of quality of product, service, or time (or a combination of these) in relation to which costs

may be ascertained or expressed.

Job is a cost unit which consists of a single order (or contract).

Batch is a cost unit which consists of a group of identical items which maintains its identity throughout one or more stages of production.

Product Group is a cost unit which consists of a group of similar products.

Thus, cost unit is a sub-division into proper nomenclatures attributable to a unit of measurements of cost. Cost

Units are of two types: 1) Single. 2) Composite. The examples of Single Cost unit are-per tone, per meter, per

kilogram etc., and the examples of composite units are-per passenger-kilometer, per tone-kilometer etc.

INSTALLATION OF COSTING SYSTEM

The need and importance of the installation and the organisation of a good system of cost accounting are being

increasingly realized presently all over the business versatility. The common experience of enthusiastic youths

climbing the business – tree and falling mid-way without even collecting the leaves owes to the ignorance of he

use installation and organisatoin of accosting system, and to the infatuation that the profits could be earned

without it. A good system is the key-point governing, the mechanism of an enterprise in the field of costcontrol, ascertainment of profitability, and managerial decision-making.

Installation of a cost system is not an expense but an investment as the rewards are much greater than the

expenses incurred. The cost system is for the business and not the business for a system of cost. Therefore, the

system has to be so designed as to meet the specific needs of the enterprise.

A) General Consideration for installing Costing System

The general considerations to be observed in installing a costing system are as follows:

• The Objective: Whether the objective of installing the costing system is limited to a specific area, e.g.

material management, or fixing selling price. Or to arrive at a certain managerial decision; or the object is to

install the system for covering all the aspects of cost affecting the business. The approach to install the systemwill be dependent on its objectives.

• The Area of Operation: Having decided the objective, the areas of operation of the system are to be

studied, by which the management can be best benefited. If production is slack, attention will have to be paid to

increase it; if production is good but the sales are receding, study will be made to increase the sales and action

taken according to the results of study and analysis. Such areas which require immediate attention are to be

carved out on priority basis to be handled by the cost system,

• The Organisation of the Business: No system of cost installation would succeed until the organisation

structure of the business is taken into account. The organizational part would help to determine the scope of

working and improvement. If the interests of management call for certain minor changes in the organizational

structure, to its advantage, the same may have to be done.

• The Conception & Reception of the Idea: The idea of the installation of the cost system is to be placed

before the staff and the workers in a manner that it is well received and not objected to on flimsy grounds. The

success of the system would depend on the cooperation of he persons engaged in the enterprise, and the

cooperation will be forth coming only if the idea and plans are well conceived and received. The benefits of

introducing the system to all the sections should be well explained.

• Collection of Data & Prompt Information: The cost data works as a base for decision-making. There

should be evolved a proper system for the collection of the required cost data and information promptly.

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Secondly, there should be a system to verify the correctness of the data supplied, otherwise the conclusionsdrawn would be wrong and time spent in its working would go waste.

• Cost Records & Cost Books: The maintenance of cost records and cost books depends on the size and

nature of the business, but the basic requirements. The manner in which the financial accounts could be

interlocked into an integral accounting system has to be studied and worked out. Decision has to be taken if two

separate set of books-one for financial accounts and other for cost accounts-have to be maintained and thereafter

the results are to be reconcile. Proper books and records are to be kept and maintained to meet the requirements

of either of the two situations mentioned above.

• Control system for the Elements of Cost: System would have to be devised for recording and controlling

costs of materials, labour and overheads, in accordance with costing principles and procedures.

• Type and Method of Costing: The choice of method of costing would depend on the nature of

production, e.g., Job Cost method or the Process Cost method. For cost control, standard costing along with

Budgetary control may have to be selected and applied. Similarly, for decision making, Marginal and

Differential costing techniques may be found useful. Preparations for the application of the particular method

and technique/type should be made initially.

• Responsibility Accounting: Responsibility accounting is a technique of cost control by delegating, etc.,

known as responsibility centres. Its has to be judged whether a particular official who had been assigned a

particular function, has implemented the same or not within the time’ allotted to him, or not, and thus theresponsibility has got to be fixed for failure-action on individual persons, for the sake of control of cost. For this

purpose, a system of responsibility accounting should be evolved.

B) Specific considerations for installing costing system

The specific considerations as distinct from general considerations to be kept in view while installing a cost

system are as follows:

• Size and Nature of Business: In a business of big size, a detailed cost system is necessary while in a

small business, the system should be within the requirements so that the expenses on the installation and its

working may not out-weigh the utility.

• The cost system is good for business engaged in manufacturing or in service-rendering concerns but for others. Even in production enterprise like colliery where the production costs are all direct costs, the financial

where the production costs are all direct costs, the financial accounts may be so designed as to obviate the need

of any cost system, unless otherwise called for.

• Products: the nature of product determines the method of costing to be applied. If the material content of

the product is more valuable, the material cost records need be kept in comparatively more elaborate manner so

as to make material cost control effective. Same is the position with regard to labour and overhead.

• Organisatoin: The organizational set up for a costing system should be modeled that the control part is

exercised by the Cost Accountant, as such, the present organizational set up of the costing department need

close study to suggest necessary changes.

• Functional study: The functional divisions of an undertaking based on cost are a) Manufacturing, b)

Administration, and c) Selling & Distribution. A study of the present working of the different departments in

necessary to suggest improvements.

C) Principles for Smooth Working

The following principles should be kept in mind while introducing the cost system:

• The system should be simple and easy to operate.

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• The system should be flexible, so that it may be expanded or contracted per needs of the business.

• The existing pattern should be disturbed only as little as may be considered desirable.

• The desired changes be introduced gradually and not in haste.

• Confidence be created by the Cost accountant in the minds of management and

• Executives regarding the utility of the system, so as to avoid unnecessary criticism

• And to obviate obstacles.

D) Line of Action

The following line of action is recommended for the installation of cost system.

• Determination of the type of costing and the method of costing, as may be suitable for the undertaking.

• To prepare forms, card, report-performs, books etc., for keeping records of all the elements of cost, viz.,

material, labour and overheads.

• To decide issues regarding material cost control, i.e., purchase, storing, issue and valuation.

• To decide matters regarding labor cost control, i.e., job evaluation, merit rating, appointment, time

recording, division of work, remuneration of labour and other allied problems like idle time, overtime, labour

turnover, casual workings, etc.

• Where the work is carried on more by machines, proper records be kept for the machines.

• To suggest a suitable system for the collection, classification and analysis of all.

• Types of everheads, i.e., manufacturing, administrative, and selling & distributive.

• To decide the methods of allocation and apportionment of overheads among the production departmentsand Service departments which should be earlier clearly demarcated, and to decide the method of absorption of

overheads.

• To decide normal capacity of production and prepare budgets and standards.

• To maintain books of cost control based on double-entry principle.

• To devise information system by which the costing department may communicate to other departments

and receive reports and other necessary informations promptly .

Merit of Cost Accounting

Helpful in Planning and Decision Making: Cost information brings to light the profitable activities of the

organisation. It provided the sound and rational basis for planning, the changes in products, plants, processes

and techniques of production. The information provided by cost accounting is also useful in evaluating the

various alternatives involved in a situation before taking any final decision.

Inventory Control: As an efficient stores accounting system is essential to an adequate system of cost accounts,

in effective check is provided on all materials and stores.

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Ascertainment of Costs: Cost accounting is very helpful in calculating the cost of an article being produced bythe enterprise. It helps in fixing the selling price of the product.

Standard Costs: It helps the production manger not only to find what various jobs and processes have cost but

also what they should have cost. The pre-planned standard costs are used for comparison of the cost of the

products.

Assistance in Manufacturing: Cost accounting pinpoints lapses in purchases of raw materials and other

articles, their utilization. It indicates where wastages are occurring long before the production is finished. It

helps to take immediate steps to avoid such losses and wastes.

Promotion of Sales: Cost accounting is also very helpful in the promotion of sales by adopting an appropriate

price policy. The technique of break even analysis serves as constant remember to increase the sales to the break

even point. It also seeks to control the selling and distribution coasts.

Evaluation of Profitability: It helps in elimination unprofitable activities and operations.

Profit can be Maximised: Cost accounting helps the management in maximizing profits by eliminating all

wastes and uneconomical processes. This cost accounts help in increasing points and minimizing loses.

COST SHEET

Cost Sheets are statements setting out the costs of a product giving details of all the costs. Presentation of costing information depends upon the method of costing. A cost sheet can be prepared weekly, monthly,

quarterly or annually.

In a cost sheet besides total expenditure incurred, cost per unit of output in case of each element of cost can be

shown in a separate column. The cost sheet should give cost per unit in the previous period for the purposes of

comparison.

Advantages of Cost Sheet

1. It is a simple and useful medium of communication which gives information about costs to all levels of

management in a simple and lucid form.

2. It helps in comparative study of the various elements of costs with the past results and standard cost.Thus it helps the management in control process.

3. It helps the management in fixing up the selling price more accurately.

4. If acts as a guide to the manufacturer and helps him in formulating a definite and profitable production

policy.

5. It enables a producer keep a close watch and control over the cost of production.

6. It shows the total cost and the per unit of the units produced during the given period.

Problem 1

The following particulars have been extracted from the costing records of a manufacturing co., for the year

ended 30th June, 1991.

Rs.

Raw material purchase 1,00,000

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Finished goods 6,000

Building is occupied 9/10 by factory and 1/10 by office. Production 20,000 (Units)

You are required to prepare a detailed cost statement showing

i) Materials consumed

ii) Prime cost

iii) Works on cost.

iv) Cost of production

v) Cost of sales and

vi) Profit earned

Solution

Cost statement of the year ended 30th June, 1991.

Particular Total Cost Cost per unit

Opening Stock of raw

material

40,000

Add Purchases 1,00,000

Add Carriage inward 2,000

1,42,000

Less Closing stock or rawmaterials

40,000

i) Materials consumed 1,02,000 5.10

Direct labour 60,000 3,00

ii) Prime Cost 1,62,000 8.10

Add: Factory overheads

Indirect Wages 10,000 0.50

Power 2,000 0.10

Plant Maintenance 8,000 0.40

Rent, rates and taxes (9/10) 1,800 0.09

Misc. Expenses 2,000 0.10

Repairs – Building (9/10)0.20 1,800 0.20

Salaries – Plant 4000 0.20

Depreciation – Plant 4,000 0.09

-Building (9/10) 1,800 34,000 1.77

iii) Works cost 1,97,400 9.87

Add: Office Overheads

Office Salaries 22,000 1.10

Rents, Rates and Taxes (1/10) 200 0.01

Misc. expenses 4,000 0.20

Repairs – Building (1/10) 200 0.01

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Depreciation- Building (1/10) 200 26,600 0.01 1.33

iv) Cost of Production 2,24,000 11.20

Add: Opening Stock of

finished product

10,000

2,34,000

Less: Closing stock of

finished goods

6,000

Cost of goods sold 2,28,000

Add: Selling and distribution

overheads

Carriage outwards 6,000

Travelling expenses 2,000

Advertising 6,000

Agent’s Commission 10,000 24,000

Cost of Sales 2,52,000

Add Profit margin 1,48,000

v) Sales value 4,00,000

Problem 2

The cost of Sale of Product A is made up as follows:

Materials used in

Manufacturing

55000 Direct Expenses 5000

Materials used in Primary

packing

10000 Indirect Expenses (factory) 1000

Materials used in selling

product

1500 Administration expenses 1250

Materials used in Factory 750 Depreciation of office building

& equipments

750

Materials used in office 1250 Dep. On factory buildings 1750

Labour required in Producting 10000 Selling expenses 3500

Labour required for factory

supervision

2000 Freight on material purchased 5000

Advertising 1250

Assuming that all products are manufactured are sold, what should be the selling price to be obtained as a profit

of 20% on selling price?

Solution

COST SHEET

STATEMENT OF COST AND PROFIT

Direct material Rs. Rs.

Materials used in manufacturing 55000 100000

Materials used in primary packing 10000

Freight on material purchased 5000 70000

Direct labour 10000

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Direct expenses-factory 5000

Direct expenses-factory 85000

PRIME COST

Factory overheads 750

Labour required for factory supervision 2000

Indirect expenses – factory 1000

Dept. on factory building 1750 5500

WORKS COST 90500

Administration O-HMaterials used in OH10 1250

Administration expenses 1250

Dept. on office building equipment 750 3250

COST OF PRODUCTION 93750

Sellings Distribution O-H

Materials used in selling the product 1500

Selling expenses 3500

Advertising 1250 6250

COST OF SALES 100000

Profit (20% on selling price or 25% on cost) 25000

SELLING PRICE 125000

Problem 3

From the following data prepare a cost & profit statement of Vijay stoves manufacturing company for the year 1990.

Stock of materials as on

1.1.1990

35000 Establishment expense 10000

Stock of materials as on

31.12.1990

49000 Completed stock in hand

1.1.90

-

Purchase of materials 52500 Completed stock in hand

31.12.90

35000

Direct wages 95000

Factory expenses 17500 Sales 189000

The number of stoves manufacturing during the year 1990 was 1000. The company wants to quote for the contract for

the stoves to be quoted are of uniform quality and make similar to those manufacturing in the previous year. But cost of

materials has increased 15% and cost of factory labour by 10%. Prepare a statement of net profit to be quoted to give the

same percentage of net profit of turnover as was realized during the year 1990 assuming that the cost per unit of O.H.

charges will be the same as the previous year.

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Solution

COST AND PROFIT STATEMENT OF STOVES 1990

Amount Rs. Amount Rs.

Opening Stock of Materials 35000

Purchase of Materials 52500

87500

Closing stock of Materials 4900

VOLUME OF MATERIAL CONSUMED 82600 20.65Direct wages 95000 23.75

PRIME COST 177600 44.40

Factory expenses 17500 4.37

WORK COST 195100 48.77

Establishment expenses 10000 2.50

COST OF PRODUCTION 205100 51.27

Opening completed stock -

Cost of production during the prd 205100

Closing completed stock 35000

COST OF SALES 170100

PROFIT 18900

SELLING PRICE 189000STATEMENT SHOWING QUOTATION PRICE FOR 1000 STOVES

Materials consumed 20650

15% increase 3098

23748

Factory wages 23750

10%a increase 2375

PRIME COST 26125

Factory expenses 49873

4370

WORK COST 54243

Establishment expenses 2500TOTAL COST 56743

(profit 10% of selling price of 1/9 of cost) 6305

SELLING PRICE 63058

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Lesson 2

Material Cost

The term ‘materials’ refers to such commodities which are supplied to the manufacturing industry in their crude

or original forms. They are raw in nature of have to be processed further. Broadly, these may be classified in the

following groups: Raw materials, components, consumable stores, Maintenance Materials, Tools etc.Since the underlying purpose of cost accounting is to minimize the cost of production, it is important that an

effective control is exercised over them. The storage space and storage costs re reduce thereby. Control over materials is

also necessary to prevent extra-expenses on their unnecessary purchase and improper use. A regular supply of materials

greatly helps the production schedule. It is necessary, therefore, that statements are prepared to accurately record thevalue of materials consumed by each department of job.

Material Cost Control envisages a proper organisatoin for the efficient purchasing and storing of the materials,

and for making them issued to the departments or the cost-centres in appropriate quantities. At the proper times and

valued at the right prices.

The materials cost control aims at keeping the material cost within reasonable limits, budgets or standards.

This control is exercised beginnings from the point the orders are prepared for being placed with the suppliers,

and ending at the point the materials are effectively utilized in production or are disposed off otherwise.

The following factors contribute to purchase control:

i) Determination of Quantity to be purchasedQuantities purchased in excessive number or weight block the working capital and the quantities purchased below

the reasonable limit endanger the continuous working of the factory.

ii) Determination of the Ordering PointThe ordering point of the ordering level is one at which the order for purchase of materials is to be placed with the

suppliers when the stock of that material is reduced to that point by consumption or otherwise.

iii) Determination of Price at which to be purchased

The selection of right suppliers and the best terms available out of the quotations received helps this factor.

The Purchase cycle constitutes the following:

1. Initiating the purchase;

2. Receiving of the Purchase Requisitions;

3. Deciding important factors relating to purchase;

4. Selecting the suppliers;

5. Placing purchase-orders and follow-up

6. Receiving the supply and returning unwarranted suppliers;

7. Inspecting the material received; and8. Passing invoices for payment.

The important factors to be decided are:

a) What to purchase;

b) When to purchase; and

c) How much to purchase.

After receiving the Purchase Requisitions, the next step is to select the suppliers to whom the orders may be sent for

the supply. This is done by inviting tenders or quotations from different suppliers.

While inviting the tenders, the supplying firms should be requested to state their terms and conditions of supply,

delivery time, mode of payment, etc., clearly and to send the tenders in sealed covers.

Having accepted the tenders, the orders are place by the Purchase Department with the firms selected fro the

purchase of requisitioned materials.

The purchaser order should be prepared on the printed form and should contain all the necessary details, so as to

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Maintenance of Stock Levels

The next important point after determination of EOQ is to decide as to when the order for purchase should be

placed. The answer is simple. The order for purchase should be placed when the stock is reduced by usage to the Order

Point. The Order Point is one where the order should be placed for the economic order quantity. For deciding Order

Point, two things, viz., (1) Lead time and (2) Usage during Lead time, are the determining factors. Lead time is thesupply time, or to be more specific, Lead Time is “the time interval between placing an order and having materials on

the factory floor ready for production…”

Usage means the sue of materials by consumptions for productions, or the stock of finished goods sold.

Sometimes purchase are made in large bulk in a season if the goods are seasonal, i.e., available in one seasononly, or at a time when it is feared that the goods may not be found available in the near future due to some reason.

Special items for which no limit or order-points are fixed may be purchased as and when needed.

To avoid over-stocking and under stocking each items of the inventory has the Maximum Level. Minimum

Level and an Order point.

Order Point

It is also known; ‘Ordering Level’; or ‘ Recorder Point’, or ‘Reordering Level or ‘Ordering Limit’, it has been

stated earlier that Order Point is at which order for supply of materials or goods is placed. To decide the Order

Point, three factors are considered, viz., (1) Lead time (2) Usage during Lead time, and (3) Minimum Limit, or

the Safety stock.

In order to ensure that the optimum quantity of material is purchased and stocked, neither less nor more, the

storekeeper applies scientific techniques of materials management. Fixing of certain levels for each items of

materials is one of such techniques.

The following levels are generally fixed.

1. Maximum level

2. Minimum level

3. Order level

4. Danger level

1. Maximum level

The maximum stock level indicates the maximum quantity of an item of material which can be held in stock at any

time.

The maximum stock can be calculated by applying the following formula.

Maximum level – Re-order level + re-order quantity – (minimum consumption X minimum re-order period)

2. Minimum level

Minimum level represents the quantity below which the inventory of any items should not allowed to fall; in other

words, an enterprise must maintain minimum quantity of stock so that the production is not hampered due to non-

availability of materials. If some buffer inventory is acting as a cushion against reasonable expected maximum

usage.

Formula:

Minimum level = Re-order level – (Normal consumption x normal re-order period)

3. Re-ordering Level Point

Re-ordering stock level in relation to an items of stock is the point at which it becomes essential to initiate purchase

orders for its fresh supplies. Normally, re-ordering level is a point between the maximum and the minimum levels.

Fresh orders must be placed before the actual stocks touch the minimum level.

Reorder level = maximum re-order period x maximum usage.

4. Danger level

The danger level is below the minimum level and represents a stage where immediate steps are taken for getting

BSPATIL 20



stock replenished. When the stock reaches danger level it is indicative that if no emergency steps are taken torestock the material, the stores will be completely exhausted and normal production stopped. Generally the danger

level of stock is fixed above the minimum level but below the re-ordering level.

Economic Order Quantity Analysis

Economic Order Quantity

This represents the normal quantity to be placed on order when the stock has reached its re-order level. Re-

ordering quantity is to be fixed taking into account the maximum and minimum stock levels. The quantity ordered must be that which, when added to the minimum stock, will not exceed the maximum stock to be carried at any point of time.

The following factors govern the re-ordering quantity.

1. Average consumption

2. Cost of pacing order

3. Cost of storage

4. Interest on capital etc.,

Carrying cost of inventory consists of

i) The costs of physical storage, such as cost of space, handling and upkeep expenses, insurance, cost of

obsolescence etc.ii) Interest on capital invested (the opportunity cost of the capital blocked up) and

iii) Cost of placing the order each time.

Economic order quantity or economic lot size (if it relates to production) refers to the number ordered in a single purchase or number of units should be manufactured in a single run so that the total costs-ordering or set up costs and

inventory carrying costs are at the minimum level. In other words, it is the quantity that should be ordered at one time so

as to minimize the total of

i) Cost of placing orders and receiving the goods, and

ii) Cost of storing the goods as well as interest on the capital invested. The economic order quantity can be

determined by the following simple formula.

EOQ = Economic order quantity or number of units in one lot.

A = Annual usage in unitsS = Ordering costs for one order (or set-up costs for one set-up)

I = Inventory carrying costs per unit per year.

This formula is based in three assumptions:

i) Price will remain constant throughout the year and quantity discount is not involved.

ii) Pattern of consumption, variable ordering costs per order and variable inventory carrying charge per unit per

annum will remain the same throughout, and

iii) EOQ will be delivered each time the stock balance, excluding safety stock, is just reduced to nil.

Problem 1

Suppose the annual consumption is 675 units, 10% is the interest and cost of storing an article costing Rs. 30 per

unit, cost of placing and order is Rs. 18. Calculate the E.O.Q.

Solution:

BSPATIL 21



The term ‘Inventory’ is used to denote (i) goods awaiting sale (the stock items of a trading concern and thefinished stocks of a manufacturer); (ii) the goods in course of manufacture, known as work-in-progress, and (iii) goods

to be used directly or indirectly in production, i.e., raw materials and supplies.

In a manufacturing company, normally the cost of materials constitutes fifty percent of the production cost andthe cost of inventory (i.e., raw materials W.I.P., and finished good) represents about one-third of the total assets. As the

costs of materials and inventory are quite formidable but at the same time controllable, there is a great need felt for

proper planning, purchasing, handling and accounting for the same, and also to organize the system of inventory control

in a manner that it may provide the maximum profitably to the management.

Objectives of Inventory Control

The objectives of inventory control as listed below:

1. To exercise proper control on the purchases and issues of inventories; proper storing; elimination of wastage;

and regulating the proper supplies to works and to customers;

2. Pricing of the inventories on suitable basis;

3. Proper recording, and scientific inventory management

4. To have proper assessment of income through the process of matching appropriate costs against revenues.

5. To maintain inventory of sufficient size for the operations to go on uninterruptedly but the size should match

with the optimum financial involvement.

Techniques of Inventory Control

The techniques or the tools generally used to effect control over the inventory are the following:

1. Budgetary techniques for inventory planning;2. A-B-C. System of inventory control;

3. Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically;

4. Maintenance of Stock levels to decide when to purchase;

5. Perpetual inventory system and the system of store verification;

6. Reduction of surplus stocks and review of slow-moving or stagnant items.

7. Control Ratios.

Budgetary Techniques

For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of

quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out

to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases

to be made and the inventories to be planned.

A-B-C Analysis

To exercise proper control on stores, it is essential that the store items should be classified according to values

so that the most valuable items may be paid greater and due a attention regarding their safety and care, as compared to

others. The stores are divided into three categories generally, viz., A, B, and C.

In the ABC system, greatest care and control is to be exercised on the items of ‘A’ list as any loss or breakage or

wastage of any items of this list may prove to be very costly; proper care need be exercised on ‘B’ list items and

comparatively less control is needed for ‘C’ list items. The rules relating to receipt maintenance issue and writing off

stores items should be formed in accordance with the utility and value of the items based on the above categorization.

Manufacturing organizations find it useful to divide materials into three categories for the purpose of exercising

selecting control on materials. An analysis of the material cost will show that a smaller percentage of items may

represent a smaller percentage of the value of items the percentage number of which is more or less equal to their value

of consumption. Items falling in the first category are treated as ‘A’ items, of the second category and ‘B’ items and

items of the third category are taken as ‘C’ items. Such an analysis of materials is known as ABC analysis. This

technique of stock control is also known as stock control according to value method or always Better Control method or

Proportional parts value. Analysis method. Thus, under this technique of material control, materials are listed in ‘A’, ‘B’

and ‘C’ categories in descending order based on money value of consumption.

ABC analysis measures the cost significance of each item of materials. It concentrated on important items, so it is also

known as ‘Control by importance and Exception’.

BSPATIL 23



Advantages:

1) A Strict Control is exercised on the items which represent a high percentage of the material costs.

2) Investment in inventory is reduced to the minimum possible level.

3) Storage cost is reduced as a reasonable quantity of materials, which account for high percentage of value ofconsumption will be maintained in the stores.

VED Analysis:

VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can bedivided into three categories – vital, essential or desirable – keeping in view the critically to production.

Perpectual Inventory System

Perpectual Inventory is a system of records maintained by the controlling department, which reflects the

physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts

and issues of 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.

The records used for perpectual inventory are:

(1) Bin Cards;(2) Store Ledger Accounts or Stores Record cards;

(3) The forms and documents used for receipt, issue and transfer of materials.

Advantages of Perpectual Inventory system

1. It keeps the record of stocks upto date.

2. The materials are kept within the Minimum and Maximum Limits. Non-observance of the limits fixed is

detected.

3. The materials going out of stock are easily detected and purchased at the appropriate time to avoid the risk of

closing down.

4. It acts as a moral check on the staff of the stores Department and so the possibilities of loss or theft of materials

are minimized.

5. The recording of stocks in Bin cards as well as Store Record cards minimizes the error in entering the receipts

and issues of stocks.

6. The discrepancies noted after physical counting are detected and corrective action is taken promptly to avoid

future occurrence.

7. The materials getting state or being wasted are detected and placed in right atmosphere.

8. The prompt balancing of closing stocks enables quick preparation of final accounts.

9. The slow moving inventories, obsolete or dormant stocks are brought to the notice of the Purchase Departmentso that such stocks may purchased future in lesser quantities as required.

10. The availability of correct figures of stocks helps in the insurance of the stocks.

Control Ratios

The control ratios are mainly two –

(1) Inventory Turnover Ratio which we have studied and

(2) Input-output Ratio.

(1) Inventory Turnover

Inventory Turnover is a ratio of the value of the materials consumed during a period to the average value of

inventory held during that period.

Certain materials are slow moving. It means their consumption rate quite show and so capital remains locked up and

storing costs continue to be incurred in such materials if these materials are stored in excess of the requirement the

rate of consumptions in terms of value or in terms of days is indicated by Inventory Turnover ratio. The number of

days in which the average inventory is consumed can be ascertained by dividing the period by the Inventory

turnover ratio.

If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover

period is short, the material is said to be fast moving. So if the rate of consumption is fast, or if the inventory

BSPATIL 24



turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properlyutilized.

2. Input-output Ratio

The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials contentof the actual output.

This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of

input of materials and output of material should be determined and the actual ratio should be compared with the

standard ratio.

Pricing of Material Issues

The pricing of issue of materials is not as simple as the pricing of receipts. As the issue are made out of the various

lots purchased at different prices, the questions arises as how to price the issues, there are several methods used for

pricing the issues and the selection of a proper method depends upon the following factors:

1. The type of work-job or process;

2. Range of price fluctuations and market trends;

3. The Inventory turnover period and the carrying or the non-carrying cost i.e., the frequency of purchases and

E.O.Q.

4. The need for maintenance of uniformity is costs of the products within the industry.

5. The nature and durability of the material – whether it evaporates or shrinks, or absorbs moisture, etc.

Method of Pricing

The various methods used for pricing of the materials are:

Cost Price Methods:

1. First in First out (FIFO)

2. Last in First out (LIFO)

3. Highest in First out (HIFO)

4. Base stock price

Average price Methods:

1. Simple Average

2. Weighted Simple Average

3. Periodic Weighted Average

4. Moving Simple Average5. Moving Simple Average

6. Moving Weighted Average

First in First out Method (FIFO):

Under this method materials received first are issued first. After the first lot of the material purchased is over,

the next lot is taken up for issue. As such, the materials are issued in the order in which they are received in the stores.

The pricing of the issue of the first lot is done at the rate of purchase of the first lot. Similarly, the pricing pattern follows

for the subsequent lots. The closing stock in this method is valued at the latest purchase price and thus it represents the

current conditions as far as possible.

Merits

1. It is simple to operate

2. The materials are charged at costs only. So the purchase price is recovered in full without showing any

profit or loss on issue.

3. This method is good where

a. The prices are falling;

b. The consumption rates of the materials is slow

4. The Closing stock is shown at current rates.

Demerits

1. It is not suitable in the situation when the prices show a rising trend, as it will charge the material at the

BSPATIL 25



lower rate than the replacement rate.2. The same type of materials issued to two jobs at two different prices will show different costs.

3. If the prices fluctuate to much, the clerical errors may be many.

Last in First Out (LIFO):

Under this method, the material received last is issued first LIFO method and as such, pricing of issues is done

in the reverse order of purchases. In times of rising prices, this method is considered best for application, as the current

cost of materials contributes to the cost of production.

Merits

1. The material cost represents current prices except when the purchases were made long ago,

2. It is simple to operate and the pricing is done on cost basis

3. It relates current cost to current sale price, and enables the management to make correct decisions.

4. It is more useful when purchases are not too many and the prices are either steady or are rising. It is more

suitable for bulky materials with high unit prices.

Demerits

1. With high fluctuations in rates, the calculations become more complicated, and give way to more clerical

errors.2. The work of pricing is held up if the latest receipt rate is not readily available.

3. As in FIFO, costs of different batches of production are distorted and more than one price is adopted, in

some cases, for pricing a single requisition.

4. Closing stock is valued at a cost which does not represent current conditions.

Highest in First Out (HIFO):

Under this method the material received at the highest price in the stock is issued first. This method is good

when it is desired to keep the inventory value of the materials at the lowest possible price.

Base Stock Price Method

In this method a minimum quantity of stock is always held at a fixed price as reserve in the stock. This

minimum stock is known as base stock or the safety stock and is not used unless an emergency arises. This stock is

valued at long-run ‘normal’ price, while the stock in excess of this stock is priced on some other basis, usually are FIFO

or the LIFO basis. It is not an independent method in itself a it is conjoined with either FIFO or the LIFO method.

Simple Average Method

The issue is prices at an average price and not at the exact cost price as in the earlier methods. The simple

average is calculated by dividing the total of the rates of the materials in the stock from which the materials to be pricedcould have been drawn, by the number of the rates of prices.

This method can be used with advantage if

(a) The purchase prices to not fluctuate considerably, and

(b) It is difficult to identify the different issues of the materials.

Weighted Average Method

Merits

1. This method irons out the wide fluctuations in the prices.

2. With every new issue, a new rate is not calculated.

3. The total value of the material issued does not behave up and down to the total value of the material received, as

is the case with Simple Average Method.

Demerits

1. Calculations are tedious. Prices are worked out in decimals to get correct results.

2. A lot of materials purchased at a very high price at one time continues to reflect its effect in the average, for a

considerable time after it is exhausted.

Periodic Simple Average Method

BSPATIL 26



This method is similar to Simple Average Method except that the average rate is calculated periodically, saymonthly or quarterly or once in the accounting period. If calculated monthly, the average of the unit prices of all the

receipts during the month is adopted as the rate for pricing issues during the subsequent month.

Periodic Weighted Average Method

This method is similar to Weighted Average Method except that the calculation is made periodically, say at an

interval or one month. The rate so arrived is used for the issues made in the next month.

Moving Simple Average MethodThis represents a price which is obtained by dividing the total of the periodic simple average prices or a given

number of periods, the last of the periods being that for which the materials are to be issued, by the number of periods.

Moving Weighted Average Method

This is just similar to the Moving Simple Average Method except that the periodic average price, in this

system, is based on the weighted average.

Problem 3

1) Show the Store Ledger entries as they would appear when using

i) FIFOii) LIFO

iii) Weighted average method

iv) Simple average method

April 1. Balance 300 units Rs. 600/-

2. Purchase 200 units Rs. 440/-

4. Issued 150 units


11. Issued 150 units




Solution

1) Stores Ledger Account as per FIFO METHOD

Date Details Receipt Issued Balance

Qty Rate Amt Qty Rate Amt Qty Rate Amt

April

1

Balance 300 2/- 600 - - - 300 2/- 600

2 Purchase 200 2.20 440 - - - 300 2.00 600

200 2.20 440

4 Issue 150 2.00 300 150 2.00 300

200 2.20 440

6 Purchase 200 2.30 460 150 2.00 300

200 2.20 440200 2.30 460

11 Issue 150 2.00 300 200 2.20 440

200 2.30 460

19 Issue 200 2.20 440 200 2.30 460

22 Purchase 200 2.40 480 200 2.30 460

200 2.40 480

27 Issue 200 2.30 460 150 2.40 360

BSPATIL 27



50 2.40 120

Value of Closing Stock : 150 units at the rate of Rs. 2.40 value Rs. 360/-

2) LIFO METHOD


Unit Rate Amt Unit Rate Amt Unit Rate Amt

April

1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 300 2.00 600

200 2.20 440

4 Issue 150 2.20 330 300 2.00 600

50 2.20 110

6 Purchase 200 2.30 460 300 2.00 600

50 2.20 110

200 2.30 460

11 Issue 150 2.30 345 300 2.00 600

50 2.20 600

50 2.30 115

19 Issue 50 2.30 115 200 2.00 400

50 2.20 110

100 2.00 200

22 Purchase 200 2.40 480 - - - 200 2.00 400

200 2.40 480

27 Issue 200 2.40 480 150 2.00 300

50 2.00 100

Value of Closing Stock : 150 units @ Rs. 2.00 value is Rs. 300/-

3) WEIGHTED AVERAGE METHODDate Details Receipt Issued Balance


April

1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 500 2.08 1040

4 Issue - - - 150 2.08 312 350 2.08 728

6 Purchase 200 2.30 460 - - 550 2.16 1118

11 Issue - - - 150 2.16 324 400 2.16 864

19 Issue - - - 200 2.16 432 200 2.16 432

22 Purchase 200 2.40 480 - - - 400 2.28 91227 Issue - - - 250 2.28 570 150 2.28 342

Value of Closing Stock : 150 units at the rate of Rs. 2.28 value Rs. 342.00/

4) SIMPLE AVERAGE METHOD



April Balance 300 2.00 600 - - - 300 2.00 600

BSPATIL 28



1

2 Purchase 200 2.20 440 - - - 500 2.10 1050

4 Issue - - - 150 2.10 315 350 2.10 35

6 Purchase 200 2.30 460 - - 550 2.17 1193..50

11 Issue - - - 150 2.17 325.50 400 2.17 868

19 Issue - - - 200 2.17 434 200 2.17 434

22 Purchase 200 2.40 480 - - - 400 2.23 892

27 Issue - - - 250 2.23 557.50 150 2.23 334.50

Value of Closing Stock : 150 units at the rate of Rs. 2.23 value Rs. 334.50

Problem 4

The following is the record of receipts and issues a certain material in the factory during a week.

April 1997

1. Opening Balance 50 tonnes @ Rs. 10 per tone.

Issued 30 tonnes @ Rs. 10 per tones

2. Received 60 tonnes @ Rs. 10.20 per tone.

3. Issued 25 tonnes @ Rs. 10.20 per tone (stock verification reveals loss of tone)

4. Received back from orders 10 tonnes @ Rs. 10.20 per tone

(previously issued at Rs. 9.15 per tone)5. Issued 40 tonnes @ Rs. 10.20 per tone.

6. Received 22 tonnes @ Rs. 10.30 per tone.

7. Issued 38 tonnes @ Rs. 10.30 per tone.

Solution

Stores Ledger Account Under LIFO

Date Receipts Issues Balance


1 30 50 10 500

1 30 10 300 20 10 200

2 60 10.20 612 - - - 20 10 200

60 10.20 612

3 - - - 25 10.20 255 20 10 200

1 10.20 10.20 35 10.20 357

20 10 200

4 10 9.15 91.5 34 10.20 346.80

- - - 20 10 200

34 10.20 346.80

10 9.15 91.50

5 - - - 10 9.15 31.50 20 10 200

3 10.20 306.0 4 10.20 40.80

6 22 10.30 226.6 20 10 200

4 10.20 40.80

7 - - - 22 10.30 226.64 10.20 40.80 8 10.00 80.00

12 10.00 120.0

BSPATIL 29



Closing Stock 8 tonnes @ Rs. 10 = Rs. 80/-

Stores Ledger Under FIFO

Date Receipts Issues Balance


1 30 50 10 500

1 30 10 300 20 10 2002 60 10.20 612 - - - 20 10 200

60 10.20 612

3 - - - 20 10 200

5 10.20 51 55 10.20 561

1(loss) 10.20 10.20 54 10.20 550.80

4 10 9.15 91.5 - 54 10.20 550.80

- - 10 9.15 91.50

5 - - - 40 10.20 408 14 10.20 142.80

10 9.15 91.50

6 22 10.30 226.6 - 14 10.20 142.80

10 9.15 31.50

22 10.30 226.607 - - - 14 10.20 142.80

10 9.15 91.50 8 10.3 82.40

22 10.30 226.60

Closing stock 8 tonnes @ Rs. 10.30 = 82.40

BSPATIL 30



Chapter – 3

Labour Cost

“Labour Cost, representing the human contribution to production, is an important cost factor which requires constant

control, measurement and analysis.”

A rational approach to the problems of labour, fair maintenance of wage records for wage ascertainment, fair

wage policy, and the incentives for earning more wages go a long way in providing a sense of security and stability to

the workmen, in minimizing the labour turnover, and in exercising effective labour cost control.

Labour cost control aims at the control of the labour cost per unit of production and not at the reduction of the

wage rates of the workmen.

Efficiency of labour (a concept meaningless to material) has an important impact on the successful working of a

business.

Labour cost is second major element of cost. Proper control and accounting for labour cost is one of the most important

problems of a business enterprise. But control of labour cost presents certain practical difficulties unlike the control of

material cost.

Labour costs represent the various items of expenditure Such as:

Monetary Benefits:

i) Basic Wages;

ii) Dearness Allowance;

iii) Employer’s Contribution to Provident Fund;

iv) Employer’s Contribution to Employee’s State Insurance (ESI) Scheme;

v) Production Bonus;

vi) Profit Bonus;

vii) Old age Pension;

viii) Retirement Gratuity;

Fringe Benefits:

i) Subsidised Food;

ii) Subsidised Housing;

iii) Subsidised Education to the children of the workers;

iv) Medical facilities;v) Holidays pay;

vi) Recreational facilities.

Economic utilization of labour is a need of the present day industry to reduce the cost of production of the products

manufactured or service rendered.

Control of labour costs is an important objective of management and the realization of this objectives depends upon the

cooperation of every member of the supervisory force from the top executive to foreman. From functional point of view,

control of labour cost is effected in large industrial concern by the coordinated efforts of the following six departments-

1) Personnel Department,

2) Engineering Department,

3) Rate or time and Motion Study department

4) Time-Keeper Department

5) Cost Accounting Department

6) Pay-roll Department

Factors Governing a Satisfactory system of Wage Payment

BSPATIL 31



The following factors should be considered while evolving a suitable and a successful system of wage payment.

a) The system should depend upon the nature of the worked and the efforts involved.

b) It should guarantee a minimum living wage to ensure a satisfactory standard of living.

c) It should be based upon a scientific time and motion study.d) It should be capable of being understood by al the employees.

e) It should be flexible and capable of being adapted to changed circumstances.

f) Its incidence on the cost per unit should be such that it does not form a considerable proportion of the total cost

per unit to deprive the employer of a fair margin of profit, given the market price of the commodity produced byconcern.

g) It should reduce the labour turnover.

h) The cost of working the system should be the least.

i) It should boost employee morale.

j) It should be acceptable to trade unions.

k) It should be correlated to the capacity of the concern to pay.

For labour-cost-control, the following factors should also be kept in view while devising the system:

1. Production Planning:

Production should be so planned as to have the maximum and rational utilization of labour. The product and

process engineering, programming, routing, and direction constitute the production-planning.

2. Setting up of standards

With the help of work study, time study and motion study are set up for production operations. The standard

cost of labour so set is compared to the actual labour cost and the reasons for variations, if any, are looked into.

3. Use of labour budgets:

Labour budget is prepared on the basis of production budget. The number and type of workers needed for the

production are provided for along with the cost of labour in the Labour budget. This budget is a plan for labour

cost and is based on the past data considered in future perspective.

4. Study of the effectiveness of Wage-policy:

How far the remuneration paid on the basis of incentive plan fro the departments help the managerial control onlabour and exercise labour cost control.

Characteristics of Good Wage System

1. Fair to both the Parties:

The system should be such as may be acceptable gladly to the employer and the employees. for this purpose,

the employer should decide the system in consultation with the workers.

2. Easy to Calculate

The workers should be in a position to calculate their wages correctly and feel sure that they have been

correctly paid. Easy calculation will help the employer also in maintaining simple records.

3. Related to Efficiency

‘Fair remunerations for fair output’, should be the idea and remuneration should be related to the individual

efficiency of the workers.

4. Minimum wage guaranteed

There should be a guarantee of minimum wages to the workers to enable them to maintain their basic

BSPATIL 32



Multiplication of the formula by 100 indicated Ratio of the turnover in percentage.

2. Replacement Method

In this method, only the actual replacement are counted irrespective of the number of workers left. If new workers are

appointed for expansion programme, they are excluded from the number or replacements.

3. Flux Method

This method is the combination of Method 1 and Method 2.

Effect of Labour Turnover on Cost

The Labour Turnover in excess of normal rate is high turnover, and the turnover below the normal rate is low

turnover. It is always better to keep the turnover low, but it should nto be construed that the factories with low turnover

are always more productive. There may be low turnover in a factory for the reason that the workers engaged therein are

below standard and so they cannot find better place in other factories. Secondly, low turnover in the senior scales maynot provide promotion factories. Secondly, low turnover in the senior scales may not provide promotion opportunities to

the young and promising employees and so they may like to shift to other factories for better prospects.

A high turnover has an adverse effect on the cost of production due to the following reasons:

1. Change in workers interrupts production and the production goes down.

2. New comers take time in learning the factory procedure and the work procedure.

3. The tools and machines cannot be handled as efficiently by the new workers as hither to done by the old staff.

There are chances of more break-downs and of greater cost of repairs of machines.

4. What is true of machines is also true of material handling and usage by the new workers.

5. The rate of accidents may increase, the rate of defectives in the finished output may increase, and there may be

increased wastage of time.

6. The cost of making selections and cost of imparting training to the new entrants would further increase the cost

and reduce the profits.

Cost of Labour Turnover

There are two types of costs

i) Preventive cost and

ii) Replacement costsAnd amenities to the workers that they may be tempted to continue at their job in the factory and not to leave it for

example:

i) Personnel Administration: Only that portion of the cost of this department which is related to the maintenance

of good relationship between labour and management.

ii) Medical Services-Preventive as well as curative.

BSPATIL 34



charged as an overhead expense to the production. If the responsibility for this type of idle-time can be fixed upon a particular department, the cost should be charged to the overheads of that department and absorbed in the production

cost of that department.

OVER-TIME

The time worked over and above the normal hours is overtime. The remuneration usually paid for the overtime work is

at double the normal rate. The need for over time work arises due to:

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 materials by working overtime;

4. Execution of urgent orders, or to complete the work o9n the same day;

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

the standard output and overtime work has to be done by the workers.

Disadvantages of overtime working

The following are the disadvantages:

1. Worker’s health is adversely affected;

2. The quality of the output is at a discount; and

3. The cost of production rises due to increased labour cost.

System of Wage Payment

Strictly speaking, there are only two basic methods of wage payment, viz., wages based on the time spent in the

factory, and wages based on the quantum of work turned out. These are thus known respectively as the ‘time wage’ and

the ‘piece wage’ methods of remuneration. Since each of these has its own advantages and disadvantages, attempts are

made to combine the two, mainly with a view to overcoming their disadvantages. We have therefore, the premium bonus

or the incentive schemes which may either be considered to be merely variations of the two, or as another of wage

payment. These three methods may also be re-classified into only two groups, viz., the time wage system and the

payment by results.

Methods of Remuneration

The methods of remuneration can be classified into:

1. Time Rate System2. Pieced Rate System

3. Incentive Schemes

Time Rate System

In this system, a worker is paid on the basis of attendance for the day or according to the hours of the day,

regardless of the output. This system is also known as time work, day work, day age rate or day rate. The wage rate of

the day worker may be fixed on hourly, daily, weekly, fortnightly, or monthly basis depending on the practice followed

in the concern.

The basic feature of this system is that the worker is paid so much per unit of time regardless of the output he

produces. The unit of time may be an hour, a day, a week or a month. Under this method, wages depend entirely upon

the time clocked, but not on the efficiency of the worker. There are three variants of this system, each differing only in

so far as the fixation of the time rate is concerned. They are:

a) Flat Time or Time Rate at Ordinary level;

b) High Day Rate or Time Rate at high level;

c) Measured Day work or Graduated Time Rate.

BSPATIL 36



Graduated Time Rate

Under this method wages are paid at time rates which vary according to

a. Merit-rating of the workers, or b. Changes in the cost of living index.

It the cost of living goes up, the wages also go up proportionately, and vice versa. Thus the works get the real wages.

Similarly, the workers having higher merit rating get higher wages, and the workers with lower rating get lower wages.

Differential Time Rate

Workers are paid rate accounting to their individual efficiency. They are paid normal rate upto a certain

percentage of efficiency and the rate increases in steps for efficiency slabs beyond the standard. As the efficiency is

measured in terms of output, this method does not fall strictly under the area of time rate system.

Payment by Results-Piece-work Rate

The payment of wages under this system is based upon the out turn of the worker. The rate is fixed per piece of

work and the worker is paid according to the pieces of work completed or the volume of work done by him, irrespectiveof the time taken by him in completing that work. A workman is free to earn as much as his ability, energy, or skill

would allow to him to produce.

The various schemes falling under ‘Payment by results’ make speed as the basis of payment, instead of time.Accordingly, these schemes are just the opposite of the time wage system. They are so called because of the fact that

wages are linked to the volume of work done regardless of the time taken by workers. Efficiency is recognized in all

these schemes and workers get wages according to their avility, efficiency, and speed. The following schemes fall under

the payment by results method of wage payment.

a. Straight Piece Rate.

b. Differential Piece Rate.

Stability of the System

This system is suitable in the following cases:

1. Where the production can be measured in standard units.

2. Where strict supervision is not possible.3. Where quality and precision are not of primary importance.

Advantages

1. It provide initiative and incentive to the workers to product more.

2. The productivity increases and cost of production per unit goes down.

3. As there is little wastage of time on the part of the workers, the fixed overheads and resources like plant,

machinery and space are well utilized.

4. Workers feel free to work, complete with fellow workers, exhibit their efficiency, and earn more of wages.

5. Less supervision is required over the workers, and happy relations are maintained with them.

6. It is easy to calculate the labor of products.

Disadvantages

1. In the race to earn more wages by producing more, the quality of products is likely to deteriorate. So it requires

strict inspection and quality control.

2. Continuous and increased working for some days may cause fatigue and ill health to the workers.

3. To speed up production, the machines, tools, and equipments are sometimes not handled with the care that they

require, and so the workers expose themselves to accidents, besides causing loss of breakdown to the machines,

equipments etc.,

BSPATIL 37



4. The inefficient workers earning less of wages start feeling jealous of other workers who earn more. This createsunhealthy atmosphere.

5. The workers feel insecure of earning during the days of ill health, holidays, etc.

6. This system is not useful for quality products.

The piece rate System can be classified into:

Straight Piece Rates

It is a simple method of making payment at a fixed rate per unit for the units manufactured.

Earnings = Number of units X Rate per unit

The rate is fixed taking into consideration

a. Time rate for the same class of workers, and

b. Standard output during a given time.

Differential Piece Rates

Under this system, efficient workers are paid wages at a lower rate. A definite standard of efficiency is set for each job and for efficiency below or above the standard different piece rates are paid according to different levels of

efficiency. The following two methods of wage payment are studied under this system:

a. Taylor Differential Piece-rate Method, and b. Merrick Differential Piece rate Method

Taylor Differential Piece-Rate

F.W. Taylor thought to improve the efficiency of workers by suggesting two rates of payment of wages:

(I) A higher rate to the workers who product equal to or more than the standard fixed for production during

the day, and

(II) A lower rate to the workers who do not achieve the standard.

Merrick Differential Piece-rate

In the Taylor Method, the effect on the wages is quite sharp in the marginal cases. To remove this defectMerrick suggested three piece rates for a job as follows:

Percentage of Standard Output Payment under Merrick Method

Upto 83% Normal piece rate

Above 83% and upto 100% 110% of normal piece rate

Above 100% 120% of normal piece rate

Incentive Schemes

Factors for Selecting Incentive Scheme

The following factors should be considered for selecting an incentive scheme:

1. Productivity

The object of the incentive scheme is to increase productivity. Therefore, this factor is very important. The increased

BSPATIL 38



productivity lowers the cost to the benefit of the employers.

2. Simplicity

The scheme should be simple in operations and well understood by the workers. The scheme should be amenable tothe setting up of standards and the comparison of the results with the actual.

3. Cost Reduction

The scheme, when introduced, is bound to increase the pay-bill of the workers, and thus increase the cost. But the

simultaneous increase in production would reduce the cost per unit or production. The fixed overheads remain

constant up to a certain limit of plant capacity. As such, the increased productivity reduces the cost of fixed

overheads per unit.

4. Better Labour Psychology

The scheme should not affect worker’s health adversely, should reduce labour turnover and help to improve the

standard of living of the workers.

Under this heading, we study the following methods:

(I) Halsey Premium Scheme;

(II) Halsey Weir Scheme;(III) Rowan Premium Scheme;

Halsey Premium Scheme

Under this plan,

(i) Time rate is guaranteed;

(ii) Standard time is fixed for the job or operation;

(iii) The workers producing more than the standard, or the workers completing the work in less than the

standard time fixed, get bonus in addition to the ordinary time wage;

(iv) The bonus of the premium, by whatever name called, is 30 to 70 percent of the wages of time saved, the

usual percentage being 50%,

(v) The remaining of the bonus percentage is shared by the employer.

Merits of Halsey Plan

(i) Day wage or the time rate is guaranteed. Even if output is less than the standard, one gets the time wage;

(ii) Workers get premium for the output above the standard. It provides incentive to the workers to produce

more;

(iii) As the premium is not 100% but only 50% or so, the employers feel happy about it is a they share the

remaining 50%;

(iv) The scheme is very simple and understood easily by the workers.

Demerits

(i) A significant share of the bonus goes to the employers. So the workers object to it;

(ii) Incentive is not so attractive as it is with the piece work;

(iii) Where the workers start saving more than 50% of the time, they earn premium in huge amounts, which

the employers do not relish.

Halsey – Weir Scheme

This schedule is similar to Halsey scheme except that in this scheme the workers and employers share the

BSPATIL 39



premium in 1:2 ratio.

Rowan Premium Scheme (variable sharing plan)

Mr. James Rowan introduced this scheme in Glasgow in 1898. It is similar to Halsey scheme but the premiumconcept here is different. Here the premium is in the ratio of Time saved to Standard time, calculated on the ordinary

wages.

Premium = Wages of time worked x Time saved / Standard Time

Or; (AT x R) TS / ST

This scheme also guarantees day wage as is done by Halsey Plan.

Problem 1

Calculate the earnings of a worker from the following information as under.

a) Time Rate Method: Standard time 30 hours Time taken 20 hours. Hourly rate of wages of Re. 1 per hour plus a

dearness allowance 50 paise per hour worked.

Solution

Time Rate Method:-

Time Put in by workers x Rate per hour = 30 x 1 = Rs. 30

Problem 2

On the basis of the following information calculate the earnings of A and B on the straight price Rate basis and Taylor’s

differential piece rate system.

Standard Production 8 units per hour

Normal time rate Rs. 0.40 per hour

Differential to be applied:-

80% of piece rate below standard

120% of piece rate at or above standard. In a 9 hour day, A produces 54 units and B products 75 units.

Solution

Standard production per hour 8 units

Normal time rate per hour Rs. 0.40

Piece Rate Rs. 0.40/8 = Rs. 0.05

Earnings under the straight piece rate system:-

A: 54 units @ Rs. 0.05 = Rs. 2.70B: 75 units @ Rs. 0.05 = Rs. 3.75

Differential Piece Rate:-

Low Piece rate: 80% of piece rate (0.05 x 80 / 100) = Rs. 0.04

High Piece rate: 120% of piece rate = (0.05 x 120 / 100) = Rs. 0.06

BSPATIL 40



Standard output per hour is 8 units, So Standard Output for a 9 hour day is 72 units. A produces only 54 units which isless than the standard output of 72 units. So he is entitled to get a lower price rate of Rs. 0.04 per unit. On the other

hand, B’s output of 75 units is more than the standard output of 72 units. So SA is to get higher piece rate of Re. 0.06

per unit.

A’s earning: 54 units @ Re. 0.04 = Rs. 2.16

B’s earning: 75 units @ Re. 0.06 = Rs. 4.50

Problem 3

Calculate the earning of workers A,B and C under Merrick’s multiple piece system from the following particulars.

Normal rate per Hour Rs. 1.80

Standard time per unit 1 minute

Output per day as follows:-

Worker A: 384 units

Worker B: 450 units

Worker C: 552 unitsWorking rows per day are 8

Solution

Standard output per minute = 1 unitsStandard Production per hour = 60 units

Standard Production per day of 8 hour = 480 units

i.e. (60 x 8) Normal rate per hour = Rs. 1.80

Normal output per hour = 60 units

Therefore Normal piece rate = (1080/60) x 5 paise

Calculation of level of Performance:-

Standard output per day = 480 units

Worker A’s Output per day = 384 units

Worker A’s level of performance = (384/480) x 100 = 80%

Worker B’s Output per day = 450 units

Worker B’s level of performance = (450/480) x 100 = 43%

Worker C’s Output per day = 550 units

Worker A’s level of performance = (550/480) x 100 = 1150%

Earnings of workers A:-

Merrick’s multiple piece rate system:-

For 384 units @ 3 paise per unit = (384 x 3) /100 = 11.50

Normal piece rate has been applied because worker A’s level of performance is 807. Which is below 83%.

Earning of Worker B:-

For 450 units @ 3.3 Paise per unit = 450 x 3.3/100 = Rs. 14.85

Worker B’s level of Performance is 93.75% which is between 83% and 100%. So he is entitled to get 110% of

BSPATIL 41



normal piece rate.

Earning of Worker C:-

For 552 units @ 3.6 paise per unit = (552 x 3.6)/100Rs. 19.87

Worker C’s level of performance is 115% which is more than 100% of standard output. So it is entitled to get 120% of

normal Piece rate.

Problem 4

Calculate the earnings of workers A and B under straight piece rate system and Taylor’s differential piece rate system

from the following particulars.

Normal Rate per hour Rs. 2.40

Standard time per unit 30 seconds

Differentials to be applied:-

80% of piece rate below standard

120% of piece rate at above standard

Worker A produces 800 units per day and

Worker B produces 1000 units per day.

Solution

Hourly Production = = 120 units

Piece rate = = 0.005

Low piece rate:-

LPR = 80% of normal piece rate

= 80% x 0.005

= 0.004

High piece rate:

HPR = 120 of 0.005

= 0.006

Standard Production per day = 120 units x 8

= 960 units

Computation of earnings of A and B:-

A B Normal Piece Rate 0.005 0.005

Production per day 800 1000

Standard Production

Per day 960 units 960 units

a. Straight piece Rate System 800 x 0.005 1000 x 0.005

Earning Rs. 4.80 Rs. 5

BSPATIL 42

3600

1000

120

2.210



Thus dis earnings are as follows:-

Price wages for 1,100 units @ 50 paise per unit Rs. 550

Add: 20% bonus (550 x 20)/100 Rs. 110

Total earning Rs. 660

Problem 6

The existing incentives system of a certain factory is

Normal working week – 5 days of 9 hours plus 3 rate shifts of 3 hrs each.

Rate Payment - Daywork = Re. 1 per hour

- Late shift = Rs. 1.50 per hour

Additional bonus payable – Rs. 2.50 per day shift

Rs. 1.50 per Late shift

Average output per operative for 54 hour week – 120 articles i.e. including 3 Late shifts

In order to increase output and eliminated overtime it was decided to with on to a system of payment by results the

following information is obtained.

Time rate Re. 1 per hour

Basic time allowed for 15 articles 5 hours

Piece work rate – Add 20% to piece

Premium – Add 50% to time

You are required to show

i) Hours worked

ii) Weekly earnings

iii) Number of articles produce and

iv) Labor cost per article for one operative under the following sysem

a) Existing time rte b) Straight piece work

c) Rowan system

d) Halsay weir system

Assume that 135 articles produces in a 45 hours work under (b) (c) and (d) and that the worker earns half time saved

under the Halsay system. The additional bonus under the existing system will be discontinued on the proposed incentive

scheme.

Solution

a) Existing time Rate:- Rs.

Weekly wages 45 hrs. @ Re. 1 per hour 4500

9 hrs @ Re. 1.50 per hour 13.50

Day shift bonus 5 x 2.50 12.50

Late shift bonus 3 x 1.50 4.50

Total Earning 75.50

b) Piece rate system:-

BSPATIL 44



Basic time : 5 hours for 15 articles

Therefore cost of 15 articles 5.00

Add: 20% 1.00

Total Earning 6.00

Therefore Rare per article Rs. 6.00 / 15 = Rs. 0.40

Articles products in a week = 45 x 15/5 = 135

Hence Earning = 135 x 0.40 = Rs. 54.00

c) Rowan Premium System:-

Basic time = 5 hrs for 15 articles

Adding 50% = 7½ has for 15 articles

Therefore time for producing one articles

= 7½ hrs / 15 = 30 minutes

Therefore time allowed for 135 articles = 67 ½ hrsActual time taken for 135 articles 45 hrs

Therefore time saved = 22½ hrs

Earning = Time wages x (% of time saved / Standard Time) x Time wage

= 45 x 1 + (22½ / 67½) x 45 = 45 + 15 = 60

d) Halsay-Weir Premium System:-

Earning = Time wage + 50% (Time saved x Time rate)

= 45 x 1 + 50% (67½ - 45) x 1

= 45 + 11.25 = Rs. 56.25

The other requirements of the problems have been shown in the following table:-

Methods:-

a b c d

i) Hours worked 45 54 45 45

ii) Weekly earning Rs. 75.50 54.00 60.00 56.25

iii) Articles produces 120 135 135 135

iv) Labour cost per article 0.629 0.400 0.444 0.417

Problem 7

The Worker earns Rs. 2 as bonus @ 50%. So total bonus at 100% should be Rs. 4. The hourly rate of wages being Re.

1. The time saves should be 4 hours.

Standard time allowed - 10 hoursLess: time saved - 4 hours

Time taken - 6 hours

A worker completes a job in a certain number of hours. The standard time allowed for the job is 10 hrs, and the hourly

rate of wages (i.e. Re. 1 the worker earns at the 50% rate of bonus Rs. Under Halsay plan.

Ascertain dis total wages under the Rowan premium plan:-

Solution

BSPATIL 45



The worker earns Rs. 2 as bonus at 50% so total bonus at 100% should be Rs. 4. The hourly rate of wages beingRe. 1 the time saved should be 4 hrs.

Standard time allowed 10 hours

Less: Time saved 4 hoursTime taken 6 hours

Earning under the roman Premium Plan:-

Earning = T x R + (S – T / S) x T x R

Where T = Time taken i.e., 6 hours

S = Standard time i.e. 10 hours

R = Rate per hour i.e. Re. 1

Therefore Earning = 6 x 1 + (10-6/10) x 6 x 1

= Rs. 6 + Rs. 2.40

= Rs. 8.40

Problem 8

For a certain work order the Standard time is 20 hours, wages Rs. 5 per hour the actual time taken is 13 hours and

factory overhead charges are 80% of standard time.

So out a comparative statement showing the effect on paying wages Halsay plan.

Solution

Earning = A.T x T.R + 50% (T.S. x T.R)

= 13 x 5 + 50% (7 x 5)

= 65 + 17.5

= Rs. 82.50

Problem 9

A Workman whose basic rate of pay is Re. 1 per hour of working under the ‘Rowan’ system of premium bonus. In

addition he gets dearness allowance of Rs. 20 per week of 48 hours. During one week he does the following jobs.

i) Job 101 for which 25 hours are allowed. He takes 20 hours.

ii) Job 102 for which 30 hours are allowed he takes 24 hours.

During the week, his waiting time amounts to 4 hours. Find the worker’s earning and the amounts to be charged to each

job and to overhead.

Solution

Workers earning form Job 101 :-

Standard time 25 hours

Time taken 20 hours

Rate per hour Re. 1

Wages for actual time = 20 hrs @ 1 Re.

Premium according to Roman System

BSPATIL 46



= Time taken x Rate per hr. + (Time saved / Standard time) x Actual time x Rate per hr

= 20 x 1 + (5/25) x 20

= Rs. 24 Rs. 24.00

Proportion of dearness allowances:-

= 20 x (25/55)Earning from job 101 Rs. 9.09

Total Rs. 33.09

The workers earning from job 102:-

Standard time = 30 hours

Time taken = 24 hours

Rate per hour = 1 Re.

Earning = T x R + (T.S /Std) x A.T x R = 24 x 1 + (6/30) x 24

= 24 + 4.8

= Rs. 28.80

Proportion of Dearness allowance:-

= 20 x (30 / 55)

= Rs. 10.91

Earning from job 102 Rs. 39.71

Total earning of the worker:-

Job 101 = Rs. 33.09

Job 102 = Rs. 39.71

Read = Rs. 4.00

Total = Rs. 76.80

Problem 10

The guaranteed time table is Re. 1 per how high piece rate is Re. 0.20 per unit and standard output is 10 units per hour.

In a day of 8 hours, A produces 70 units and B produces 80 units and C produces 90 units. Calculate the earning of A,B

and C under Gantt task plan.

Solution

Standard Output at 10 units per hour is 80 units.

A’s output is below the Standard

B’s output is at the standard and C’s output is above the standard.

Accordingly A gets time wages, B gets a bonus of 20% of the time rate and C gets high piece rate.

Earnings: A = 8 hours x Re. 1 = Rs. 8

B = 8 hours x Re. 1.20 = Rs. 9.60

C = 90 hours x Re. 0.20 = Rs. 18

BSPATIL 47



Problem 11

Standard output is 10 units per hour and basic wage rate is Re. 1.50 per hour. In a day of 8 hours. A produces 40 units. B

75 units and C produces 90 units. Calculate the wages of A,B and C under Merrick’s differential piece rate.

Solution

Standard output = 10 units per hour Basic wage Rate = Rs. 1.50 per hour

Piece rate = 1.50 / 10 = Rs. 0.15

Percentage efficiency:-

= (Actual output / Standard output) x 100

For A = (40 x 100/80) = 50%

For B = (75 x (100/80) = 93.75%

For C = (90 x 100/90) = 112.5%

A’s efficiency being less than 83% he is paid the ordinary piece rate. B’s efficiency being 83% to 100%. He is paid at

110% of ordinary piece rate. C’s efficiency being more than 100% he is paid at 120%.

Thus: A gets 40 x Re. 0.15 = Rs. 6.00

B gets 75 x 0.165 = Rs. 12.37

C gets 90 x Re. 0.18 = Rs. 16.20

BSPATIL 48



Lesson – 4

OVERHEAD COST

Overhead is “the aggregate of indirect material cost, indirect wagers (indirect labor cost) and indirect expenses”.

Classification of Overheads

The Overheads can be classified according to:i) Elements;

ii) Functions;

iii) Behaviour;

iv) Controllability;

Element-wise classification

Overhead Materials Cos is the which cannot be allocated but which can be apportioned to, or absorbed by, cost

centres or cost units. Consumable stores, lubricating oil, loose tools, cotton waste, etc. are the examples.

Indirect Labour Cost is the cost of wages which cannot be allocated but which can be apportioned to, or

absorbed by, cost centres or cost units. Salary of foremen, supervisors, works manager, storekeepers, etc. Wages of

maintenance dept. employer’s contribution to provident Fund, overtime wages, etc., are the examples.

Indirect Expenses are the expenses which cannot be allocated but which can be apportioned to, or absorbed by,

cost centres or cost units. Factory rent, lighting, heating, depreciation, insurance, other factory expenses, all

administrations, selling, and distribution expenses fall under this group.

Overhead is divided according to functions into:

i) Production or Manufacturing Overhead;

ii) Administration Overhead;

iii) Selling Overhead;

iv) Distribution Overhead

Production Overhead

It includes all overheads incurred from the stage of procurements of materials till the completion of themanufacture and the primary packing of the product.

1. Rent, municipal taxes, depreciation, insurance, etc., of the factory land and building.

2. Depreciation insurance etc. of the factory plant, machines and equipments.

3. Factory lighting, heating and air conditioning;

4. Fuel and power;

5. Consumable stores, small tools, etc,;

6. Indirect materials, such as cotton waste, lubricating oil, brushes etc.;

7. Repairs of factory building, plant, machines and equipments.

8. Store-keeping expenses;

9. Cost of idle time, overtime, holiday pay etc.

10. Salary of foremen, timekeepers, works manager etc.;

11. Repairs and maintenance of Power house;

12. Other expenses, e.g., Worker’s training and welfare, Inspection, Research and Development, Factory telephone

and Stationary etc.

Classification According to Behaviour

BSPATIL 49



Fixed Overheads

Fixed overheads is one which tends to be unaffected by variation in volume of output. This overhead remains

constant, i.e., does not change with the increase or decrease in production, within a certain range. The fixed overheadsare related to the periods, and so the fixed costs are also known as Period Costs, e.g., the rent of the building or the

salaries of the office staff.

Variable OverheadsThe variable overhead is one which tends to vary directly with volume of output. The variable cost increases in

direct proportion with the increase in production, and decrease in production. It is known as Direct cost.

Salesman’s Commission; Discounts to customers; Bad debts; Branch expenses; Postage; Stationery; Travelling;

Salesman’s expenses; Packing charges; Carriage outward; Variable expenses on delivery vans; etc.

It means that a part of the expenses does not change while the other part of the same expense charges with

volume of output. Generally, on costs are truly fixed or truly variable.

Classification According to Controllability

The overheads can be classified on the basis of controllability into a) Controllable, and b) Un-controllable.

The controllable cost is one which can be controlled, i.e., maintained or reduced. The variable costs fall under this category. The un-controllable cost is one which cannot be influenced by the action of a specified member of the

undertaking.

Allocation of cost

Allocation of cost means charging the full amount a cost to a cost centre, i.e. to the job, process, or to the

product etc. The nature of the expense is such that it can easily be identified and allocated to the cost centre or to the cost

unit of production.

Apportionment of cost

Where the expense is a common one and it is to be allotted to different cost centres proportionately on an

appropriate basis, it is known as ‘apportionment’. For example, rent of the factory is an expense which cannot be

allocated to any one department, but is to be shared by all the production departments and service department, onsuitable basis, e.g., floor area basis.

Absorption of Overhead

With the help of allocation and apportionment, the different production departments get their due share of the

total production overheads. After that, the process of absorption starts. The overheads of a particular department are to

be allotted to the production units of the department. This allotment to the unity is absorption.

Ability to Pay Principle, Efficiency or Incentive principle:

Overheads is to recover or absorb the overheads in the cost of products, individual jobs, processes, batches, or

other convenient units. The overheads falling to the share of a department through the process of allocation or

apportionment, is to be absorbed by the cost units of that department. This is known as ‘Absorption of overheads’.

Problem 1

BSPATIL 50



The New Enterprises Ltd., has three Production Departments A,B,C and two Service Departments D and E. Thefollowing figures are extracted from the records of the company:

Rs.

Rent and rates 5,000

General lighting 600

Indirect Wages 1,500

Power 1,500

Depreciation of Machinery 10,000Sundries 10,000

The following further details are available:

Total A B C D E

Floor Space(Sq. ft)

10,000 2,000 2,500 3,000 2,000 500

Light points 60 10 15 20 10 5

Direct

Wages (Rs.)

10,000 3,000 2,000 3,000 1,500 500

H.P. of

Machines

150 60 30 50 10 -

Value of

Machinery

(Rs.)

2,50,000 60,000 80,000 1,00,000 5,000 5,000

Working

Hours

- 6,226 4,028 4,066 - -

The expenses of D and E are allocated as follows:

A B C D E

D 20% 30% 40% - 10%

E 40% 20% 30% 10% -

What is the total cost of an article if its raw material cost is Rs. 50, labour cost Rs. 30 and its passes through

Departments A,B and C for 4,5 and 3 hours respectively?

Solution

Statement of Allocation and Apportionment of Overhead:

Total Production Service Rate of Appointment

Rs. A B C D E

Direct Wages 2000 - - - 1500 500 Actual

Rent & Rates 5000 1000 1250 1500 1000 250 Re. 0.5 per

sq.ft.

General

Lighting

600 100 150 200 100 50 Rs. 10 per

Point

Indirect Wages 1500 450 300 450 225 75 Rs. 0.15 per

Re. of Direct

wages

Power 1500 600 300 500 100 - Rs. Per H.P.

Depreciation 10000 2400 3200 4000 200 200 4% of value

of

machinery

BSPATIL 51



Sundries 10000 3000 2000 3000 1500 500 100% of

Direct

Wages

30600 7550 7200 9650 4625 1575

Service Dept.D

- 966 1449 1933 -4831 483

30600 8516 8649 11583 -206 2058

Service Dept.

D

- 823 412 617 206 -2058

30600 9339 9061 1220 - -

Working hours - 6226 4028 4066 - -

Rate per hours - 150 225 300 - -

Ascertainment of cost of an article Rs.

Material 50.00

Labour Cost 30.00

80.00

Overhead cost

Dept. A, 4 hrs @ 1.50 = 6.00

Dept. B, 5 hrs @ 2.25 = 11.25

Dept. C, 3 hrs @ 3.00 = 9.00 26.50Rs. 106.25

Note: Sundry expenses are apportioned on the basis of direct wages.

Problem 2

You are supplied with the following information and required to work out the production hour rate of recovery of

overhead in Department A,B, and C.

Production Departments Service

Departments

Total A B C P Q

Particulars: Rs. Rs. Rs. Rs. Rs. Rs.

Rent 12000 2400 4800 2000 2000 800

Electricity 4000 800 2000 500 400 300

Indirect

Labour

6000 1200 2000 1000 800 1000

Depreciation

of Machinery

5000 2500 1600 200 500 200

Sundries 4500 910 2143 847 300 300

Estimated

working hrs.

1000 2500 1400

Expenses of Service Departments P and Q are apportioned as under:

A B C P Q

P 30% 40% 20% - 10%

Q 10% 20% 50% 20% -

BSPATIL 52



Solution

a) Repeat Distribution Method

Overhead Distribution Summary for the period……………

Total A B C P Q

Particulars: Rs. Rs. Rs. Rs. Rs. Rs.

Rent 12000 2400 4800 2000 2000 800

Electricity 4000 800 2000 500 400 300

Indirect Labour 6000 1200 2000 1000 800 1000Depreciation of

Machinery

5000 2500 1600 200 500 200

Sundries 4500 910 2143 847 300 300

Total Rs. 31500 7810 12543 4547 4000 2600

Department P 1200 1600 800 -4000 400

9010 14143 5347 - 3000

Department Q 300 600 1500 600 -3000

9310 14743 6847 600 -

Department P 180 240 120 -600 60

9490 14983 6967 - 60

Department Q 6 12 30 12 -60

9496 14995 6997 12 -Department P 4 5 3 -12 -

Total Rs. 31500 9500 15000 7000 - -

Working Hours 1000 2500 1400

Rate per Hour 9.50 6.00 5.00

b) Equation Method (alternative method)

Let x be the expenses of Service Department P; and

y be the expenses of Service Department Q.

Then x = 4000 + 1/5y (since 20% of y well be apportioned to Department P) ; and

y = 2600 + 1/10x

= 2600 + 1/10 (4000 + 1/5y), substituting the value

of x:

= 2600 + 400 + 1/50y

= 3000 + 1/50y

50y = 150000 + y

49y = 150000

y = 3061

x = 4000 + 1/5 x 3061 = 4,612

Overheads Distribution Summary

Production Departments Service Departments

A B C P Q

Rs. Rs. Rs. Rs. Rs.

Total as given above 7,810 12,543 4,547 4,000 2,600

Expenses of Dept. P

(Rs. 4,612)

1,384 1,845 922 -4,612 461

Expenses of Dept Q

(Rs. 3,061)

306 612 1,531 612 -3.061

BSPATIL 53



Rs. 9,500 15,000 7,000 - -

No. of working hours 1,000 2,500 1,400

Rate per hour 9.50 6.00 5.00

Problem 3

The following information are available for Production departments A,B, & C the Service the Dept D & E.

Particular Production Dept Service DeptTotal A B C D E

Rent 1000 200 400 150 150 100

E.B 200 50 80 30 20 20

Fire Ins 400 80 160 60 60 40

Plant Dept 4000 1000 1500 1000 300 200

Transport 400 50 50 50 100 150

The expenses of services dept D & E are apportioned as under

A B C D E

D 30% 40% 20% - 10%

E 10% 20% 50% 20% -

Apportion the expenses of service dept to production dept by

1) Repeated Distribution Method

2) Simultaneous Equation Method

Solution

REPEATED DISTRIBUTION METHOD

Over Head Analysis Sheet

Production Departments Service Departments

A B C P Q

Rs. Rs. Rs. Rs. Rs.

Rent 200 400 150 150 100

E.B. 50 80 30 20 20

Fire, Insur 80 160 60 60 40

Plant Dept. 1000 1500 1000 300 200

Transport 50 50 50 150 100

Total Exp. 1380 2190 1290 630 510

Service Dept. D% 189 252 126 630 63

1569 2442 1416 - 573

Service Dept E% 57 115 286 115 573

Service Dept E% 35 46 23 115 11

Service Dept D% 1 2 6 2 11

Service Dept D% 1 1 - 2 -

Total 1663 2606 1731 -

BSPATIL 54



BY SIMULTANEOUS EQUATION METHOD

Total A B C D E

Total 1380 2190 1290 630 510

D% 30% 40% 20% - 10%

E% 10% 20% 50% 20% -

Let x be the total exp of D to be apportioned

Let y be the total exp of E to be apportioned

x = 0.2y + 630 (1)

y = 0.1x + 510 (2)

Substituting the value of x in (2)

y = 0.1 (0.2y 630) + 51

= 0.02y 63 + 510

0.98 y = 573

Therefore y = 585

Therefore x = 747

A B C

1380 2130 1290

Service Dept D 30% :

40% : 20%(of 747)

224 299 149

Service Dept E (1:2:5 of

585)

58 117 293

Total 1662 2606 1732

Problem 4

Superfine Ltd. has furnished the following particulars for the half year ended March 31, 1982. Compute the

deprs O/H rates. For the each of the productions department assuming that the O/H charges are recovered as a % of

direct wages.

Particular Production Dept. Service Dept.

A B C D E

Direct Wages 4000 6000 8000 2000 4000

Direct Material 2000 4000 4000 3000 3000

No. of Employee 100 150 150 50 50

EB KWH 8000 6000 4000 2000 2000

Light point 10 16 4 6 4Assert value 120000 80000 60000 20000 20000

Area occupied (sq.meters)

150 250 100 50 50

Over Head expenses for the above period

BSPATIL 55



Motive Power 3300

Lighting 400

Stores exp 800

Staff welfare 4800

Deprecation 30000

Repair 15000

Rent & Rates 1200

General exp 12000

Apportion the expenses of service dept D in proportion to the direct wages & that of E in the ratio 5:3:2 to

production dept A,B,C

Solution

OVER HEAD DISTRIBUTION SUMMARY

Particular A B C D E

Direct Material - - - 3000 3000

Wages 2000 4000

Power 4:3:2:1:1 1200 900 600 300 300

Lighting 5:8:2:3:2 100 160 40 60 40Stores exp.

2:4:4:3:3 (Material)

100 200 200 150 150

Staff 2:3:3:1:1 360 1440 1440 480 480

Deprec. 6:4:3:1:1 12000 8000 6000 2000 2000

Rent & rates

3:5:2:1:1

300 500 200 100 100

Repairs (assert

ratio)

6000 4000 3000 1000 1000

General exp. (staff

ratio)

2400 3600 3600 1200 1200

Total 23060 18800 15080 10290 2270

Abortionment of

Ser. dept D in the

ratio of wages

2287 3430 4573 - -

Abortion of E in theratio 5:3:2

6335 3681 2454 - -

Total 31702 25811 21907 - -

Over Head Recovery (as per the rate wages)

Dept A = (3170.2/4000) x 100 = 792.55%

Dept B = (2581.1/6000) x 100 = 430.2%

Dept C = (2190.7/8000) x 100 = 272.8%

BSPATIL 56



Solution

Computation of Machine Hour Rate

Machine No……..

Standing Charges Per day

Rs.

Per hour

Rs.

Lubricating Oil 2Wages 4

Consumable Stores 10

16

Hourly rate (16+8) 2.00

Machine Expenses

Depreciation – cost Rs. 1,00,000

Yearly depreciation 10,000

Hourly depreciation 10000 + 2000 5.00

Repairs 50% of depreciation 2.50

Power 10 units @ 10 paise per unit 1.00Machine hour rate (Comprehensive) 10.50

Problem 6

Compute from the following information relating to machine No. 18, machine hour rate

Rs.

Cost of machine 11,000

Scrap value 680

Repairs for the effective working life 1,500

Standing charges for 4 weekly period 1,600

Effective working life 10,000 hours

Power used 6 units @ 5 paise per unitHours worked in 4 weekly period 120 hours.

No. of machines in the workshop is 40, of which each bears equal charges.

Solution Computation of Machine Hour Rate

Machine No. 18

Per hour

Rs.

Standing charges 1600 /(40x120) 33

Machine Expenses

Depreciation – cost 11,000Less-scrap value - 680

Value to be written off Rs. 10,320

Hourly rate = 10,320 + 10,000 1.03

Repairs Rs. 1,500 for entire life

Hourly rate 1500 + 10,000 15

Power consumed 6 units @ 5 paise per unit 30

Machine Hour Rate 1.81

BSPATIL 58



Problem 7

Calculate the machine hour rate from the following:

Rs.

Cost of Machine 8,000

Cost of Installation 2,000

Scrap value after 10 years 2,000

Rates and rent for a quarter for the shop 300

General lighting 20 p.m.Shop supervisor’s salary 600 p.a. quarter

Insurance premium for a machine 60 p.a.

Estimate repair 100 p.a.

Power 2 units per hour @ Rs. 5 per 100 units

Estimated working hour p.a. 2,000

The machine occupier 1/4th of the total area of the shop. The supervisor is expected to devote 1.6 th of his time for

supervising the machine, General lighting expenses are to be apportioned on the basis of floor area.

Solution

Computation of Machine Hour Rate

Machine No:

Per year Per hour

Standing Charges: Rs. Re.

Rent and Rates 1/4th 300

General lighting as per floor area 60

Supervisor’s Salary 1/6th 400

Insurance premium 60

Total yearly Standing charges 820

Hourly rate 820 + 2,000 0.40

Machine expenses

Depreciation Cost 8,000

Installation 2,000

Total 10,000

Less Scrap value 2,000

Amount to be written off Rs. 8,000 0.40

Repairs etc. 0.05

Power 2 units @ 5 paise per unit 0.10

Machine Hour Rate 0.96

BSPATIL 59



Problem 8

Calculate the machine hour rate, for the machine No. 45 from the following particulars:

Rs.

Cost of Machine 10,000

Estimated scrap value 250

Estimated working life 15,000 hours

Hours required for maintenance 200 hours

Productive working hours p.a. 2,000 hours

Setting up time 5%Power 20 units @ 7 paise per unit

Cost of repairs p.a. 1,500

No. of operators looking after 4 machines 2

Wages of operator p.m. 150

Chemical required p.m. 100

Overheads chargeable to this machine 200 p.m.

Insurance premium 1% p.a.

Solution

Calculation of Machine Hour RateMachine No. 45 Per hour

Rs. Rs.Yearly Standing Charges

Overheads Rs. 200 x 12 = 2,400

Insurance 1% of 10,000 = 100

Wages (2 x 150 x 12) / 4 = 900

Total 3,400

Effective working hours in a year 1,900

Therefore 3,400 1.79

1,900

Machine Expenses

Depreciation Rs. (10,000 – 250) / 15,000 0.65Repairs Rs. 1,500 + 1,9000.79

Chemicals Rs. (100 x 12) / 1900 0.63

Power 7 paise x 20 units 1.40 1.40

Machine hour rate 5.26

Note: It has been presumed that the hours required for maintenance have already been adjusted in the total yearly hours.

Secondly 5% time needed in setting up, has been considered as productive, and hence has been adjusted accordingly i.e.

as normal loss in terms of hours for it has already caused in increase in machine hour rate. Also it is presumed that no

power is used in setting up operations.

Problem 9

Compute comprehensive machine hour rate from the following data:

(a) Total of machine to be depreciated – Rs. 2,30,000

Life – 10 years; Depreciation on straight line.

(b) Departmental overheads (annual):

Rent – 50,000; Heat and light – 20,000 ; supervision 1,30,000.

(c) Departmental Area 70,000 sq. metres.

Machine Area 2,500 sq. metres.

(d) 26 machines in the department.

(e) Annual cost of reserve equipment for the machine Rs. 1,500.

BSPATIL 60



(f) Hours run on production 1800(g) Hours for setting and adjusting 200

(h) Power cost Rs. 0.50 per hour of running time.

(i) Labour (1) when setting and adjusting, full time attention

(2) when machine is producing, one man can look after 3 machine(j) Labour rate Rs. 6 per hour.

Using the machine hour rate as calculated value work out the amount of factory overhead to be absorbed on the

following:

Total hours Production time Setting up timehrs

Job No. 605 100 80 20

Job. No. 595 100 80 30

Solution

Computation of comprehensive machine hour rate

Standing charges

Rent, heat and light (70,000 x 2,500) / 70,000 2500

Supervision (1,30,000 ) / 26 5,000

Depreciation 10% of Rs. 2,30,000 23,000Reserve equipment cost (1500/26) 58

Labour cost during setting and adjustment 200 hrs @ Rs. 6 =

(1,200 / 31,758)

Hourly Rate for standing charges 31,758 / 1800 17.64

Machine charges

Power 0.50

Labour (1/3 of Rs. 6) 2.00

Comprehensive machine hour rate 20.14

If the machine hour rate over the various jobs will be:

Job No. 605 = 20.14 x 80 = 1,611.20

Job No. 595 = 20.14 x 70 = 1,409.80

User and over absorption of overhead

The amount of overhead absorbed in costs is sum total of overhead cost allotted to individual cost units by

application of overhead rates under the actual rate method, overhead cost are fully charged to production so that

overhead absorbed in equal to overhead incurred.

Pre-determined overhead rate is calculated on the basis of budgeted overheads and this is applied to actual base. The

amount absorbed may not be identical with the amount of overheads incurred it is called under absorption and in reverse

condition it is called over absorption. This may happen due to error in esteeming expenses, error in estimating the base,major changes in methods of production and seasonal fluctuation of overhead.

BSPATIL 61



Lesson – 5

JOB COSTING & BATCH COSTING

Job Costing is the method of costing used to determine the cost of non-standard jobs carried out according to

customers’ specifications. In this method is also known are separately indentified and are coasted individually. Jobcosting is applicable to job printers, engineers, furniture makers, builders, contractors, hardware and machine

manufacturing industries, repairing shops, etc.

The Costing Department prepares job cost sheet (Fig. 2) for each job, containing the production order No., andother details relating to the job. Where a job requires several major operations or components, sub-cost sheet. The job

cost sheet is the document detailing the cost of the job under Direct material. Direct labour, Works overheads etc., It is

not prepared for a specific period but for a specific job.

The cost of all the job in process are debited to the Work-in-Progress Control Account. On the completion of a

job, this account is credited and Finished Goods Control Account is debited with its cost. The difference between the

cost and the price charged is the profit or the loss on the job.

On the completion of a job Completion Report is submitted by the production shop to the planning Department

with a copy to Costing Department. This report is an indication that further expenses on the job should cease and the jobcost sheet be closed.

Problem 1

Find out in the suitable cost sheets form the selling rater per tone of special paper manufacturing by a paper mill

for a private firm a January 1997 under the following divisions of cost:

a. Prime Cost

b. Works cost,

c. Total cost,

d. Selling price

The cost sheet is to be prepared with reference to the data given below:

Direct Materials

Paper plup – 1,000 tonnes @ Rs. 50 per tone.

Other Miscellaneous Materials, 200 tonnes at Rs. 30 per tone.

Direct Labour

100 skilled men @ Rs. 5 per day for 20 days.

50 unskilled men @ Rs. 3 per day for 20 days.

Direct Expenses

Special equipment Rs. 5,000

Special dies Rs. 2,000

Works Overhead

Variable 10% on direct wages.

Fixed 60% on direct wages

Administrative overhead at 10% of works cost.

Selling and distributive overhead at 15% of works cost.

Profit 10% in total cost

BSPATIL 62



Finished paper manufactured 800 tonnesSale of waste paper Rs. 1,000

There was not work in progress in the beginning or at the end of the month. The scarp value of special equipment is nil

after use. Work was done only for 20 days in the month. Selling price is to be worked to the nearest rupee.

Solution:

Cost-Sheet for Special Paper Rs. Rs.

Direct material

Paper pulp 1,000 tonnes @ Rs. 50 per tone 50,000

Other materials 200 tonnes @ Rs. 30 per tone 6,000 56,000

Direct Labour

100 skilled men at Rs. 5 for 20 days 10,000

50 unskilled man at Rs. 3 for 20 days 3,000 13,000

Direct Expenses

Special Equipment 5,000

Special dies 2,000 7,000

Prime Cost 76,000

Works overheadVariable 100% of direct labour 13,000

Fixed 60% of direct labour 7,800 20,800

96,800

Less : sale of waste 1,000

Works cost 95,800

Office Overhead

Administrative 10% of works cost 9,580

Selling and distributive 15% of works cost 14,370 23,950

Total Cost 1,19,750

Profit 10% 11,975

Selling Price @ Rs. 164.65 or Rs. 165 for 800

Tonnes

1,31,725

Problem 2

The information give below has been taken from the costing record of an Engineering Works in respect of Job

No. 303.

Materials Rs. 4,010

Wages:

Dept. A – 60 hours @ Rs. 3 per hour

B – 40 hours @ Rs. 2 per hour C – 20 hours @ Rs. 5 per hour

Overhead expenses for these three departments were estimated as follows:

Variable overheads:

Dept. A – Rs. 5,000 for 5,000 labour hours

B – Rs. 3,000 for 1,500 labour hours

C - Rs. 2,000 for 500 labour hours

BSPATIL 63



Fixed overheads:Estimated at Rs. 20,000 for 10,000 normal working hours. You are required to calculate the cost of job 303 and

calculate the price to give profit of 25% on selling price.

Solution

Amount Amount

Rs. Rs.

Direct Materials 4,010

Wages – Dept. A 60 hrs. x Rs. 3 180B 40 hrs. x Rs. 2 80

C 20 hrs. x Rs. 5 100 360

Overheads – variable

Dept. A 60 x (Rs. 5000 / 5000 hrs.) 60

B 40 x (Rs. 3000 / 1500 hrs.) 80

C 20 x (Rs. 2,000 / 500 hrs.) 80 220

Fixed overheads:

120 hours @ (Rs. 20,000 / 10000 hrs) 240

Total cost 4,830

Profit 25% on selling price or 1/3 on Cost

Price

1610

Selling Price 6440

Advantages of job Costing

Job Costing offers the following specific advantages:-

σ The cost material, labour, and overhead for every job or product in a department is available daily, weekly or as

often as required while the job is still in progress. This enable the management to know the trend of the costs

and this by the efficiency of operations.

σ On completion of a job, the cost under each element is immediately ascertained. Cost may be compared with the

selling prices of he products in order to determine their profitability and to decide which product lines should be pushed or discontinued or whether prices or price quotation could be revised. The application of marginal

costing techniques may be useful in such situations.

σ Historical costs for past periods for each product, compiled by orders, departments, or machines, provide useful

statistics for future production planning and for estimating the costs of similar jobs to be taken up in future. This

assists in the prompt furnishing of price quotations for specific jobs.

σ The adoption of predetermined overhead rates in job costing necessitates the application of a system of

budgetary control of overhead with all its advantages.

σ The actual overhead costs are compared with the overhead applied at predetermined rates; thus at the end of an

accounting period, overhead variances can be analyzed.

σ Spoilage and defective work can be easily identified with specific jobs or products so that responsibility may be

fixed on determents or individuals.

σ Job costing is particularly suitable for cost-plus and such other contracts where selling price is determined

directly on the basis of costs.

BSPATIL 64



Limitations of job costing:

• Job costing is comparatively more expensive as more clerical work is involved in identifying each element of

cost with specific departments and jobs.

• With the increase in the clerical processes, chances of errors are enhanced.

• The cost as ascertained, even where they are complied very promptly, are historical as they are compiled after

incidence.

• The cost compiled under job costing system represents the cost incurred under actual conditions of operation.

The system does not have any scientific basis to indicate what the cost should be or should have been, unless

standards of performance efficiency are established. Estimated cost, prepared by some concerns in respect of joborders, also do not serve the purpose.

• If major economic changes take place, comparison of cost of a job for one period with that of another becomes

meaningless. Distortion of cost also occurs when the batch quantities are different.

BATCH COSTING

Batch costing a modified from of job costing. While job costing is concerned with producing articles according

to customer’s requirements and specifications, batch costing is used where the articles are manufactured in a good

number in definite batches. Component parts of watches, radio sets, television sets etc., are extensively produced under

batch costing, for being assembled in the product. If one component of a special design is ordered by a customer for

manufacture, it is Batch costing, Batch costing, therefore, is also known a “Lot Costing”.

A batch of workers is assigned to perform the task of producing a certain number of articles in a particular

period. Thus the cost of production can be compared batch wise, and efficiency ascertained. Like job order system, one

number is allotted to each batch. The material requisitions are prepared batch wise, labour is engaged batch wise, and

the overheads are also charged batch wise. This it is a modified form of job costing.

The cost control in batch costing depends upon ascertainment of the optimum number of batch production. The

Economic Batch Quantity can be decided on the same principle and same formula as applied to Economic Order

Quantity is case of materials.

Cost comparison between the two batches is possible if both batches are allowed the same facilities, time to

produce, and the same number of articles. The comparison can be fruitfully done with the help of cost sheets of the two

batches.

Problem 1

A joining factory has undertaken to supply 200 pieces of a component per month for the ensuing six months.

Every month a batch order is opened against with material and labour hours are booked at actual. Overheads are levied

at a rate per labour hour. The selling price contracted for is Rs. 8 per piece. Form the following data present the cost and

profit per piece of each batch order and overall position of the order for 1200 pieces.

Months Batch output Material cost Direct wages Direct labour

hours

Rs. Rs.

January 210 650 120 240

February 200 640 140 280March 220 680 150 280

April 180 630 140 270

May 200 700 150 300

June 220 720 160 320

BSPATIL 65



The other Details are:

Months Chargeable expenses Direct labour hours

Rs. Rs.

January 12,000 4,800

February 10,560 4,400

March 12,000 5,000

April 10,580 4,600May 13,000 5,000

June 12,000 4,800

Solution:

COST SHEET

Jan Feb. Mar. April May June Total

Batch output 210 200 220 180 200 220 1230

Sales Value

Rs.

1680 1600 1760 1440 1600 1760 9840

Material Cost

Rs.

650 64 680 630 700 720 4020

Direct Wages

Rs.

120 140 150 140 150 160 860

Chargeable

expenses Rs.

600 672 672 621 780 800 4145

Total Cost

Rs.

1370 1452 1502 1391 1230 1680 9025

Profit per

Batch Rs.

310 148 258 49 -30 80 815

Total Cost

per unit Rs.

6.52 7.26 6.83 7.73 8.15 7.64 7.34

Profit per

unit Rs.

1.48 0.74 1.17 0.27 -0.15 0.36 0.66

Over all position of the order for 1,200 units.

Sales value of 1,200 units @ 8/- per units. Rs. 9,600

Total cost of 1,200 units @ 7.34 per unit Rs. 8,808

_______________

Profit Rs. 792

BSPATIL 66



Lesson – 6CONTRACT COSTING

Contract is an agreement enforceable by law. It is an agreement between two parties – Contractor and the

Contractee. The contractor agrees to undertake and complete the work, as per terms of contract, within a specific period

and for a particular monetary consideration. The terms of contract regarding work to be undertaken, period in which to

be completed, value of the contract advances to be made by the Contractee to the contractor on the certificate of

architect, compensation payable by the contractor for the breach of contract, etc., are decided upon between the two

parties before the work is started. These contracts related to the works of construction of roads, buildings, bridges, dams

and banks, ports, etc,

Contract costing is the technique of ascertaining cost of a contract. Here the unit of cost is one only, e.g., a

building, or a bridge etc. it is similar to job in principle, and so the method of recording cost is the same. A ContractLedger book is kept in which a separate account for each contract is opened.

The following items appear on the debit side of the Contract A/c:

1. Direct Materials

2. Direct Labour

3. Direct Expenses

4. Overheads

5. Plant and Machinery

6. Sub-Contract Cost7. Extra Work done

The following items appear on the credit side of the Contract A/c:

1. Materials Returned

2. Materials Transferred

3. Materials at the end

4. Plant and Tools at the end

5. Work Certified

6. Work done but Uncertified7. Contract Price

Work Certified

As per terms of the contract, the contractee advances some 80 or 90 percent of he work done to the contractor on

the basis of the work certified by the contractee’s architect or engineer periodically. The balance of 20 or 10 percent

amount is retained by the contractee, so that the contractor may continue to work and not leave the contract if the

contract is not proving to be profitable one to him. The amount retained is known as ‘Retention of Money’.

Work done but not yet Certified

A work done by the contractor but which remains to be certified by the architect on the date of accounting is

known as work done but not yet certified.

Contract Price

The contract price is the value of contract agreed to be paid to the contractor by the contractee on the

satisfactory completion of the contract. So on the completion of the Contract the Contract A/c is credited with the

contract price and ‘Contractee’s A/c’ is debited.

Cost – plus – contract

Where a contractor feels hesitant to quote for a work of contract which is absolutely new to him, and new to

other contractors as well, and he is unable to estimate the cost of the works offered to him for execution. It is decided

with the contract or that he would be paid the total cost of work whatever it be, plus his profit as a rate percent on the

total cost. Such s contract is known as ‘Cost – plus – Contract’.

Ascertainment of Profit/Loss on Contract

BSPATIL 67



Solution:

Contract 101 Account

Rs. Rs.

To Materials Purchased 37,500 By work-in-Progress

Account:

To Wages 43,750 Work certified 90,000

To Plant 6,750 Work done but Uncertified2,500

92,500

To Proportionate share of

indirect expenses

1,875

To Outstanding Wages 625 By Material at site 1,500

To Balance c/d 9,000 By Plant at site (dep. Value) 5,000

Total 99,000 Total 99,000

To Profit and Loss A/c 4,500 By Balance c/d 9,000

To Work-in-Progress

Account

4,500


* Profit has been ascertained as follows:Rs. 9,000 x 2/3 x 67,500 / 90,000 – Rs. 4,500.

vi) if the contract work has sufficiently advanced, or the contract is almost complete, the profit is ascertained as follows:

The expenses of the part of the contract remaining to be executed are estimated, and added to the expenses

already incurred, to give an idea of the total cost of the full contract. On deducting the estimated total cost from thecontract price, we get the notional or the computed profit. Of this computed profit only that part is credited to P & L A/c

as is reduced by the proportion of.

(i) ‘Work credited’ to ‘Contract Price’ or more conservatively.

(ii) ‘Cash received’ to ‘Contract Price’ so:

i. Profit = Estimated Profit on completed contract x Work certified / Contract Price

ii. Profit = Estimated Profit on completed contract x Cash Received / Contract Price.

An Estimated Contract A/c or Estimated Contract Statement is required to be prepared to find out the estimated cost of

the full contract and to find out the national profit for the purpose of calculating the Profit to be credited to the Profit and

Loss Account in the main Contract A/c.

Work-in-progress and Balance Sheet

The Work-in-progress A/c is debited with the sums

(i) Work certified (valued at contract price), and(ii) Work done but not yet certified (valued at cost).

This account is credited with the balance of the notional profit not taken to the Profit and Loss Account.

This account shows debit balance which is taken to the Balance Sheet on the Asset side. The Contractee’s A/c which

shows credit balance on account of cash received in advance, is not shown on the Liability side of the Balance Sheet but

is shown as a deduction from the Work-in-Progress A/c on the Asset side of the Balance Sheet.

BSPATIL 69



Problem 2

The following information relate to Contract No. 123. You are required to prepare the Contract Account and the

Contractee’s Account assuming that the amount due from the contractee was duly received.

Rs.

Direct Material 20,250

Direct Wages 15,500

Stores Issued 10,500Loose Tools 2,400

Tractor Expenses:

Running Material 2,300

Wages of Drivers 3,000 5,300

Other Direct Charges 2,650

The contract price was Rs. 90,000 and the contract took 13 weeks in its completion. The values of Loose Tools and

Stores returned at the end of the period were Rs. 200 and 3,000 respectively. The plant was also returned at a value of

Rs. 16,000 after charging depreciation at 20%. The value of tractor was Rs. 20,000 and depreciation was to be charged

to the contract @ 15% per annum. The Administration and office expenses are to be provided at 10% on works cost.

Solution:

Contract 123 Account

Particulars Amount Particular Amount

Rs. Rs.

To Direct Materials 20,250 By Stores Returned 3,000

To Direct Wages 15,500 By Loose tolls returned 200

To Stores Issued 10,500 By Plant Returned 16,000

To Plant (original cost) 20,000 By Balance being 58,150

To Loose Tools 2,400 Work Cost A/c

To tractor expenses:

Running Materials 2,300

Wages of drivers 3,000 5,300

To Depreciation on Tractor @ 15% on Rs. 20,000 for

13 weeks

750

To other Direct Charges 2,650


To Balance being work cost

b/d

58,150 By Contractee’s A/c 90,000

To Administration andoffice expenses @ 10% on

works cost

To profit & Loss A/c 26,035


Contractee’s Account

Rs. Rs.

To Contract A/c 90,000 By Bank 90,000


The plant was depreciated @ 20% (not @ 20% annum). The depreciated value is Rs. 16,000. So the original cost of the

plant comes to Rs. 20,000.

BSPATIL 70



PROFIT ON INCOMPLETE CONTRACTS

Problems 3

A firm of building contractors began to trade on 1st April, 1990. The following was the expenditure on the contract for

Rs. 30,00,000:

Rs.Materials issued to contract 51,000

Plant used for contract 15,000

Wages incurred 81,000

Other Expenses incurred 5,000

Cash received on account to 31st March, 1991 amounted to Rs. 1,28,000 being 80% of the work certified. Of the plant

and materials which cost Rs. 2,500 were lost. On 31st March, 1991 plant which cost Rs. 3,000 and materials which cost

Rs. 2,000 was returned to stores, the cost of work done but uncertified was Rs. 1,000 and materials costing Rs. 2,300

were in hand on site. Charge 15% depreciation on plant, reserve ½ profit received and prepare a Contract Account from

the above particulars.

Solution: Contract Account

Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.

To materials 51,000 By Profit & Loss a/c

To Wages 81,000 Plant Lost 3,000

To Plant 15,000 Material 2,500 5,500

To Other expenses 5,000

By Plant returned

to store

2,000

To Profit to date 27,000 Less: Dep 300 17,00

By plant at site 10,000

Less: Dep 1,500 8,500

By Material at site 2,300

By Work-in-Progress A/c:

Work certified 1,60,000

Work done but

uncertified

1,000 1,61,000

Total 1,79,000 Total 1,79,000

To Profit & Loss A/c (½ of profit recd.)

10,800 By Profit to date b/d 27,000

To Work in Progress:

Reserve (½ of

profit recd.)

10,800

Balance (20% of

Rs. 27,000)

5,400 16,200


BSPATIL 71



Notes:

1. Ascertainment of Profit:

Profit to date 27,000

Profit received 4/5 (in the ratio of cash received to work certified) 21,600

Reserved ½ of profit received 10,800

Transferred ½ of profit received to Profit & Loss Account 10,800

Balance ( 27,000 – 21,000) i.e. 20% of 27,000 5,400

2. The value of the plant on 31st March, 1991 has been ascertained as follows:

Original Value Dep. Net Value

Rs. Rs. Rs.

Plant Lost 3,000 - -

Plant returned to

store

2,000 300 1,700

Plant at site 10,000 1,500 8,500

15,000 1,800 10,200

BSPATIL 72



Lesson – 7

PROCESS COSTING

Process costing is the type of costing applied in industries where there is continuous or mass production. Thenecessity for compilation of the costs of a process or a department for a given period, as distinct from the cost of a whole

job or a specific batch of production units, has given rise to the concept of process cost accounting. There are many

industries engaged in continuous processing in which the end products are the results of a number of operations

performed in sequence. In such industries, it is necessary to apply process costing.

Process costing is suitable for a large number of mining, manufacturing and public utility industries like mines

and quarries, cotton, wool and jute textiles, chemicals, soap making, paper, plastics, distillation processes, e.g. alcohol,

tanning, oil refining, screws, bolts and rivets, canning, food products, dairy, and electricity and gas undertakings.

Features of Process Costing:-

1. The production is continuous and the end product is the result of a sequence of processes.

2. The product is homogeneous and the units product are identical and standardized.

3. The sequence of operations for processing the product is specific and predetermined.4. The finished products of one process works as raw material for the next or process until completion.

Process Costing and Job Costing:-

A comparison of the basic principles of process costing with those of job costing, given below, will assist inappreciating process costing procedures.

Job Costing Process Costing

1. Production is by specify orders 1. Production is in continuous flow, the

products being homogeneous.

2. Costs are determined by jobs or

batches of products

2. Cost are compiled on time basis, i.e.

for production for a given accounting

period, for each process or

departments.

3. The various jobs are separate and

independent of each other.

3. Being manufactured in a continuous

flow, products lose their individual

entity.

4. Unit cost of a job is calculated bydividing the total cost incurred into the

units produced in the lot or batch.

4. The unit cost of a process, which iscomputed by dividing the total cost for

the period (after adjustment of the

opening and closing work-in-process),

is an average cost for the period.

5. Costs are calculated when a job iscompleted.

5. Costs are calculated at the end of thecost period.

6. There may or may not be any work-

in-progress at the beginning or end of

an accounting period.

6. Production being continuous there is

usually some work-in-process at the

beginning as well as at the end of the

accounting period.

7. There are usually no transfers from

one job to another unless it is necessary

7. As a product moves from one

process to another, transfers of cost

BSPATIL 73



5. Normal and abnormal losses occurring in process but there is no closing stock or the closing stock is fullycomplete.

6. Process consisting of partially completed closing stock.

7. Normal loss or abnormal loss involved-closing stock partially complete.

8. Process consisting of partially completed opening stock.9. Normal and/or abnormal losses and both opening and closing work-in-processes.

Problem 1: (Process accounts with Cost sheets)

Am article has to undergo three different processes before it becomes ready for sale. From the following

information find out cost of production per unit of that article, if 200 units of article were manufactured upto 31st

December, 1991.

Manufacturing

Process

Refining Process Finishing Process

Rs. Rs. Rs.

Material 2000 1000 700

Labour 1500 2500 1000

Direct Expenses 400 200 300

The indirect expenses for the period amount to Rs. 6,000 in the factory out of which Rs. 2000 is attributable tothis product. There was no stock at the end in any process. The indirect expenses should be allocated to each process on

the basis of labour.

Solution:

Manufacturing Process A/c with Cost Sheet

(Output : 200 units of article)

Particulars Cost per

unit

Amount Particulars Cost per

unit

Amount

Rs. Rs. Rs. Rs.

To Material 10.00 2.00 By Transfer toRefining Process

A/c

22.50 4500

To Labour 7.50 1500

To Direct Expenses 2.00 400

To Indirect

Expenses

3.00 600

Total 22.50 4,500 Total 22.50 4500

BSPATIL 75



Refining Process Account

(Output : 200 units of articles)

Particulars Cost

per

unit

Amount Particulars Cost

per

unit

Amount

Rs. Rs. Rs. Rs.

To Transfer from

ManufacturingProcess A/c

22.50 4500 By Transfer of

Finishing ProcessA/c

The cost per unit is

Rs. 46.00

46.00 9200

To Material 5.00 1000

To Labour 12.50 2500

To Direct Expenses 1.00 200

To Indirect

Expenses

5.00 1000

Total 46.00 9200 Total 46.00 9200

Refining Process Account

(Output : 200 units of articles)

Particulars Cost

per

unit

Amount Particulars Cost

per

unit

Amount

Rs. Rs. Rs. Rs.

To Transfer from

Refining Process

A/c

46.00 9200 By Finished Stock

A/c

58.25 11650

To Material 46.00 9200

To Labour 3.75 750

To Direct Expenses 5.00 1000To Indirect

Expenses

1.50 300

Total 58.25 11,650 Total 58.25 11650

Note: The indirect Expenses of Rs. 2000 have been allocated to the three processes in the proportion of direct

labour Rs. 3 : 5: 2 (Rs. 1500 : 2500 : 1000)

Problem 2: (Treatment of Bye-product and Scrap)

A particular brand of phenyl passed through three important processes. During the week ended 15 th January, 1952, 600

gross of bottles are produced. The cost book show the following information:

Process 1 Process 2 Process 3

Rs. Rs. Rs.

Material 4000 2000 1500

Labour 3000 2500 2300

Direct Expenses 600 200 500

Cost of bottles Nil 2030 Nil

Cost of corks Nil Nil Nil

BSPATIL 76



The indirect expenses for the period were Rs. 1600. The bye-products were sold for Rs. 240 (Process 2). The residue

sold for Rs. 125.50 (Process 3).

Prepare the account in respect of each process showing its cost and cost of production of the finished product per grossof bottles.

Solution:

Process 1 (Output 600 gross of bottles)

Rs. Rs.To Materials 4000.00 By Transfer to Process No.

2 (cost per gross of bottles

Rs. 13.69 approximately)

8215.38

To Labour 3000.00

To Direct Expenses 600.00

To Indirect Expenses 615.38

Total 8215.38 Total 8215.38

Process 2

To Transfer from Process

1

8215.38 By Sale of Bye-Product 240.00

To Materials 2000.00 By Transfer to Process of

bottles (cost per gross of

bottles Rs. 25.36

approximately)

15218.20

To Labour 2500.00



2030.00

Total 15458.20 Total 15458.20

Process 3

To Transfer from Process

2

15458.20 By Sale of residue 125.50

To Materials 1500.00 Bu Finished products

account (Cost per gross of

bottles Rs. 33.65)

20189.50

To Labour 2300.00



To Cost of rocks 325.00

Total 20315.00 Total 20315.00

Note: Indirect Expenses have been charged to three processes in the labour ratio of 30 : 25 : 23

Abnormal Loss and Abnormal Gain:-

Abnormal spoilage or defective work may arise in a process due to unforeseen factors. The cost of such

abnormal loss is not included in the cost of the process but the average cost of the lost units is charged to an Abnormal

Loss Account which is credited with the scrap and closed to the Profit and Loss Account. Thus, in computing the

abnormal loss, scrap value of the abnormal lost units will be ignored but in working out the loss for charging to Profit

BSPATIL 77



and Loss Account, this will be taken into consideration.

Sometimes, when the actual loss in a process is less than the anticipated loss, the difference between the two is

considered to be abnormal gain. The value of the abnormal gain is calculated in the same way as described above for

abnormal loss and is credited to an Abnormal Gain Account which is ultimately closed. Profit and Loss Account. Thescrap value of the normal anticipated loss in the process where abnormal gain occurs is credited to the process account

with the result that the net debit to the process is the cost of abnormal gain less the value of scrap for the normal loss.

Problem 3:(Normal wastage – Loss in weight and sale of scrap)

The Bengal Chemical Co. Ltd., produced three chemicals during the months of July 1995 by three consecutive

processes. In each process 2 per cent of the total weight put in is lost and 10 percent is scrap which from process (1) and

(2) realizes Rs. 100 a ton and form process (3) Rs. 20 a ton.

The product of three processes is dealt with as follows:

Process I Process II Process III

Passed to next

process

75% 50% -

Stock kept for sale 25% 50% 100%

Process I Process II Process III

Rs. Tons Rs. Tons Rs. Tons

Raw materials 120000 1000 28000 140 107840 1348

Manufacturing Wages 20500 - 18520 - 15000 -

General Expenses 10300 - 7240 - 3100 -

Prepare Process Cost Account, showing the cost per ton of each product.

Solution: Process I

Tons Rs. Tons Rs.To Raw Materials 1,000 1,20,000 By Loss of weight

(2% of 1000 tons)

20 -

To Manufacturing

Wages

20,500 By Sales of scrap

(10% of 1000tons)

100 10,000

To GeneralExpenses

10,300 By Transfer toWarehouse

220 35,200

By Transfer to

Process II (cost

per ton Rs. 160)

660 1,05,60

Total 1,000 1,50,800 1,000 1,50,800

BSPATIL 78



Process II

Tons Rs. Tons Rs.

To Transfer from

Process I

660 1,05,600

To Raw Materials 140 28,000 By Loss of weight

(2% of 800 tons)

16 -

To Manufacturing

Wages

- 18,520 By Sales of scrap

(10% of 800 tons)

80 8,000

To General

Expenses

- 7240 By Transfer to

Warehouse

352 75,680

By Transfer to

Process III (cost

per ton Rs. 215)

352 75,680

Total 800 1,59,360 800 159360

Process III

Tons Rs. Tons Rs.

To Transfer from

Process II

352 75,680

To Raw Materials 1,348 1,07,840 By Loss of weight(2% of 1700 tons)

34 -

To Manufacturing

Wages

- 15,000 By Sales of scrap

(10% of 1700

tons)

170 3,400

To General

Expenses

- 3,100 By Transfer to

Warehouse

1,496 198220

By Transfer to

Process III (cost

per ton Rs. 215)

352 75,680

Total 1700 2,01,620 Total 1700 201620

Problem 4:(Showing Process A/cs and Abnormal Wastage A/cs)

The Imperial Manufacturing Company’s product passes through two distinct processes A and B and then to Finished

Stock. It is known from past experience that wastage occurring in the process is as under:

In process A 5% of the units entering the process.

In process B 10% of the units entering the process.

The Scrap Value of the wastage in Process A is Rs. 8 per 100 units and Process B is Rs. 100 units.

The Process figures are:

Process A Process B

Rs. Rs.Materials consumed 3000 1500

Wages 3500 2000

Manufacturing expenses 1000 1000

5,000 units were brought into Process A costing Rs. 2500.

The outputs were:

Process A 4,700 Units

Process B 4,150 Units

BSPATIL 79



Prepare Process Cost Accounts showing the cost of the output. Also show abnormal Wastage Account.

Solution:

Process A Account

Units Rs. Units Rs

To Units introduced 5,000 2,500 By Normal wastage 250 20

To Material 3,000 By Abnormal

wastage

50 105*

To Wages 3,500 By Process B 4,700 9,875

To Mfg. Expense 1,000

5,000 10,000 5,000 10,000

* The Value of abnormal wastage in Process A is calculated as follows:

Normal output is 5,000 – 250 = 4,750 units Normal cost is 10,000 – 20 = Rs. 9,980

Therefore, Normal cost of one unit is 9,980 / 4,750 = Rs. 2.10

Therefore, Cost of 50 units of Abnormal wastage is 2.10 x 50 = Rs. 105.

As the Abnormal wastage is sold for Rs. 4, therefore, the amount of loss to be transferred to Profit and Loss Accountshall be Rs. 105 – 4 = Rs. 101.

Abnormal Wastage A/c (Process A)

Units Rs. Units Rs

To Process A 50 105 By sale of Scrap @

Rs. 8 per 100

50 4

By P & L A/c Loss

transferred

101

50 105 50 105

Process B Account

Units Rs. Units Rs

To Process A 4700 9875 By Normal Wastage

A/c

470 47

To Materials 1500 By Abnormal

wastage A/c

80 *271

To Wage 2000 By Finished Stock

A/c

4150 14057

4,700 17,375 4,700 14,375

* The value of abnormal wastage in Process B is calculated as follows:

The normal cost of 4230 units is Rs. 14328Therefore, Normal Cost of one unit = 14,328/4,230 = Rs. 3.39

Therefore, the Cost of 80 units = Rs. 3.39 x 80 = Rs. 271

The abnormal wastage will realize Rs. 8, therefore the loss transferable shall be Rs. 271 – 8 = Rs. 263.

Abnormal Wastage A/c (Process B)

BSPATIL 80



Units Rs. Units Rs

To Process B 80 271 By sale of Scrap @

Rs. 10 per 100

80 8

By P & L A/c Loss

transferred

263

80 271 80 271

Problem 5:

From the following details extracted form the costing records of an oil mill for a year ended 31st March, you are required

to prepare the process cost account of

(a) Groundnut Crushing Process;

(b) Refining Process; and

(c) Finishing Process including casking, and determine the cost per tone of each process and the total cost per tone

of finished oil.

Purchase of 5,000 tonnes of groundnut – Rs. 48,00,000

Crushing Plant

Rs.

Refining Plant Rs. Finishing Plant

Rs.Wages 25,000 10,000 15,000

Power 6,000 3,600 2,400

Sundry Materials 1,400 20,000 -

Repairs to Plant &

Machinery

2,800 3,350 1,400

Steam 6,000 5,200 4,500

Factory

Overheads

13,200 6,600 2,100

Cost o Casks - - 59,600

3000 tonnes of crude oil were produced; 2,500 tonnes of oil were produced by the refining process; and 2,480

tonnes of refined oil were finished for delivery.

Groundnut shells sold – Rs. 400; 1,750 tonnes of groundnut residue sold – Rs. 11,000; loss in weight in crushing

– 250 tonnes; 450 tonnes of by-products obtained from Refining Process – Rs. 16,750.

Solution:

Groundnut Crushing Process

Tonnes Rs. Tonne Rs.

Groundnut 5000 4800000 Crude oil (C/o) 3000 4843000

Wages 25000 Groundnut

residue

1750 11000

Power 6000 Groundnut

shells

400

Sundry materials 1400 Process loss 250 -Repairs to Plant

& Machinery

2800

Steam 6000

Factory

overheads

13200

5000 4854400 5000 4854400

Cost per tone of crude oil = Rs. 1614.33

BSPATIL 81



Prepare the process accounts and abnormal wastage account, assuming that the abnormal wastage collected together for

all the three processes was sold in one lump and fetched a price of Rs. 10000.

Solution:

For Process A:

1. Actual wastage = 20000 – 19500 = 500 units2. Normal wastage = 2% of 20000 = 400 units

3. Scrap sale value = 400 x Re. 0.50 = Rs. 200

4. Abnormal wastage = Actual wastage less normal wastage

= 100 units

5. Prorata cost = Rs. 176000 / (20,000 – 400) = Rs.

19,600

6. Cost of abnormal wastage Rs. 176600/19600 x 100

= Rs. 900 (rounded off)

Process A

Units Rs. Units Rs.

Units 20000 80000 Transfer toProcess B

19500 175500

Material 40000 Normal wastage 400 200

Labour 42000 Abnormal

wastage

100 900

Overhead 14600

20000 176600 20000 176600

Calculations in respect of Process B and C are made in a similar manner. Process B

Units Rs. Units Rs.

Transfer from

Process A

19500 175500 Transfer to

Process C

18800 244400



wastage

115 1495

Overhead 8380

19500 246480 19500 246480

Process C

Units Rs. Units Rs.

Transfer from

Process B

18800 244400 Transfer to

Finished stock

16000 288000



wastage

920 16560

Overhead 13920

18800 308320 18800 38320

Abnormal Wastage Account

Process A 900 Sale 10000

BSPATIL 83



Process B 1495 Loss (Profit and

loss account)

8955

Process C 16560

Total 18955 Total 18955

Accounting of Inter-Process Profits:-

Inclusion of inter-process profit creates complications in the accounts. As the internal profits remain merged in process stock, work-in-progress, and finished stock suitable adjustment is required to be made in the Balance Sheet in

order to exclude such unrealized profit.

When inter-process profit is included in the accounts, it is advisable to have three columns in the ledger to

indicate the cost, profit, and the total. This facilitates the calculation of the profit to be provided for inclusion in closing

stock in each process and in the final finished stock.

Problem 7:

A product passes through three processes before it is completed and transferred to finished stock. The following

data are available for a month.

Process

No.1 Rs.

Process

No.2 Rs.

Process

No.3 Rs

Opening stock (at prime cost) 2000 12000 10000

Direct material 13000 20000 40000

Direct Labour 10000 10500 50000

Factory overhead 10000 25000 25000

Closing stock (at prime cost) 5000 6000 32000

Inter-process transfers of output included profits at the following rates:

Process 1 to Process 2 - 20% on transfer priceProcess 2 to Process 3 - 25% on transfer price

Process 3 to Finished Stock - 10% on transfer price

Inter-process profit included in the opening stock were:-

In Process 2 - Rs. 2,000

In Process 3 - Rs. 2,800

In Finished Stock - Rs. 10,000

Finished Stock:-

Opening balance - Rs. 25,000

Closing balance - Rs. 33,000Sales during the month - Rs. 3,00,000

Complete the process accounts, determine the gross profit for the month and indicate the value at which the closing

stock will appear in the Balance Sheet on the last day of the month.

Solution:

Total

Rs.

Cost Rs. Pft

Rs.

Total

Rs.

Cost Rs. Pft

Rs.

Stock (b/f) 2000 2000 - Transfer 37500 30000 7500

BSPATIL 84



Total

Rs.

Cost

Rs.

Pft.

Rs.

Total

Rs.

Cost

Rs.

Pft.

Rs.

Stock (b/f) 10,000 7,200 2,800 Transfer

to

finished

stock

250000 186562 63438

Transfer from

process

No. 2

132000 90,212 41,788

Direct

material

40,000 40,000 -

Direct

labour

50,000 50,000 -

Total 232000 187412 44588

Less stock

(c/f)

32,000 25,850 6,150

Prime cost 200000 161562 38438

F.y.

Overhead

25,000 25,000 -

Process

cost

225000 186562 38438

Profit at

10% on

transfer

price of

cost

25000 25000

Total 250000 186562 63438 250000 186562 63438

Stock (c/f) 32000 25850 6150

BSPATIL 86



Process 3 6150

Finished

Stock

8812

15,674

Analysis of gross profit for the month:

Rs. Rs. Rs.

Process 1 7500Process 2 33000

Plus Provision not

made

1288 34288

Process 3 25000

Less Provision 3350 21650

Finished Stock 58000

Plus Provision 1188 59188

*122626

* This agrees with the profit in the Finished Stock Account

Balance Sheet

Process Stock 5,000

Process 1 6000

Process 2

Less Profit 712 5,288

32000

Process 3

6150

25850

Finished Stock 33000

Less Profit 8812

24188

Problem: 8

A product passes through three processes to completion. These processes are known at A, B, C. The output of

each process is charged to the next process at a price calculated to give a profit of 20% on the transfer price. The output

of process C is charged to Finished Stock on a similar basis.

There was no partly-finished work in any process on December 31, on which date the following information

was obtained.

Process A Process B Process C

Materialsconsumed

4000 6000 2000

Labour 6000 4000 8000

Stock on De. 31 2000 4000 6000

Stock in each process were valued at Prime Cost to the process

There was no stock into finished stock, Rs. 4000 remained in hand on December 31, and the balance has been sold for

Rs. 36,000. Show Process Accounts.

BSPATIL 88



Solution:

Process ‘A’ Account

Total

Rs.

Cost

Rs.

Profit

Rs.

Total

Rs.

Cost

Rs.

Profit

Rs.

To

Material

4000 4000 - By

Process

B A/ctransfer

10000 8000 2000

To

Labour

6000 6000 -

Total 10000 10000 -

Less :

Closing

Stock c/d

2000 2000 -

Prime

cost

8000 8000 -

To Gross profit

25% on

cost

2000 2000

10000 8000 2000 10000 8000 2000

To stock

b/d

2000 2000 -

Process ‘B’ Account

Total

Rs.

Cost

Rs.

Profit

Rs.

Total

Rs.

Cost

Rs.

Profit

Rs.

To

Process

A -transfer

10000 8000 2000 By

process

A/c

20000 14400 5800

To

Material

6000 6000 - 2000

To

Labour

4000 4000 -

Total 20000 18000 2000

Less :

Closing

Stock c/d

Prime

cost

16000 14400 1600

To Gross

profit

25% oncost

4000 - 4000

BSPATIL 89



20000 14400 5600

To stock

b/d

Process ‘C’ Account

Total

Rs.

Cost

Rs.

Profit

Rs.

Total

Rs.

Cost

Rs.

Profit

Rs.

ToProcess

B -

transfer

20000 14400 5600 Byfinished

To

Material

2000 2000 - Stock

A/c

30000 19520 10480

To

Labour

8000 8000 -

Total 30000 24400 5600

Less :

Closing

Stock c/d

6000 4880 1120

Primecost

24000 19520 4480

To Gross

profit

25% on

cost

6000 - 6000

30000 19520 10480 30000 19520 10480

To stock

b/d

6000 4880 1120

BSPATIL 90



Finished Stock A/c

Total

Rs.

Cost

Rs.

Profit

Rs.

Total

Rs.

Cost

Rs.

Profit

Rs.

To

Process

C -

transfer

30000 19520 1048 By

Sales

36000 16917 19083

Less :Closing

Stock c/d

4000 2603 1397

26000 16917 9083

To Gross

profit

10000 - 10000

36000 16917 19083 36000 16917 19083

To stock

b/d

4000 2603 1397

(1) Calculation of Profit on Closing Stock

Formulae:

Note: The amount of cost column and Total Column are those which appear above the Closing stock line.

Process ‘A’ : No profit included

4000 – 3600 = 400

6000 – 4880 = 1120

4000 – 2603 = 1397

(2) Actual Profit Realised

Process Unrealised Profit Actual Profit

BSPATIL 91



Profit

Rs.

in Closing Stock

Rs.

Rs.

Process ‘A’ 2000 - 2000

Process ‘B’ 4000 400 3600

Process ‘C’ 6000 1120 48880

Finished Stock A/c 10000 1397 8603

Total 22000 2917 **19083

** Varify this figure with that shown in the credit profit column of Finished Stock Account. It tallies.

(3) Valuation of Closing Stock for Balance Sheet

The amount of Cost Columns of Finished Stock Account will be taken to the Balance Sheet. It is comprised of:

Cost of closing stock

Rs.

Process ‘A’ 2000

Process ‘B’ 3600

Process ‘C’ 4880

Finished Stock 2603Total 13083

(4) Test Check

Individual cost of Process

= Rs. 30000

‘A’ ‘B’ ‘C’

= i.e. (10000 + 10000 + 10000)

Less : Cost of Sales (See Finished Stock A/c)

= Rs. 16917

-----------------

Closing Stock = Rs. 13083

-----------------

BSPATIL 92



LESSON – 8

STANDARD COSTING & VARIANCE ANALYSIS

STANDARD COST & STANDARD COSTING

Standard cost is a “predetermined cost which is calculated from management standard of efficient operation and the

relevant necessary expenditure.” - I.C.M.A ENGLAND

Standard costing is “the preparation of standard costs their comparison of actual costs and the analysis of variances to

their causes and points of incidence” - I.C.M.A ENGLAND

Thus, it is clear from these definitions that standard costs represent the scientifically planned or predetermined costs

based on technical estimate, labour and overhead for selected period of time and for a prescribed set of working

conditions. The word ‘standard’ connotes a thing serving as a basic for comparison. Standards can be established in

respect of quantitative and qualitative like material and labor.

OBJECTIVE OF STANDARD COSTING

The main objectives of standard costing are:

-To control the factors which affect production.

- to supply reports promptly to the management showing the progress of production and how expenditure to date

compares with estimates so that corrective actions may be taken in time, and

- To disclose the effect of temporary increase or decrease in the volume of output and sales or revenues.

TECHNIQUES OF STANDARD COSTING

The technique of standard costing involves:

- The ascertainment of standard costs.

- The use of standard costs.

- Their comparison with the actual cost and the measurements of variances.

- the location of responsibility for the variances and the corrective action to be taken.

- the analysis of variances for ascertainment the reasons for the same.

ESTABLISHMENT OF A STANDARD COSTING SYSTEM

The installation of standard costing system in a manufacturing concern involves the following steps:

a) Standardization of functions i.e. all activities should be standardized and the technical processes of operations

should also be susceptible to planning.

b) Establishment of cost centres.

c) Classification of Accounts i.e., the different accounts can be codified and different symbols may be used to

facilitate speedy collection, analysis reporting.

d) Setting up of standards: Standards may be basic (long period) and current (short period), From the point of view

of efficiency level they will fall into the three broad categories.

BSPATIL 93



i) Strict ideal

ii) Attainable or expected / actual and

iii) Loose

The standard should be realistic and attainable. Unrealistic standards provoke resentment and depress performance.

Loose standard leads the management to indulge in self congratulation. Normally a period of one year is more realistic

as it coincides with the budget period and the normal accounting period.

e) Setting of standard costs:

Standard costs should be determined for each element of cost separately and accurately. Like the budget committee or standards division which will be versed with the work of the standard costs. the standard committee generally consists of

all functional heads like production manager, personal manager, etc. In determining the output regard must be had to the

limiting factors affecting sales, production etc. setting up of standard cost involves the determination of cost standards.

A cost standard is a usage, price or other standard upon which a standard cost is based.

ADVANTAGES OF THE STANDARD COSTING

The utility of standard help the management in fixation of prices and in laying down production policies.

1. Standards costs help the management in fixation of prices and in laying down production policies.

2. The help in readily showing up and then elimination of avoidable wastages and losses.

3. They provide constant and uniform bases for management on the operational efficiency of workers and other members of the staff.

4. Management, through the study of variances, needs to concentrate only areas and problems which call for its

attention i.e., the system management by exception’ can be practiced.

5. Delegation of authority becomes effective the concerned men know what they have to achieve and by what

standard they will be judged.

6. The whole concern in stimulated with a dynamic forward looking mentality.

7. Performance of employees at all levels can be judged objectively, this enables the concern to promote and

regard the right person.

8. Standards act as a ‘yardstick’ to measure the actual performance and the efficiency of labour and other factors.

9. Valuation of closing stock is facilitated by the standard cost of production.

10. As standards are set for every element of cost, the costing procedures are simplified.

LIMITATIONS OF STANDARDS COSTING

Standard costing technique has the following short comings.

1. Setting of standards is a difficult task as it involves technical skill.

2. The fixation of inaccurate standards especially those that are incapable of achievement adversely affects themorale of the employees and act as hindrances to increased efficiency.

3. The system is not suitable for the jobbing type of industries producing articles according to customers

specifications even if it is installed, the fixation of standards for type of job becomes difficult and expensive.

4. It is necessary to distinguish between controllable and uncontrollable variances in order to localize deviations

and fixing responsibilities.

5. The system may not be suitable even in the case of industries that are liable to frequent technological changes

BSPATIL 94



affecting the conditions of production even if it is installed, a constant revision of standards become necessary.

6. Small concern cannot afford this system due to higher cost associated with standard costing.

7. There is no unanimity regarding the circumstances to be taken as the basis for setting standard costs. even if there is unanimity a revision of standard is essential to suit to the changing circumstances. The revision of

standards becomes expensive. If they are not revised, they become outmoded.

DETERMINATION OF STANDARDS

For any given product or unit the following standards must be determined.

1. Standard material costs.

2. Standard labour costs.

3. Standard direct costs.

4. Standard variable overhead costs

5. Standard Fixed over head costs.

6. Standard selling prices and profit.

The standard direct material cost is found by multiplying the quantity of materials to be purchased with the rate of price

at which they are available.

Determination of standard labour cost involves fixations of

(a) Standard labour grades

(b) Standards labour times i.e., standard hours through time, motion and fatigue study with the help of work study

engineers and

(c) Standard wage rates based on the time rate, piece rate and premium plans.

Standard direct cost is any expenditure which is directly to be incurred on a specific cost unit. It is charged directly tothe particular cost standard concerned.

Standard overhead costs are classified as manufacturing, administration, selling, and distribution over heads. They are

also classified as fixed, variable and semi variable so that current estimate for each class may be prepared for the budget

period. Standard overhead rate is determined on the basis of past records and future trend of prices.

VARIANCE ANALYSIS

The main aim of the standard costing is the control of the cost. So the management is provided with the information

about situations where in the actual results are not as they were planned to be. Hence management is informed of only

the deviations or variances from the original plans, their favourable or unfavorable nature and the causes of such

deviations. In this context standard costing subscribes to the principles of “management by exception”.

Variance is the difference between standard cost and actual cost. It is expressed by a simple formula as follows:

variance = actual cost – standard cost.

Variance analysis is therefore the process of analysis variance by dividing the total variance in such a way that

management can assign responsibility for off standard performance. If variance is to increase the profit it is said to be

favourable shown as (F). It would result when the actual cost are lower than the standard costs. It is also known as positive or credit variance and viewed only as savings. If variance is not to increase the profit it is adverse or

unfavorable shown as (A) it would result when actual costs exceed the standard costs. It is also known as negative or

debit variance and viewed as additional costs or losses.

1. MATERIAL NOT VARIANCE (MCV)

This is the difference between the standard cost of materials specified for the output achieved and the standard cost of

the materials used

BSPATIL 95



Material Cost Variance = Total std. – Total Actual Cost.

MCW = (SQ*SP) – (AQ * AP)

Where :

SQ = Standard Quantity

SP = Standard Price

AQ = Actual Quantity

AP = Actual Price

a) MATERIAL PRICE VARIANCE (MPV)

This is the difference between the standard price specified and the standard price paid.

MPV = AQ (SP – AP)

CAUSES

1. Change in basic purchase price of material.

2. Change in quantity of purchase or uneconomical size of purchase order.

3. Rush order to meet shortage of supply or purchase in less or more favourable market.

4. Failure to take advantage of off – season price, the failure to purchase when price is cheaper.

5. Failure to obtain cash and trade discounts or change in the discount rates.

6. Weak purchase organisation.

7. Payment of excess or less freight

8. Transit losses and discrepancies if purchase price is inflated to include the loss.

9. Change in quality or specification or materials purchased.

10. Use of substitute material having a higher or lower unit price.

11. Change in materials purchase, unkeep and store keeping cost (this is applicable only when such charges areallocated to direct material costs on a predetermined or standard cost basis.)

12. Change in the pattern or amount of taxes and duties.

b) MATERIAL USAGE VARIANCE (MUV)

This is the difference between the standard quantity specified and actual quantity used.

MUV = SP (SQ – AQ)

Material usage variance is subdivided into

i) Material mix variance

ii) Material yield variance or scrap variance

i) MATERIAL MIX VARIANCE (MMV)

This is the portion of the direct material usage variance which is due to the difference between the standard and the

actual composition of a mixture.

BSPATIL 96



a) When the ratio of mix is different but the total quantities of standard mix and the total quantities of actual mixare the same.

MMV = SP (SQ – AQ)

b) When the total actual quantity and total standard quantity and the ratio of mix are different, then the standard

quantity of the each material will be revised.

MMV = (RQ – AQ) * SP

Where RQ denotes Revised standard quantity, which is equal to

Total weight of actual mix

--------------------------------- * Standard Quantity

Total weight of standard mix

ii) MATERIAL YIELD OR SCARP VARIANCE

This is the portion of the direct material usage variance which is due to the difference between standard yield specified

and actual yield obtained.

MYV = SP * Abnormal Loss / Gain

Or

MYV = SP (SY – AY)

The difference between standard yield and actual yield is called abnormal loss or gain. If the standard yield is less than

the actual yield, the difference is called abnormal gain, and if the standard yield is higher than the actual yield the

difference is called abnormal loss.

CAUSES FOR MATERIAL USAGE VARIANCE

The causes of material usage variance are:

1. Variation is usage of materials due to inefficient or careless use or economic use of materials.2. Change in specification or design of product.

3. Inefficient and inadequate inspection of raw materials.

4. Purchase of inferior material or change in quality of materials.

5. Rigid technical specification and strict inspection leading to more rejections which require more materials for

rectifications.

6. Inefficiency in production resulting in wastages.

7. Use of substitute materials.

8. Theft or pilferage of materials.

9. Inefficient labour force leading to excessive utilization of materials.

10. Defective machines, tools, and equipments, and bad or improper maintenance leading to breakdown and more

usage of materials.

11. Yield from materials in excess of or less than that provided as the standard yield.

12. Faulty materials processing. Timber for example, if not properly seasoned may be wasted while being used in

subsequent processes.

13. Accounting errors, e.g. when materials returned from shop or transferred form one job to another are not

properly accounted for .

BSPATIL 97



14. Inaccurate standards

15. Change in composition of a mixture of materials for a specified output.

II LABOUR COST VARIANCE (LCV)

It is the difference between standard direct specified for the activity achieved and the actual direct wages paid.

LCV – SLC – ALC (Standard Labour Cost – Actual Labour Cost)

Labour cost variance is sub-divided into

1) Rate of pay variance and

2) Efficiency variance, which is further sub divided into

a. Idle time

b. Calendar variance

c. Mix variance

d. Yield variance

1. LABOUR RATE OF PAY VARIANCE (LRV)

This is that portion of labour cost variance which is due to the difference between the standard rate of pay specified andthe actual rate paid.

LRV = AT (SR - AR)

= Actual time (standard rate – actual rate)

CAUSES FOR LABOUR COST VARIANCE

Direct labour rate variance occur due to the following:

1. Change in basic wage structure or change in piece work rate. This will give rise to the variance till such time

the standards are not revised.

2. Employment of workers of grades and rates of pay different from those specified due to shortage of labour

of the proper category, or through mistake, or due to the retention of surplus labour.

3. Payment of guaranteed wages to workers who are unable to earn their normal wages if such guaranteed

wages form part of direct labour cost.

4. Use of a different method of payment e.g. payment of day – rates while standards are based on piece work

method of remuneration.

5. Higher to lower rates paid to casual and temporary workers employed to meet seasonal demands or urgent

or special work.

6. New workers not being allowed full normal wage rates.

7. Over time and night shift work in excess of or less than the standard, or where no provision has been madein their standard. This will be applicable only if overtime and shift differential payments form that laid down

in the standard.

2) LABOUR EFFICIENCY VARIANCE (LEV)

This is also that portion of labour cost variance which is due to the difference between the standard labour hours

specified for the outputs achieved and the actual labour hours expended. This is otherwise known as labor time variance.

Labour spending variance, labour usage variance, labour quantity variance.

BSPATIL 98



LEV = SR (ST – AT)

CAUSES FOR LABOUR EFFICIENCY VARIANCE

The causes giving rise to direct labour efficiency variance as follows:

1. Lack of proper supervision or stricter supervision that specified.

2. Poor working conditions

3. Delay due to, waiting for materials tools, instructions etc. if not treated as idle time.

4. Defective machine tools, and other equipments.

5. Machine break down if not booked to idle time.

6. Work on new machines requiring less tike then provided for as long as the standard is not revised.

7. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions, incorrect

scheduling of jobs etc.

8. Use of non standard material requiring more or less operation wages.

9. Carrying our operations not provided for and booking them as direct wages.

10. In correct standards11. Wrong selection of workers, e.g. no employing the right type of man for doing the job.

12. Increase in labour turnover.

13. Incorrect recording of performances, i.e. time and output.

LABOUR IDLE TIME VARIANCE (LITV)

This is that the portion of labour cost variance which is due to the abnormal idle time of workers on account of

failure of power supply, machine break – down, shortage of materials etc.

LITV = IH * SR (Idle hours * standard rate per hour)

LABOUR CALENDAR VARIANCE (LCV)

This arises only when workers are paid for the days for which they have not worked and for which no provision

was made while determining standards. This will happen only when some special public holidays be declared.

LCV = SR * Holidays

LABOUR MIX VARIANCE (LMV)

It is due to the difference in the standard output specified and actual output obtained.

LYV = Standard labor cost per unit (actual output – standard output)

PROBLEM 1

The standard cost of the chemical mixture ‘PQ’ is as follows:

40% of material P@ Rs. 400 Per k.g.

60% of material Q@ Rs. 600 per kg.

BSPATIL 99



A standard loss of 10% is normally anticipated in production. The following particulars are available for the month of September 1984.

A standard loss of 10% is normally anticipated in production. The following particulars are available for the month of

September 1984.

180 kgs. of material P have been used @ Rs. 360 per kg.

220 kgs. of material Q have been used @ Rs. 680 per kg.

The actual production of ‘PQ’ was Rs. 369 kgs.

Calculate the following variance:

a. Materials price variance

b. Materials usage variance

c. Materials mix variance

d. Materials yield variance

Also show the reconciliation of standard cost with actual cost with actual cost with help of the above variance.

Solution

Standard loss is 10%

Hence for productions of 90 kgs require input of 100 kgs.

Therefore production of 369 kgs requires input of?

369 / 90 * 410 kgs.

MCV = (Standard cost of input of (410 kgs of production) (actual cost of production of 369 kgs)

P40% of 410 = 164 kgs at 400 = 65600 P 180*360 = 64,800

Q60% of 410 = 246 kgs at 600 = 147600 Q 220*680 = 149,600

----- -------------- ------- ----------

Input 410 kgs 213200 400 214400

Loss 41 31 ----

----- -------------- ------- ----------

Production 369 kgs 213200 369 214000

1. Material Cost Variance (MCV) = SC – AC= 213200 – 214400

= Rs. 1200 (A)

2. Materials Price Variance (MPV) = AQ (SP-AP)

P = 180 (400 – 360) = 7200 (F)

Q = 220 (600 – 680) = 17600 (A)

---------------------

10400 (A)

---------------------

BSPATIL 100



3. Material Usage Variance (MUV) = SP (SQ-AQ)

P = 400 (164 – 180) = 6400 (A)

Q = 600 (246-220) = 15600 (F)

----------------------9200 (F)

----------------------

Material Usage Variance is to be analysed into Mix Variance and yield variance as follows:

(i) Material Mix Variance (MMV) = SP (RSQ – AQ)

P = 400 (164 * 400 / 410 – 180)

= 400 (160-180) 8000 (A)

Q = 600 (246*400/410 – 220)

= 600 (246-220) 12000 (F)

---------------

40000 (F)

---------------

Material yield variance (MY) = SYR (SY-AY)

Standard Cost per unit at output = 213200/369

= Rs. 577.1778 per kg.

For an input of 410 Kgs. – Standard yield is 369 kg

For an input of 400 Kgs. – Standard yield is ?

400 / 410 * 369 = 360 kgs. Standard yield for actual input

MY = Rs. 577.1778 (360-368) =Rs. 5200(F)

(ii) Labour Efficiency Variance (LEV)

= SR (SH-AHP)

= 3.00 (7000-8000)

= 3000 (A)

(iii)Labour Cost Variance (LCV)

= SCAP – AC= 21,000 – 24160

= 3160 (A)

Note:- When there is difference between actual hours paid (AHP) and Actual Hours Worked (AHW) there will be

Labour Efficiency Sub-variance and Idle time Variance which are calculated as follows:

Labour Efficiency Sub Variance = SR (SH-AHW)

= 3.00 (7000-8000)

= Rs. 2400 (A)

Labour Idle Time Variance = SR * No. of Hours lost

= 3.00 * 200

= Rs. 600 (A)

--------------

Rs. 3000 (A)

--------------

BSPATIL 101



This is reconciled with Labour Efficiency Variance as calculated above.

Reconciliation:

MUV = MMV + MYV9200(F)= 400 (F) + 5200 (F)

Final Reconciliation:

MCV = MPV + MMV + MYV1200 (A) = 10400 (A) + 4000(F) + 5200(F)

PROBLEM 2

The following details are available form the records of ABC Ltd. engaged in manufacturing Article ‘A’ for the

week ended 28th September.

The Standard Labour hours for the week 1000 hrs and rates of payment per article ‘A’ were as follows:

Hours Rate per hour Total

Rs. Rs.

Skilled Labour 10 3.00 30

Semiskilled Labour 8 1.50 12Unskilled Labour 16 1.00 16

58

The actual labour hours and rates of pay per hour were given below:

Hours Rate per hour Total

Rs. Rs.

Skilled Labour 9000 4.00 36000

Semiskilled Labour 8400 1.50 12600

Unskilled Labour 20000 0.90 18000

66,600

From the above set of data you are asked to calculate:

a. Labour Cost Variance

b. Labour Rate Variance

c. Labour Efficiency Variance

d. Labour Mix Variance

Solution

SCSM SCAM

SM Hours Rate Amount

Rs.

AM Hours Rate Amount

Rs.

Skilled 1000 x

10 =

10000

3,00 30000 Skilled 9000 3.00 27,000

BSPATIL 102



Semi-skilled 1000 x

8 =

8000

1.50 12000 Semi-skilled 8400 1.50 12,600

Un-skilled 1000 x

16 =

16,000

1.00 16000 Un-skilled 20000 1.00 20,000

34,000 58000 37400 59,600

(SCSM)

a. Labour Cost Variance (LCV) = SC-AC

= 58000-66600

= 8600(A)

b. Labour rate Variance (LRV) = AHP (SR-AR)

Skilled = 9000 (3-4) = 9000(A)

Semi-Skilled = 8400 (1.50 – 1.50) = Nil

Un-Skilled = 20,000 (1 - .90) = 7000 (A)

c. Labour Efficiency Variance (LEV)

= SR (SH-AHP)= 3.00 (10000 – 9000) = 3000(F)

= 1.50 (8000 – 8400) = 600(A)

= 1.00 (16000 – 20000) = 4000(A)

----------------

1600(A)

d. Labour Mix Variance (LMV) = SCSM – SCAM

= 58000 – 59600

= 1600(A)

Problem 3

In the production of Finished product 50 employees were engaged at a Standard rate of Rs. 3 per hour. The standard performance was set at 200 numbers per hour. A 40 hour per week was in operation. In a particular period of 4 weeks 35

employees were paid at the standard period of 4 weeks 35 employees were paid at the standard rate, but 10 employees

were paid at Rs. 3.20 per hour and 5 employees at Rs. 2.80 per hour. The factory stopped production for 4 hours due to

equipment failure. Actual production was 28000 Units. Calculate the labour (i) rate and (ii) efficiency Variances.

Solution

50 employees x Rs. 3 per hour = Rs. 150

Output product = 200

Standard cost of actual production (SCAP) = 28000 x 0.75

= Rs. 21,000

Actual Cost (AC)

Employees Weeks Hours Rate

Rs.

Amount

BSPATIL 103



35 x 4 x 40 = 5600 x 3.00 = 16,800

10 x 4 x 40 = 1600 x 3.20 = 5,120

5 x 4 x 40 = 800 x 2.80 = 2,240

50 8000 24,160

AHP = 8000

AHW = 8000 – Idle time of 4 hours 8000 – 200 = 7200in respect of all 50 employees

(i) Labour Rate Variance (LRV) = AHP (SR – AR)

= 5600 (3.00 – 3.00) = Nil.= 1600 (3.00 – 3.20) = 320 (A)

= 800 (3.00 – 2.80) = 160 (F)

-------------

160 (A)-------------

OVERHEAD VARIANCE

Overhead Variance can be classified into (A) Variable Overhead Variance and (B) Fixed Overhead Variance.

OVERHEAD COST VARIANCE

Fixed Overhead Variance Variable Overhead Variance

ExpenditureVariance

VolumeVariance

ExpenditureVariance

EfficiencyVariance

Efficiency Capacity Calendar Seasonal

1. Variable Overhead Variance: They are caused by difference between the actual variable overhead expenditure

incurred and the standard allowed:

VOHC = SOHC – AOHC

Variable Overhead = Standard Variable Overhead Cost on Cost Variance – Actual Output – Actual Variable

Overhead Cost

= (Actual output Standard Overhead Rate – Actual Overhead

Alternatively, the following variable overhead variance may be computed to make the position more clear:

(i) Variable Overhead Expenditure Variance (VCHE x V) Cost

This is the difference between standard variable Overhead allowance of actual output, and the standard variable

overhead of actual time.

VOHE efficiency Variance = Standard Overhead Rate (Actual Time – Standard time for actual production)

BSPATIL 104



Total Variable Overhead = Expenditure Variance + Efficiency Variance

Fixed Overhead Cost Variance (FOHCV) : It is that portion of overhead variance which is due to the difference between

fixed overhead recovered and the actual fixed overhead cost incurred.

FOHCV = (Actual output * Standard fixed overhead Rate) – Actual Overhead

This variance is divided into (i) fixed Overhead Expenditure Variance and (ii) Fixed Overhead Volume Variance

(i) Fixed Overhead Expenditure (FOHEV) : It is the difference between actual overhead expenditure and the

budgeted expenditure.

FOHEV = Budgeted fixed Overhead – Actual Fixed Overhead

= (Standard Recovery Rate * Budgeted Production) –

Actual Fixed Overheads

If the actual output is more than the budgeted output, it leads to over-recovery of overheads costs and a favourable

variance results an vice versa. This variance is also known as Budget Variance or Cost Variance or Spending Variance.

(ii) Fixed Overhead Volume Variance (FOHVV) : It is the difference between the standard cost of overhead

absorbed in actual output and the standard allowance allowed for the output. This variance is caused due to the

difference between the budgeted output and the actual output.

FOHVV = Standard Fixed Overhead Rate (Actual Quantity – Budgeted Quantity)

Or

= Actual output * Standard Rate – Budgeted Fixed Overhead

If the actual output is more than the budgeted output, it leads to over-recovery of overhead costs and a favourable

variables results and vice versa.

The Volume Variance can further be analysed as under –

(a) FIXED OVERHEAD EFFICIENCY VARIANCE (FOHEff.V)

It is that portion of volume variance which is due to the difference between the budgeted efficiency (in standard unit)

and the actual efficiency achieved. This variance is like labour efficiency variance.

FOHEff.V = Standard Overhead Rate per unit (Actual Quantity – Standard Quantity)

When the actual output is more than the standard quantity of output.

Overhead Cost Variance: Causes Controllability

A. OverheadExpenditure Variance

1. Rise in prices, wages Uncontrollable

2. Lack of control over

Expenditure

Dept. Manager

3. Change in production Production Manmager

4. Change in nature of

service eg. Use gas in

lieu of electricity

--do--

B. Volume Variance 1. Declining Sales (Lack

of orders) or Customer

Sales Manager

BSPATIL 105



demands

2. Lack of proper

supervision

Foreman

3. Defect in Machinery

(Breakdown)

Maintenance Engineer

4. Low efficiency of

worker

Foreman / Personnel

Manager

5. Poor quality material Purchase Manager

6. Abnormal idle time (if not booked as part of

time spent on jobs)

Foreman /Uncontrollable

7. More or less working

days / Calendar

Uncontrollable

8. Strikes, absenteeism

including lateness

Personnel Manager

PROBLEM 4

The following figures have been extracted from the cost records for the month of March 1997.

Standard Actual Number of units

produced

7500 8000

Capacity 100% 105%

Number of days worked 25 26

Fixed overheads Rs. 22500 Rs. 23500

Variable overheads Rs. 15000 Rs. 15750

Analyse the total overhead variance into

(i) Fixed overhead variance,

(ii) Variable overhead variance, and

(iii)Sub-variances under each head

Solution

Overhead Cost Variance = Std. cost for Actual production – Actual cost

= 40,000 - 38,900= Rs. 1,100 (F)

Overhead Cost Variance = FOHCV + VOHCV

Rs. 1100 (F) = Rs. 850 (F) + 250 (F)

(a) FOHCV = (AP * SOHR) – APOH= 8000 x 3 – 23150

= Rs. 850 (F)

(b) Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overheads

= Rs. 22500 – Rs. 23150

= Rs. 650 (A)

(c) FOHVV = BOHR – AP * SOHR

BSPATIL 106



= 8000 x 3 – Rs. 22500= Rs. 1500 (F)

Or

SOHR (Budgeted output – Actual output)

= 3 x (7500 – 8000)= Rs. 1500(F)

(d) Capacity variance – Fixed Overhead Standard Rate per unit

(Standard Quality for actual hours)For actual hours / days

= Rs. 3

Standard production for actual hours

=

= 7875 units

(e) Calendar Variance = per unit Standard Fixed Cost –

(Actual Quantity – Standard

Quantity for actual capacity)

= Rs. 3 (8000-7875)

= Rs. 375 (F)

=

= 7875

FOHCV = FOHEV + FOHVV

= Rs. 650(A) + Rs. 1500 (F)

= Rs. 850 (F)

Proof

FOH V.V. = Cal. V. + Cap. V. + Eff. V.

Rs. 1500(F) = Rs. 900(F) + Rs, 225 (F) + Rs. 375(F)

(i) Variable overheadVariance = SC – AC

Where

= Rs. 16000 – Rs. 15750

= Rs. 250(F)

BSPATIL 107



(ii) Variable overhead

Expenditure variance = BC – AC

= 26 x 600

= 15600 – 15750= Rs. 150(A)

(iii) Variable overhead efficiency variance

Where standard overhead rate per hour / day is given

Variable overhead

Efficiency variance = SR (AT – ST)

= 600 (26 – 26.67)

= Rs. 400 (F)

Where standard overhead rate per unit is given:

Variable overhead

efficiency variance = SR (AP – SP)= 2 (8,000 – 7,800)

= Rs. 400(F)

Check :VOHCV = VOH EX. V. + VOH Eff. V.

Rs. 250(F) = Rs. 150(A) + Rs. 400(F)

Problem 5

The standard cost per unit for product ‘A’ is as under :

Standard Cost : - The cost of operations to produce 1000 units during January 1971 is as under:

Rs. Rs.

Material 1 Unit Rs. 10 10 Material 950 at Rs. 11 10,450

Labour 5 hours at Rs. 2 10 Labour 4,500 hours at Rs.

2.20

9,900

Overheads: Overheads:

Variable 5 hours at Rs. 2 Variable 11,000

Fixed 5 hours at Rs. 1 5 Fixed 6500

Total cost per unit 35 Total cost of 1000 units of

product A

37,850

The flexible budget for this department for normally monthly activity was called for 6,600 direct labor hours of

operations. At this level the fixed indirect cost was budgeted at Rs. 6,000.

You are required to compute the various variance from the above solution.

Solution

i) Material cost variance = Standard cost of actual output – Actual cost of actual material used

= Rs. 10,000 – Rs. 10450

= Rs. 450 (A)

BSPATIL 108



ii) Material price variance = AQ (SP-AP= 950 (10-11)

= 350 (A)

iii) Material usage variance = Standard unit price (SQ-AQ)= Rs. 10 (1,000 – 950)

= Rs. 500 (F)

Verification :

Material cost variance = Materials price variance + material usage variance

Rs. 450(A) = Rs. 950(A) + Rs. 500 (F)

iv) Labour cost variance = SLC – ALC

= 5,000 * Rs. 2 – 4,500 * Rs. 2.20

= Rs. 10,000 – Rs. 9,900

= Rs. 100 (F)

v) Labour rate of pay variance = Actual time (Standard rate – Actual rate)

= 4,500 (2 – 2.20)

= Rs. 900 (F)

vi) Labour Efficiency variance

= Standard rate (Standard time – actual time)

= Rs. 2(5,000 – 4,500)

= Rs. 1000 (F)

Check : LCV = LRV + LEV

Rs. 100(F) = Rs. 900 (A) + Rs. 1000 (F)

vii) Variable over head

Variance = (Actual output * standard rated of fixed overheads) – Actual fixed over head incurred

= (1,000 x 5) - 6,500

= Rs. 1,500 (A)

Proof

Overhead Cost Variance = Variable overhead variance + fixed over head variance

Rs. 2,500 (A) = Rs. 1,000 (A) + Rs. 1,500 (A)

SALES VARIANCE

The cost variance so for explained ultimately affects profit favourably or adversely. Budgeted profit may be

affected due to increase or decrease i) in the selling price and ii) the quantum of sales.

The are two distinct method of computing and presenting sales variance.

i) Sales value or turnover method and

ii) Sales margin profit method.

The first method shows the effect of variance in terms of turnover. The second shows the effect in terms of profit.

BSPATIL 109



Sales Value Method

(i) Sales Value Variance:

It is difference between standard

Or

Budgeted sales and the actual sales

Sales Value Variance = Standard sales – Actual sales

Note: Standard Sales = Standard sales * Actual quantities of sales

If actual sales are more than the budgeted or standard sales, a favourable variance would result and vice versa.

ii) Sales Price Variance:

If is that portion of the sales value variance which is due to the difference between standard price specified and

the actual price charged.

Sales Price Variance = Actual quantity Sold (Standard Price – Actual Price)

iii) Sales Volume Variance

This is the difference between the budgeted sales and the standard value of the actual mix of sales.

Sales Volume Variance = Standard Price (Actual Quantity – Standard Quantity)

Or

= Budgeted Sales – Standard Sales

If actual sales at standard price exceed the budgeted sales, there is a favourable variance and vice versa.

Thus, Sales Value Variance = Price Variance + Volume Variance

The volume variance can further be analyzed into

(a) Mix Variance and

(b) Quantity Variance

(a) Mix Variance:

It is that portion of the sales value variance which is due to the difference between the standard and the actual

interrelationship of the quantities of each product or product group of which sales are composed, where products are

BSPATIL 110



homogeneous.

- Standard Cost of Actual Mix

Sales Margin Quantity Variance:

This is the difference between sales margin volume variance and sales margin mix variance.

Margin Quantity Variance = Standard Margin Rate (Standard Quantity – Actual Quantity)

Sales Margin Due to Sales Allowance:

It is that portion of total margin variance which is due to the difference between the budgeted rebates, discounts,

etc., allowance on those sales:

Profit (or Loss) Variance:

It is the difference between the budgeted profit (or Loss) and the actual profit (or loss).

Types Causes Controllability

A. Sales Price

Variance

1. Unexpected Competition

2. Rise in general price level

3. Poor quality of material

Uncontrollable

- Do –

- Do -

B. Sales Volume

Variance

1. Unexpected Competition

2. Ineffective Sales Proportion

3. Ineffective Supervision and

control of salesman

Uncontrollable

Publicity Manager

Sales Manager

DISPOSAL OF VARIANCES

There is difference of opinion among accountants as regards disposal of cost variance. However, the following

methods are usually used to close the Standard Cost Variances:

i) Transfer to profit and loss account.

ii) Allocation of finished stock, work in progress, and cost of sales;

iii) Transfer to Reserve Account i.e., to carry forward to the next financial year and to be set off in the

subsequent year of years

The standard cost are also incorporated in the accounting system so as to increase its statistical utility. The following are

the methods for accounting based on standard costing.

i) Partial plan method,

ii) Single plan method and

iii) Dual plan method.

PROBLEM 7

From the following particulars of Sri Dhanalakshmi mills Ltd., calculate:

i) Total sales margin variance

BSPATIL 111



ii) Sales margin variance due to selling price.iii) Sales margin variance due to volume.

Standard Actual in (Rs.)

Qty Cost p.u. Price p.u. Units Cost Price

Prod X 3,000 10 12 2,200 10.50 13

Prod Y 2,000 15 18 1,600 14.00 17

Solution

i) Total Sales Margin

Variance = Actual quantity of sales x Actual profit per unit

- budgeted quantity of sales x Budgeted profit

per unit

(i.e. Actual profit – Budgeted profit)

Prod. X : 3,200 * Rs. 2.50 – 3000 * Rs. 2.00 = Rs. 2,000 (F)

Prod. Y : 2,600 * Rs. 3.00 – 2000 * Rs. 3.00 = Rs. 1,200 (A)

-------------------

Total Sales Margin Variance Rs. 800 (F)

ii) Sales Margin Variance due to

Selling price = AQ (AP – SP)

Prod. X : 3,200 (Rs. 13 – Rs. 12) = Rs. 3,200 (F)

Prod. Y : 1,600 (Rs. 17 – Rs. 18) = Rs. 1,600 (A)

-------------------------

Total sales margin due

selling price Rs. 160 (F)

iii) Sales margin due to volume = SP (AQ – SQ)

Prod X: Rs. 2 (3,200 – 3000) = Rs. 400 (F)

Prod Y: Rs. 3 (1,600 – 2000) = Rs. 1,200 (A)--------------------------

Total sales margin variance

due to volume = Rs. 800 (A)

BSPATIL 112



PROBLEM 8

For a month, the budgeted and actual figure for sales in a company were as under:

Product Qty Price

Rs.

Budget

Value

Rs.

Qty Actual

Price

Rs.

Actual

value

Rs.

I 20 2 40 15 2 30II 10 1 10 15 1.50 22.50

III 5 3 15 10 2.50 25

IV 10 3.50 35 10 3 30

45 100 50 107.50

The budgeted costs were the different products were:

I Rs. 1.50

II Rs. 0.80

III Rs. 2.00

IV Rs. 3.00

Calculate the sales variance based on :

a) Turnover and b) Profits verify your calculation.

Solution

a) Sales variance based on turnover:

Standard Sales (SS)

Actual Budget

Revised Standard Sales SS

Product Qty Price Balue Standard price per Unit of Standard

I 15 2 30.00 Mix = 100 / 45 = 2.2222II 15 1 15.00 RSS = 50 * 2.2222 = Rs. 111.11

III 10 3 30.00

IV 10 3.50 35.00

50 110.00

Total sales value Variance = BS – AS

= 100 – 107.50

= Rs. 7.50 (F)

Sales Rate Variance (SRV) = AQ (SR – AR)

I = 15 – (2 – 2) = Nil

II = 15 – (1 – 1.50) = 7.50 (F)

III = 10 (3 – 2.50) = 5.00 (A)

IV = 10 (3.50 – 3) = 5.00 (A)

2.50 (A)

Sales Volume Variance (SVV): = (SR – (BQ – AQ)

BSPATIL 113



I = 2 (20 – 15) = 10.00 (A)

II = 1 (10 – 15) = 5.00 (F)

III = 3 (5-10) = 15.00 (F)

IV = 3.50 (10 – 10) = Nil

10.00 (F)

Reconciliation I:

Total sales value Variance = SRV + SVV

7.50 (F) = 2.50 (A) + 10.00 (F)

Sales Quantity Variance (SQV) = BS – RSS= 100 – 111.11

= 11.11 (F)

Sales Mix Variance (SMV) = RSS – SS= 111.11 – 110.00

= 1.11 (A)

Note : if RSS is more than SS, it is adverse variance and vice versa.

Final Reconciliation:

Total Sales Value Variance = SRV + SQV + SMV

7.50 (F) = 2.50 (A) + 11.11 (F) + 1.11 (A)

b) Sales Various based on Profit:

Budget Profit

Product Qty. Rate of Profits Total Rs.

I 20 2.00 – 1.50 = 0.50 10.00

II 10 1.00 – 0.80 = 0.20 2.00III 5 3.00 – 2.00 = 1.00 5.00

IV 10 3.50 – 3.00 = 0.50 5.00

45 22.00

ACTUAL PROFITS AP

Product Qty. Rate of Profits Total Rs.

I 15 2.00 – 1.50 = 0.50 7.50

II 15 1.50 – 0.80 = 0.70 10.50

III 10 2.50 – 2.00 = 0.50 5.00IV 10 3.00 – 3.00 = Nil. Nil

50 23.00

Standard Profit (SS)

Actual Budget

Revised Standard Profit

Product Qty Rate Value Standard Margin per Unit of

BSPATIL 114



of

Profit

Standard Mix

I 15 0.50 7.50 = 22 / 45

II 15 0.20 3.00 = Rs. 0.4889

III 10 1.00 10.00 RSP = 50 x 0.4889

IV 10 0.50 5.00 = 24.44

50 25.50

Total sales Profit Variance = BP – AP

= 22.00 - 23.00

= Rs. 1.00 (F)

Sales Rate of Profit

Variance (SRPV) = AQ (SRP – ARP)

I = 15 (0.50 – 0.50) = Nil

II = 15 (0.20 – 0.70) = 7.50 (F)

III = 10 (1.00 – 0.50) = 5.00 (A)

IV = 10 (0.50 – Nil) = 5.00 (A)

2.50 (A)

Sales Volume Variance (SVV) : = (SRP – (BQ – AQ)

I = 0.50 (20 – 15) = 2.50 (A)

II = 0.20 (10 – 15) = 5.00 (F)

III = 1.00 (5 – 10) = 5.00 (F)

IV = 0.50 (10 – 10) Nil

3.50 (F)

Reconciliation 1:Total sales Profit Variance = SRPV + SVV

= 2.50 (A) + 3.50 (F)

= Rs. 1.00 (F)

Sales Quantity Variance (SQV) = BP – RSP

= 22.00 – 24.44

= Rs. 4.44 (F)

Sales Mix Variance (SMV) = RSP – SP

= 24.44 – 25.50

= 1.06 (F)

Reconciliation II:

SVV = SQV + SMV

3.50 (F)= 2.44 (F) + 1.06 (F)

= 1.00 (F)

CONTROL RATIOS

The management wants to know whether performance of its business is going as per estimated schedule or not.

BSPATIL 115



This can be identified with the help of control ratios. If the ratio are more than 100% then the performance will befavourable but if these ratios are less than 100% then the performance will be unfavourable or unsatisfactory. The

formula for computing certain control ratios are given below.

The ratio indicates how much budgeted hours have been actually utilized. If the ratio if 80% then it means that 80%

budgeted hours have been utilized and the remaining 20% capacity remain idle.

This ratio shows the level of activity attained during the period.

This ratio shows the level of efficiency attained during a particular period. If this ratio is 130% then it shows that the

efficiency is more by 30% or it has gone up by 30%.

This ratio shows whether actual working days available are more or less than the budgeted working days. If the ratio is

more than 100% then actual working days are more than the budgeted number of working days and vice versa if the

ratio is less than 100%.

Example

Product X takes 5 hours to make and Y requires 10 hours. In a month of 25 effective days of 8 hours a day, 1000

units of X and 600 units of Y were produced. The company employees 50 workers in the production department. The budgeted hours are 1,02,000 for the year. Calculate capacity ratio, activity ratio and efficiency ratio.

Solution

Standard Hours for Actual Production:

Product X : 1000 x 5 = 5000 Hours

Product Y : 600 x 10 = 6000 Hours

---------------

11000 Hours

---------------

Budgeted Hours (Monthly = 1,02,000 / 12

= 8500 Hours

Actual Hours Worked = 50 x 25 x 8

= 10,000 Hours

BSPATIL 116



= 117.65%

= 129.41%

= 110.41%

Since al the there control ratios are more than 100% organisation is performing well in producing the products X and Y.

BSPATIL 117



LESSON 9

COST LEDGER ACCOUNTING

Cost accounting system can be introduced in an organization in two ways. They are:

1. Cost Leger Accounting

2. Integral Accounting.

Cost Leger Accounting: Under this method separate set of cost accounts have to be maintained so as to derive cost

details. It will differ from general financial accounting system adopted in the organisation. Hence, it requires two

weparate set of accounts. It can be called inter-locking system. Under cost Ledger Accounting the books are kept only

for the impersonal accounts. To make this system self-balancing certain set of control accounts have to be prepared.

As in the case of general accounting system, transactions relating to factory operations which are ultimately

reflected in the cost accounts are recorded in the books of original entry. Summaries from these books are journalized

and posted in the general ledger which contain control accounts and subsidiary books. The following ledger accounts in

this system.

Stores Ledger:

In consists of accounts of individual items of raw materials, components and consumable stores. Receipts are posted into

the stores ledger on the basis of stores received notes and issues are recorded on the basis of requisition slip. The balance

of this account shows the stock in hand.

Work in Progress Ledger:

It consists of accounts of each job pending on the floor. Each job accounts is debited with all direct costs

charged to the job and a share of overheads. It is credited with the values transferred to finished stock ledger and when

job is completed.

Stock ledger:

It contains item wise accounts in respect of finished stock intended for sale. A separate account is opened is for

each finished product or job.

Cost Ledger:

It is the main ledger of the costing department. It contains control accounts in respect of each ledger like storeledger, stock ledger and work in progress ledger. In addition, it contains general ledger control accounts, wages control

accounts and overhead control accounts.

Control accounts:

A control account is maintained in the cost ledger so that double entry in the cost ledger may be completed and

make it self – balancing. These control accounts are nothing but total accounts or adjustment accounts, summarizing

mass of information contained in the subsidiary ledgers. These control accounts are posted with the totals of items which

have been debited or credited in detail to the accounts in the ledgers to which they relate. The balance in control

accounts represents the total of balances in a number of accounts of similar nature maintained in that subsidiary ledger to

which the control relates.

Advantages of Control accounts:

Control accounts helps

- to provide a check for ensuring that all expenditure are recorded.

- provides a basis for reconciliation with financial accounts.

- provided ready means of preparing monthly or periodical financial statements.

BSPATIL 118



Types of Control Accounts:

A brief description about different control accounts are given below:

Stores Ledger Control Accounts:

This accounts reveals the value of stores received, issued and balances in hand. Receipts are posted from goods

received posted on the basis of material requisition in the credit side of the account. The balance of this account

represents the total balance of stock which should agree with aggregate of the balance of individual accounts in thestores ledger.

Wage Control Account:

This accounts records labour transactions in aggregate. It is debited with gross wages shown in wages analysis

sheet. It is closed by transfer of direct labour to work in progress and indirect labour to overhead.

Work-in-progress Control Account:

It represents the total WIP at any time. It is debited with the totals of materials, wages and overheads as

transferred from the respective control accounts. The completed job will be credited in this account. Thus, this accountshows the shows the total value of unfinished jobs.

Works Overhead Control Account:

It deals with factory overhead expenses in aggregate. It is debited with the amount of indirect material, indirect

material analysis and wage analysis sheets. It is credited with the amount of overheads, recovered, as obtained from the

applied overhead analysis sheets. The balance represents under or over absorption which is transferred to overhead

adjustment account.

Administrative Overhead Control Account:

It is debited with the administration overhead incurred and credited with the amount of administrative overhead

absorbed by finished goods. The balance represents under or over absorption of administrative overhead which is

transferred to overhead adjustment account.

Setting and Distribution Overhead Control Account:

It is debited with the amount of selling and distribution overhead incurred and credited with overhead aabsorbed by cost of sales. Balance represents under / over absorption.

Cost of Sales account:

It is debited with the cost of goods sold by transfer from finished goods ledger control and also by the selling

distribution overhead absorbed. It is closed by transferring its balance to costing profit and loss account.

Costing Profit and Loss Account:

It is debited with the cost of sales, abnormal losses and under absorbed overhead and credited with sales value,

abnormal gain and over-absorbed overhead. Balance represents profit or loss which is transferred to cost ledger control

account.

Cost ledger control account or General ledger Adjustments A/c:

BSPATIL 119



It is maintained to make the cost ledger self-balancing. The main object of this account is to complete doubleentry in cost accounting. All the financial transactions on account of material purchases, wages, salaries and

miscellaneous expenses are credited to cost ledger control account by contra debit to various control accounts. All

financial receipts are debited to this account. The balance is this represents the total of the balance of all personal

accounts in the financial ledger.

Problem 1.

From the following data write up the various accounts as you envisage in the cost ledger and prepare a trial balance as on 31st March 1984.

a) Balance as on 1.4.83: Rs. (thousands)

Material control 1240

Work – in – progress 625

Finished goods 1240

Production overhead 84

Administration overhead 120 (credit)

Selling & Distribution overhead 65

General ledger control 3134

b) Transactions for the year ended 31.3.84 : Rs. (thousands)Materials :

Purchases 4,801

Issued to:

Jobs 4,774

Maintenance works 412

Administration office 34

Selling departments 72

Direct wages 1,493

Indirect wages 650

Carriage inward 84

Production overhead :

Incurred 2,423

Absorbed 3,591

Administration overhead:

Incurred 740

Absorbed 529

Allocated to sales 148

Sales overhead:

Incurred 642

Absorbed 820

Finished goods produced 9,584

Finished goods sold 9,773

Sales realization 12,430

Solution:

BSPATIL 120



Cost Ledger General Ledger Adjustment Account

Dr. Cr

Rs. Rs.

To costing P/L

Account (sales) 12,430 By balance 3,134

By material control a/c 4,801

To balance c/d 3,226 By wages control a/c 2,143

By production overheadcontrol a/c (carriage)

84

By production overhead

control a/c

2,423

Admini. Overhead control

a/c

740

By selling & dis. Overheadcontrol a/c.

642

By closing P/L a/c 1,689

15,656 15,656

Material Control AccountTo Balance b/d 1240 By WIP control A/c 4774

To General Ledger

Adjustment a/c

4801 By Production Overhead

Control A/c

412

By Administration overheadcontrol a/c

34

By selling & dis overhead

control a/c

72

By balance c/d 749

6041 6041

Wages Control Account

To General Ledger

Adjustment a/c

2143 By WIP Control A/c 1493

By production overhead

Control a/c

650

2143 2143

Production Overhead Control Account

To balance b/d 84 By WIP Control a/c 3591

To Material Control a/c 412 By Balance c/d 62

To General Ledger

Adjustment account

84

To Wages Control a/c 650

To General Ledger

Adjustment a/c

2423

3653 3653

Work – in – Progress Control Account

BSPATIL 121



To Balance b/d 625 By Finished Goods Control

A/c

9584

To Material Control a/c 4774 By Balance c/d 899

To wage Control a/c 1493

To Production Overhead

Control A/c

3591

10483 10483

Administration Overhead Control Account

To Material Control a/c 34 By Balance b/d 120

To General Ledger

Adjustment a/c

750 By Finished Goods Control

a/c

529

To Balance c/d 23 By Cost Sales a/c 148

197 197

Finished Goods Control Account

To Balance b/d 1240 By Cost of sales a/c 9773

To Administration Overhead

Control a/c

529 By Balance c/d 1580

To WIP Control a/c 9584

11353 11353

Selling and Distributions Overhead Control Account

To Balance b/d 65 By cost of sales 820

To Material control a/c 72

To General Ledger

Adjustments a/c

642

To Balance c/d 41

820 820

Cost of Sales Account

To Finished goods Control

a/c

9773 By Costing P/L a/c 10741

To Selling & Dis. Overhead

Control a/c

820

To admin. Overhead Control

a/c

148

10741 10741

Costing Profit and Loss AccountTo Cost of Sales a/c 10741 By General ledger

Adjustment a/c (Sales)

12430

To General Ledger

Adjustments a/c

1689

12430 12430

BSPATIL 122



Trial Balance as on 31.3.1984

Dr. Cr.

Rs. Rs.

Material Control Account 749

WIP Control Account 899

Finished goods ledger control account 1580

Production overhead control account 62

Administration overhead control account 23Sales & Distribution overhead control a/c 41

General Ledger Adjustment account 3226

Problem : 2

From the following balances and transactions extracted from the Cost. Books of Gupta Engineering Co., journalise and write up the accounts in the Cost Ledger and prepare a Trial Balance as at 31 st Dec. 19… Also show the

profit or loss for the month.

Balance as at 1-12-19…

Dr. Cr.

Rs. Rs.Worn-in-Progress Account 5200

Finished Goods Account 2300

Factory Overhead Suspense Account 50

Office Overhead Suspense Account 30

Store Ledger Control Account 1150

General Ledger Adjustment Account 8730

8730 8730

Transactions for the months were; Rs.

Direct Wages 7500

Indirect Wages 500

Works Overhead absorbed in production 2200

Office Overhead absorbed in production 1200

Stores issued to production 4900

Goods finished during the months 18000

Finished Goods Sold 21000

Stores Purchased 5000

Stores issued to factory repair orders 200

Carriage inwards on stores issued for Production 80

Factory Expenses 1450

Office Expenses 1170

BSPATIL 123



Solution: Journal

Date Dr. Cr.

19… Rs. Rs.

Dec.1 Work-in-Progress Ledger Control A/c Dr. 5200

Finished Goods Ledger Control A/c Dr. 2300

Factory Overhead Suspense A/c Dr. 50

Office Overhead Suspense A/c Dr. 30

Stores Overhead Suspense A/c Dr. 1150

To General Ledger Adjustment A/c 8730

19…

Dec. 1 Stores Ledger Control a/c

To General Ledger Adjustment A.c

(Being stores purchased)

Dr. 5000

5000

W.I.P. Ledger Control A/c

To stores Ledger Control A/c

(Being the stores issued to production Rs.4900 and carriage inward on stores issued

Rs. 80)

Dr. 4980

4980

Factory Overhead Control A/c

To stores Ledger Control A/c

(Being stores issued to factory repairs)

Dr. 200

200


To Wages Control A/c

(Being indirect Wages charged to factory

overhead)

Dr. 7500

7500


To Wages control A/c(Being the total wages brought into Costing

Books from financial books)

Dr. 500

500

Wages control A/c

To General Ledger Adjustment A/c

(Being the total wages brought into Costing

Books from financial books)

Dr. 8000

8000


To Factory Overhead suspense A/c

(Being the latter transferred to former A/c

reversing the entry

Dr. 50

50


To General Ledger adjustment A/c

(Being the actual factory expenses brought

into costing books)

Dr. 1450

1450


To Factory Overhead Control A/c(Being the overheads charged to production)

Dr. 2200

2200

BSPATIL 124



Office Overhead Control A/c

To office Overhead Suspense a/c

(Being Suspense A/c transferred to former

reversing the entry)

Dr. 30

30

Office Overhead Control A/c


(Being the actual office overheads broughtinto costing books)

Dr. 1170

1170


To Office Overhead Control A/c

(Being the office overheads charged to

production)

Dr. 1200

1200

Finished Goods Control A/c

To W.I.P. Ledger Control A/c

(Being the finished goods transferred to

former account)

Dr. 18000

18000

Cost of Sales A/c

To Finished Goods Control A/c

(Being the Finished Stock transferred to

former account)

Dr. 20300

20300

General Ledger Adjustment A/cTo Costing Profit & Loss A/c

(Being the amount of sales brought into

costing P&L A/c)

Dr. 2100021000

Costing Profit & Loss

To General Ledger Adjustment A/c(Being the amount of Profit)

Dr. 700

700

COST LEDGER

General Ledger Adjustment Account

Rs. Rs.

To Costing P & L A/c

(Sales)

21000 By Balance b/d 8730

To Balance c/d 4050 By Stores Ledger Control

A/c

5000

By Wages Control A/c 8000

By Factory OverheadControl A/c

1450

By Office Overhead Control

A/c

1170

By Costing P & L A/c 700

25050 25050

Stores Ledger Control Account

Rs. Rs.

BSPATIL 125



To Balance b/d 1150 By W.I.P Ledger Control A/c 4980

To General Ledger

Adjustment A/c

5000 By Factory Overhead

Control A/c

200

By Balance c/d 970

6150 6150

To Balance b/d 970


To General Ledger

Adjustment A/c

8000 By W.I.P. Ledger Control

A/c

7500

By Factory Overhead

Control A/c

500

8000 8000

Factory Overhead Control Account

Rs. Rs.

To Stores Ledger Control

A/c


A/c

2200

To Wages Control A/c 500

To Factory Overhead

Control A/c

50

To General Ledger

Adjustment A/c

1450

2200 2200

Office Overhead Control Account

Rs. Rs.

To Office Overhead

Suspense A/c


A/c

1200

To General Ledger

Adjustment A/c

1170

1200 1200

Work-in-Progress Ledger Control Account

Rs. Rs.


A/c

18000


A/c


To Wages Control A/c 7500To Factory Overhead

Control A/c

2200

To Office Overhead Control

A/c

1200

21080 21080

To Balance b/d 3080

BSPATIL 126




Rs. Rs.

To Balance b/d 2300 By Cost of sales A/c 20300

To W.I.P. Ledger Control 18000

20300 20300

Cost of Sales AccountRs. Rs.

To Finished Goods control

A/c

20300 By Costing P & L A/c 20300

20300 20300

Costing Profit and Loss Account

Rs. Rs.

To Cost of Sale A/c 20300 By General Ledger

Adjustment A/c (sales)

21000

To General Ledger Adjustment A/c (profit)

700

21000 21000

Trial Balance (As at 31st December ………..

Rs. Rs.


A/c

970 General Ledger Control A/c 4050

Work-in-Progress Ledger

Control

3080

4050 4050

Problem : 3

The following balances are extracted from the costs books of Ajith Traders Ltd., for the year ended 31st Dec. 1995

Dr. Cr.

Rs. Rs.

Stores in Hand 16000 24500

Stock of Finished Goods 24600 26100

Work-in-Progress 32000 33500

Purchases - 76000

Carriage Inwards - 500Stores Issued - 68000

Wages – Direct - 67200

Wages - - Indirect - 22000

Work Expenses 69200

Cost of Finished Goods 240000

Cost of Finished Goods sold 238500

Selling Expenses 6100

Office & Administration Expenses 14000

BSPATIL 127



The Cost Journal shows that Rs. 92700 and Rs. 13900 were allocated to Work-in-Progress for works overheads andoffice overheads respectively. Prepare Cost Ledger Account and a Trial Balance from the above information as at 31st

Dec. 1995.

Solution:

Rs. Rs.

To Balance c/d 327600 By Balance b/d 72600

By Stores Ledger Control

A/c

76000

By Stores Ledger control A/c(Carriage)

500


By Production Overhead

Control A/c

69200

By Administration Overhead

Control A/c

14000

By Selling and Distribution

Overhead Control A/c

6100

327600 327600

By Balance b/d 327600

Store Ledger Control Account

Rs. Rs.

To Balance b/d 16000 By Work-in-Progress Ledger

Control A/c

68000

To General Ledger

Adjustment A/c (Purchases)


To General Ledger

Adjustment A/c (Carroage)

500

92500 92500

To Balance b/d 24500


Rs. Rs.

To General Ledger

Adjustment A/c

89200 Work-in-Progress Ledger

Control A/c

67200

Production Overhead Control

A/c

22000

89200 89200


Rs. Rs.

To Wages Control A/c 22000 By W.I.P. Leger Control A/c 92700

To General Ledger

Adjustment A/c

69200

To Overhead Adjustment

A/c

1500

92700 92700

BSPATIL 128




Rs. Rs.

To General Ledger

Adjustment A/c


A/c

13900

By Overhead Adjustment

A/c

100

14000 14000

Selling and Distribution Overhead Control Account

Rs. Rs.

To General Ledger

Adjustment A/c

6100 By Cost of Sales A/c 6100

6100 6100


Rs. Rs.


A/c

240000


A/c

68000 By Loss in Production A/c 300

To Wages Control A/c 67200 By Balance c/d 33500


Control A/c

92700 To Administration Overhead

Control A/c

13900

273800 273800



Rs. Rs.

To Balance b/d 24600 By Cost of Sales A/c 238500

To W.I.P. Ledger Control

A/c

240000 Balance c/d 26100

264600 264600


Rs. Rs.

To Finished Goods Control

A/c

238500 By Balance c/d 244600

To Selling & Distribution


6100

244600 244600


BSPATIL 129



Overhead Adjustment Account

Rs. Rs.

To Administrative Overhead

Control A/c


Control A/c

1500

To Balance c/d 1400

1500 1500

By Balance b/d 1400

Loss in Production Account

Rs. Rs.


A/c


300 300

Trial Balance

(As at 31st December 1995)

Dr. Cr.

Rs. Rs.General Ledger Adjustment A/c 327600

Stores Ledger Control A/c 24500

Work-in-Progress Ledger Control A/c 33500

Finished Goods Control A/c 26100

Cost of Sales A/c 244600

Overhead Adjustment A/c 1400

Loss in Production A/c 300

329000 329000

Rs. Rs.To Cost of Sales A/c 20300 By General Ledger

Adjustment A/c (Sales)

21000

To General Ledger

Adjustment A/c (profit)

700

21000 21000

Trial Balance

(As at 31st December ………….)

Dr. Cr.

General Ledger Control A/c 4050

Stores Ledger Control A/C 970Work-in-Progress

Ledger Control A/c 3080

4050 4050

Problem : 3

The following balances are extracted from the coasts books of Ajith Traders Ltd., for the year ended 31 st Dec.,

1995.

BSPATIL 130



1-1-1975 31-12-1975

Rs. Rs.

Stores in Hand 16000 24500

Stock of Finished Goods

Work-in-Progress

Purchases

Carriage Inward

Stores- Direct

Wages-DirectWages-Indirect

Works Expenses

Cost of Finished Goods

Cost of Finished Gods sold

Selling Expenses

Office & Administration Expenses

The Cost Journal shows that Rs. 92700 and Rs. 13900 were allocated to Work-in-Progress for works overheads and

office overheads respectively. Prepare Cost Ledger Account and a Trial Balance from the above information as at 31st

Dec. 1995.

Solution:General Ledger Adjustment AccountRs. Rs.

To Balance c/d 327600 By Balance b/d 72600


A/c

76000


A/c (Carriage)

500


By Production Overhead

Control A/c

69200

By Administration Overhead

Control A/c

14000

Overhead Control A/c 6100

327600 327600

By balance b/d 327600

Stores Ledger Control Account

Rs. Rs.

To Balance b/d 16000 By Work-in-Progress Ledger

Control A/c

68000

To General Ledger Adjustment A/c (Purchases) 76000 By Balance c/d 24500

To General Ledger

Adjustment A/c (Carroage)

500

92500 92500


BSPATIL 131




Rs. Rs.

To General Ledger

Adjustment A/c

89200 By Work-in-Progress Ledger

Control A/c

67200

By Production OverheadControl A/c

22000

89200 89200


Rs. Rs.

To Wages Control A/c 22,000 By W.I.P. Ledger Control

a/c

92700

To General Ledger

Adjustment A/c

69200

To Overhead Adjustment

A/c

1500

92700 92700


Rs. Rs.

To General Ledger

Adjustment A/c

14000 BY W.I.P Ledger Control

A/c

13900

By Overhead Adjustment

A/c

100

14000 14000

Selling and Distribution Overhead Control Account

Rs. Rs.


6100 By Cost of Sales A/c 6100

6100 6100


Rs. Rs.


A/c

240000

To Store Ledger Control

A/c

68000 By Loss in Production A/c 300

To Wages Control A/c 67200 By Balance c/d 33500


Control A/c

92700 To Administration Overhead

Control a/c

13900

273800 273800


BSPATIL 132




Rs. Rs.

To Balance b/d 24600 By Cost of Sales A/c 238500

To W.I.P. Ledger ControlA/c

240000 Balance c/d 26100

264600 264600


Rs. Rs.

To Finished Goods Control

A/c

238500 By Balance c/d 244600

To Selling & Distribution


6100

244600 244600


Overhead Adjustment Account

Rs. Rs.To Administrative Control

A/c


Control A/c

1500

To Balance c/d 1400

1500 1500

Loss in Production Account

Rs. Rs.


A/c


300 300

Trial Balance

(As at 31 st December, 1995)

Dr. Cr.

Rs. Rs.

General Ledger Adjustment A/c 327600

Stores Ledger Control A/c 24500

Work-in-Progress Ledger Control a/c 33500

Finished Good Control a/c 26100

Cost of Sales A/c 244600

Overhead Adjustment A/c 1400Loss in Production A/c 300

329000 329000

BSPATIL 133



Lesson 10

Integral Accounting

Integral accounting system is defined as a single set of accounts which provides both financial and cost accounting

information. Cost and financial accounts are kept in one self contained ledger which is known as integrated ledger. Thissystem does not recognize the need for separate set of accounts. Hence, there is no need for reconciliation of cost and

financial accounts.

Advantages is Integral systems:

An integrated accounting system has the following advantages.

1. There is not problem of reconciliation as there will be only profit amount.

2. This system is economical and easy to understand.

3. Duplication of work and labor is avoided.

4. Cost data can present promptly and regularly.

5. All cost data and accounts are automatically checked and thus cost figures are accurate.

6. In broaden the outlook of accountant and his staff.

Problem 1. Journalize following transactions assuming cost and financial accounts are integrated.

Raw materials purchases 40000Direct materials issued to production 30000

Wages and (30% indirect) 24000

Direct wages charged to production 16000

Manufacturing expenses incurred 19000

Manufacturing overhead charged to

production

18400

Selling and distribution costs 4000

Finished products at cost 40000

Sales 58000

Closing stock ---

Receipts from debtors 13800

Payments to creditors 22000

Solution:

1. Stores ledger control a/c

To Bought ledger control a/c

4000

4000

2. Work-in-progress control a/c

To stores ledger control a/c

30000

30000

3. Wage control a/c

To bank a/c

24000

24000

4. Factory overhead a/c

To wages control a/c

Dr. 7200

7200

5. Work-in-progress ledger control a/c

To wages control

Dr. 16800

168006. Factory overhead a/c

To bank a/c

Dr. 19000

19000

7. Work-in-progress ledger control a/c

To Factory overhead a/c

Dr. 18400

18400

8. Selling & distribution overhead a/c

To Bank a/c

Dr. 4000

4000

9. Finished stock ledger control a/c

To Work-in-progress control a/c

Dr. 40000

40000

10. Cost of sales a/c Dr 44000

BSPATIL 134



To finished stock ledger control a/c

To selling & distribution control a/c

40000

4000

11. Sales ledger control account

To cost of sales A/c

Dr. 58000

58000

12. Bank A/cTo Sales ledger control a/c

Dr. 1380013800

13. Bought ledger control a/c

To Bank a/c

Dr. 2200

2200

Note: It has been assumed that all manufactured units have been sold and selling and distribution overhead have been

charged to cost of sales.

Problem 2:

The following are the balances of A co. Ltd. in its integrated ledger on 1st January:

Dr. Cr.

Stores Control Account 36000

Work-in-progress Account 24000

Finished Goods Account 26000

Cash at bank 20000

Creditors Control Account 16000Fixed Assets Account 110000

Debtors Control Account 24000

Share capital Account 160000

Depreciation Provision Account 10000

Profit & Loss Account 64000

250000 250000

Transactions for the twelve months ended 31st December were:

Dr. Cr.

Wages-direct 174000

Wages-Indirect 10000

Stores purchased on credit 200000

Stores issued to repair order 4000

Stores issued to production 220000

Goods finished during the period at cost 430000

Goods sold at cost 440000

Production overhead recovered 96000

Production overhead 80000

Administration overhead 24000

Selling and Distribution overhead 28000

Depreciation (works) 2600

Payments to suppliers 202000

Payments from customers 580000Rates prepaid included in production overhead

incurred

600

Purchases of fixed assets in cash 4000

Charitable Donations 2000

Fines paid 1000

Interest on bank loan 200

Income-tax 40000

You are required to write upto the account in the integral ledger and take out a trial balance. The administration

BSPATIL 135



overhead is written off to profit and loss account.

Solution:

In the Integral Ledger of A Co. Ltd.Stores Control Account

Dr. Cr.

Date Particular Amt. Date Particular Amount

Jan 1 To Balance b/d 36000 Dec31 By Work-in-Progressa/c 220000

Dec.31

To Creditors ControlA/c

200000 Dec31 By Productionoverhead ac

4000

Dec.31 By Balance c/d 12000

236000 236000

Jan1 To Balance b/d 12000

Work control Account

Dec.

31

To Bank 184000 Dec. 31 By Work-in-Progress

A/c

174000

Dec.31 By Productionoverhead a/c

10000

184000 184000

Production Overhead Account

Rs. Rs.

Dec.31 To Wages Control 10000 Dec.

31

By Pre-paid expenses

A/c (Rent)

600

Dec.31 To Stores Control

A/c

4000 Dec.

31

By Work-in-progress

A/c

96000

Dec. 31 To DepreciationProvisions A/c

2600

966000 96600

Administration Overhead Account

Rs. Rs.

Dec.31 To Bank 24000 Dec.

31

By Cost of Sales

A/c

24000

24000 24000

Selling and Distribution Overhead Account

Rs. Rs.

Dec.

31

To Bank 28000 Dec.31 By Cost of Sales

A/c

28000

28000 28000

BSPATIL 136



Work-in-Progress Account

Rs. Rs.

Jan1 To Balance b/d 34000 Dec. 31 By Finished Good

A/c

430000

Dec. 31 Wages Control a/c 174000 Dec.31 By Balance c/d 94000

Dec. 31 To Stores Control a/c 220000

Dec.31 To Production

Overhead A/c

96000

524000 524000

Jan 1 To Balance b/d 94000

Finished Goods Account

Rs. Rs.

Jan1 To Balance b/d 26000 Dec. 31 By Cost of Sales 440000`

Jan.1 To Work-in-progress

A/c

430000 Dec.31 By Balance c/d 16000

456000 456000

Jan 1 To Balance c/d 16000


Rs. Rs.

De. 31 To Finished Goods

A/c

44000 Dec.

31

By Debtors

Control A/c

600000

Dec.31 To S & D Overhead

a/c

28000

Dec.31 To Costing P & LA/c

132000

Jan 1 To Balance b/d 6,00,000 6,00,000

Costing P & L Account for the year ending 31st December

Rs. Rs.

De. 31 Administration

Overhead A/c

24000 Dec.

31

By Cost of Sales 132000

Dec. 31 To P & L 108000

132000 132000

P & L for the year ending 31st December

Rs. Rs.Dec. 31 To Charitable

Donations

2000 Jan 1 By Balance b/d 64000

To Fines 1000 Jan1 By Costing P & L

A/c

108000

To interest on Bank

Loan

2000

To Income-tax 40000

To Net Profit 128000

BSPATIL 137



172000 172000

Pre-paid expenses account

Rs. Rs.

Dec.31 To Production A/c 600 Dec.

31

By Balance c/d 600

600 600Jan 1 To Balance b/d 600

Depreciation Provision Account

Rs. Rs.

Dec. 31 To Balance c/d 12600 Jan.1 By Balance b/d 10000

Dec.

31

By Production

Overhead A/c

2600

12600 12600

Jan. 1 By balance b/d 12600

Debtors Control Account

Rs. Rs.

Dec. 31 To Balance b/d 24000 Dec.31 By Bank 580000

Dec.31 To cost of sales

a/c

600000 Dec.31 By Balance c/d 44000

Jan 1 To Balance b/d 624000 624000

Jan1 To Balance b/d 44000

Creaditors Control Account

Rs. Rs.

Dec. 31 To Bank 202000 Jan1 By Balance b/d 16000

Dec.31 To Balance c/d 14000 Dec.31 By Stores

Control A/c

200000

216000 216000

Jan1 By Balance c/d 14000

BSPATIL 138



Share Account

Rs. Rs.

Jan.1 To Balance b/d 20000 Dec. 31 By Wages

Control

184000

Dec.31 To Debtors

Control A/c

580000 Dec.31 By Fixed

Assets A/c

Dec.31 By Production

overhead a/c

80000

Dec31 By admin.

Overhead

24000

Dec.31 S&D overhead 28000

Dec.31 By creditors

control a/c

202000

Dec.31 By Fines A/c 1000

Dec.31 By Charitable

Donations

2000

Dec.31 By interest on

Bank Loan

200

De.31 By Income-tax 40000

Dec.31 By balance c/d 34800

600000 600000

Jan.1 To Balance b/d 34800

To Trial Balance as on 31st December

Head of Account Dr. Bal Cr. Bal

Rs. Rs.

Stores Control A/c 12000

Work-in-progress A/c 94000

Finished goods A/c 16000

Prepaid expenses A/c 600

Depreciation Provision A/c 12600

Debtors Control A/c 44000

Creditors Control A/c 14000

Fixed Assets A/c 114000

Bank A/c 34800

Share Capital A/c 160000

Profit & Loss A/c 128800

Total 315400 315400

BSPATIL 139



Lesson 11

Reconciliation of Cost and Financial Accounts

When the Cos Ledger Accounting system is adopted in an organizations the results shown by the accounting records i.e.financial accounting and cost ledger accounting differ from each other. Hence, it becomes necessary to reconcile the

profit or loss shown by the two sets of records.

Need for Reconciliation:

1. It is necessary to find out the reasons for the differences in the profitability of both the records.

2. Reconciliation enables to test the reliability of cost accounts. Costing figures in total should agree with the

financial records.

Reasons for disagreement:

The difference in the profitability of cost and financial records may be due to the following reasons.

1. Items included in the financial accounts but not in cost accounts.

a. Purely financial income- such as interest received on bank deposits, interest and dividend on

investments, rent receivables, transfer fee received, profit on the sale of assets etc. b. Purely financial charges – such as losses due to scraping of machinery, losses on the sale of investments

and assets, interest paid on the bank loans, mortgages, debentures etc., expenses of company’s transfer

office, damages payable at law etc.

c. Appropriation of profit – the appropriation of profit is again a matter which concerns only financialaccounts. Items like payment of income tax and dividends, transfer to reserve, heavy donations, writing

off of preliminary expenses, goodwill and patents appear only in profit and loss appropriation account

and the costing profit and loss a/c is not affected.

2. Items included in cost accounts only:

There are certain items which are included in cost accounts but not in financial accounts. They are: Charges in

lieu of rent where premises are owned, interest on capital employed in production but upon which no interest is actually

paid.

3. Under/Over absorption of overhead expenses:

In cost accounts, overheads are absorbed at predetermined rates which are based on past data. In the financial accounts

the actual amount incurred is taken into account. There arise a difference between the actual expenses and the predetermined overheads charged to product or job.

If overheads are not fully recovered, which means that the amount of overheads absorbed in cost accounts is less than

the actual amount, the shortfall is called as under recovery or under absorption. If overhead expenses recovered in cost

accounts is more than that of the actually incurred, it is called over absorption. Thus, both the over and under recovery

may cause the difference in the profits of both the records.

4. Different basis of stock valuation:

In cost accounts, the stock of finished goods are valued at cost by FIFO, LIFO, average rate, etc. But, in financial

accounts stocks are valued either at cost or market price, whichever is less.

The valuation of work-in-progress may also lead to variation. In financial books only prime cost may be taken into

account for this purpose whereas in cost accounts, it may be valued at prime cost plus factory overhead.

5. Different basis of depreciation adopted:

The rates and methods of charging depreciation may be different in two sets of accounts.

Method of reconciliation of profits:

BSPATIL 140



The are two alternative forms of presentation of reconciliation of profits revealed by cost and financial accounts, namely

Statement form

Account formIn the statement form it is known as Reconciliation Statement and in the accounts form it is known as Memorandum

Reconciliation Account.

In both forms, the profits as per one set is taken to start with and addition / adjustments are made to arrive at the profit of

another set of books.

Memorandum Reconciliation Accounts:

It is an account form of reconciling the profitability of two records. The amount of profit as per cost records is credited

to the Memorandum account. The items to be deducted are debited and those to be added are credited to this amount.

The balancing figure is profit/loss of financial accounts.

The process of preparing reconciliation statement is worked out here in the form of problems.

A proforma Memorandum Reconciliation Account is give below:

Memorandum Reconciliation Account

(As on ……………….)

Rs. Rs.

To Loss as per Cost Book By Profit as per Cost Books…To Items of expenses shown in

Finance books but not in Cost books

By Items of expenses shown in cost

but not in Fin. Books…

To Items of expenses

undercharged in Cost Books or

overcharged in Fin. Books.

By items of over charges in Cost

Books…

To items of income over-

charged in Cost Books or not

included in Fin. Books…

By Over – valuations of opening

stock in Cost Books…

To Over-valuation of opening

stock in Fin. Books

By Under-valuation of closing stock

in Cost Books

To Under-valuation of closingstock in Fin. Books..,.

To Depreciation under-chargedin Cost Books or over charged

in Fin. Books…

By Depreciation over-charged inCost Books…

To Profit as per Financial

Books…

Problem : 1

The profit as per cost accounts is Rs. 150000. The following details are ascertained on comparison of cost and financial

accounts.

Rs. Rs.

a. Opening Stock:

Materials

Finished goods

10000

18000

15000

16000

b. Closing Stock:

MaterialsFinished goods

1200020000

1300017000

c. Interest charged but not paid Rs. 10000

d. Write of preliminary expenses Rs. 500; Goodwill Rs. 1500

BSPATIL 141



e. Dividend on UTI received Rs. 1000

f. Indirect expenses charged in financial accounts Rs. 80000 but Rs. 75500

recovered in Cost Accounts.

Find out the profit as per financial accounts by drawing up a Reconciliation

statement.

Solution: Reconciliation Statement

Rs. Rs.

Profit as per Cost accounts 150000

Add : Opening stock of finished goods over

valued in cost accounts

2000

Closing stock of materials under recovered in

cost accounts

1000

Interest charged only on cost accounts 10000

Dividend on UTI not included in cost accounts 1000 14000

164000

Less : Opening stock of material under valued in

cost accounts

5000

Closing stock of finished goods over valued in

cost accounts

3000

Preliminary expenses written off in financial

accounts

500

Goodwill written off in Final accounts 1500

Indirect expenses under recovered in cost

accounts

4500 14500

Profit as per financial accounts 149500

Alternatively, the above information may also be presented in the form of an account known as Memorandum

Reconciliation Account.

Memorandum Reconciliation Account

Rs. Rs.

To Opening stock of material

under valued in cost A/c

5000 By profit as per Cost Account 150000

To Closing stock of finished

good over valued in cost

account

3000 By Opening stock of finished

goods over valued in cost a/c

2000

To Preliminary expenses

written off

500 By closing stock of material

under valued in cost accounts

1000

To Goodwill written off 1500 By interest charged only in

cost A/c

10000

Overheads under recovered 4500 By dividend received 1000

To Profit as per financial

Accounts (balancing fig)

149500

164000 164000

Problem: 2

BSPATIL 142



Following are the figures available in financial accounts of the year ended 31.3.76.

Direct Material consumption 250000

Direct Wages 100000

Factory overheads 380000

Admini. Overhead 250000

Selling and Dis. Overhead 480000

Bad debts 20000

Preliminery expenses 10000

Legal charges 5000Dividend received 50000

Sales (120000 units) 700000

Interest on deposit received 10000

Closing Stock:Finished stock 40000 units 1,20,000. Work-

in-progress

80000

The cost account reveal direct material consumption

as

280000

Factory overhead recovered at 20% on price cost.

Administration overhead at Rs. 2 per unit or production. Selling and distribution

overheads at Rs. 4 per unit sold, prepare

1. Costing profit and loss account

2. Statement reconciling the profits disclosed by the costing profit and loss account and financial profit and

loss account.

Solution

Closing Profit and Loss account for the year ending 31.3.96

Rs. Rs.

To direct materials 280000 By Sales 700000

To direct wages 100000 Closing stock: Finished goods 120000

To factory overhead 76000 Work-in-progress 80000To administration overhead 480000 By net loss 516000

To selling & Dis. Overhead 480000

1416000 1416000

Profit & Loss Account as per Financial Books

Rs. Rs.

To direct materials 250000 By sales 700000

To direct wages 100000 By dividend received 50000

To Factory overhead 380000 By Interest received 10000

To Administration overhead 250000 By Closing stock:

To Selling & Dis. 480000 Finished goods 120000

To Bad debts 20000 Work-in-progress 80000

To Preliminary expenses 10000 Net loss 535000

To legal charges 5000

1495000 1495000

Reconciliation Statement

Loss as per cost account 516000

BSPATIL 143



Less:

a. Over charging of materials in Cost accounts 30000

b. Over absorption of administration overhead in cost

account

230000 260000

256000

Add:

a. Under absorption of factory overhead 304000

b. Bad debts not included in cost accounts 20000 324000

580000

Less :

Adjustment of income items not included in cost

accounts

50000

Interest on deposit received 10000 60000

520000

Add:

Adjustments not shown in cost accounts

Preliminary expenses 10000

Legal Charges 5000 15000

Net loss as per financial books 535000

Notes:

1. In the costing profit and loss account factory overheads have been calculated as 20% of Rs. (280000 + 100000 –

76000)

2. Administration overhead at Rs. 3 per unit of production. Number of units produced = sales – 120000 + closing

stock of 40000 units)

Problem : 3

From the following particulars, prepare(a) A statement of cost of manufacture for the year.

(b) A statement of profit as per cost accounts and

(c) Profit and loss account in the financial books and a reconciliation of the difference in the profits as shown by (b)

and (c) above:

Rs.

Opening stock of raw materials 100000

Closing stock of raw materials 150000

Opening stock of finished product 200000

Closing stock of finished product 50000

Purchase of raw materials 600000

Wages 250000

Calculate factory overhead at 25 percent on prime cost. Office overhead will be levied at 75 percent on factory

overhead. Actual works expenditure amounted to Rs. 193750 and actual office expenses amounted to Rs. 152500. The

selling price was fixed at 25% above cost price.

BSPATIL 144



COST LEDGER ACCOUNTING

Cost of manufacture Rs. Rs.

a) Raw materials

Opening stock

Add purchases

Less closing stock

100000

600000

150000 550000

Wages 250000Factory overhead (25% on Prime cost) 200000

Office overhead (75% on Fy. Overhead) 150000

Cost of manufacture 115000

Statement of Profit (Cost Accounts)

Rs.

b) Opening Stock of Finished goods 200000

Cost of manufacture 1150000

Less Closing Stock of Finished goods 50000

Cost of sales 1300000Profit (25% of cost) 325000

Sales 1625000

Profit and Loss Account

Rs. Rs.

To opening Stock 200000 By sales 1625000

To Raw materials: By Closing Stock 50000

To Opening Stock 100000

To Purchase 600000

Less Closing Stock 150000 550000

To Wages 250000

To Factory overhead 193750

To office overhead 152500

To Profit 328750

1675000 1675000

Reconciliation Statement

Profit as per Cost Accounts 325000

Add Over-absorption of F.Y. overhead 200000

-193750 6250

Less under-absorption of office overhead 152500

-150000 2500

Profit as per Financial Accounts 328750

Problem 4:

A company’s net profit as per the cost books was RS. 23063 whereas the audited final accounts showed a profitof Rs. 16624. With the help of the following data, you are required to prepare a reconciliation statement, and explain the

reason for the difference between the two figures.

BSPATIL 145



Profit and Loss Account

Year ended 31st March, 19….

Rs. Rs.

Opening Stock 247179 Sales 346500

Purchase 82154

329333

Closing Stock 75121 254212

Direct Wages 23133Factory Overhead 20826

Gross profit c/d 48329

Total 346500 346500

Administrationexpenses

9845 Gross profit b/d 48329

Selling expenses 22176 Miscellaneous

income

316

Net Profit 16624

Total 48,645 48645

The costing records show:

(a) Stock balance of Rs. 78179

(b) Direct wages absorbed during the year – Rs. 24876

(c) Factory overhead absorbed – Rs. 19714

(d) Administration expenses charged @ 3 per cent of selling prices.

(e) Selling expenses charged @ 5 per cent of value of sales

(f) No mention of miscellaneous income

Solution

Rs. Rs.Profit as per Cost Accounts 23063

Less : Difference in valuation of closingstock

7819775121 (-)

3076

Factory overhead under absorbed 20826

19714 (-)

1112

Selling expenses under-absorbed 22176

17325 (-)

4851

Add: Wages over-absorbed 24867

23133 1734

Administration overhead over-absorbed 10395

9845 550

Sundry income not shown in Costing

Profit

316

Profit as per financial accounts 16624.

MODEL QUESTION PAPER

B.Com.,

Cost Accounting

BSPATIL 146



Maximum:100 marks PART – A

Answer any FIVE questions

1. What are the objectives of cost accounting?

2. What do you mean ABC analysis? Explain it with an illustration.

3. What do you mean by labour turnover? What are its causes?

4. What are the different methods of allocation of joint costs to joint products.5. What are the advantages and limitations of standard costing?

6. From the following particulars, calculate the economic order quantity and find out the number of orders to be

placed in a year:

Annual requirements : 1600 units

Cost of material per unit : Rs. 40

Cost of placing and receiving on order : Rs. 50

Annual carrying cost of inventory values : 10% in inventory

7. A furniture manufacturer uses sunmica tops of tables. From the following information, find out price variance,

usage variance and cost Variance:

Standard quantity of sunmica per table : 4 sq. metre

Standard price per sq. metre of sunmica : Rs. 5

Actual production of tables : 1000

Sunmica actually used : 4300 sq. meter

Actual purchase price of sunmica : Rs. 5.50 per sq.meter

PART – B ( 4 x 15 ) = 60

Answer any FOUR questions8. What are the objectives and advantages of cost audit? How is it different form management audit?

9. What do you mean by non-integrated accounting? What are the causes for reconciliation of cost and financial

profits?

10. An engineering works, the standard time for a job is 16 hours and the basic wage is Rs. 1 per hour.

A bonus scheme is instituted so that worker is to receive his normal rate for hours actually worked and 50% for

the hours saved.

Materials for the job cost Rs. 20 and overheads are charged on a basis of Rs. 2 per labour hour.

Calculate the wages and effective rate of earning per hour if the job is completed (i) in 12 hours and (ii) in 14

hours. Also ascertain factory cost of the job on the same basis.

11.The following information relates to the activities of a production departments for a certain periods in a factory:

Materials use : Rs. 72000

Direct wages : 60000

Hours of machine operations : 20000

Labour hours worked : 24000

Overheads vhareable to the department : 48000

On one order carried out in the departments during the period, the relevant data were:

Hours Rs.

Materials used 4000

Direct wages 3300

BSPATIL 147



Labour hours 1650

Machine hours 1200

Prepare a comparative statement of cost of this order by using the following three methods of recovery of overheads:

a) Direct labour hour rate method

b) Direct labour cost method

c) Machine hour rate method

12. A product is obtained after passing it through three processes. The following information is collected for

January 1989.

Process

I II III

Direct materials (Rs.) 5200 3879 4329

Direct wages (Rs.) 4000 5989 2987

Units produced 879 456 234

Normal loss 5% 10% 15%

Values of scrap per units (Rs.) 4 8 10

1000 Units at Rs. 6 Each was introduced in process. The indirect expenses for the month Rs. 18000. Prepare processaccounts.

13. From the information given below, prepare (a) a statement showing profit or loss and (b) another statement

reconciling the costing profit with those shown by financial accounts

Trading and Profit and Loss Account for the year 1989

Rs. Rs.

Materialconsumed

150000 Sales (150000units)

320000

Direct wages 75000

F t 45000

cost accounting book of 3rd sem mba @ bec doms

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