Cost Accounting - (Al Jamia Arts and Science College, Poopalam)

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Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Module I (Introduction) 2. A cost should be charged only after it


Cost Accounting is a branch of accounting has been incurred: While determining the
and has been developed due to limitations cost of individual units those costs which
of financial accounting. The limitations of have actually been incurred should be
Financial Accounting which led to the considered.
development of cost accounting are as 3. The convention of prudence should be
follows. ignored: Usually accountants believe in
Limitations of financial accounting historical costs and while determining cost,
 It provides only past data they always attach importance to historical
 It does not show profit of each job or cost. In Cost Accounting this convention
process must be ignored, otherwise, the
management appraisal of the profitability
 It fails to measure control over
of the projects may be vitiated. According to
resources
W.M. Harper, “a cost statement should, as
 It does not measure organizational
far as possible, give facts with no known
efficiency
bias. If a contingency needs to be taken into
 It fails to provide adequate data for
consideration it should be shown
price fixation
separately and distinctly”.
 It does not provide data for comparison
4. Abnormal costs should be excluded
of costs
from cost accounts: Costs which are of
 It fails to take into account the price
abnormal nature (eg. Accident, negligence
level changes
etc.) should be ignored while computing the
 It cannot disclose controllable &
cost, otherwise, it will distort costs figures
uncontrollable costs
and mislead management as to working
 It provide only limited information for
results of their undertaking under normal
management for decision making conditions.
Costing and Cost Accounting 5. Past costs not to be charged to future
The costing terminology of C.I.M.A ., London period: Costs which could not be recovered
defines costing as the “the techniques and or charged in full during the concerned
processes of ascertaining costs”. These period should not be taken to a future
techniques consist of principles and rules period, for recovery. If past costs are
which govern the procedure of ascertaining included in the future period, they are likely
cost of products or services. The important to influence the future period and future
objective of costing are cost control and results are likely to be distorted.
cost reduction. Cost Accounting may be 6. Principles of double entry should be
regarded as “a specialized branch of applied wherever necessary: Costing
accounting which involves classification, requires a greater use of cost sheets and
accumulation, assignment and control of cost statements for the purpose of cost
costs.” ascertainment and cost control, but cost
General Principles of Cost Accounting ledger and cost control accounts should be
1. A cost should be related to its causes: kept on double entry principle as far as
Cost should be related as closely as possible possible.
to their causes so that cost will be shared Objectives of Cost Accounting
only among the cost units that pass 1.To analyze and classify all expenditure
thorough the department of which the with reference to the cost of products and
expenses are related. operations.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

2. To arrive at the cost of production of of the organization and to check wastage


every unit, job, operation, process, and losses. The various advantages derived
department or service and to develop cost by the management from a good system of
standard. costing are as follows:
3. To indicate to the management any 1. Cost accounting helps in periods of
inefficiencies and the extent of various trade depression and trade competition.
forms of wastages. 2. Cost accounting aids price fixation
4. To provide data for periodical profit and 3. Cost accounting helps in making
loss accounts and balance sheets estimates
5. To reveal sources of economies in 4. Cost accounting helps in channelizing
production having regard to methods, types production on right lines
of equipment, design, output and layout. 5. Cost accounting eliminates wastages
6. To provide actual figures of costs for 6. Cost accounting makes comparisons
comparison with estimates and to serve as possible
a guide for future estimates or quotations
7. Cost accounting provides data for
and to assist the management in their price
periodical Profit and Loss Account.
fixing policy.
8. Cost accounting helps in determining
7. To show, where Standard Costs are
and enhancing efficiency
prepared, what the cost of production
ought to be and with which the actual costs 9. Cost accounting helps in inventory
which are eventually recorded may be control.
compared. b) Costing as an aid to Creditors:
8. To present comparative cost data for Investors, banks and other money lending
different periods and various volume of institutions have a stake in the success of
output and to provide guidance in the the business concern are therefore
development of business. This is also benefitted immensely by the installation of
helpful in budgetary control. an efficient system of costing. They can base
their judgment about the profitability and
9. To record the relative production results
future prospects of the enterprise on the
of each unit of plant and machinery in use
costing records.
as a basis for examining its efficiency. A
comparison with the performance of other c) Costing as an aid to employees.:
types of machines may suggest the Employees have a vital interest in their
necessity for replacement. employer’s enterprise in which they are
employed. They are benefited by a number
10. To provide a perpetual inventory of
of ways by the installation of an efficient
stores and other materials so that interim
system of costing. They are benefited,
Profit and Loss Account and Balance Sheet
through continuous employment and
can be prepared without stock taking and
higher remuneration by way of incentives,
checks on stores and adjustments are made
bonus plans, etc.
at frequent intervals
d) Costing as an aid to National Economy:
Importance of Cost Accounting
An efficient system of costing brings
a) Costing as an aid to management:- prosperity to the business enterprise which
Cost accounting provides valuable aid to in turn brings prosperity to the business
management. It provides detailed costing enterprise which in turn results in stepping
information to the management to enable up of the government revenue. The overall
them to maintain effective control over economic development o f a country takes
stores and inventory, to increase efficiency
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

place as a consequence of increase in do not provide provide valuable


efficiency of production. Control of costs, information on the information on the
elimination of wastages and inefficiencies relative efficiencies relative efficiencies
led to the progress of the industry and, in of various workers of various workers.
consequence of the nation as a whole. stocks are valued at stocks are valued at
Cost Accounting and Financial cost or market cost price
Accounting- price whichever is
Financial Cost Accounting less
Accounting Cost units-
aims at renders The Chartered Institute of Management
safeguarding the information for the Accountants, London, defines a unit of cost
interest of the guidance of the as “a unit of quantity of product, service or
business & parties. management time in relation to which costs may be
meets the generally kept ascertained or expressed”. The forms of
requirements of the voluntarily to meet measurement used as cost units are usually
Companies Act, the requirements of the units of physical measurements like
Income Tax Act and the management number, weight, area, length, value, time
other statues. etc.
emphasizes the aims at Cost centre –
measurement of ascertainment of According to Chartered Institute of
profitability costs Management Accountants, London, cost
disclose the net disclose profit or centre means “a location, person or item of
profit and loss of loss of each equipment (or group of these) for which
the business as a product, job or costs may be ascertained and used for the
whole service. purpose of cost control”. Cost centre is the
provides operating gives information smallest organizational subunit for which
results and through cost separate cost collection is attempted.
financial position reports to the Profit centre –
management A profit centre is that segment of activity of
deal mainly with deal partly with a business which is responsible for both
actual facts and facts and figures revenue and expenses and discloses the
figures profit of a particular segment of activity.
Profit centres are created to delegate
stress is on the emphasis is more
responsibility to individuals and measure
ascertainment and on aspects of
their performance.
exhibition of profits planning and
earned or losses control Cost classification
incurred in the 1. By Nature or Elements. According to this
business classification the costs are classified into
concerned with concerned with three categories i.e., Materials, Labour and
external internal Expenses.
transactions transactions 2. By Functions: This classification is on
reported in broken into unit the basis of costs incurred in various
aggregate in basis in cost functions of an organization ie. Production,
financial accounts accounts administration, selling and distribution.
According to this classification, costs are
divided into Manufacturing and Production
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Costs and Commercial costs. influenced by the action of a specified


Manufacturing and Production Costs are member of an undertaking”.
costs involved in manufacture, construction 7. By Normality: There are normal costs
and fabrication of products. and abnormal costs. Normal costs are the
Commercial Costs are (a) administration costs which are normally incurred at a
costs (b) selling and distribution costs. given level of output under normal
3. By Degree of Traceability to the conditions. Abnormal costs are costs
Product : According to this, costs are incurred under abnormal conditions which
divided direct costs and indirect costs. are not normally incurred in the normal
Direct Costs are those costs which are course of production. Eg:- damaged goods
incurred for a particular product and can be due to machine break down
identified with a particular cost centre or 8. By Relationship with Accounting
cost unit. Eg:- Materials, Labour. Indirect Period: There are capital and revenue
Costs are those costs which are incurred expenses depending on the length of the
for the benefit of a number of cost centre or period for which it is incurred. The cost
cost units and cannot be conveniently which is incurred in purchasing an asset
identified with a particular cost centre or either to earn income or increasing the
cost unit. Eg:- Rent of Building, electricity earning capacity of the business is called
charges, salary of staff etc. capital cost,
4. By Changes in Activity or Volume: The cost which is incurred for maintaining
According to this costs are classified into an asset or running a business is revenue
fixed, variable and semi-variable. Fixed expenditure.
Costs are those costs which remain fixed in 9. By Time.. Costs can be classified as 1)
total amount with increase or decrease in Historical cost and 2) Predetermined Costs.
the volume of the output or productive The costs which are ascertained and
activity for a given period of time. Variable recorded after it has been incurred is called
Costs are those costs which vary in direct historical costs. Predetermined costs are
proportion to the volume of output. Semi- also known as estimated costs as they are
variable Costs are those which are partly computed in advance of production taking
fixed and partly variable. into consideration the previous periods’
5. Association with the Product: Cost can costs and the factors affecting such costs.
be classified as product costs and period Types, Methods and Techniques of
costs. Product costs are those which are Costing
traceable to the product and included in Basically, there are two principal methods
inventory cost, thus product cost is full of costing, namely (i) Job Costing, and (ii)
factory cost. Period costs are incurred on Process costing.
the basis of time such as rent, salaries etc.
1. Job costing: It refers to a system of
thus it includes all selling and
costing in which costs are ascertained in
administration costs. These costs are
terms of specific jobs or orders which are
incurred for a period and are treated as
not comparable with each other. Job
expenses.
Costing includes the following methods of
6. By Controllability: The CIMA defines costing:
controllable cost as “a cost which can be
(a) Contract Costing: The term is usually
influenced by the action of a specified
applied to the costing method adopted
member of an undertaking” and a non-
where large scale contracts at different
controllable cost as “a cost which cannot be
sites are carried out, as in the
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

case of building construction. 7. Departmental Costing: When costs are


(b) Bach Costing: A batch of similar ascertained department by department, the
products is regarded as one job and the cost method is called “Departmental Costing”.
of this complete batch is ascertained. It is Elements of Cost-
then used to determine the unit cost of the The elements of costs are three and they
articles produced. are materials, labour and other expenses.
(c) Terminal Costing: This method is also a These can be further analyzed as follows.
type of job costing. This method By grouping the above elements of cost, the
emphasizes the essential nature of job following divisions of cost are obtained.
costing, ie, the cost can be properly 1. Prime cost = Direct Materials + Direct
terminated at some point and related to a Labour+ Direct Expenses
particular job.
2. Works or Factory Cost = Prime Cost +
(d) Operation Costing: This method is Works or Factory Overheads
adopted when it is desired to ascertain the
3. Cost of Production = Works Cost +
cost of carrying out an operation in a
Administration Overheads
department, for example, welding
4. Total Cost or Cost of Sales = Cost of
2. Process Costing: Where a product
Production + Selling and Distribution
passes through distinct stages or processes,
Overheads
the output of one process being the input of
the subsequent process, it is frequently The difference between the cost of sales
desired to ascertain the cost of each stage and selling price represents profit or loss..
or process of production. This is known as These terms can be explained as follows
process costing. 1. Direct Materials are those materials
3. Unit or single or output or single which can be identified in the product and
output costing: This method is used where can be conveniently measured and directly
a single article is produced or service is charged to the product.
rendered by continuous manufacturing 2. Indirect Materials are those materials
activity. which cannot be classified as direct
4. Operating Costing: This method is materials.
applicable where services are rendered 3. Direct Labour is all labour expended in
rather than goods produced. The procedure altering the construction, composition,
is same as in the case of single output confirmation or condition of the product.
costing. Thus direct wages means the wages of
5. Multiple or Complete Costing: Some labour which can be conveniently identified
products are so complex that no single or attributed wholly to a particular job,
system of costing is applicable. It is used product or process
where there are a variety of components 4. Direct Expenses are expenses directly
separately produced and subsequently identified to a particular cost centre. Hence
assembled in a complex production. expenses incurred for a particular product,
6. Uniform Costing: It is not a distinct job, department etc are direct expenses.
method of costing by itself. It is the name 5. Overheads may be defined as the
given to a common system of costing aggregate of the cost of indirect materials,
followed by a number of firms in the same indirect labour and such other expenses
industry. This helps in comparing including services as cannot conveniently
performance of one firm with that of be charged direct ot specific cost units.
another.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Overheads may be sub-divided into (i) 3. The time lag between indenting and
Manufacturing Overheads; (ii) receiving materials can be reduced.
Administration Overheads; (iii) Selling 4. Technical requirements of each plant can
Overheads; (iv) Distribution Overheads; (v) be ascertained.
Research and Development Overheads. Purchase Procedure:
Cost sheet or Statement of Cost: When 1. Indenting for materials : The stores
costing information is set out in the form of department prepares indents for the
a statement, it is called “Cost Sheet”. purchase of materials for replenishment of
Module II (Materials) stocks (regular indents) or for a special
Materials: - job(special indents) and sends it to the
The materials are a major part of the total purchase department.
cost of producing a product and are one of 2. Issue of tenders to suppliers: The
the most important assets in majority of the purchase department issue tenders to
business enterprises. Hence the total cost of suppliers or publish them in papers. The
a product can be controlled and reduced by suppliers quote their terms of price and
efficiently using materials. The materials delivery/payment. After the last date for
are of two types, namely: (i) Direct receipt of quotations is over, the tenders
materials and Indirect materials are opened and a comparative statement is
Purchasing Control and Procedure: prepared.
Purchasing is an art. Wrong purchases 3. Placing of purchase orders: Normally
increase the cost of materials, store six copies of purchase order are made. The
equipment and the finished goods. Hence it supplier, stores, inspection department,
is imperative that purchases should be store accounting section, purchase
effectively, efficiently and economically department and progress department are
performed. So scientific purchasing should sent one copy each.
be done. 4. Inspection: The supplier delivers goods
According to Alford and Beatty, “Purchasing at the place specified. Two delivery challans
is the procuring of materials, supplies, are prepared by the supplier one of which
machines tools and services required for is returned. It is a proof of delivery. After
the equipment, maintenance and operation receiving the goods, the inspection
of a manufacturing plant”. department checks that the materials are in
Methods of PurchasingPurchasing can be accordance with the quality required,
broadly classified as centralized and standard expected, tolerances allowed etc.
localized purchasing. 5. Receiving Stores: The stores
(a) Centralized Purchasing: In a large department prepares a Stores Receipt Note
organization, manufacturing units are for the quantity of stock accepted in
many. In such cases centralized purchasing inspection. After issuing of the Stores
is beneficial. It is the process of purchasing Receipt, the Storekeeper is responsible for
from few dealers. the stocks. The stores receipt is the
document for the posting of receipts in Bin
(b) Decentralization of Purchases: The
Card and the Stores Ledger.
advantages of decentralization of purchases
6. Checking and passing of bills for
1. Each plant may have its own particular
payment: Bills received by the purchase
need. This can be given special attention.
department are forwarded to the stores
2. Direct contact can be established with accounting section to check the authenticity
suppliers. regarding quantity and price and the
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

arithmetical accuracy Reorder level (ordering level): This is the


Storekeeping: level at which order is placed for further
Store keeping is a service function. The supply of materials. When stock of material
storekeeper is a custodian of all the items reaches this level, the storekeeper should
kept in the store. The stores should be initiate action for the purchase of material.
maintained properly and cost minimized. Re-ordering Level= Maximum Level x
Requisitioning for Stores Minimum re-order period.
One of the duties of the storekeeper is to  Average stock level – this is the
send requisitions for materials for average stock held by a business
replenishment in time so that the enterprise.
production is not held up due to shortage of Average Stock Level = Minimum Stock Level
materials. The storekeeper should also see + ½ of Re-order Quantity.
that there is no unnecessary blocking of  Danger level – this is the level of
capital due to overstocking of materials. For stock below which the stock should
this he keeps a check on the re-order level, never be allowed to fall. If the stock
economic ordering quantity, and the level falls below the minimum level is
maximum and minimum quantity which he called the danger level.
is authorized to store in respect of each Danger Level = Average consumption x
kind of material. Max.re-order period for emergency
Stock levels purchases.
In order to avoid overstocking and  Reorder period.- the term reorder
under stocking inventory management period refers to the time required to
should fix the levels of stocks such as obtain new materials.
maximum level, minimum levels, etc Economic Order Quantity (EOQ)
 Maximum level – maximum stock is The EOQ enables the firm to
the upper level of inventory. It is the determine the optimum level of inventory.
maximum quantity of items of EOQ can be defined as the quantity which
material that can be held in stock at is most economical to order at a time. It is
any time. This is the level above the ordering quantity which minimizes the
which stock should not be total cost of inventory. The total inventory
maintained. comprises ordering cost and carrying
Maximum Stock level = Reordering level + costs.
Re-ordering Quantity – If the ordering quantity is less, then
(Minimum consumption x Minimum re- the ordering cost will be high and the
ordering period) carrying cost will be lesser and vice versa. It
 Minimum level – minimum stock is because of more number of order to be
level is the minimum quantity of placed. Therefore, the ordering quantity
stocks that should be held at all should be fixed at that level where the total
times. It is that level below which cost of inventory is lowest. This is possible
stock should not normally be allowed when the ordering cost is equal to carrying
to fall. cost. Thus EOQ is that quantity at which the
Minimum Stock Level = Re-ordering level – total inventory cost is minimum.
(Normal consumption x Normal Re-order Assumptions of EOQ
period)  The demand for material is known
 Consumption rate is constant
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

 Purchase price of material is fixed balance after every receipt and issue, to
 Carrying or storage cost per unit is facilitate regular checking to avoid closing
fixed down of factory for stock taking.
 Ordering cost per unit is fixed. ABC analysis
 The quantity of material ordered is In the case of large concerns large number
received immediately. The lead time of items are kept in the stores. Therefore, it
is zero is practically impossible to concentrate on
Costs of inventory each and every item. In such situations,
 Ordering cost – ABC analysis is used with view to exercise
these are cost of placing an orders. This better control over materials. Under ABC
cost depends on number of orders. It analysis all materials are classified into
includes preparation of purchase order, three categories. A, B and C according to
cost of receiving order, transport costs, etc. value. Category A include high value of
materials, category B includes medium
 Carrying cost – value of materials and category C consist
these are the cost incurred in keeping lower value materials. According to this
inventory. These includes storage technique a greater or strict control is
costs(rent, lighting), handling costs, exercised over category A, moderate
insurance, security cost, damage etc. control is exercised over category and
 Stock out cost – relatively lesser degree of control over
a stock out is a situation when the firm is category C materials
not having items in store but there is a Issue of materials
demand for the same. Materials issued from stores are debited to
Stores (or Materials) records the jobs or work orders which received
In the stores the most important two them and credited to the materials account.
records kept are bin cards and stores There are many methods of pricing
ledger. (a) Bin Card. A bin card is a record material issues. The most important being:
of the receipt and issue of material and is FIFO, LIFO, simple and weighed average
prepared by the store keeper for each item methods.
of stores. In a bin card not only the receipt 1) First in First Out (FIFO) :Under this
and issue of material is recorded, minimum method material is first issued from the
quantity, maximum quantity and ordering earliest consignment on hand and priced at
quantity are stated on the card. the cost at which that consignment was
(b) Stores Ledger: This ledger is kept in the placed in the stores. In other words,
costing department and is identical with materials received first are issued first. This
the bin card except that receipts, issues and method is most suitable in times of falling
balances are shown along with their money prices because the issue price of materials
values. to jobs or work order will be high while the
Perpetual inventory system cost of replacement of materials will be low.
The system of material control on 2) Last in Last Out (LILO):Under this
continuous basis while the material is in method, issues are priced in the reverse
storage is called perpetual inventory order of purchase i.e., the prices of the
system. Under this system the actual stock latest available consignment is taken. This
is taken continuously and is compared method is suitable in times of rising prices
with the stock as shown by the material because material will be issued from the
records. It is a method of recording stores latest consignment at a price which is
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

closely related to the current price levels. used it should make a correct record of the
3) Simple Average Method: In this time and the method should be cost
method, price is calculated by dividing the effective and minimize the risk of fraud.
total of the prices of the materials in the The manual methods of time keeping are
stock from which the material to be priced as follows:
could be drawn by the number of the prices a) Attendance Register Method, and
used in that total. b) Metal Disc Method
4) Weighted Average Methods: In this Attendance Register Method: This is the
method, price is calculated by dividing the traditional method where an attendance
total cost of materials in the stock from register or muster roll is kept at the time
which the materials to be priced could be office near the factory gate or in each
drawn by the total quantity of materials in department. The timekeeper records the
that stock. In the periods of heavy name of the worker, the worker’s number,
fluctuations in the prices of materials, the the department in which he is working, the
average cost method gives better results rate of wages, the time of arrival and
because it tends to smooth out the departure, normal time and overtime.
fluctuations in prices by taking the average
Metal Disc Method: Under this method,
of prices of various lots in stock.
each worker is allotted a metal disc or a
Module III( Labour) token with a hole bearing his
Labour cost is a second major element of identificationnumber. A board is kept at the
cost. The control of labour cost and its gate with pegs on it and all tokens are hung
accounting is very difficult as it deals with on this board. These boards can be
human element. Labour is the most maintained separately for each department
perishable commodity and as such should so that the workers can remove the token
be effectively utilized immediately. Labour without delay and put it in a tray or box kept
is of two types (a) direct labour, (b) near the board. Immediately after the
indirect labour. scheduled time for entering the factory, the
Time keeping box is removed and the latecomers will have
Time-keeping will serve the following to give their tokens to the timekeeper and
purposes: their exact time of arrival is recorded. The
1. Preparation of Pay Rolls in case of time- tokens or disc left on the board will
paid workers. represent the absentee workers.
2. Meeting the statutory requirements. Mechanical Methods: The mechanical
methods that are generally used for the
3. Ensuring discipline in attendance.
recording of time of workers may be as
4. Recording of each worker’s time ‘in’ and
follows:
‘out’ of the factory making distinction
between normal time, overtime, late (a) Time Recording Clocks
attendance, early leaving. (b) Dial Time Records
5. For overhead distribution when Time Recording Clocks: The time
overheads are absorbed on the basis of recording clock is a mechanical device
labour hours. which automatically records the time of the
Methods of Time-keeping: There are two workers. Under this method, each worker is
methods of time-keeping. They are the given a Time Card which is kept in a tray
manual methods and the mechanical near the factory gate and as the worker
methods. Whichever method is enters the gate, he picks up his card from
the tray, puts it in the time recording clock
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

which prints the exact time of arrival in the System of Wage Payment
proper space against the particular day  Time wage system and
Dial Time Records: Under this method, a  piece rate wage system
dial time recorder machine us used. It has a Time Wage System: Under this method of
dial with number of holes (usually about wage payment, the worker is paid at an
150) and each hole bears a number hourly, daily, weekly or monthly rate. This
corresponding to the identification number payment is made according to the time
of the worker concerned. There is one worked irrespective of the work done
radial arm at the centre of the dial. As a Merits
worker enters the factory gate, he is to
press the radial arm after placing it at the  Simple to understand
hole of his number and his time will  Helps to maintain quality of product
automatically be recorded on roll of a paper  Job safety
inside the dial time recorder against the  Trade union accept this
number.  good relation with management
Time Booking  Save machines from overload
 Guarantee fixed wages
Time booking is the recording of time spent
by the worker on different jobs or work Demerits
orders carried out by him during his period  No distinction between efficient &
of attendance in the factory. inefficient workers
Idle Time  Continuous supervision is required
There is always a difference between the  Difficult to measure labour cost
time booked to different jobs or work Piece Rate System (payment by result):
orders and the time recorded at the factory Under this system of wage payment, a fixed
gate. This difference is known as idle time. rate is paid for each unit produced, job
Idle time is of two types. completed or an operation performed.
(a) Normal Idle Time (b) Abnormal Idle Thus, payment is made according to the
Time
quantity of work done no consideration is
Normal Idle Time: This represents the
given to the time taken by the workers to
time, the wastage of which cannot be
avoided and, therefore, the employer must perform the work.
bear the labour cost of this time. But every Merits
effort should be made to reduce it to the  Simple to understand
lowest possible level.  More quantity
Abnormal Idle Time: It is that time the  Strict supervision is not required
wastage of which can be avoided if proper  Cost per unit can easily be calculated
precautions are taken. Example: time  Reduce cost of production
wasted due:- to breakdown of machinery  Management can distinguish between
Over Time: - efficient & inefficient workers
It is the work done beyond the normal Demerits
working period in a day or week. For  Reduce quality
overtime done, the workers are given  Minimum wage are not guaranteed
double the wages for the overtime done.  Chance for machine breakdown
The additional amount paid on account of  Promotes jealousy or suspicion
overtime is known as overtime premium.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Methods of piece rate wage system. (i) Halsey Premium Plan: Under this
a) Straight piece rate system method, the worker is given wages for the
b) Taylor’s differential piece rate system actual time taken and a bonus equal to half
of wages for time saved. The standard time
c) Merrick’s multiple piece rate system
for doing each job or operation is fixed. In
d) Gant’s task and bonus plan practice the bonus may vary from 33⅓ %
(a) Straight piece rate system: Payment is to 66⅔ % of the wages of the time saved.
made as per the number of units produced Thus if S is the standard time, T the time
at a fixed rate per unit. Another method is taken, R the labour rate per hour, and % the
piece rate with guaranteed time rate in percentage of the wages of time saved to be
which the worker is given time rate wages given as bonus, total earnings of the worker
if his piece rate wages is less than the time will be: T x R + % (S-T) R. Under Halsey-
rate. Weir plan, the premium is set at 30% of the
(b) Taylor’s Differential Piece Rate time saved.
system: This system was introduced by The advantages of Halsey Premium Plan
Taylor, the father of scientific management 1. It is simple to understand and relatively
to encourage the workers to complete the simple to calculate.
work within or less than the standard time.
2. It guarantees time wages to workers.
Taylor advocated two piece rates, so that if
a worker performs the work within or less 3. it is helpful in reducing labour cost per
than the standard time, he is paid a higher unit.
piece rate and if he does not complete the 4. It motivates efficient workers
work within the standard time, he is given a 5. Fixed overhead cost per unit is reduced
lower piece rate. with increase in production.
c) Merrick’s Multiple Piece Rate System: 6. The employer is able to reduce cost of
This method seeks to make an production
improvement in the Taylor’s differential Disadvantages
piece rate system. Under this method, three 1. Quality of work suffers
piece rates are applied for workers with
2. Workers criticize this method on the
different levels of performance. Wages are
ground that the employer gets a share of
paid at ordinary piece rate to those workers
wages of the time saved.
whose performance is less than 83% of the
standard output, 110% of the ordinary (ii) Rowan Plan: The difference between
piece rate is given to workers whose level Halsey plan and Rowan Plan is the
of performance is between 83% and 100% calculation of the bonus. Under this method
of the standard and 120% of the ordinary also the workers are guaranteed the time
piece rate is given to workers who produce wages but the bonus is that proportion of
more than 100% of the standard output. the wages of the time taken which the time
saved bears to the standard time allowed
Premium and Bonus Plan
Total Earnings = T x R + S-T x T x R
Under a premium plan, a standard time is
fixed for the completion of a specific job or Advantages
operation at an hourly rate plus wages for a 1. It guarantees time wages to workers
certain fraction of the time saved by way of 2. The quality of work does not suffer
a bonus. The plan is also known as 3. Labour cost per unit is reduced
incentive plans. 4. Fixed overhead cost is reduced with
The following are some of the important increase in production.
premium plans.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Disadvantages iii) Element-wise classification:


1. workers do not get the full benefit of the Overheads can be classified into the
time saved following categories as per element.
2. does not differentiate efficient and (a) Indirect materials
inefficient workers (b) Indirect labour
Overheads: - (c) Indirect expenses
Cost related to a cost center or cost unit Allocation and Apportionment of
may be divided into two ie. Direct and Overhead to Cost Centres (Depart-
Indirect cost. The Indirect cost is the mentalisation of Overhead)
overhead cost and is the total of indirect When all the items are collected properly
material cost, indirect labour cost, indirect under suitable account headings, the next
expenses. It is also called ‘burden’, step is allocation and apportionment of
‘supplementary costs’, ‘on costs’, such expenses to cost centres. This is also
‘indirect expenses’. known as departmentalization or primary
Classification of Overheads distribution of overhead.
Overheads can be classified on the Allocation of Overhead Expenses
following basis: Allocation is the process of identification of
i) Function-wise classification: Overheads overheads with cost centres. An expense
can be divided into the following categories which is directly identifiable with a specific
on functional basis. cost centre is allocated to that centre. Thus
(a) Manufacturing or production overheads it is allotment of a whole item of cost to a
eg:- indirect materials like lubricants, cost centre or cost unit
cotton wastes, indirect labour like salaries Apportionment of Overhead Expenses
and wages of supervisors etc. Cost apportionment is the allotment of
(b) Administration overheads eg:- indirect proportions of cost to cost centres or cost
materials like office stationery and printing, units. If a cost is incurred for two or more
indirect labour salaries of office clerks etc. divisions or departments then it is to be
(c) Selling and Distribution overheads eg:- apportioned to the different departments
indirect materials like catalogues, printing, on the basis of benefit received by them.
stationery, price list, indirect salary of Basis of Apportionment
salesmen, agents, travellers, etc. Suitable bases have to be found out for
ii) Behavior-wise classification: apportioning the items of overhead cost to
Overheads can be classified into the production and service departments and
following categories as per behavior then for reapportionment of service
pattern. departments costs to other service and
(a) Fixed overheads like managerial production departments. The basis selected
remuneration, rent of building, insurance of should be correlated to the expenses and
building, plant etc. the expense should be measurable by the
(b) Variable overheads like direct material basis. This process of distribution of
and direct labour. common expenses over the departments on
some equitable basis is known as ‘Primary
(c) Semi-variable overheads like
Distribution’. The following are the main
depreciation, telephone charges, repair and
bases of overhead apportionment utilized
maintenance of buildings, machines and
in manufacturing concerns:
equipment etc.
1).Direct Allocation. Under direct
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

allocation, overheads are directly allocated department receives service from another
to the department for which it is incurred. department, the department receiving such
(i) Direct Labour/Machine Hours. Under service should be charged. If two
this basis, overhead expenses are departments provide service to each other,
distributed to various departments in the each department should be charged for the
ratio of total number of labour or machine cost of services rendered by the other.
hours worked in each department. There are three methods available for
(ii) Value of materials passing through dealing with inter-service departmental
cost centres. This basis is adopted for transfer:
expenses associated with material such as a. Simultaneous Equation Method
material handling expenses. b. Repeated Distribution Method
(iii) Direct wages. Expenses which are c. Trial and Error Method
booked with the amounts of wages (a) Simultaneous Equation method:
2) Re-apportionment of Service Under this method, the true cost of the
Department Costs to Production service departments are ascertained first
Departments with the help of simultaneous equations;
Service department costs are to be these are then redistributed to production
reapportioned to the production departments on the basis of given
departments or the cost centres where percentage.
production is going on. This process of re- (b) Repeated Distribution Method: Under
apportionment of overhead expenses is this method, the totals are shown in the
known as ‘Service Distribution’. The departmental distribution summary, are
following is a list of the bases of put out in a line, and then the service
apportionment which may be accepted for department totals are exhausted in turn
the service departments. repeatedly according to the agreed
The following are the various methods of percentages until the figures become too
re-distribution of service department costs small to matter.
to production departments. (c) Trial and Error Method: Under this
1. Direct re-distribution method method, the cost of one service department
2. Step distribution method is apportioned to another centre. The cost
of another centre plus the share received
3. Reciprocal Services method
from the first centre is again apportioned to
1).Direct re-distribution method: Under the first cost centre and this process is
this method, the costs of service repeated till the balancing figure becomes
departments are directly apportioned to negligible.
production departments without taking
ABSORPTION OF OVERHEAD
into consideration any service from one
service department to another service Absorption means the distribution of the
department. overhead expenses allotted to a particular
department over the units produced in that
2) Step Distribution Method: Under this
department. Overhead absorption is
method, the cost of most serviceable
accomplished by overhead rates.
department is first apportioned to other
service departments and production Methods of Absorption of Manufacturing
departments. Overhead
3) Reciprocal Services Method: This The following are the main methods of
method recognizes the fact that if a given absorption of manufacturing or factory
overheads.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

(a) Direct Material Cost Method. Under convenient physical units like number,
this method percentage of factory expenses weight, volume etc. the rate is calculated as
to value of direct materials consumed in under:
production is calculated to absorb Overhead Rate= Overhead expenses
manufacturing overheads. (budgeted)/Budgeted production
The formula is Overhead Rate = Production (g) Sale Price Method: Under this method,
Overhead Expenses (Budgeted) / budgeted overhead expenses are divided by
Anticipated Direct Material Cost the sale price of units of production in
(b) Direct Labour Cost (or Direct Wages) order to calculate the overhead recovery
Method. This is a simple and easy method rate., the formula is
and widely used in most of the concerns. Overhead Recovery Rate= Budgeted
The overhead rate is calculated as under: overhead expenses / Sale value of units of
Overhead Rate= Production Overhead production
Expenses / Direct Labour Cost Module IV(Methods of Costing)
(c) Prime Cost Method. Under this UNIT COSTING
method the recovery rate is calculated
It is an important method of costing. It is
dividing the budgeted overhead expenses
also known as output costing or single
by the aggregate of direct materials and
costing. It is used to ascertain the cost of
direct labour cost of all the products of a
producing a unit of output.. This method is
cost centre. The formula is
called ‘unit’ costing since every unit of
Overhead Recovery Rate = Production production is identical in all respects and
Budgeted Overhead Expenses / Anticipated the cost unit is a standard product.
Direct Materials and Direct Labour Cost
Cost sheet:
(d) Direct Labour (or Production) Hour
Cost sheet is a device used to determine
Method. This rate is obtained by dividing
and present the cost under unit costing. It is
the overhead expenses by the aggregate of
a statement of costs incurred at each level
the productive hours of direct workers. The
of manufacturing a product or service. In a
formula is Overhead rate = Production
Cost sheet all the elements of cost is taken
Overhead Expenses / direct labour hours.
into consideration. It includes Prime cost,
(e) Machine Hour Rate. Machine hour rate Factory/manufacturing cost, cost of
is the cost of running a machine per hour. It production, cost of sale Profit/loss etc.
is one of the methods of absorbing factory
Items excluded from Cost Sheet:
expenses to production. What is needed for
computing the machine hour rate is to 1. Pure financial expenses like interest on
divide overhead expenses for a specific capital, interest on loan, discount on
machine or group of machines for a period debentures, loss on sale of fixed asset
by the operating hours of the machine or provision for bad debts and doubtful debts,
the group of machines for the period. It is writing off goodwill, copyright, preliminary
calculated as follows: Machine hour rate = expenses etc.
Amount of overheads / Machine hours 2. Pure financial incomes like interest
during a given period received, profit on sale of investment,
(f) Rate Per Unit of Production. This dividend received, rent received,
method is simple, direct and easy. It is commission received, discount received etc.
suitable for mining and other extractive In addition to the above, no appropriation
industries, foundries and brick laying items will include in cost sheet
industries, where the output is measured in
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Tenders or Quotations: types,, fixed, variable and semi variable.


A tender or quotation is an offer made by a Tender price is calculated on the basis of
person to supply certain goods at a degree of variability
specified price. It is an estimated price JOB COSTING
which is determined in advance of It means ascertaining costs of an individual
production. job, work order or project separately.
Computation of Tender price According to ICMA London, “job costing is
I. Calculation of Tender price on the that form of specific order costing which
basis of Percentages of Overheads applies where work is undertaken to
In this case a cost sheet is prepared for the customer’s specific requirements and each
past period with the total amount of order is of comparatively of short duration.”
different elements of cost. Here Indirect or Under this method of costing, each job is
overhead costs are charged on a percentage considered to be a distinct cost unit. As
basis. The percentage is calculated on the such, each job is separately identifiable.
basis of the past year’s cost sheet. Advantages of Job costing:
II. Computation of Tender price on the 1. It helps to distinguish profitable jobs
basis of Previous year’s per unit cost: from unprofitable jobs
Under this situation , previous periods cost 2. It helps to identify defective work and
and output figures are available. Tender spoilage with a department or person
price is fixed by multiplying the quantity 3. Selling price of special orders can easily
with previous periods per unit cost and be fixed.
adding the required percentage of profit. 4. It helps to prepare estimates of cost for
There are three different situations under submitting quotations and tender for
this method. similar jobs
a. When there is no change in past cost 5. It helps to control future cost.
and past percentage of profit. In this case CONTRACT COSTING
a detailed probable cost sheet is prepared
it is a form of specific order costing which
by multiplying previous period’s cost of
applies where the work is undertaken to
each unit with the quantity of tender. Profit
customer’s requirements and each order of
is added at the same percentage of profits
long duration as compared to job costing. It
of the past period.
is also known as terminal costing.
b. When there is change in past cost, but
Contract Account
no change in past percentage of profit: -
Here the cost of the tender is calculated by A contract account is a nominal account in
making necessary adjustments in the nature. It is prepared to find out the cost of
elements of cost. Same percentage of cost is contract and to know profit or loss made on
added as profit to get tender price. the contract. A contractor may undertake a
number of contracts at a time. For each
c. When there is change in past cost and
contract a separate account is opened. In the
past percentage of profit: - Here the total
contract account all direct cost such as
cost tender is calculated by making
material, labour and other direct expenses
necessary adjustments in the cost and the
incurred during an accounting period are
tender price is then calculated by adding
debited and the indirect expenses are
the required percentage of profit.
apportioned on an equitable basis. The
III Calculation of Tender price based on differences between the two sides are
fixed and variable costs: Here, costs are
classified according to variability into three
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

known as Notional profit or notional loss. 3. Process Costing is simple and less
Special terms in contract account expensive in relation o job costing.
1. Work in Progress: It is the unfinished 4. By evaluating the performance of each
contract at the end of the accounting period process effective managerial control is
and it includes amount of work certified possible.
and amount of work uncertified. Disadvantages of Process Costing
2. Work certified: The sales value of work 1. Valuation of work in progress is difficult.
completed as certified by the architect is 2. It is not easy to value losses, wastes,
known as ‘work certified’. scraps etc.
3. Work Uncertified: It means work which 3. The apportionment of total cost among
has been carried out by the contractor but joint products and by-products is difficult.
has not been certified by the architect. 4. Process cost are not accurate, they are
4. Retention money: - Regardless of the only average costs
amount of work certified, the contractor is 5. Process costs are only historical.
paid a specified percentage of the same and
Difference between Process Costing and
the balance is held or retained by the
Job Costing
contractee. The unpaid balance of work
certified or the amount held back or Process Costing Job Costing
retained by the contractee is known as Production is Production is
‘retention money’. continuous according to
5. Sub contract: Sometimes the contractor customers’ orders
enters into contracts with another Production is for Production is not
contractor to give a portion of work stock for stock
undertaken by him. All units produced Each job is
6. Escalation clause: This is clause which is are identical or different from the
provided in the contract to cover up any Homogeneous other
increase in the price of the contract due to
increase in the prices of raw material or
There is regular There is no
labour or in the utilization of any other transfer of cost of regular transfer of
factors of production. one process to cost
PROCESS COSTING subsequent from one job to
Process costing is the method of costing processes another
applied in the industries engaged in
Work in progress Work in progress
continuous or mass production. Process
always exists may or may not
costing is a method of costing used to
exist
ascertain the cost of a product at each
process or stage of manufacturing. Hence, Accounts
this costing is also called as “Average The preparation of Process Account
Costing” or “Continuous Costing”. depends upon the following situations
Advantages of Process Costing 1. Simple Process Account
1. It is easy to compute average cot because 2. Process costing with normal process loss
the products are homogeneous in Process 3. Process costing with abnormal process
Costing. loss
2. It is possible to ascertain the process 4. Process costing with abnormal process
costs at short intervals. gains
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Simple Process Account: Under this case it rather than production of commodities. The
is very easy to prepare process account. A services may be in the form of transport,
separate account is opened for each supply service, welfare service, etc.
process. All costs are debited to the process Module V (Cost Control Techniques)
account. The total cost of the process is BUDGET AND BUDGETORY CONTROL
transferred to the next process. At the end
Meaning and definition of budget:
of each process the cost per unit is obtained
by dividing the total cost by the number of It simply means a financial plan expressed
units. in terms of money. The budget pertaining to
any of the activities of business is always
Process losses: The process loss is
forward looking. The term ‘budget’ has
classified into two- normal process loss and
been derived from the French word,
abnormal process loss.
”bougette”, which means a leather bag into
Normal process loss: This is the loss
which funds are appropriated to meet the
which is unavoidable on account of
anticipated expenses.
inherent nature of production process. It
arises under normal conditions. It is usually Budgeting and Budgetary control:
calculated as a certain percentage of input. Budgeting simply means preparing budgets.
Normal process los includes either waste or It is a process of preparation,
scrap or both. implementation and the operation of
abnormal Process Loss: Any loss caused budget. Being a plan of action, a budget
by unexpected or abnormal conditions such guides every manager in the decision
as plant break don, substandard materials, making process.
carelessness, accident etc. or loss in exceeds In the words of Rowland Harr, “Budgeting
of the margin anticipated for normal is the process of building budgets”..
process loss can be called as abnormal Objectives of Budget and Budgetary
process loss. control:
Abnormal Gain (or Abnormal Effective): The following points reveal the objectives
Sometimes actual loss or wastage in a of Budget and budgetary control:-
process is less than expected normal loss. In 1. To aid the planning of annual operations
this case the difference between actual loss 2. To co ordinate the activities of the
and expected loss is known as abnormal various parts of the organization
gain or abnormal effective. It is the excess
3. To communicate plans to the various
of actual production over normal output..
responsibility centre managers
Equivalent Production
Equivalent production represents the 4. To motivate managers to strive to
achieve the organizational goals.
production of a process in terms of
completed units. In other words, it means 5. To control activities
converting the incomplete units into its 6. To eliminates the wastes of all kinds
equivalent of completed units. It is also 7. To provide a yard stick against which
known as effective production. actual results can be compared
OPERATING COSTING (SERVICE 8. To evaluate the performance of
COSTING) managers.
It is the costing procedure used for 9. To reduce the uncertainties
determining the cost of per unit of service Meaning of Estimate, forecast and
rendered. It is a method of costing applied Budget:
to undertaking which provides service
An estimate is predetermination of future
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

events either on the basis of simple guess purposes, the entire organization will be
work or following scientific principles. split into a number of departments, area or
Forecast is an assessment of probable future functions, known as ‘centres’, and budgets
events. Budget is based on the implication of will be prepared for each such centers
a forecast and related to planned events. 4. Clear cut objectives and reasonably
Steps involved in Budgetary Control: attainable goals
The following steps may be considered 5. Participative budgeting: Every
necessary for a comprehensive budgetary executive responsible for the
control programme:- implementation of budgets should be given
1. Laying down organizational goals or an opportunity to take part in the
objectives preparation of budgets.
2. Formulating the necessary plans to 6. Budget committee: The work of
ensure that the desired objectives are preparing a budget manual should be
achieved. entrusted to a Budget committee.
3. Translating plans into budget 7. Comprehensive budgeting: Budgeting
4. Relating the responsibilities of executives should not be partial, it should cover all the
to the requirements of a policy. functions .
5. Recording and reporting actual 8. Adequate accounting system:
performance 9. Periodic reporting: - There should be a
6. Continuous comparison of actual with prompt and timely communication and
budgeted results reporting system for the effective
7. Ascertainment of deviations, if any implementation of a budgetary control
8. Focusing attention on significant system.
deviations Budget manual:
9. Investigation into deviations to establish It is a written document which guides the
causes executives in preparing various budgets.
10. Presentation of information to Budget period:
management, relating the variations to This may be defined as the period for which
individual a budget is prepared and employed. The
responsibility. budget period will depend on the type of
11. Taking corrective action to prevent business and the control aspects.
recurrence of variations. Classification of Budget
12. Provide a basis for revision of budgets.
1. Classification according to time factor
Essentials of a Budgetary Control
2. Classification according to flexibility
system:
factor
1. Support by top management: The
3. Classification according to function.
wholehearted support of all managerial
persons is very necessary for the success of I. Classification according to time factor:
a budgetary control system. On this basis, budgets can be of three types:
2. Formal organization: The existence of a 1. Long term budget – for a period of 5 to 10
formal and sound organizational structure years
is of an absolute necessity for an effective 2. Short term budgets – Usually for a period
system of budgetary control. of one to two years
3. Budget centers: For budgetary control 3. Current budgets - Usually covers a period
of one month or so,
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

II. Classification according to flexibility: 2. Production budget: It is the forecast of


It includes the quantity of production for the budget
1. Flexible budgets and period. It is usually expressed in physical
2. Fixed budgets quantity.
Flexible budgets: It is a dynamic budget. It 3. Material budget: It shows the estimated
gives different budgeted cost for different quantities as well as cost of raw material
levels of activity. It is prepared after making required for the production of different
an intelligent classification of all expenses product during the budget period.
between fixed , semi variable and variable 4. Purchase budget: It shows the quantity
because the usefulness of such a budget of different type of materials to be
depends up on the accuracy with which the purchased during the budget period taking
expenses can be classified. into consideration the level of activity and
Fixed Budget: It is a budget which is the inventory levels.
designed to remain unchanged irrespective 5. Cash budget: It is prepared only after all
of the level of activity attained. It does not the other functional budgets are prepared.
change with the change in the level of It is also known as financial budget. It is a
activity. statement showing estimated cash inflows
III. Classification according to function: and cash outflows over the budgeted
It includes: period.
1. Functional budgets and 2. Master Recent trends in budgeting:
budgets 1. Zero Base Budgeting (ZBB): Under ZBB
Functional budgets are those which are the programmes and activities get
prepared by heads of functional evaluated and ranked from zero base as if
department s for their respective these were launched for first time. In this
departments and are subsidiary to the technique of budgeting the unwanted
master budget. Functional budget may be projects and activities get dropped and
Operating budgets or financial budget. wanted and desirable activities and projects
Operating budgets are those budgets which get included in the budget.
relate to the different activities or Features:
operations of a firm. Financial budgets are a. It starts from zero
those which incorporate financial decisions b. All activities are identified in appropriate
of an organization. They show in detail the decision packages
inflow and outflow of cash and the overall c. All programmes are considered totally
financial position. afresh
Master budget is the summary of all d. A detailed cost benefit analysis of each
functional budgets. It summarizes sales, programme is undertaken
production, purchase, labour, finance
e. There is an officer responsible for each
budgets etc. It is considered as the overall
decision packages
budget of the organization.
f. Priorities are established and decision
Different types of functional budgets:
packages are ranked
1. Sales budget: It is forecast of total sales
Advantages of ZBB
expressed in quantities and money. It is
prepared by the sales manager. While 1. It considers every time alternative ways
preparing sales budget we have to consider of performing the same job. It helps the
the past sales data , market conditions, management to get a critical appraisal of its
general trade and business conditions etc activities.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

2. It is helpful to the management in making Meaning of ‘standard’ and ‘standard


optimum allocation of scarce resources cost’:
3. ZBB is particularly useful for service Standard cost is a pre determined operating
departments and Governments cost calculated from management’s
4. It ensures active participation of standards of efficient operation and the
managers in the budgeting process. relevant necessary expenditure.
5. It promote high level of motivation at the Definition of standard costing:
level of unit managers The CIMA official terminology defines it as “
6. It focuses on output in relation to value a control technique which compares
for money. standard costs and revenues with actual
7. It makes managers cost conscious and results to obtain variances which are used
helps them in identifying priorities in the to stimulated improved performance.”
overall interest of the organization. In standard costing the actual costs
Difference between Traditional incurred are compared with the standard
budgeting and ZBB costs. The difference between the two is
called variance.
Traditional ZBB
budgeting Distinction between standard costing
and budgetary control:
Begins with Begins with zero
previous year’s Budget Standard costing
budget Based on Based on technical
Focuses on money Focuses on goals performance estimates
and objectives Consider both Consider only
Produces a single Produces income and expenditures
level of alternative level of expenditures
expenditure for an expenditure and It projects financial It project cost
activity desired result accounts accounts
Resources are Resources are Variance is not Variance are
allocated not on allocated on the possible analyzed
the basis of cost basis of cost Fix minimum limit Fix targets
benefit analysis benefit analysis Used for the It cannot used for
Prepared annually Prepared once in forecasting men, forecasting
every five years money and
materials
2) Activity base budgeting: In the case of Applicable to all Useful only for
activity based budgeting, however, the types of business manufacturing
budget centres are activity based cost pools firms
or cost centres in relation to which budgets Prepared for Expressed in per
are prepared. Separate cost pools are specific periods unit
established for each type of activity. and expressed in
3. Performance budgeting: - Performance total
oriented budgets are established in such a Does not require It requires
manner that each item of expenditure standardization of standardization of
related to a specific responsibility centre is product product
closely linked with the performance of that
centre.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Objectives of standard costing: conditions, while expected standard is that


1. Performance measurement which is expected to be attained during a
2. Cost control specified budget period.
3. Stock valuation 4. Normal standard: This standard is
defined as “the average standard which it is
4. Establishing selling prices
anticipated can be attained over a future
5. Profit planning and decision making period of time, preferably long enough to
6. Basis of estimating cover one trade cycle.”
7. Assisting establishment of budgets Analysis of Variances:
Steps involved in Standard Costing:- Variance is the difference between a
The procedure for establishing standard standard cost and the comparable actual
costing is summarized as follows:- cost incurred during a period. It is the
1. Establishment of cost centres: - A cost deviation of actual cost from the standard
centre is a location, person or item of cost. If the actual cost is less than the
equipment for which costs may be standard, the difference is known as
ascertained and used for the purpose of favourable. If the actual cost is more than
cost control. Cost centres are set up for cost the standard cost, the difference is known
ascertainment and cost control. as unfavorable variance.
2. Classification and codification of Types of variances
accounts: - It facilitates quick collection Analysis of variances may be done in
and analysis of cost information. respect of each element of cost and sales. It
3. Establishment of standards: The includes
success of the standard costing system 1. Direct material variance
depends up on the reliability and accuracy 2. Direct labour variance
of standards. Standards are always 3. Overhead variance
established scientifically.
4. Sales variance
4. Ascertainment of actual cost:
MATERIAL VARIANCES
Measuring the actual cost which is incurred
in the next step in the standard costing. It includes:
5. Comparison of Standard cost and a. Material Cost Variance (MCV): It is the
Actual cost. difference between the standard cost of
materials allowed for the output achieved
6. Analysis of Variances
and the actual cost of materials used. It may
7. Reporting of variance be expressed as:
Types of standards MCV=Standard cost of materials for actual
1. Basic standards: A standard established output – Actual cost of materials used
for use over a long period is known as the Std. cost of material = std qty x std price per
basic standard. It remains unaltered over a unit
long period.
Actual cost of material = Actual qty x actual
2. Current standard: A standard price
established for use over a short period of
b. Material Price Variance (MPV): It is
time and related to current conditions, is
that portion of the material cost variance
known as the ‘current standard’.
which is due to the difference between the
3. Ideal standards & Expected standard cost of materials used for the
standards:- Ideal standard is that which output achieved and the actual cost of
can be attained under the most favourable materials used.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

MPV = Actual qty x (std price – Actual price) allowed for actual output achieved and the
c. Material Usage Variance or Material actual cost of labour.
Quantity Variance(MQV): It is that portion LCV = Std cost of labour – Actual cost labour
of material cost variance which is due to the 2. Labour rate variance: It is that part of
difference between the standard quantity of labour cost variance, which arises due to
materials specified for the actual output the difference between standard rate
and the actual quantity of materials used. specified and the actual rate paid.
MUV = Std price per unit (Std qty – Actual LRV = Actual time x (Std rate – Actual rate)
qty) 3. Labour Efficiency Variance: It is that
d. Material Mix Variance (MMV): It is that portion of labour cost variance which arises
portion of the material usage variance due to the difference between standard
which is due to the difference between labour hours specified for the activity
standard and actual composition of a achieved and the actual labour hours
mixture. In case of material mix variance, expended.
two situations may arise: Actual weight of LEV = Standard rate x (Standard time for
mix and the A. Standard weight of mix do actual output – Actual time)
not differ: - In this case material mix
Overhead Variances:
variance is calculated by applying the
following formula The term overhead, which comprises
indirect materials, indirect labour and
MMV= Std price (Std qty x Actual qty)
indirect expenses, may relate to factory,
If the standard is revised due to shortage of office or selling and distribution. It is the
a particular type of material, the material sum of variable overhead variance and
mix variance is calculated as follows: fixed overhead variance.
MMV= Std price (Revised std qty – Actual Variable overhead Cost variance: This
qty) represents the difference between the
B. Actual weight of mix differ from standard standard cost of variable overhead allowed
weight weight of mix:- In such a case, for actual output and the actual variable
material mix variance is calculated as overhead incurred during the period.
follows: Variable Over head Expenditure
x Std of std mix - Std of actual Variance:
It is the difference between the standard
e. Material Yield Variance :- It is that
variable OH rate per hour and the actual
portion of the material usage variance
variable OH rate per hour, multiplied by the
which is due to the difference between the
actual hours worked.
standard yield specified and the actual yield
obtained. This variance measures the Variable OH efficiency Variance: It is the
abnormal loss or saving of material. difference between the variable overhead
allowed for production and the variable
Labour Variance:
overhead absorbed through production.
When standard cost of labour differs from
Fixed Over head variance:
actual wage cost, the labour variance arises.
The following are the important types of It is the difference between standard fixed
labour variances overhead allowed for actual output and the
actual fixed overhead incurred
1. Labour cost variance: It is the
difference between standard cost of labour Fixed OH Expenditure variance: It is the
difference between budgeted fixed
overhead and actual fixed overhead.
Cost Accounting– (Al Jamia Arts and Science College, Poopalam)

Fixed OH volume Variance: It is the


difference between Std fixed OH allowed for
actual output and the budgeted fixed
overhead for the period.

MUHAMMED RIYAS N
ASST.PROF.
AL JAMIA ARTS AND SCIENCE COLLEGE
STUDY
WELL…
POOPALAM
PERINTHALMANNA
PH: 9747799772
E-mail: riyasmuhammed89@gmail.com

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