Cost and Management Accounting: B.Balaram

COST AND MANAGEMENT
ACCOUNTING
B.BALARAM
MODULE - I
INTRODUCTION TO COST ACCOUNTING:
• Introduction,
• Terminology (Cost, costing,
cost unit, cost centre, profit centre, cost object)
• Objectives of Cost Accounting
• Cost Accounting Vs Financial Accounting
• Necessity for Cost Accounting
• Essentials of Good Cost Accounting System
• Practical difficulties in installation of costing system.
• Methods of costing & types of costing
• Classification of costs (by nature, by activities, by
behaviour, by time, in relation to managerial
decision making).
• Strategic Cost Management (SCM)
INTRODUCTION
• Business concerns continuously
strive to reduce costs and
enhance the quality of their
goods and services.
• The entities which enhance

customer satisfaction can hope
to increase their market share.
• The burden of rising costs with the effect of

reducing selling prices due to better technology,
cut-throat competition etc. are squeezing sales
volumes and /or profit margins.
• In time of trade depression, the costing
information will help the Management to know
the areas-wastage elimination, increase
efficiency etc.
• Costing divides costs into fixed cost and variable
cost, which can be used to determine the prices
in periods of trade depression.
• Costing information provides sufficient ground in
location of inefficiencies, wastages etc. to
exercise cost control and cost reduction
programs.
• This will help in reduction of selling prices to
meet trade competition. It helps in
survival and growth of the concerns
even in unfavourable economic
conditions.
FINANCIAL ACCOUNTING
Definition: It is “ the art of recording, classifying and
summarising in a significant manner and in terms
of money, transactions and events, which are in
part at least, of a financial character and
interpreting the results thereof”.
Information summarised in three statements :
(i) Profit and loss account- shows net profit/loss
(ii) Balance sheet- shows financial position
(iii) Cash flow statement- shows inflows/outflows of
cash
Objective: is to present a true and fair view of
company’s income and financial position at
regular intervals of one year.
LIMITATIONS OF FINANCIAL ACCOUNTING:
1. Shows only overall performance: It does not give

data regarding costs by departments, products, processes etc.
2. Historical in nature: data recorded at the end of the period

3. No performance appraisal: no system of developing
norms/standards to appraise the efficiency ( No comparison).
4. No material control system: no proper system in

losses in the form of obsolescence, deterioration etc.
5. No labour cost control: no system of recording idle time,

labour cost is not recorded by jobs, processes or departments.
Cont…..
6. No proper classification of costs: Expenses are
not classified into direct/indirect, fixed/variable etc.
7. No analysis of losses: it does not record idle plant

capacity, inefficient labour, etc. so, exact causes of the losses are
not known.
8. Not helpful in the price fixation: costs are not

available
9. No cost comparison: data not available for

comparision of costs of different periods,/jobs/departments etc.
10. Fails to supply useful data to mgt: in

decisions like replacement of labour by machines, introduction of
new products, make or buy, selection of the most profitable
product mix, etc.
COST ACCOUNTING
• Compared to financial accounting, cost
accounting is relatively a recent development.
• It has got importance in the modern age
because of the growth of complexities
in modern industry.
• It is not restricted to past.
• It provides detailed cost
information to various
levels of management for
efficient performance of their
functions.
TERMINOLOGY OF COST
ACCOUNTING
• COST: means the price paid for something.
(i) Cost is “the amount of expenditure (actual
or notional) incurred or attributable to a
given thing” (CIMA, UK)
(ii) “Cost is a measurement, in monetary
terms, of the amount of resources used for
the purpose of production of goods or
rendering services” (ICWA of India)
Cost vs. Expense and loss:
• Often the terms are used interchangeably
• Expense is defined as “an expired cost
resulting from a productive usage of an
asset”. Ex: Depreciation, Pre-paid
insurance
• Loss is defined as “reduction in a firm’s
equity, other than from withdrawals of
capital for which no compensating value
has been received” Ex: Obsolescence or
destruction of stock by fire
• COSTING:
(i) may be defined as “the techniques and
process of ascertaining costs” (CIMA, UK)
(ii) “The classifying, recording

and appropriate allocation of
expenditure for the determination
of costs, the relation of these
costs to sales value and the
ascertainment of profitability.”
(Wheldon)
• COST ACCOUNTING
(i) as “ the establishment of budgets,
standard costs and actual costs of
operations, processes activities or
products; and the analysis of variances,
profitability or the social use of funds”
(CIMA, UK)
Costing – cost accounting
• The terms are often used interchangeably.
• In simple words,
Costing means finding out the cost of
product or service by any technique or
method,
cost accounting means costing using the
double entry system.
• COST ACCOUNTANCY
It is a wide term. It means and includes the principles,
conventions, techniques and systems which are employed in a
business to plan and control the utilisation of its resources.
It is defined as “ 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
as well as presentation of information for the
purpose of managerial decision making”
(CIMA, UK)
It is the science, art and practice of a cost accountant.
It includes costing, cost accounting, cost control, and cost audit.
• COST CENTRE:
• It is defined as “ a location, person, or item
of equipment (or group of these) for which
costs may be ascertained and used for the
purpose of control” (CIMA, UK)
• Cost centres may be
Personal cost centre- consists persons are group of persons
(EX: sales man, a machine operator etc)
Impersonal cost centre-location or an equipment or a group .

Production cost centre- where production work takes place
Ex: melting shop, machine shop, welding shop, finishing shop, etc.
Service cost centre- render services to production cost centres.

Ex: power house, tool room, stores department, repair shop, canteen.
• COST UNIT:
• Cost unit which breaks up the cost of a cost centre into a smaller
.
sub- divisions
CIMA defines cost unit as “unit of

product, service or time in relation to which
costs are ascertained”
INDUSTRY NORMAL COST UNIT
Cement/Flour/Mines Tonne
Shoes Pair or Dozen pairs
Soft drink Crate of 24 or 12 bottles
Electricity Kilowatt hour (KWH)
Transport Passenger kilometre
Cont….
Chemicals Tonne,kg,litre,gallon etc.
Bricks 1000 bricks or 500 bricks
Nursing home Bed per day
Pencils Dozen or gross
Printing press Thousand copies
Cotton or jute Bale
Timber Cubic foot
Carpets Square foot
Hotel Room per day
Gas Cubic foot/cubic metre
• COST OBJECT
• Colin Dury defined as “any activity for which a
separate measurement of costs is desired”
• Ex: Particular area of sales, Particular function in
production process, Operating a particular
account , Mfg. a particular item of product.
Cost object requires all

costs relating to it to be
traced and accumulated.
• PROFIT CENTRE
• It is that segment of an organisation for
which both cost as well as profit are
traced. The scope of profit centre is
broader than that of cost centre.
• CIMA defines profit centre as “a segment
of the business entity by which both
revenues are received and expenses are
incurred or controlled”
OBJECTIVES OF COST
ACCOUNTING
• To ascertain cost per unit of production
• To help in determining the selling price
• To help in cost control and cost reduction
• To ascertain the cost and profitability of
each division, unit, activity, centre etc.
• To assist the management in decision
making.
• To provide a basis for operating policies
Cont…..
• To inform about inefficiency and
carelessness
• To inform the real situation of production
activity.
• To provide the principles and procedures
to be followed in costing system.
• To provide basis for comparative analysis
through data collection.
• To facilitate cost estimation.
COST ACCOUNTING AND
FINANCIAL ACCOUNTING
BASIS FINANCIAL COST ACCOUNTING
ACCOUNTING
1. Purpose To prepare P&La/c and Balance To provide detailed cost
sheet for reporting internal users information to management.
and external users. i.e internal users.
2. Statutory Accounts are obligatory and to Maintenance of these accounts
requiremen be prepared according to the is voluntary except in certain
-ts legal requirements of companies industries which are obligatory
act and Income tax act. according to companies act.
3.Analysis It does not show figures of cost It shows the detailed cost and
of cost and and profit for individual profit data for each product ,
profit products, departments and department, process etc.
processes.
Cont…..
4. Periodicity of Financial reports are Cost reporting is a
reporting prepared periodically, continuous process andmay
usually annual basis. be daily, weekly, monthly .
5. Control aspect It does not attach It provides detailed system
importance to control of controls with the help of
aspect. standard costing and
budgetary control.
6. Historical and It is concerned almost It is concerned not only with
predetermined exclusively with historical historical costs but also with
cost records. predetermined cost.
7. Format of It has a single uniform It has varied forms of
presenting format of presenting presenting cost information
information information . i.e p&l a/c, which are tailored to meet
b/s, cash flow . the needs of management.
8. Types of It records only external It records external and
transactions transactions like sales, internal transactions like
recorded. purchases, receipts etc. issue of materials etc.
9.statements It prepares general prepares special purpose
prepared purpose statements like statements like idle time
p&l a/c, b/s. report, variance report etc.
NECESSITY FOR COST
ACCOUNTING SYSTEM
• Reveals profitable and unprofitable activities
• Helps in cost control through standard costing
and budgetary control
• Helps in decision making in new products,
replacement, make or buy etc.
• Guides in fixing selling prices
• Helps in inventory control through ABC analysis,
level setting etc.
• Aids in formulating policies like production ,
pricing and preparing estimates and tenders.
• Helps in cost reduction.
Cont….
• Reveals idle capacity because of shortage of
demand, machine breakdown etc.
• Checks the accuracy and financial accounts
• Prevents frauds and manipulation through cost
audit system
• Introduction of incentive plans to Workers results
higher productivity .
• Efficient cost system reduce the cost of
production and the same charged to public
• Govt. agencies like wage tribunals, trade unions
will use this for wage level fixation, settlement of
industrial disputes etc.
ESSENTIALS OF GOOD COST
ACCOUNTING SYSTEM
• Suitability – method of costing is adopted based on suitable
industry.
• Specially designed system- readymade system
may not suitable so cost accounting system should be tailor made .
• Support of executives- system is successful when it is
supported by all department costing executives.
• Cost of the system- installing and operating should be
reasonable
• Clearly defined cost centres should be built to get
maximum benefits.
Cont….
• Controllable costs and non controllable should be
separately shown.
• Integration with financial accounts – should be

made to avoid duplication of accounts,
• Continuous education- well trained and educated staff
should be employed and meetings should be arranged continuously.
• Prompt and accurate reports should submit to take
necessary action.
• Avoid unnecessary details-
only useful cost information should be
compiled and used whenever required.
The resources should not be wasted
unnecessarily,
PRACTICAL DIFFICULTIES IN
INSTALLATION OF COSTING SYSTEM
• Lack of support from top management – in
order to make the costing system a success whole hearted support of
every member in management is required.
• Resistance from the accounting staff- the existing
staff may not welcome the new system.
• Non-cooperation of working and supervisory
staff- proper education should be given to the staff regarding benefits
of the system and the important roles they have to play to make it
successful.
• Shortage of trained staff- in the initial stage shortage may
be there. Later on they will be trained .
Suggestions to overcome practical difficulties:
• Mgt. should be convinced of the benefits of a cost
system
• To overcome resistance , the existing staff should
be properly trained to take up the responsibilities
of the costing system.
• The system should be simple to understand and
easy to operate.
• The benefits should be more than its cost
• A qualified and experienced cost accountant
should be appointed.
• The cost system designed and installed should
meet specific requirements.
• Regular meetings should be conducted to clarify
all doubts of staff.
LIMITATIONS OF COST
ACCOUNTING
• Cost accounting is not an exact science.
• It lacks a uniform procedure.
• A suitable system is to be devised for each
individual concern and it would be time
consuming and expensive.
• Most of the cost accounting techniques are
based on some presumed notions.
• Different views are held for inclusion of certain
items of cost in ascertaining of total cost.
METHODS OF COSTING
There are two methods of costing-
(i) Specific order costing : CIMA defines it
as “the basic costing method applicable where the
work consists of separate contracts, jobs or
batches, each of which is authorised by a special
order or contract.”
(ii) Continuous operation costing: CIMA
defines it as “the basic costing method applicable
where goods or services result from a series of
continuous or repetitive or processes to which
costs are charged before being averaged over the
units produced during the period”
Specific order costing
is classified into the following
Specific
order costing
Job Costing Contract Costing Batch Costing

• JOB COSTING: this method “applies where
work is undertaken to customers’ special
requirements”. (CIMA) Ex: Printing press,
repair shops, painting, interior decorators etc
• CONTRACT COSTING or terminal costing:

When the job is big and spread over long
periods of time, it is used . Ex: construction
of buildings, dams, bridges and roads, ship
building etc.
• BATCH COSTING: A batch may represent a

group of identical products passed through
the factory . Ex: Biscuit manufacturing,
Readymade Garments, Spare parts and
components manufacturing, Toys, shoes,
pharmaceutical companies etc.
Continuous operation costing is classified
into the following 4 types.
Continuous
operation
costing
Process Operation Unit Service

costing costing costing costing
1. PROCESS COSTING: Process costing is used
when identical units are produced through an
on-going series of uniform production steps.
In order to know the cost at each stage of
production, a separate account is opened for
each process.
Ex: Textiles, Paper, Sugar, Oil, Chemical
works etc
2. OPERATION COSTING: is applicable where
there is mass and repetitive production
conducted through different operations.
Ex: Different operations in machine screw are
- Stamps, Knurl, Thread, and Trim
Cont….
3. SINGLE, OUTPUT (OR) UNIT COSTING: This is
suitable for industries where manufacture is
continuous and units are identical.
Ex; Mines, Quarries, Oil drilling ,Breweries,
Cement works, Brick works, etc.
4. OPERATING (OR) SERVICE COSTING: This is

suitable for industries which render services.
Ex: Transport organisations, Power supply
companies, Municipal services, Hospitals ,Hotels,
Gas company etc.
MULTIPLE (OR) COMPOSITE COSTING : It represents

the application of more than one method of
costing in respect of the same product. This is
suitable for industries where a number of
component parts are separately produced and
subsequently assembled in to a final product.
Ex: Manufacturing of cycles, Automobiles,
Engines, Radios, Type writers , Aero planes etc.
TYPES OF COSTING
• HISTORICAL COSTING: costs are ascertained
only after they have been incurred. (costs which
are incurred in the past)
• ABSORPTION COSTING: It is a traditional

method of costing whereby all fixed and variable
costs are charged to products.
• DIRECT COSTING: It is a method of costing in

which the product is charged with only those
costs which vary with volume.
Cont….
• MARGINAL COSTING: in this , costs are
classified into fixed and variable . Variable costs
are charged to unit cost and the fixed cost is
treated as period cost and no attempt is made
for allocation.
• STANDARD COSTING: In this technique ,

standard cost is pre-determined as a target of
performance and actual performance is
measured against standard.
• UNIFORM COSTING:
It is simply denotes a situation
in which a number of firms adopt
a uniform set of costing principles.
CLASSIFICATION OF COSTS
• CLASSIFICATION OF COSTS BY NATURE:
The total cost of a product or service is basically classified
into material cost, labour cost and expenses as follows.
Material cost: include cost of procurement, freight inwards,
taxes and duties, insurance etc. directly attributable to
the acquisition. Trade discounts, rebates, duty
drawbacks, refunds on taxes deducted.
Labour cost: include monetary benefits payable
immediately- salaries, wages, D.A ; Monetary benefits
payable sometime in the future- P.F, ESI, pension ;
Non-monetary benefits (fringe benefits)-free food,
medical , free education , free housing etc.
Expenses: other than the above two-
expenditure on utilities, payment for bought out
services, job processing charges etc
•Classification by functions/Activities
Based on functions, the costs can be classified as follows:
Total Cost
Administra- Research &

Production Selling Distribution
-tion Development
cost cost cost
cost cost
(i)Production cost (Also called Works cost/Factory
cost/Manufacturing cost) include all direct costs and
manufacturing expenses (indirect costs concerned with Mfg.
activity).
The Mfg. expenses which can be classified as production costs
include:
• Factory rent, rates, lighting and heating
• Insurance of P&M, factory buildings, furniture ,equipment.
• Repairs and maintenance of P&M, factory premises.
• Salaries , wages, incentives to indirect workers-office boys, time
keepers, store keepers, factory clerical staff, maintenance staff tool
room operators etc
• Idle time wages, Fire protection service, Carriage inwards
• Canteen and staff welfare
• Depreciation of P&M, factory buildings, and other assets
• Remuneration paid to directors concerned with factory
• Consumable stores and material of little value
• Factory administration cost like printing and stationery, postage
and telegrams, telephone, computer department cost.
(ii) Administration costs may include:
• Office rent, rates and taxes
• Office lighting, heating, and cleaning
• Depreciation, insurance, repairs and maintenance of
office buildings, furniture, equipment and fittings.
• Salaries of administrative staff
• Printing and stationery, postage and telegrams,
telephones etc.
• Accounts and secretariat costs
• Audit and legal fees
• Bank charges
• Salaries to office staff
• Directors remuneration and sitting fees.
(iii)Selling costs include the following:
• Salaries, Commissions and travelling expenses
to sales staff
• Remuneration of sales director
• Administration and upkeep of sales office and
showrooms.
• Advertising and publicity expenses
• Cost of catalogues, price lists and samples
• Depreciation, insurance, repairs, maintenance of
sales office and showrooms.
• Bad debts and costs incurred for collection of
bad debts
• Discount and rebates
(iv) Distribution costs include the following:
• Carriage and freight outwards
• Packing and delivery charges
• Depreciation, insurance and maintenance
of delivery vehicles
• Rent, depreciation, insurance and
maintenance of distribution outlets
• Administration cost of distribution outlets
• Wages of packers, drivers and delivery
boys
• Running expenses of delivery vehicles
(v) Research and Development
expenditure include:
• Cost of raw materials used in research
• Salaries and wages of R&D staff
• Subscriptions to books and journals
• Subscriptions to research associations
• Cost of tests conducted and trail runs
• Depreciation, insurance, repairs and
maintenance of buildings and research
equipment, plant etc.
• Patent fees
• Up-keep and maintenance of R&D office
• Travelling cost for surveys etc.
• CLASSIFICATION OF COSTS BY
BEHAVIOUR:
Depending on variability of behaviour , costs can
be classified into three. They are:
(a) Fixed cost is a cost that remain constant over
a wide range of activity for a specified period of
time. Ex: salaries, rent, lease, taxes etc.
(b) Variable cost is a cost tend to vary in direct
proportion to the volume of output. Ex: Direct
material, wages, royalties, small tools etc.
(c) Semi-variable cost are costs that partly fixed
and partly variable. Ex: Telephone expenses,
Electricity etc.
• CLASSIFICATION OF COSTS BY TIME:
(i) Historical cost is the actual cost, determined
after the event.
(ii) Pre-determined costs are computed in
advance of the production. They may be either
standard or estimation.
• Standard cost is a predetermined calculation
of how much costs should be under specified
working conditions.
• Estimated cost is a pre-determined cost
based on past performance adjusted to the
anticipated changes.
•CLASSIFICATION OF COSTS FOR
MANAGEMENT DECISION MAKING:
Following are the cost concepts for managerial
decision making.
(i) Marginal cost is the additional cost of producing
one additional unit. It is the same thing as variable
cost.
Marginal costing (or variable costing) is a
technique of charging only variable costs to
products. Fixed cost is treated as period cost and
written off in P&L a/c.
(ii) Differential (or incremental cost) is the
difference in total cost that will arise from the
selection of one alternative to the other.
The alternative choice may arise because of change
in method of production, in sales volume, change
in product mix, make or buy decision, take or
refuse decision, etc.
Cont….
(iii) Opportunity cost: It is the value of a
benefit sacrificed in favour of an
alternative course of action.
It can be defined as the revenue foregone
by not making the best alternative use.
(iv) Replacement cost: This is the cost at
which there could be purchased an asset
identical to that which is being replaced .
Replacement cost is the current market
cost of replacing an asset.
Cont….
(v) Relevant cost: It is a cost appropriate in aiding
to make specific management decisions. A
relevant cost is a future cost which differs
between alternatives.
It can also be defined as any cost which is
affected by the decision in hand.
(vi) Irrelevant cost: These are the costs that will
not be affected by a decision.
Ex: Journey by own car or by public transport bus.
Insurance cost of a car is irrelevant because it
wont change, whatever alternative is chosen.
Cost of petrol and other operating costs will differ ,
and are relevant for this decision.
(vii) Imputed costs: These are hypothetical
costs which are specially computed outside
the accounting system for the purpose of
decision-making.
Ex:Interest on capital , rent of building owned
by the firm.
The imputed cost is a cost which does not
involve actual cash outlay, but only for
decision making.
(viii) Sunk cost: A sunk cost is an
expenditure made in the past that cannot be
changed and over which management has no
control.
Cont….
(IX) Normal cost may be defined as a
cost which is normally incurred on
expected lines at a given lines of
output. This cost is part of cost of
production.
(X) Abnormal cost is that which is not
normally incurred at a given level of
output. Such cost is over and above the
normal cost and is not treated as a part
of the cost of production. It is charged
to costing P&L account.
(Xi) Avoidable costs: are those which can be
eliminated if a particular product or department
with which directly related, is discontinued.
Ex: salary of the clerk can be eliminated if the
department is discontinued.
(Xii) Unavoidable cost is that cost which will not
be eliminated with the discontinuation of a
product or department.
Ex: salary of a factory manager or factory rent
cannot be eliminated even if a product is
eliminated.
Cont….
(xiii) Product cost is aggregate of costs that
are associated with a unit of product.
Ex: direct materials, direct labour, and some
factory overheads.
(i) costs will not be incurred if there is no production
(ii)These are called inventoriable costs because these are
included in the cost of product as work-in-progress,
finished goods, or cost of sales
(xiv) Period cost is a cost that tends to be
unaffected by changes in level of activity
during a given period of time.
Ex: Show room rent, salary of executives etc.
(i) costs will be incurred even if there is no production
(ii) These costs are not inventoried i.e not included in stock.
(xv) Traceable costs are those which can
be identified easily and indisputably with a
unit of operation or costing unit or cost
centre.
(xvi) Common costs cannot be allocated
but which can be apportioned to cost
centres and cost units. Ex: all indirect
costs.
(xvii) Out of pocket costs or explicit costs
are those costs that involve cash outlays
or require the utilisation of current
resources.
Ex: Wages, material cost, insurance etc.
Depreciation on plant and machinery is an
implicit cost and not out of pocket cost.
(xviii) Future costs are costs expected to be
incurred at a later date. Future costs are
relevant costs.
Cont…
Fixed costs are further divided into committed or
discretionary costs
(xix) Committed costs are those that are incurred
in maintaining physical facilities and managerial
set up. These costs are the result inevitable
consequences of commitments previously made
or are incurred to maintain certain facilities and
cannot be quickly eliminated. Ex: rent, insurance,
depreciation on building etc.
(xx) Discretionary costs are those which can be
avoided by management decisions. such costs
are not permanent. Ex: Advertising, R&D cost etc.
These costs may be avoided or reduced in the
short run if so desired by the management.
(xxi) Controllable costs are the costs which may
be directly regulated at a given level of management
authority.
Ex: cost of raw material controlled by
purchasing large quantities.
(xxii) Non-controllable costs are those costs

which cannot be influenced by the action of a specified
member of an enterprise.
Ex: Factory rent, managerial salaries cannot
be controlled.
• Strategic Cost Management (SCM)
SCM is fundamentally new way of managing an organisation.
It comprises:
• A Strategic analysis of the new business to identify unprofitable
products, customers, marketing and distribution channels, etc.
• An evaluation of the business from a value chain perspective.
Linkages, both internally and externally, are taken into consideration.
• The optimisation of business processes and activities instead of
functions, and the evaluation of the effect of both upstream and
downstream decisions.
• The implementation of continuous cost improvement programmes
instead of comparisons with outdated standard costing approaches.
• The use of performance measurement systems that are early
indicators of corporate success in critical areas such as time, quality
and cost
• The improvement in activities that add value while value-destroying
activities are identified and eliminated. Particular emphasis is placed
on the evaluation of support activities.
Cont….
• The elimination of capacity and other constraints.
• The integration of quality management programmes with the costing
system, not only to identify wastage but also to develop the methods
to value and to eradicate it.
• The implementation of productivity management programmes that
are supplemented by appropriate benchmarking and service level
evaluations.
• Value engineering and value analysis that are used as important
tools to restructure product costs.
• Changes in costing and accounting systems to reflect total cost
approaches instead of conventional classifications of cost between
production, marketing , administration, etc. (or only the minimum
information that is required by law.)
• A thorough understanding by management of the cost behaviour
and the underlying cost drivers.
• The introduction of cost of capital theory as well as residual income
theory to cost decision making in order to optimise the use of capital
resources.
• Managing costs with a long-term focus. Few costs are considered
fixed and therefore non-manageable.
Module – II
Costing Practices:
• Preparation of cost sheet
• Output and Job costing.
• Contract costing
• Process costing
(Valuation of work-in-progress excluded)
• Joint product and by product.
· Service costing
· Activity based costing
• ELEMENTS OF COSTS : The total cost is devided
into material, labour and overheads.
Elements of costs
________________________________________________
  
Material Labour Expense
_ ___________ _______ __________ _______________
     
Direct Indirect Direct Indirect Direct Indirect
______________________ ___ _____________________

Overheads
_________________________________________________
   
Factory Office Selling
Distribution
• Direct Material: Direct material is all
that material which can be identified in
the product and can be conveniently
measured and directly charged to the
product. Ex: Timber in chair or
table, cloth in shirt ,all raw
materials like pig iron in foundry,
fruits in canning industry.
• Direct Labour:
Direct labour is that labour which can be
conveniently identified or attributed wholly
to a particular job, product or process.
In other words, it is all labour expended
in converting raw materials into
manufactured articles or altering the
construction, composition or condition of
the product. Ex: Labour
engaged in the actual production-
machine operator, shoe maker etc.
• Direct Expenses:
All expenses other than the direct
material or direct labour that are
specifically incurred for a particular
product or process are treated as direct
expenses. These are directly charged to
products and form part of prime cost.
Ex:Cost of special patterns,
drawings, tools, etc made for a
specific product or process, cost
of patent rights.
• Overheads: All indirect costs are
termed as overheads. These are
classified as follows:
• (i.)Factory Overhead: It refers to those
expenses which are incurred in the
factory and are concerned with the
running of the factory. It includes,
indirect material, indirect labour and
indirect expenses in producing an
article. Ex: Rent of factory
building, repairs, depreciation, wages of
indirect workers, storekeeping expenses,
etc.
• (ii)Office or Administration overheads:
It includes all the expenses incurred by the
administrative office. Ex: Office rent, staff
salaries, postage, stationery etc.
• iii) Selling overhead: This is the cost of
promoting sales and retaining customers.
Ex: Advertisement, salaries of sales men,
commission on sales, market research etc.
• (iv) Distribution overheads: It refers
to all the expenses incurred in
executing orders.
Ex: cost of warehousing, Cost of
packing, transportation cost for
dispatching goods etc.
• COST SHEET OR STATEMENT OF
COST:
Cost sheet is “a document which
provides for the assembly of the detailed
cost of a cost centre or cost unit.” (CIMA)
Cost sheet is a
statement designed to show the output of
a particular accounting period along with
break-up-of costs.
The data incorporated in cost sheet are
collected from various statements of accounts
which have been written in cost accounts, either
day-to-day or regular records .
Advantages:
1)It discloses the total cost and the cost per
unit of the units produced during the period.
2) It enables a manufacturer to keep a close
watch and control over the cost of production.
3) It helps in fixing up the selling price more
accurately.
4) It helps in minimising the cost of production
5) It helps Mgt. in cost comparison, analysis and
control.
SPECIMEN OF COST SHEET OR
STATEMENT OF COST
______________________________________________
Total costs(Rs.)
Direct materials xxx
Direct Labour xxx
Direct Expenses xxx__________________
Prime cost: xxx
Add: Works or factory Overheads _____ _xxx___
Works cost or Factory Cost: xxx
Add: Administration overheads _____________________xxx_______
Office or Admn. Cost or Cost of production: xxx
Add: Selling and Distribution overheads: ______________ xxx_______
Total cost or Cost of sales xxx
Add: Profit: xxx_______
Total Sales price xxx
_________________________________________________________
Ex:1 Prepare cost sheet from the following details:
Direct materials Rs. 5,000; Direct labour Rs 2,500;
Direct expenses Rs.1,000;Factory expenses Rs 1,500;
Administration expenses Rs 800; Selling expenses Rs.
700 and sales Rs. 15,000
Ans:______________________________________________
Total costs(Rs.)
Direct materials 5,000
Direct Labour 2,500
Direct Expenses 1,000________________
Prime cost:
8,500
Add: Works or factory Overheads 1,500
Works cost or Factory Cost: 10,000
Add: Administration overheads 800__
Office or Admn. Cost or Cost of production: 10,800
Add: Selling and Distribution overheads: _700__
Total cost or Cost of sales 11,500
Add: Profit: 3,500
Total Sales price 15,000
Ex:2
Mr. Gopal furnishes the following data relating to the
manufacture of a standard product during the month of
April 2009.
Raw materials consumed : Rs. 15,000
Direct labour charges : Rs. 9,000
Machine hours worked : 900
Machine hour rate : Rs. 5
Administration overheads : 20% on works cost
Selling overhead : Re. 0.50 per unit
Units produced : 17,100
Units sold : 16,000 at Rs. 4 per unit
You are required to prepare a cost sheet from the above,
showing:
(a) The cost per unit
(b) Cost per unit sold and profit for the period
Ans: Cost sheet
Per
Total unit
Direct materials 15,000 0.877
Direct labour 9,000 0.526
Prime cost 24,000 1.403
Production overheads (900 machine hours@Rs. 5) 4,500 0.263
Works cost 28,500 1.666
Administration overheads @20% on works cost 5,700 3.334
Cost of production 34,200 2
Less: Closing stock on 30th april, 2009 2,200
(1,100 units@2)
Cost of goods sold 32,000 2
Selling overhead (@Re. 0.50 per unit for 16,000) 8,000 0.5
Cost of sales 40,000 2.5
Profit 24,000 1.5
Sales (16,000 units) 64,000 4
SPECIMEN OF DETAILED COST SHEET
_____________________________________________
Total costs(Rs.)
Material consumed (opening stock +Purchases –closing stock)xxx
Direct Labour xxx
Direct Expenses xxx Prime cost:
xxx
Add: Works or factory Overheads xxx
Add: Opening stock of work in progress xxx
Less: Closing stock of work in progress xxx
Works cost or Factory Cost: xxx
Add: Administration overheads xxx_______
Office or Admn. Cost or Cost of production: xxx
Add: opening stock of finished goods xxx
Less: closing stock of finished goods xxx
Cost of goods sold xxx
Add: Selling and Distribution overheads: xxx_______
Total cost or Cost of sales xxx
Add: Profit (or loss) xxx_______
Total Sales price xxx
_________________________________________________________
• Items excluded from cost:
1. Cash discount
2. Interest paid
3. Preliminary expenses written off
4. Good will written off
5. Provision for taxation
6. Provision for bad debts
7. Transfer to reserves
8. Donations
9. Income tax paid
10. Dividends paid
11. Profit/loss on sale of fixed assets
12. Damages payable at law, etc
Ex:3) From the following particulars, prepare a
cost sheet showing cost per unit and profit for
period.
Opening stock at raw materials Rs.30,000
Purchase of raw materials Rs. 1,00,000
Closing stock of raw materials Rs. 50,000
Direct wages Rs. 45,000
Units produced 5000 units
Units sold 4500 units
Selling Price per unit Rs. 40.00
Factory overhead is 20% of direct wages
Office overhead is 10% of factory cost
Selling overhead is Rs. 2.00 per unit
Cost sheet
PARTICULARS TOTAL COST PER UNIT COST

(5,000 UNITS)
Opening cost of Raw Materials 30,000
(+) Purchase of Raw Materials 1,00,000
1,30,000
(-) Closing stock of Raw materials 50,000
Raw materials consumed 80,000 16
Direct Wages 45,000 9
--
Direct expenses -
PRIME COST 1,25,000 25
(+) Factory Overheads (20% of 45,000) 9,000 1.8
FACTORY COST 1,34,000 26.8
(+) Office Overheads (10% of 1,34,000) 13,400 2.68
OFFICE COST 1,47,400 29.48
(+) Selling and Distribution Overheads

( 4,500 units sold @ Rs.2 each) 9,000 2
TOTAL COST 1,56,400 31.48
(+) PROFIT (Balancing figure) 23,600 8.52
SALES (4500X40) 1,80,000 40
Ex:4) The following extract of costing information relates to
commodity ‘A’ for the half year ending 31st December, 2007.
Purchases of raw materials 1,20,000 Stock (31st Dec., 2007) :
Works overheads 48,000 Raw materials 22,240
Direct wages 1,00,000 Finished products(2000 tons) 32,000
Carriage on purchases 1,440 Work –in –progress 4,800
(1-7-2007)
Stock (1st July, 2007):
Raw materials 20,000 Work –in-progress (31-12-2007) 16,000

Finished products (1,000 tones) 16,000 Sales----finished products 3,00,000
Selling and distribution overheads are Re.1 per ton sold. 16,000 tons of
commodity Were produced during the period.
You are to ascertain (i) cost of raw materials used (ii) cost of output
for the Period, (iii) cost of sales, (iv) Net profit for the period , and (v) Net
profit per ton of The commodity.
----------------------------------------------------------------------------------------------------
Units (tons) Rupees
Opening stock of raw materials 20,000
Add: Purchase of raw materials 1,20,000
Add: Carriage on purchases 1,440
1,41,440
Less : Closing stock of raw materials 22,240
(i) Value of raw materials used 1,19,200
Add: Direct wages 1,00,000
Prime cost: 2,19,200
Add: Works overheads 48,000
Add: Opening stock of work –in-progress 4,800
2,72,000
Less: Closing stock of work-in-progress 16,000
(ii) Cost of output for the period: 16,000 2,56,000
Add: Opening stock of finished goods; 1,000 16,000
17,000 2,72,000
Less: closing stock of finished goods 2,000 32,000
Cost of goods sold 15,000 2,40,000
Selling and distribution overheads (15,000@1per ton) 15,000
(iii) Cost of sales 2,55,000
(iv) Net profit of the period 45,000
Sales 3,00,000
(v) Net profit per tonne= 45,000/15,000= Rs. 3.
• Treatment of scrap:
Scrap may be difined as an unavoidable
residue material arising in certain types of
manufacturing processes.
Ex: trimming, turnings or boring from metals
or timber.
Scrap usually has a small realisable value.
This is deducted from either factory
overhead or factory cost while preparing
a cost sheet.
Ex: 5) From the following information prepare a
cost sheet to show: (a) Prime cost (b) Works
cost (c) Cost of production; (d) Cost of sales;
and (e) Profit.
Raw materials purchase : Rs. 32,250
Carriage on purchases : 850
Direct wages : 18,450
Factory overhead : 2,750
Selling overhead : 2,450
Office overhead : 1,850
Sales : 75,000
Sale of factory scrap : 250
Opening stock of finished goods : 9750
Closing stock of finished goods : 11,100
Sol: Cost sheet
Raw materials Rs. 35,250
Add: Carriage on purchases 850 36,100
Direct wages 18,450
(a) Prime cost 54,550
Factory overhead 2,750
57,300
Less: Sale of factory scrap 250
(b) Works cost 57,050
Office overhead 1,850
(c) Cost of production 58,900
Add: Opening stock of finished goods: 9,750
Less: Closing stock of finished goods: 11,100
Cost of goods sold 57,550
Selling overhead 2,450
(d) Cost of sales 60,000
(e) Profit 15,000
Sales 75,000
SINGLE /OUTPUT/UNIT COSTING
• Single/output/unit costing is a method of
cost ascertainment which is used in those
industries which have the following
features:
(i) Production consists of a single product or
a few varieties of the same product with
variations in size, shape, quality etc. and
(ii) Production is uniform and on continuous
basis.
Ex: Cement, Steel, Sugar, paper, brick
works, quarries, breweries, dairies etc.
Cost units are a tonne of cement or steel or
sugar, 1000 bricks, a barrel of beer, a
gallon of milk etc.
Cost sheet is prepared to ascertain cost of
products.
Ex:1) Work out in cost sheet from the unit cost of production
per ton of special paper, manufactured by a paper mill in
june 2009 from the following data:
Direct materials:
Paper pulp 500 tons@50 per ton
Other materials 100 tons@30 per ton
Direct expenses:
Special equipment Rs. 3,000
Special dyes Rs. 1,000
Direct labour:
80 skilled men @Rs. 3 per day for 25 days
40 unskilled men @Rs.2 per day for 25 days
Works overhead:
Variable @ 100% and fixed @60% on direct wages.
Administration overhead @10% and selling and Distribution
overhead @15% on works cost.
400 tons of special paper was manufactured and Rs.800 was
realised by the sale of waste material during the course of
manufacture. The scrap value of the special equipment after
utilization in manufacture is nil.
particulars Total cost per ton
Direct material:
Paper pulp (500 tonsx Rs. 50) 25,000 62.5
Other material (100 tons XRs. 30) 3,000 7.5
28,000 70
Less: sale of waste realised 800 2
27,200 68
Direct labour:
80 skilled men (25 days @ Rs. 3) 6,000 15
40 unskilled men (25 days @Rs. 2) 2,000 5
Direct expenses:
Special equipment 3,000 7.5
Special dyes 1,000 2.5
Prime cost 39,200 98
Works overhead:
Variable (100% on direct wages) 8,000 20
Fixed (60% of direct wages) 4,800 12
Works cost 52,000 130
Administrative overhead (10% of works cost) 5,200 13
Cost of production 57,200 143
Selling and distribution overhead (15 % on works cost) 7,800 19.5
JOB COSTING
• It is a method of cost ascertainment used in
specific (job) order industries.
The features are:
(a) Production is against customer’s order and not
for stocks
(b) Each job has its own characteristics and
requires special attention.
(c) The flow of production from one department to
another is not uniform.
Ex: printing work, motor car repair, machine tools,
general engineering, interior decoration etc.
• Objectives of job costing:
(i) Cost of each job /order is ascertained
separately.
(ii) It enables management to detect which
are profitable , which are unprofitable.
(iii) It provides a basis for determining the
cost of similar jobs undertaken in future.
(iv) It helps management in controlling costs
by comparing actual costs with
estimated costs.
• Pre-requisites for job order costing:
(i)A sound system of production control
(ii)Comprehensive works documentation, typically
this includes: work order and /or operation
tickets, bills of materials and/or materials
requisitions, jig and tool requisitions etc.
(iii)An appropriate time booking system using
either time sheets or piece work tickets.
(iv)A well organised basis to the costing system
with clearly defined cost centres, good labour
analysis, appropriate overhead absorption rates
and a relevant issue pricing system.
Advantages:
• The profit or loss made on each job can be
measured if cost is set against the price
tendered for the job.
• It generates the cost data useful for the
analysis and control by the management.
• It highlights whether or not a job is likely to
be profitable or not.
• It readily fits into the double entry system,
and lends itself to performance evaluation
and review of costs.
• Job costing enables a comparison to be
made with performance on other jobs so
that inefficiencies are identified and
rectified.
• Some jobs are negotiated on a ‘cost plus’
basis, if there is difficulty in estimating the
price and customer agrees.
• The cost incurred to date on the job are
known before the job is completed, and
any mistakes or excessive costs show up
at an early stage.
Disadvantages of Job Order Costing :
Major disadvantages are :
(i) It is too expensive
(ii) Time consuming in maintenance of cost records
for each job undertaken.
• Job costing procedure:
(i) Job number: Each accepted job will be
given a number so that they are
identified .
(ii) Production order: The production control

department then makes out a production
order thereby authorizing to start work
on the job. Several copies of production
order passed onto all departments.
Specimen of production order is as follows:
Production order
Name of the customer……………. job no…………………
Date of commencement…………. Date…………………
Date of completion………………. Bill of material No……..
Special instructions…………….. Drawing attached Yes/No…

quantity Description Machines to be used Tools required

Signature
Head of production control dept.

(iii) Job cost sheet: It will record the cost of materials used , the
labour, overheads and machine time taken of each job. Each concerns
has to design a job cost sheet to suit it needs.
PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
Job-Order Costing
Manufacturing
Manufacturing
overhead
overhead(OH)
(OH)
Applied
Appliedto toeach
each
Direct
Direct Tra job
jobusing
usingaa
material ced
material dire predetermined
predetermined
to e ctly
ach rate
rate
job
The
The Job
Job
ec tly
dir
ac ed j ob
Tr a ch
Direct
Direct to e
labor
labor
Sequence of Events in a Job-
Order Costing System
Receive
Receive
orders
ordersfrom
from Begin
Begin
customers
customers production
production
Schedule
Schedule Order
Order
jobs
jobs materials
materials
Direct
DirectMaterials
Materials
Charge
Charge
Job
JobNo.
No.11 direct
direct
material
material and
and
Direct
DirectLabor
Labor direct
direct labor
labor
Job
JobNo.
No.22
costs
costs to
to
each
each job
job as
as
Manufacturing
Manufacturing Job
JobNo.
No.33 work
work isis
Overhead
Overhead
performed.
performed.
Direct
DirectMaterials
Materials
Job
JobNo.
No.11 Apply
Apply
overhead
overhead to to
Direct
DirectLabor
Labor each
each job
job
Job
JobNo.
No.22
using
using aa
predeter-
predeter-
Manufacturing
Manufacturing Job
JobNo.
No.33
Overhead
mined
mined rate.
rate.
Overhead
Job-Order Cost Accounting
The primary
document for tracking
the costs associated
with a given job is the
job cost sheet.
Let’s investigate
Date Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Direct Labor
Total Cost
Unit Product Cost
Date Completed
Item Wooden cargo crate A materials requisition
Direct Materials Direct Laborform Manufacturing
is used to Overhead
Req. No. Amount Ticket Hours Amount Hours
authorize the Rateuse of Amount
materials on a job.
Direct Labor
Let’s see one
Total Cost
Unit Product Cost
Materials Requisition Form
Will E. Delite
Materials Requisition Form
Cost
Costof
ofmaterial
materialis
is
charged
charged to
to job
jobA-143.
A-143.
Type,
Type,quantity,
quantity, and
and
total
totalcost
cost of
of material
material
charged
chargedtotojob
jobA-143.
A-143.
Will E. Delite
Workers use
time tickets to
record the time
spent on each
job.
Let’s see one

Employee Time Ticket – FYI
automated
Apply manufacturing overhead to jobs using a

predetermined overhead rate of $4 per direct
labor hour (DLH).
Let’s do it
Q-1: The information given below has been taken from the
costing records of an engineering works in respect of job no.
303.
Materials: Rs. 4,010
Wages:
Department –A : 60 hours @Rs. 3 per hour
Department –B : 40 hours @Rs. 2 per hour
Department –C : 20 hours @Rs. 5 per hour
Overhead expenses for these departments were estimated as
follows:
Variable overheads:
Department-A: Rs. 5,000 for 5,000 labour hours
Department-B: Rs. 3,000 for 1,500 labour hours
Department-C: Rs. 2,000 for 500 labour hours
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.
Sol:
Working notes:
(i) Calculation of variable overhead rate per
labour hour:
Dept-A= Rs.5,000/5,000 = Re. 1
Dept-B= Rs. 3,000/1,500=Rs.2
Dept-C= Rs.2,000/500 = Rs. 4
(ii) Calculation of fixed overhead rate per
hour= 20,000/10,000=Rs. 2
COST SHEET OF JOB NO. 303
Materials: 4,010
Wages- Dept.A(60 hoursX Re.3) 180
Dept.B(40 hours X Re.2) 80
Dept.C(20 hours X Re.5) 100 360
Variable overheads: D-A(60X1) 60
Dept. B (40 hours X Rs. 2) 80
Dept. C (20 hours X Rs. 4) 80 220
Fixed overheads: (120hours X 2) 240
Total cost 4,830
Profit(25% on selling price or 1,610
331/3 % on cost)
Sales 6,440
CONTRACT COSTING
• Contract cost is the aggregated costs relative
to a single contract designated a cost unit.
(CIMA)
• Contract costing is that form of specific order
costing which applies where work is undertaken
to customers’ special requirements and each
order is of long-term duration. (CIMA)
Ex: applied mainly in civil construction and
engineering projects, ship building, road and
railway line contracts, construction of bridges
etc.
• Features of contracts:
• Contracts are undertaken to special
requirements of the customers.
• Duration of contracts are relatively for a
long period.
• Contract work is done on the sites unlike
manufacturing under a roof.
• Contract work mainly consists of
construction activities.
Distinction
Basis
Job costing Contract costing
place 1. Job work is carried in the 1. Contract work is carried at site.
premises.
Cost unit 2. An order, a unit, lot or batch of 2. Each contract is a cost unit.
product may be taken as cost unit.
Allocation 3. Cost is first allocated to cost 3. Most of the expenses are directly
of costs centres and then charged to charged to respective contract
individual jobs. accounts. Only general overheads
and head office expenses are
apportioned to individual contracts.
pricing 4. The prices of the jobs are fixed 4. The pricing is generally through
basing on the nature of costs and bidding and external forces have
policy of the firm. major influence in fixing the offer
price.
duration 5. The duration of the job work is 5. Generally the contract works will
smaller. take more time to complete.
value 6. The value of the job work would 6. The contract works are bigger in
be lesser. nature and the value of the contract
would also be higher.
• Accounting procedure in contract costing:
• A separate contract account is maintained for each contract.
• All costs relating to contracts are charged to the respective contract
accounts.
• Materials:
• Labour:
• Plant:
• Sub-contract charges:
• Payment based on Architect/surveyor/civil engineer Certificate- not
entered in contract a/c
• Work-in-progress----work certified and uncertified
Work certified- approved by architect for payment. It is valued at
contract price (i.e selling price), and includes an element of profit.
Work uncertified- not approved by architect, valued at cost and not
includes profit.
• Retention money and cash ratio: It is usual practice not to pay the
full amount of work certified. The contractee may pay a fixed
percentage say 80% - this is cash ratio. The balance money not
paid is known as retention money- 20%.
• Extra work: (additions/alterations in the work). The cost of such
extra work is debited to the contract account and extra price realised
is credited to the contract account.
• Profit on completed contracts- All profit transferred to profit and loss
account.
• Profit on incomplete contracts:
– If loss is arrived on incomplete contracts, the entire loss is
debited to profit and loss account.
– Profit should be considered only in respect of work certified. The
uncertified work should be valued at cost
– If the amount of work certified is less than 25% of the contract price, no
profit should be taken to profit and loss account. The entire balance is
reserve.
– If the amount of work certified is more than 25% but less than 50% of
the contract price, 1/3 of the profit is transferred to profit and loss
account. The balance amount is treated as reserve.
Transfer to P&L account = Notional profit X 1/3 X (Cash received/work
certified)
* Notional profit is the difference between the value of work-in-progress
certified and the cost of work-in-progress certified.
---If the amount of work certified is 50% or more of the contract
price, then 2/3 of the profit is transferred to profit and loss
account.. Balance amount is in reserve.
Transfer to P&L account = Notional profit X 2/3 X (Cash
received/work certified)
----If the work is nearing completion – say the completion stage is
between 91 and 99 per cent.– the estimated profit should be
calculated on the whole contract.
Transfer to P&L a/c = Estimated profit x (work certified/contract
price) x (Cash received / work certified)
* Estimated profit is the excess of the contract price over the
estimated total cost of the contract.
Contract account
To Materials purchased By Materials returned to stores
To Materials sent to site By Materials in hand
To Labour (all wages & out standing)
To Plant issued By Plant in hand
or Depreciation / hire charges ------
To payments made to sub-contract By Work-in-progress:
Work certified XXX
Work uncertified XXX
Ex: The following was the expenditure on a
contract for Rs. 6,00,000 commenced in january,
2008:
Materials Rs. 1,20,000; Wages Rs. 1,64,400;
Plant Rs. 20,000; Business charges Rs. 8,600.
Cash received on account to 31st December,
2008 amounted to Rs. 2,40,000 being 80% of
work certified; the value of materials in hand on
31-12-2008 was Rs. 10,000.
Prepare contract account for 2008 showing the
profit to be credited to years profit and loss
account. Plant is to be depreciated at 10%.
Contract account
To Materials 1,20,000 By Plant in hand 20,000
To wages 1,64,400 Less 10% dep. 2,000 18,000
To Plant 20,000 By materials in hand 10,000
To Business charges 8,600 By Work-in-progress:
15,000 Work certified
To Notional profit c/d ------------- (2,40,000X100/80) 3,00,000
3,28,000 3,28,000
8,000 By Notional profit b/d 15,000
To Profit & Loss a/c
(15,000 x 2/3 x 80/100) 7,000
To Reserve -------------- --------------
15,000 15,000
--------------
--------------
Ex: From the information given below relating to an unfinished contract
ascertain: (a) Profit on work certified. (b) Cost of work-in-progress at
the end of the year.
Materials sent to site 86,000 Work certified 1,90,000

Labour engaged on site 65,000 Uncertified work 7,700
Plant issued 80,000 Materials in hand 2,000
Direct expenses 8,000 Wages accrued 300
Establishment charges 4,000 Cash received 1,61,500
Materials returned to Depreciation of plant 7,000
stores 600
Contract account
To Materials sent to site 86,000 By materials returned to
65,300 stores 600
To Labour (with O/S) 80,000 By Materials in hand 2,000
8,000 By Plant in hand
To Plant issued 4,000 ( 80000-7000) 73,000
By Work-in-progress:
To Direct expenses Work certified
30,000 1,90,000
To Establishment Work uncertified
charges 7,700
To Notional profit c/d ------------- --------------
2,73,300 2,73,300
20,000 --------------
By Notional profit b/d 30,000
To Profit & Loss a/c 10,000
(30,000 x 2/3 ) -------------- ----------------
To Reserve 30,000 30,000
----------------
--------------
Cost of work-in-progress at the end of the year:
------------------------------------------------------------
Work certified 1,90,000
Work uncertified 7,700
1,97,700
Less: Reserve 10,000
o/s wages 300 10,300
Cost of work in progress 1,87,400
------------------------------------------------------------
Ex: The following contract data of a large building complex are available.
(Rs. In thousands)
Contract price 35,000 Plant hire charges 1,750
Work certified 20,000 Wages related costs 500
Progress payments received 15,000 Site office costs 678
Materials issued to site 7,500 H.O expenses apportioned 375
Planning & estimation cost 1,000 Site expenses incurred 902
Direct wages paid 4,000 Work not certified 149
Materials returned from site 250
The contractors own a plant which originally cost Rs. 20 lakhs has been
Continuously In use in this contract throughout the year. The residual value
of the plant after 5 years Of life is expected to be Rs. 5 lakhs. Straight line
method of depreciation in use.
As on 31st march, 2001 the direct wages due and payable amounted
to Rs. 2,70,000 and the materials at site were estimated at Rs. 2,00,000.
Required:
(i) Prepare the contract account for the year ended 31st march, 2001.
(ii) Show the calculation of profit to be taken to the P & L a/c of the year
(iii) Show the balance sheet.
Contract account (Rs. In thousands)
To Materials 7,500 By Materials returned 250
To Direct wages 4,000 By Materials at site 200
Add: Outstanding 270 4,270 By Work-in-progress:
To Wages related costs 500 Work certified 20,000
To Site expenses 902 Work uncertified 149 20,149
To Plant hire charges 1,750
To Planning& estimation cost 1,000
To Site office cost 678
To H.O expenses apportioned 375
To Depreciation on plant
(20 lakhs – 5 lakhs)/5 300
To Notional profit c/d 3,324 ----------
20,599 20,599
To P & L a/c By Notional profit b/d 3,324
3,324x2/3x(15000/20000) 1,662
To Reserve 1,662 ----------
3,324
3,324
BALANCE SHEET (Rs. ‘000)
Liabilities Assets
Out standing wages 270 Plant at site (2000-300) 1,700
Profit and loss a/c 1,662 Materials at site 200
Work –in-progress:
Work certified 20,000
Work uncertified 149
20,149
Less:
Profit in reserve 1,662
18,847
Less:
cash received 15,000 3,487
Ex: Surya construction ltd. with a paid up share capital of Rs. 50 lakhs
undertook a contract to construct MIG apartments. The work
commenced on the contract on 1st April 2000. The contract price was
Rs. 60 lakhs. Cash received on account of the contract up to 31t
march, 2001 was Rs.18 lakhs (being 90% of the work certified).
Work completed but not certified was estimated at Rs. 1,00,000. As
on 31st March 2001 material at site was estimated at Rs. 30,000,
machinery at site costing Rs. 2,00,000 was returned to stores and
wages outstanding were Rs. 5,000. Plant and machinery at site is to
be depreciated at 5%.
The following were the ledger balances (Dr.) as per trial balance as on
31st March, 2001:
Land and Buildings Rs. 23,00,000
Plant and Machinery(60% at site) 25,00,000
Furniture 60,000
Materials 14,00,000
Fuel and power 1,25,000
Site expenses 5,000
Office expenses 12,000
Rates and taxes 15,000
Cash at bank 1,33,000
Wages 2,50,000
Prepare the contract account and balance sheet.
CONTRACT ACCOUNT
To materials 14,00,000 By materials at site 30,000

To Wages(250000+5000) 2,55,000 By Machines returned
To P&M at site (60%) 15,00,000 (2,00,000 – 5%of 200000) 1,90,000
To Fuel and power 1,25,000 By P&M at site
To Site expenses 5,000 (13,00,000-5%of 1300000) 12,35,000
To Office expenses 12,000 By Work in progress A/c:
To Rates and taxes 15,000 Work certified
To Notional profit c/d 2,43,000 (18 lakhs X 100/90)=20 lak
Work uncertified = 1 lakh 21,00,000
------------- -------------
- -
35,55,000 35,55,000
To P&L a/c ------------- By Notional profit b/d -------------
(243000 x 1/3 x 90/100) - -
To Reserve 2,43,000
72,900
1,70,100
BALANCE SHEET
Liabilities Rs. Assets Rs.
Share capital 50,00,000 L&B 23,00,000
Profit and loss a./c 72,900 P&M at site 12,35,000
Wages outstanding 5,000 P&M at store 11,90,000
Furniture 60,000
Cash at bank 1,33,000
Work-in-progress:
work certified 20 lakh
Work uncertified 1 lakh
21
lakh
Less
cash received 18 lakh
3,00,000 1,29,900
Less reserve 1,70,100 30,000
-------------- Material at site ------------------
- 50,77,900
PROCESS COSTING
It is used when identical units are produced
through an on going series of uniform
production steps. In order to know the cost
at each stage of production, a separate
account is opened for each process.
CIMA defines process costing as “ the costing
method applicable where goods or services
result from a sequence of continuous or
repetitive operations or processes, costs are
averaged over the units produced during the
period”
Ex: Chemicals and drugs, Oil refining, food
processing, paints and varnish, plastics, soaps,
textiles, paper etc.
• Features of process costing:
(i) The production is continuous and the final product is
the result of a sequence of processes.
(ii) Costs are accumulated by processes.
(iii) The products are standardised and homogeneous.
(iv) The cost per unit produced is the average cost which
is calculated by dividing the total process cost by the
number of units produced.
(v) The finished product of each process becomes the
raw material for the next process in sequence and that
of the last process is transferred to the finished goods
stock.
(vi) The sequence of operations or processes is specific
and predetermined.
(vii) Some loss of materials in process (due to chemical
action, evaporation etc), is unavoidable.
(viii) The output from the process may be a single product,
but there may also be a by-products and /or joint
products.
Job costing Process costing
1.Costs are separately ascertained for 1. Costs are compiled process-wise
each job and each job is a cost unit. and cost per unit is the average cost.
2. Production is of non-standard item 2. Production is of standardized
with specifications and instructions products and cost units are identical.
from the customers.
3. Production is against orders from 3. Production is for stocks
customers.
4. Costs are calculated when a job is 4. Costs are computed at the end of
completed specific period
5. Cost of a job is not transferred to5. The cost of one process is
another job but to finished stock a/c transferred to the next process in
the sequence.
6. There may or may not be WIP in the 6. On account of continuous nature or
beginning and end of the production, WIP in the beginning
accounting period. and end of the accounting period
is a regular feature.
7. Cost control is comparatively 7. Cost control is easy.
difficult
Ex: A chemical product passes through three processes. In the
month of March, 2005, 1000 units were produced.
Prepare process account and find out per unit of each process.
Process-1(Rs) Process-II (Rs) Process-III(Rs)
Raw Materials 50,000 30,000 20,000
Wages 30,000 25,000 25,000
Overhead expenses were Rs. 12,000 and it should be apportioned
on the basis of wages.
Process-1
Particulars Units Rs. Particulars Units Rs
To Raw material 1000 50,000
To Wages 30,000
ToOverheads 4,500 By Transfer to 1000 84,500
(12,000x30/80) process-2
1000 84,500 1000 84,500
Per unit cost of Process -1 = 84,500/1000 = 84.5

Process-2
Particulars Units Rs. Particulars Unit Rs

s
To Raw material 30,000
To Wages 25,000
To Overheads 3,750 By Transfer 1000 1,43,250
(12,000x25/80) to process-3
To Transferred 84,500
1000
from process-1
1000 1,43,250 1000 1,43,250
Per unit cost of Process-2 = 1,43,250 / 1000 = 143.25

Process-3
To Raw material 20,000
To Wages 25,000
To Overheads 3,750 By 1,92,000
(12,000x25/80) Transfer to
To Transferred 1000 1,43,250 Warehouse
from process-2
1000 1,92,000 1000 1,92,000
Per unit cost of Process-3 = 1,92,000 / 1000 = 192

Normal loss: It is the loss which is unavoidable on
account of inherent nature of production
processes. Such loss can be estimated in
advance on the basis of past experience or
data. The normal process loss is recorded only
on items of quantity and the cost per unit of
usable production is increased accordingly.
Scrap possesses some value as a waste product

or as raw material for an earlier process, the
value thereof is credited to process account.
This reduces the cost of normal output.
Ex: BCC ltd produced three chemicals during the month of july, 2008
by three consecutive processes. In each process 2% of the total
weight put in is lost and 10% is scrap which from processes (1) and
(2) realises Rs. 100 a ton and from process (3) Rs. 20 a ton.
The products of three processes are dealt with as follows:
P-1 P-2 P-3
Passed on to the next process 75% 50% ----
Sent to warehouse for sale 25% 50% 100%
Expenses incurred :
Process-1 Process-2 Process-3
Rs Tons Rs Tons Rs Tons
Raw materials 1,20,000 1,000 28,000 140 1,07,840 1,348
Mfg. expense 20,500 --- 18,520 --- 15,000 ---
Gen. expenses 10,300 --- 7,240 --- 3,100 ---
Prepare process cost accounts showing the cost per ton of each
product.
Process-1
Tons Rs Tons Rs
To Raw materials 1000 1,20,000 By loss of weight 20 ---
To Mfg. wages -- 20,500 (2% of 1000 tons)
To Gen. expenses 10,300 By sale of scrap
(10% of 1,000 tons) 100 10,000
By transfer to
warehouse 220 35,200
By transfer to
process-2 (cost per
ton Rs. 160)
660 1,05,600
1,000 1,50,800 1,000 1,50,800

Process-2
Tons Rs Tons Rs
To transfer from P-1 660 1,05,600 By loss of weight 16 ---
To Raw materials 140 28,000 (2% of 800 tons)
To Mfg. wages -- 18,520 By sale of scrap
To Gen. expenses 7,240 (10% of 800 tons) 80 8,000
By transfer to
warehouse 352 75,680
By transfer to
process-3 (cost per
ton Rs. 215)
352 75,680
800 1,59,360 800 1,59,360

Process-3
Tons Rs Tons Rs
To Transfer from P-2 352 75,680 By loss of weight 34 ---
To Raw materials 1,348 1,07,840 (2% of 1700 tons)
To Mfg. wages -- 15,000 By sale of scrap
To Gen. expenses 3,100 (10% of 1,700 tons) 170 3,400
By transfer to
warehouse 1,496 1,98,220
(cost per ton
Rs. 132.50)
1,700 2,01,620 1,700 2,01,620

• Abnormal Loss: Any loss caused by unexpected
or abnormal conditions such as plant break
down,sub-standard materials, carelessness,
accident etc or loss in excess of the margin
anticipated for normal process loss should be
regarded as abnormal process loss.
• Value of abnormal loss=(Normal cost of normal
output/Normal output)xUnits of abnormal loss
• Abnormal loss representing the cost of
materials, labour, and overhead incurred on the
wastage should be transferred to an abnormal
loss account. If this abnormal loss account and
the balance is ultimately written off to costing
profit and loss account.
Ex: In process-A 100 units of raw materials
were introduced at a cost of Rs. 1000. The
other expenditure incurred by the process
was Rs.602.Of the units introduced 10%
are normally lost in the course of
manufacture and they possess a scrap
value of Rs.3 each. The output of process-
A was only 75 units. Prepare process-A
account and abnormal loss account
Process-A a/c
To raw materials 100 1000 By Normal loss 10 30

(10% of 1000)
To other expenses 602 By Abnormal loss 15 262*
(100-10-75)
By Process-B (output) 75 1310
100 100 1602
Abnormal loss = (Normal cost of normal output/Normal output)

x Units of abnormal loss
= (1572/90)x15 = 262*
Abnormal loss a/c
To Process A a/c 15 262 By Cash 15 45

(Scrap value of loss
of 15 units @ Rs. 3)
By Costing Profit and 217
loss a/c
15 262 15 262
• Abnormal gain: When actual loss in a process is
smaller than was expected, an abnormal gain
results. The value of the gain will be calculated
in similar manner to an abnormal loss, then
posted to an abnormal gain account.
• Abnormal gain being the result of actual loss
being less than the normal, the scrap realisation
shown against normal loss gets reduced by the
scrap value of abnormal gain. Consequently,
there is an apparent loss by way of reduction in
the scrap realisation attributable to abnormal
gain by debiting this account. The balance of this
account becomes abnormal gain and is
transferred to costing profit and loss account.
Ex: In process-B, 75 units of a commodity
were transferred from process-A at a cost
of Rs.1,310. The additional expenses
incurred by the process were Rs. 190.
20% of the units entered are normally lost
and sold @ Rs.4 per unit. The output of
the process was 70 units. Prepare
process-B account and abnormal gain
account.
Process-B a/c
To Transferred from 75 1310 By Normal loss 15 60

Process-A account(75x20% =15
units @ Rs. 4)
To Additional expenses 190 By Process -C account 70 1680
(output)
To Abnormal gain 10 240*
85 1740 85 1740
Normal output = Units entered minus Normal loss

= (75 - 15) = 60 units
-Actual output = 70 units
Abnormal gain = 10 units
Value of Abnormal gain =(Normal cost of Normal output /Normal output)
x abnormal gain units
=(1440/60) x 10 = 240 *
Abnormal gain a/c
To Normal loss (Loss of 10 40 By Process-B account 10 240

income)
To Costing profit and 200
loss a/c
10 240 10 240
Ex: A product passes through three distinct processes I, II, and III completion. The following
cost information is available for this operation.
_______________________________________________________________
Particulars Process-I Process-II Process-III
Materials Rs. 2,600 Rs. 2,000 Rs. 1,025
Labour Rs. 2,250 Rs. 3,680 Rs. 1,400
_______________________________________________________________
Production overhead amounting Rs. 7,330 is to be absorbed as a percentage of direct
labour.
500 units @ Rs.4 per unit was introduced in Process-I. The actual output and normal
loss of the respective processes are:
______________________________________________________________
Process Output(Units) Normal loss on input Value per unit
(Rs.)
_______________________________________________________________
I 450 10% 2
II 340 20% 4
III 270 25% 5
_______________________________________________________________
There is no stock or work -in-progress in any process.
(i) Show the three process accounts. (ii) Abnormal loss and abnormal gain accounts.
Process- 1 account
To Opening stock 500 2,000 By Normal loss 50 100
(500x10%) @2
To Material 2,600
To Labour 2,250
To Production 2,250 By Transfer 450 9,000

Overheads to process-2
500 9,100 500 9,100
Process- 2 account
To Material 2,000 By Normal loss 90 360

(450x20%)@
4
To Labour 3,680 By Abnormal 20 1,000*
loss
To Production 3,680 By Transfer to 340 17,000

Overheads process-3
To Transferred
450
from process-1 9,000
450 18,360 450 18,360

Abnormal loss = (Normal cost of normal output/Normal output) x abnormal loss
= (18000/360)x20 = 1000*
Process- 3 account
To Raw material 1,025 By Normal loss 85 425

(340x25%)@5
To Labour 1,400
To Production 1,400 By Transfer to 270 21,600

Overheads Warehouse
To Transferred 340 17,000
from process-2
To Abnormal 15 1,200*
gain
355 22,025 355 22,025

Value of Abnormal gain =(Normal cost of Normal output /Normal output)

x abnormal gain units
=(20400/255) x 15 = 1200 *
Abnormal loss account
Particulars units Rs Particularls units Rs

To process-2 20 1000 By sale proceeds 20 80
@4
By costing P&L a/c 920
20 1000 20 1000
Abnormal gain account
To Normal loss@5 15 75 By Process-3 15 1,200

To Costing P&La/c 1,125
15 1,200 15 1200
JOINT PRODUCT: (Also called Co-products) Joint products are
products that are produced simultaneously by a common
process or series of processes. When two or more products of
equal importance are simultaneously produced from the same raw
material, such products are regarded as Joint products.
Joint products imply the following:
(i.) They are produced from the same basic raw material.
(ii) They are comparitively of equal importance .
(iii) They are produced simultaneously by a common process.
(iv) They may require further processing after their point of separation.
Ex: In oil-refining products, several products emerge. They include
gasoline, kerosene, fuel oil and paraffin.
BY PRODUCT: By products are products of comparitively small value

that are produced incidental to the main product. They are jointly
produced with other major products and remain inseparable up to
the point of split-off.
Ex: In sugar industry, sugar is the main product, molasses for
manufacture of spirit is by-product.
Whether a product should be treated as by-product or joint product
depends upon its relative value in comparison to other co-products.
End of Chapter 2
Module – III
Management Accounting :
• Definition, Scope and functions of
Management Accounting and difference
between Management Accounting and
Financial Accounting.
• Break-even and Cost-volume-profit analysis.
• Marginal costing and practical application (In
situations like key factor analysis, optimizing
product mix, make or buy decision,
discontinuance and diversification of
products, accept or reject special offer, close
down of operations).
Management Accounting
• Meaning:
The term “Management Accounting” is
applied to the provision of information for
management activities such as planning,
controlling and decision making, etc.
In the words of R. Anthony, “Management
Accounting is concerned with accounting
information that is useful to management”
• Definitions:
• According to National Association of
Accountants (USA), Management
Accounting is “the process of identification,
measurement, accumulation, analysis,
preparation and communication of
financial information used by management
to plan, evaluate, and control within the
organisation and to assure appropriate
use and accountability for its resources”
Cont…..
• According to CIMA, London
“Management accounting is an integral part of
management concerned with identifying,
presenting and interpreting information used
for----
(i) Formulating strategy;
(ii) Planning and controlling activities;
(iii) Decision making;
(iv) Optimising the use of resources;
(v) Disclosure to shareholders and others external
to the entity;
(vi) Disclosure to employees; and
(vii) Safeguarding assets.
• Scope of Management Accounting:
(i) Financial Accounting provides basic historical data which
helps management to forecast and plan for the future.
(ii) Cost Accounting: Many of the techniques of cost control like
standard costing and budgetary control; and techniques of profit
planning and decision making like marginal costing, CVP
analysis and differential cost analysis are used by the
management accounting.
(iii) Budgeting and forecasting: Forecasting helps in the
preparation of budgets, and budgeting helps management
accountant in exercising budgetary control.
(iv) Tax planning: Management accountant depends upon tax
accounting to minimize its tax liabilities and to save funds.
(v) Reporting to management: for effective and timely
decisions, both routine and special reports are prepared to the
needs of Mgt.
cont…..
(vi) Cost control procedures like inventory control, labour
control, overhead control, budgetary control are required to
management accounting.
(vii) Statistical tools like graphs, tables, charts, etc are used in
preparing reports for use by the management.
(viii) Internal control and internal audit are used by the
management accountant for finding loopholes in the financial
system of the concern.
(ix) Financial analysis and interpretation is required to
understand and use to the management.
(x) Office services: Management accountant is expected to
maintain procedures like filing, copying, communicating, electronic
data processing and other allied services.
• Functions (or Objectives) of
Management Accounting:
(i) Planning: Management accounting helps management to
forecast and prepare short term and long term plans with the
help of standard costing, budgeting marginal costing, probability
and correlation and regression etc.
(ii) Coordinating : Management accounting techniques also help
in coordinating various business activities (Ex: for preparing
budgets coordination among sales, production etc. Departments).
(iii) Controlling: Management accounting helps in controlling
performance by controlling techniques such as standard costing,
budgetary control, control ratios, internal audit etc.
(iv) Communication: Management accounting system prepares
in the form of reports to communicate various levels of
management.
Cont…..
(v) Financial analysis and interpretation: Ratio analysis,
cash flow and funds flow statements , trend analysis etc. are
some of the techniques used for financial analysis and
interpretation.
(vi) Qualitative information: Apart from quantitative data,
qualitative data like quality of goods, customers, employees, legal
judgments, opinion polls, etc are used by the management
accountant.
(vii) Tax policies : Management accounting system is responsible
for tax policies and procedures and supervises and coordinates
the reports prepared by various authorities.
(viii) Decision making: Management Accounting uses
Techniques like marginal costing, differential costing, discounted
cash flow etc., helps in decisions such as pricing of products,
make or buy, discontinuance of a product line, capital
expenditure, etc.
• Tools and techniques used in Management
Accounting:
(i) Budgeting
(ii) Standard costing and variance analysis
(iii) Marginal costing and CVP analysis
(iv) Ratio analysis
(v) Comparative financial statements
(vi) Differential cost analysis
(vii) Funds flow and cash flow statements
(viii) Responsibility accounting
(ix) Accounting for price level changing
(x) Statistical and graphical techniques
(xi) Discounted cash flow
(xii) Risk analysis
(xiii) Learning curve
(xiv) Value analysis
(xv) Work study
• Difference between Management
Accounting and Financial Accounting:
Nature Fin. Accg. Mgt. Accg.

1. Governed by Company law etc. Needs of managers.
2. Basic Transaction recording, Decision support,

publication of external provision of mgt.
functions financial statements information
3. users External Internal
4. Availability Publicly available confidential
5. Time focus Past and present Present and future
6. Period Usually one year As appropriate

Nature Fin. Accg. Mgt. Accg.
7. Main emphasis Explanation Planning and control
8. Speed of Slow but detailed Past but

preparation and accurate approximate
9. Form of Whole of legal Segmented to
presentation entity control units
10. Style and Standardised Tailored to
requirement and
details summarized
11. criteria Objective, verifiable Relevant, useful and
and consistent understandable
12. Unit of Money Money or
account physical units
13. Nature of Some what For use by non-
data technical accountants
BREAK EVEN AND
COST-VOLUME-PROFIT ANALYSIS
• Break Even Analysis is a specific way of
presenting and studying the inter-relationship
between costs, volume and profits. It provides
information to management in a most lucid and
precise manner. It is an effective and efficient
financial reporting system.
• Break Even Analysis establishes a relationship
between revenues and costs with respect to
volume. It indicates the level of sales at which
costs and revenues are in equilibrium. The
equilibrium point is commonly known as the
Break-even Point.
• The Break-even point is that point of sales
volume at which total revenue is equal to
total costs. It is a no-profit, no-loss point.
• Two approaches can be used to compute
the Break-even point.
(i) The Graphical or Chart approach and
(ii) The Formula approach .
• BREAK EVEN CHART or GRAPHICAL
APPROACH:
• A Break-even chart portrays a pictorial view of
the relationships between costs, Volume and
profit. The break even point indicated in the
chart will be one at which total cost line and total
sales line intersect.
• Let us take one example and plot the details in
the graph.
Ex: TOTAL SALES
(1,00,000 units @ Rs.20 per unit) =20,00,000
LESS TOTAL VARIABLE COSTS
(1,00,000 units @ 12 per unit) =12,00,000
CONTRIBUTION = 8,00,000
LESS FIXED COSTS = 4,00,000
NET PROFIT = 4,00,000
STEPS:
1. Sales line: Sales volume is plotted on the horizontal
axis. Sales volume may be expressed in terms of
Rupees, Units and as a percentage of capacity. Equal
distances are cut along the horizontal line to show sales
volume at different activity levels.
2. Cost and Revenue lines: Vertical axis is used to
represent revenue and fixed and variable costs. The
vertical line is also spaced in equal parts. A similar
vertical line may be drawn on the right hand side of the
chart to complete the square.
3. Fixed cost line: The fixed cost line is parallel to X-axis ,
can be drawn through the fixed cost point. (i.e 4,00,000)
4. Sales and costs line: To draw sales line, the Zero sales
point should be connected with the sales budget
point(20,00,000) on the right hand vertical line.
Similarly, Total costs line can be drawn by connecting
fixed costs point (4,00,000) with the total costs budget
point (16,00,000) on the right hand vertical line.
5. Break-even point: The point of intersection between
sales and total costs line is the Break even point. It
occurs a sales volume of Rs. 10,00,000, which is 50%
of budgeted capacity and is realised when 50,000 unit
are sold.
6. Angle of incidence: The angle formed by the intersection
of sales and total costs line is known as the angle of
incidence. Larger this angle , lower the Break-even
point, vice versa.
7. Profit-Loss: The area to the left of the Break-even point
is loss area represents the uncovered fixed costs,
while to the right of it is the profit area.
8. Margin of safety: The excess of actual or budgeted sales
over the break-even sales is known as Margin of
safety. Here margin of safety is 20,00,000-10,00,000 =
10,00,000.
9. The variable cost: is represented by the gap between the
total cost and the fixed cost. Here variable cost is
16,00,000-4,00,000 = 12,00,000.
Cost-Volume-Profit Graph
Break-even Total sales
point
rea
f it a
o
Sales in Dollars
Pr
Total expenses
Fixed expenses
r ea
s sa
Lo Margin of safety
Units Sold
• ASSUMPTIONS:
• Cost segregation: The total cost can be separated into
fixed and variable components.
• Constant fixed costs : The total fixed costs that
remains unchanged with changes in sales volume.
Constant unit variable cost: The variable cost per
unit is constant and total variable costs changes in
direct proportion to the sales volume.
• Constant Selling Price: The selling price per unit remains
constant; that is, it does not change with volume or
because of other factors.
• Constant sales mix: The firm manufactures only one
product or if there are multiple products, the sales mix
does not change.
• Synchronised production and sales: Production and
sales are synchronised; that is, inventories remain the
same.
• ADVANTAGES:
• Understanding accounting data: The Break-even point is a simple
concept to comprehend and interpret the accounting data. When
the accounting data is presented though Break Even Charts, it
becomes very easy to grasp and interpret them.
• Diagnostic tool: The Break-even analysis is a useful diagnostic tool.
It indicates to the management the causes of increasing Break-even
point and falling profits. The analysis of these causes will reveal to
the management as to what actions should be taken.
• Profit improvement: It provides basic information (such as Break-
even point, P/V ratio, Break-even charts, P/V graphs, and analysing
the report of the effect of changing factors of profits), and is
important to evaluate the reasonableness and usefulness of profit
plans and other budgets and forecasts prepared by the
management.
• Risk evaluation: The desirability of an action should be considered
on the basis of its profit as well as risk. If profit alone is considered,
a firm may commit to a risky action. The Break-even analysis, to
some extent, is a useful method for considering the risk implications
of alternative actions. It considers probability of reaching the break-
even point.
• LIMITATIONS:
• Cost segregation : It is difficult to separate costs into fixed and
variable components. Some of the costs can be easily identified as
fixed, such as rent of building, or variable, such as direct material
cost. But a large number of costs belong to the mixed category.
Such costs, known as semi-variable or semi-fixed, costs, consist of
fixed as well as variable elements and are difficult to separate.
• Constancy of Fixed costs: It is not correct to assume that total fixed
cost would remain unchanged over the entire range of volume.
Fixed costs are constant over a relevant range of activity and would
increase in a step-wise fashion.
• Constant selling price: Selling price hardly remains constant.
Selling price may remain constant under perfect competition. But in
real market situations of monopolistic competition or oligopoly
selling price will have to be reduced to increase the sales volume.
Sales revenue will not change in direct proportion to output.
• Change in unit variable costs: The variable cost per unit also does
not remain constant, and therefore, total variable costs do not
change proportionately to output.
• If you plot all these curves in one graph two break even points will
come.
• Applicability to multi-product firm: It is
difficult to use the break even analysis
for a multi product firm.
• Static Tool of Analysis: The assumptions
of the Break-even analysis make it a rigid
device of analysis and a static measure
of a dynamic process.
• Short-term focus: The Break-even
analysis is a short run concept and has a
limited use in long range planning .
• FORMULAE APPROACH: The formula’s for the
Break-even point (BEP) are as follows:
1)BEP(Units) = Fixed Costs / Contribution per unit
= Fixed costs / (Selling price per unit – Variable cost
per unit)
2)BEP(in Rs.) = Fixed cost / Profit Volume ratio
Profit Volume (P/V) ratio = Contribution / Sales or
=(Sales-Variable cost or Marginal cost) / Sales
= (Fixed cost + Profit) / Sales or
= Change in profits / Change in sales
= Change in contribution / Change in sales
• PV ratio can be called as Contribution ratio.
3)BEP(in % of Capacity) = Fixed costs / Total Contribution
4) Margin of safety: The excess of actual or budgeted sales over the
break-even sales is known as margin of safety. (Margin of
safety = Total sales – Break even sales)
• Margin of safety ratio = (Budgeted sales – Break-even sales) /
Budgeted sales
• The margin of safety indicates the extent to which sales may fall
before the firm suffers a loss. Larger the margin of safety, safer the
firm. Lower the margin of safety, low safety to the firm.
5) Target sales(Before tax) = (Fixed cost + Desired profit) /
Contribution ratio
• Target sales(After tax) = Fixed cost + [Desired profit after tax
/(1-tax rate)] / PV ratio
Ex: PV ratio = 40%, Desired profit(after tax)=54,000 , Tax = 40% ,
Fixed cost = 1,00,000,
calculate required sales?
Sol: Target sales = {1,00,000 + 54,000/[1-0.40]}/ 40%
= (1,00,000 + 90,000) / 40% = 4,75,000
6) (Contribution ratio) x (Margin of safety ratio) = Profit margin
or Contribution ratio = Profit margin / Margin of safety ratio
or Margin of safety ratio = Profit margin / Contribution ratio
• Profit-Volume Graphs (or P/V charts): Although a break-even chart
can be used to show the effect of changes in various factors on profit,
yet the drawing of the chart will become very complicated. The results
of the changing factors can best be presented in tabular forms and the
by the use of Profit-Volume(P/V) graphs or charts. P/V charts are used
as supplements to break-even charts, and these two charts can be
used to get the best advantages of the graphic presentation of profit
patterns.
• The profit-Volume graph relates profits to volume. The following steps
are involved to construct the P/V graph.
• The graph has two parts, separated by sales line.
• The upper part of the graph indicates profits. Fixed costs are marked
on the lower part. The amount of fixed costs un recovered is loss
incurred.
• Profit line is drawn by joining fixed cost point and sales line at the
break-even point.
• One can read the amount of profit or loss by drawing a vertical line on
the profit line from the assumed level of sales.
• Ex: Sales= 5,00,000 , Variable costs = 3,00,000 and Fixed costs =
1,00,000 , Draw P/V graph?
• Sol: The P/V graph is as follows:
Profit-Volume Graph
Some
Some managers
managers likelike the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses on
on profits
profits and
and volume.
volume.
rea
f it a
o
Pr
Profit
rea
s a
o s Break-even
L
point
1 2 3 4 5 6 7 8
Units sold (00s)
• Ex: Utkal Ltd has provided the following
information :
Year Sales(in Rs.) Cost (in Rs.)
2003 1,20,000 1,11,000
2004 1,40,000 1,27,000
Assuming that the cost structure and the
selling prices remain the same, find out :
(a) Break-even point,
(b) Profit-Volume ratio ,
(c) Fixed Cost, and
(d) Sales required to earn a profit of Rs. 20,000.
Sol: Year Sales Costs Profit
2003 1,20,000 1,11,000 9,000
2004 1,40,000 1,27,000 13,000
Break Even Point (BEP) in Rs. = Fixed Costs / P.V Ratio

• P.V.Ratio =Change in profits / Change in sales
• = (13000-9000)/((140000-120000) =20%
• P.V Ratio = (Fixed Costs + Profit) / Sales
• Therefore Fixed Costs = (P.V ratio x Sales) – Profit
• = (20% x 1,20,000) – 9,000 = 24000-9000 =15,000
• or = (20% x 1,40,000) –13,000 = 28,000-13000=15,000
• BEP in Rupees = Fixed Costs/P.V ratio = 15,000/20% = 75,000
• Required Sales = (Fixed Costs + Desired Profit)/ P.V.ratio
• = (15000 + 20000) / 20% = 35000/20%
=1,75,000
Ex: Konark Ltd. Has an annual capacity of 50,000
units . It currently sells 40,000 units at a price
of Rs. 105. It has the following cost structure:
• Variable manufacturing cost per unit Rs. 45.
• Fixed manufacturing costs Rs. 8,00,000
• Variable marketing and distribution costs per unit
Rs. 10.
• Fixed marketing and distribution costs Rs.
6,00,000
• Find out its break-even point and margin of
safety.
• Sol: Capacity is 50,000 but currently producing and selling 40,000
units only.
• Current Status:
• Total Sales :40,000units @ Rs. 105 42,00,000
• Less Variable cost:
• Manufacturing Cost(40,000@45) = 18,00,000
• Mkg & Distri. Costs(40,000@10) = 4,00,000 22,00,000
• Contribution: 20,00,000
• Less Fixed Costs:
• Manufacturing cost = 8,00,000
• Mkg. & Dist. Cost = 6,00,000 14,00,000
• Profit : 6,00,000
• P.V Ratio = Contribution/Sales = 20,00,000/42,00,000
• = 47.61904762%
• BEP = Fixed Costs / P.V Ratio = 14,00,000/47.61904762%
• = 29,40,000
• Margin of safety = Total Sales – BEP sales
• = 42,00,000-29,40,000 = 12,60,000.
Ex: Utkal ltd. Provides the following data for the year
ended 31st March, 2005:
• Selling price per unit : Rs. 10
• Production and sales : 400 units
• Variable cost per unit : Rs. 5
• Fixed cost : Rs. 1,000
• You are required to show the impact of the following
actions on the P/V ratio, Break-even point and
margin of safety:
• (a)The variability cost increases to Rs. 6 per unit.
(b)The fixed cost increases to Rs. 1,500
(c) The selling price increases to Rs. 20 per unit.
PARTICULARS PRESENT ACTION-(a) ACTION-(b) ACTION- ( c)
POSITION
Total Sales 400x10=4,000 400x10=4,000 400x10=4000 400x20=8000
LessVariable cost 400x05=2,000 400x06=2,400 400x05=2000 400x05=2000
Contribution: 2,000 1,600 2,000 6,000
Less Fixed costs 1,000 1,000 1,500 1,000
Profit 1,000 600 500 5,000
a)The Variability cost increases to Rs.6 per unit

(i)P.V ratio = Contribution / Sales = 1,600/4,000 = 40%
(ii)BEP = Fixed Cost / P.V ratio = 1,000/40% = 2,500
(iii)Margin of safety = Total Sale-BEP sales = 4,000-2,500=1,500
b) The fixed cost increases to Rs. 1,500
(i)P.V.Ratio= Contribution/Sales =2000/4000=50%
(ii)BEP = Fixed cost/P.V ratio= 1500/50%= 3,000
(iii)Margin of safety = Sales – BEP sales = 4000-3000=1,000
c) The Selling price increases to Rs.20 per unit
(i)P.V. ratio = Contribution/sales=6000/8000=75%
(ii)BEP = Fixed cost/P.V.ratio = 1000/75% = 1,333
(iii)Margin of safety = Sales – BEP sales = 8000-1333=6,667
Ex: Raj Ltd. Manufactures three products-
X,Y and Z. The unit selling prices of these
products are Rs.100,Rs. 160 and
Rs.75 respectively. The corresponding unit
variable costs are Rs.50,Rs.80 and
Rs.30. The proportions (Quantity -wise) in
which these products are manufactured
and sold are 20%, 30% and 50%
respectively. The total fixed costs are Rs.
14,80,000. Calculate overall Break
even quantity and the product-wise break-
up of such quantity.
Sol:
• Contribution per unit = Sales price per unit -
Variable cost per unit
• Contributions : X = 100-50 = 50, Y = 160 - 80
=80, Z = 75-30 = 45
• Quantity proportions are X=20%, Y=30% , Z =
50%
• Let us assume that the Total quantity at BEP =
x , then X=.20x, Y=.30x , Z=.50x
• Contributions are X = (.20x)(50) = 10x , Y
=(.30x)(80) =24x , Z = (.50x)(45)=22.5x
• By equation Fixed cost + Profit = Sales -Variable
cost
• 14,80,000 + 0 = 10x + 24x + 22.5x ;
x = 14,80,000/56.5 = 26,195
Ex:
ABC Ltd provided you the following data:
Sales (4,000 units @ Rs. 25 each) Rs. 1,00,000
Fixed costs Rs. 18,000
Variable costs:
Material consumed Rs. 40,000
Labour charges Rs. 20,000
Variable overheads Rs. 10,000 Rs. 70,000
Calculate: (i) Break-even point (units and rupees) ,

(ii) Sales needed to earn a profit of 20% on sales
(iii) Selling price to be fixed to bring down its BEP to
600 units under present conditions .
Sol:
(i)Break-even point (Rs) = Fixed cost / P.V ratio
• P.V ratio = Contribution/Sales = Sales –Variable cost /Sales =
1,00,000-70,000/100,000=30%
• B.E.P (Rs) = 18,000 / .30 = 60,000
• Break-even point (Units) = Fixed cost / Contribution per unit
• Contribution per unit = Selling price per unit(100000/4000) –
Variable cost per unit (70000/4000)
• B.E.P (Units) = 18,000 / (25-17.50) = 18,000 / 7.50 = 2400
(ii) P/V ratio = Fixed cost + Profit / Sales .,
Required sales = Fixed cost + Profit / P.V.ratio
• = 18000 + 20000/.30 = 1,26,667.
(iii) BEP (Units) = Fixed cost / Contribution per unit
• = Fixed cost / Selling price per unit – Variable cost per unit
So, Selling price per unit =(Fixed cost /BEP units) + Variable cost
per unit
= (18000/600) + 17.50 = 47.50.
MARGINAL COSTING
Marginal cost is the additional cost of
producing one additional unit. It is the
same thing as variable cost.
It is the amount at any given volume
of output by which aggregate costs
are charged if the volume of output is
increased or decreased by one unit.
Marginal costing (or variable costing)
is a technique of charging only variable
costs to products. Fixed cost is treated
as period cost and written off against
the contribution for that period.
It is a principle whereby variable
costs are charged to cost units and
fixed costs are attributable to the
relevant period and are written off in
full against the contribution for that
period.
In marginal costing, the stock of work-in-
progress and finished goods are valued at
marginal cost of production.
Under this, the difference in the magnitude
of opening stock and closing stock does
not affect the unit cost of production, since
all the product costs are variable costs.
In this, Fixed costs are considered as period
costs and charged to the concerned period
irrespective of the quantam or level of
production or sale.
• Features of marginal costing:
• All costs are categorised into fixed and variable
costs.
• Fixed costs are considered period costs and are
not included in product cost, only variable costs
are considered as product costs.
• Stock of work-in-progress and finished goods
are valued at marginal cost of production.
• In marginal process costing, products are
transferred from one process to another are
valued at marginal costs only.
• Prices are determined with reference to marginal
cost and contribution margin.
Cont….
• Profitability of departments, products etc. is
determined with reference to their contribution
margin.
• In accounting, marginal cost, the overhead
control account in the cost ledger represents
only the variable overhead. Fixed costs are
taken as expenses in the profit and loss account
and thus excluded from costs.
• Presentation of data is oriented to highlight the
total contribution and contribution from each
product.
• The difference in the magnitude of opening stock
and closing stock does not affect the unit cost of
production since all the product costs are
variable costs.
• Practical applications of marginal
costing:
The marginal costing technique is useful in
managerial decision making in the following
situations:
(a) Key or limiting factor analysis and Optimising
product mix
(b) Make or buy decisions
(c) Discontinuance and Diversification of products
(d) Accept or Reject special offer and sub-
contracting
(e) Temporary cessation or close-down of
operations
(a) Key or limiting factor analysis :
Marginal costing is used to determine profit
maximising budget in a situation of scarce
resources like limit to machine capacity,
shortage of skilled labour, scarcity of raw
material, shortage of working capital etc.
The limiting factor is often sales demand itself, firm
produces enough goods/services to meet the
demand in full, provided sales earn a positive
contribution towards fixed costs and profits.
When the limiting factor is a production resource,
the firm must decide which part of the sales
demand it should meet, and which part must
be left unsatisfied.
Module – IV
• Budgetary Control & Standard Costing:
• Budgeting process
• Preparation of Sales or Revenue budget &
other budgets, Flexible budgeting.
• Efficiency Ratio, Activity Ratio, Capacity Ratio.
• Standard Costing – Objectives, problems,
Advantages and disadvantages of standard
costing system.
• Variance analysis material and labour –
Interpretation of variances
• Decisions under risk and uncertainty (meaning
of business risk and financial risk)
• Sensitivity Analysis.

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COST AND MANAGEMENT

• The entities which enhance

• The burden of rising costs with the effect of

1. Shows only overall performance: It does not give

2. Historical in nature: data recorded at the end of the period

4. No material control system: no proper system in

5. No labour cost control: no system of recording idle time,

7. No analysis of losses: it does not record idle plant

8. Not helpful in the price fixation: costs are not

9. No cost comparison: data not available for

10. Fails to supply useful data to mgt: in

(ii) “The classifying, recording

Impersonal cost centre-location or an equipment or a group .

Service cost centre- render services to production cost centres.

CIMA defines cost unit as “unit of

Cost object requires all

• Integration with financial accounts – should be

Job Costing Contract Costing Batch Costing

• CONTRACT COSTING or terminal costing:

• BATCH COSTING: A batch may represent a

Process Operation Unit Service

4. OPERATING (OR) SERVICE COSTING: This is

MULTIPLE (OR) COMPOSITE COSTING : It represents

• ABSORPTION COSTING: It is a traditional

• DIRECT COSTING: It is a method of costing in

• STANDARD COSTING: In this technique ,

Administra- Research &

(xxii) Non-controllable costs are those costs

PARTICULARS TOTAL COST PER UNIT COST

(+) Selling and Distribution Overheads

Raw materials 20,000 Work –in-progress (31-12-2007) 16,000

(ii) Production order: The production control

PearCo Job Cost Sheet

Cost Summary Units Shipped

Cost Summary Units Shipped

Let’s see one

Apply manufacturing overhead to jobs using a

Materials sent to site 86,000 Work certified 1,90,000

To materials 14,00,000 By materials at site 30,000

Particulars Units Rs. Particulars Units Rs

To Raw material 1000 50,000

1000 84,500 1000 84,500

Per unit cost of Process -1 = 84,500/1000 = 84.5

Particulars Units Rs. Particulars Unit Rs

1000 1,43,250 1000 1,43,250

Per unit cost of Process-2 = 1,43,250 / 1000 = 143.25

1000 1,92,000 1000 1,92,000

Per unit cost of Process-3 = 1,92,000 / 1000 = 192

Scrap possesses some value as a waste product

1,000 1,50,800 1,000 1,50,800

800 1,59,360 800 1,59,360

1,700 2,01,620 1,700 2,01,620

To raw materials 100 1000 By Normal loss 10 30

100 100 1602

Abnormal loss = (Normal cost of normal output/Normal output)

To Process A a/c 15 262 By Cash 15 45

To Transferred from 75 1310 By Normal loss 15 60

Normal output = Units entered minus Normal loss

To Normal loss (Loss of 10 40 By Process-B account 10 240