Cost Accounting

Cost: Cost means the amount of expenditure incurred on a

particular thing. Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

Costing: Costing means the process of ascertainment of costs.

Costing involves the following steps (i) Ascertaining or collecting costs (ii) Analyzing or classifying costs into basic elements such as Material, Labor, Expenses etc. and (iii) Allocating total costs to a particular thing i.e. a product, a contract or a process. Thus cost can now be defined as the total expenditure, duly classified into materials, labor, expenses etc. allocated to a particular product or contract or process.

Cost Accounting: The Institute of Cost and Management

Accountant, has defined Cost Accounting as the process of accounting for the costs from the point at which expenditure incurred, to the establishment of its ultimate relationship with cost centres and cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned. Cost accounting is a term broader than costing. It covers costing plus the reporting and control of costs. Thus Cost Accounting = Costing + Cost Reporting + Cost Control. Cost accounting can be defined as the technique of recording, classification, allocation, reporting and control of costs.

1|Page

Objectives of cost accounting:

Cost accounting has the following basic aspects or objectives: 1. Costing: It involves the following basic aspects or 5 As: 1. Ascertain costs relating to a particular period, 2. Analyze or classify costs under different heads of accounts such as material, labor, expenses etc., 3. Allocate costs fully to the direct expenses or the specific costs such as raw materials, labor to the relevant products, contracts or processes, 4. Apportion or distribute common costs to each product, contract or process on a suitable basis and 5. Absorb the total expenses of a department over its products so as to finalise the cost of each product that is then reported to the management. 2. Cost reporting: Cost reporting has the following aspects:1. What to report or the nature of information to be presented should be relevant and precise. 2. Whom to report will determine the scope of the report to be submitted to the top management. 3. When to report daily, weekly, monthly, quarterly or yearly etc. 4. How to report or the format will depend on the factors mentioned above. Once the cost report is received, management can take action to control the costs.

2|Page

3. Cost Control: Cost control has been defined by the ICMA as the guidance and regulation by executive action of the costs of operating an undertaking. Thus cost control means the control of costs by management. Following are the aspects or stages of cost control. 1. Set targets for cost, production, profits etc. for each period. 2. Measure Actual Performance relating to cost, production profits for the period concerned. 3. Compare targets with actual to find out the variations 4. Analyze variations, the causes for variations whether favorable or adverse are to be investigated. While adverse variations denote wastages and loses, favorable variations may indicate the targets fixed are very low. In both cases the exact reasons for the variations are to be known. 5. Take action once the causes are known to eliminate avoidable losses etc. 4. Other aspects: The other aspects or objectives of cost accounting are as follows: 1. Provide required data for fixing sales price for submitting tenders, quotations etc. 2. Assist the management in controlling inventory for raw materials, goods in process, finished goods, spares and consumables etc. 3. Advice management on future policies regarding expansion, growth, capital investment etc. 4. Install labour incentive system for getting maximum productivity from labour at optimum cost. 5. Advice management in deciding optimum productmix, merits and demerits of alternative courses of
3|Page

actions (make or buy etc.,) introduction of automation, mechanization, rationalization of system of production etc. Thus the objectives can be summarized as follows: 1. Ascertainment of costs 2. Estimation of costs 3. Cost control 4. Cost reduction 5. Determining selling price 6. Facilitating preparation of financial and other statements 7. Providing basis for operating policy Importance and advantages of Cost Accounting: Cost accounting is not only important to the management and owners but also to many others like the workers, the Government, the consumers, the public at large and so on. The advantages are as follows. 1. To the management and the owners: Cost accounting helps the management of the concern to ascertain the cost and profitability of each individual product / service/ contract/ process/ division/ branch separately. This also helps in valuation of the closing stock of goods at the end of the year. It helps the management of the concern in controlling costs in reducing the avoidable expenditure, and minimizing wastages and losses. It ensures the reconciliation of quantity of input with the quantities of output, wastages and scrap. The management is thus able to regulate and monitor the movement of materials thus
4|Page

preventing theft and loss of materials during processing and handling. It is of great help to the management in taking several decisions such as, which products to produce more, how much to produce, whether to make or buy a component, what price to charge or quote. Thus cost accounting is an invaluable decision aid to decision making. It also facilitates in preparation of budgets and implementation of budgetary control in the organization. The end result of all the above advantages of cost accounting is maximization of profits of the concern thus benefiting the owners by increasing their net worth or the share prices, higher dividends etc. 2. To the workers: Cost accounting has an elaborate system of assessing the performance of workers and rewarding them suitably through incentives and bonus. The increase in profits due to a cost accounting system also leads to higher remuneration and bonus to the workers. 3. To the Government / Consumers / Public: In case the products are under price control, cost accounting furnishes the data required by the government for fixing fair prices. Consumers benefit since the prices fixed on the basis of the cost data are just and reasonable and cannot be too high. It also leads to efficiency and productivity in the industrial sector. It ensure optimum utilization of the scarce economic resources of the country. Cost accounting leads to maximum profits for an organization. Naturally the Government also gains by way of more taxes on production, income and sales etc. The higher revenue is used by the Government for public welfare and economic development.
5|Page

Functions of Cost Accountant: The main functions of a cost accountant can be summarized as follows: 1. Determining cost and analyzing income: A cost accountant determines the cost of a job, product or process as the case may be. He analyses and classifies costs according to different cost elements, viz., materials, labour and expenses. Such analysis enables him to tell the management the significance of the different cost elements and fixation of the selling prices of the products manufactured by the business. He advises the management about the profitability or otherwise of each job, product or process. Thus, he helps the management in maximizing business profits. 2. Providing cost data for planning and control: A cost accountant collects, classifies and presents in appropriate form suitable data to the management for planning and controlling the operations of the business. He makes constant endeavour to control and reduce the cost by the following techniques: 1. He submits regular reports to the management regarding wastage of material, idle time, idle capacity, etc. He identifies the causes and suggests suitable controlling measures to prevent or reduce losses on account of these causes. 2. He makes product-wise or process-wise comparisons to identify non-profitable products or processes.

6|Page

3. He develops cost consciousness in the organization by adoption of budgetary control and standard costing techniques. 4. He maintains an even flow of materials and at the same time prevents unnecessary investment of materials through different material control techniques e.g. ABC analysis, perpetual inventory system, materials turnover ratios, fixation of different levels of materials etc. 5. He organizes various cost reduction programmes with the co-operation and co-ordination of different departmental heads. 3. Undertaking special cost studies for managerial decision-making: A cost accountant undertakes special cost studies and carries out investigation for collecting and presenting suitably the data to the management for decision-making regarding the following areas: 1. Introduction of new products, replacement of manual labour by machines etc. 2. Make or buy decisions, replacing or repairing old machines, accepting orders below cost, etc. 3. Expansion plans, installation of new capital project, etc. 4. Utilisation of idle capacity and development of a proper information system to provide prompt and correct cost information to the management. 5. Installation of a cost audit system. All types of manufacturing concerns can broadly be classified into two categories (i) Mass-production concerns, (ii) Special order concerns. Mass production concerns such as chemical
7|Page

plants, flour mills, paper manufacturing, tyre and rubber companies etc., produce uniform standard products and involve generally a continuous production process. The finished products are the result of successive operations. On the other hand, special-order concerns manufacture products in clearly distinguishable lots in accordance with special orders and individual specifications. Printing shops, construction companies, machine tool manufacturing, repair shops, woodworking shops etc., come in this category. In case of mass production concerns the products when produced are of the same type, and involve the same material and labour and pass through the same set of process. In such industries each process is designated as a separate cost-centre and the cost per unit is calculated by dividing total cost of the process with the total number of units produced by the process. The cost of production of the product is obtained by adding the unit costs of various processes through which the product has passed. This method of costing is known as process costing.

8|Page

costing methods
job contract batch costing costing costing
process operation service costing costing costing

9|Page

Batch Costing

INTRODUCTION

Historically, because of the industrial background of cost accounting, specific order costing has tended to centre around the manufacturing environment. Given the developments both in cost accounting and performance evaluation over the last 20 years or so, cost accounting is now being applied in manufacturing, non manufacturing , service and even in non profit making organizations. Cost Accounting is usually considered only as it applies to manufacturing operations. In todays economy, however every type and size of organization should benefit form the use of cost accounting concepts and techniques. For example financial institutions, governmental agencies and NGOs may apply cost accounting principles. In specific order costing products are made according to the orders of the clients. Every product has different style than the other. There is another method, which is process costing in which products are made simultaneously without differentiation.
10 | P a g e

batch is a group of items that are closely related, and are being made for a single customer, or are being made all at the same time; and the key point for our purposes is that the group of items maintains its identity as a batch, serial numbers, product numbers, production numbers, all identify the goods as a batch. The accumulation and recording of costs under batch costing is very similar to the techniques used with job costing. In batch costing articles are produced in a lot i:e one unit of product is not produced but a lot of say 500 or 1000 units of such product is produced.

This is a form of job costing. Under job costing, executed job is used as a cost unit. Whereas under batch costing, a lot of similar units which comprises the batch may be used as a cost unit for ascertaining cost.

In the case of batch costing separate cost sheet are maintained for each batch of products by assigning a batch of product number. Cost per unit in a batch is ascertained by diving the total cost of a batch by number of items produced in that batch. In batch costing material cost, direct labour engaged in batch wise and overheads are also recovered in batch wise. Such
11 | P a g e

method of costing is used in the case pharmacentical or drug industries, ready made garments , industries manufacture=ing electronic parts of, tv radio sets etc. Cost per unit = total cost of batch/ no. of items Batch costing is a modified form of job costing. While job costing is concerned with costing of jobs that are executed against specific orders of the customers, batch costing is used where articles are manufactured in definite batches. The articles are usually kept in stock for selling to customers on demand. The term batch refers to the lot in which the articles are to be manufactured. Whenever a particular product is required, one unit of such product is not produced but a lot of say 500 or 1000 units of such product are produced. It is therefore also known as Lot Costing. This method of costing is used in case of pharmaceutical or drug industries, ready-made garment factories, industries manufacturing component parts of radio sets, television sets, watches, etc. The costing procedure for batch costing is similar to that under job costing except with the difference that a batch becomes the cost unit instead of a job. Separate job cost sheets are maintained for each batch of products. Each batch is allotted a number. Material requisitions are prepared batchwise, the direct labour is engaged batchwise and the overheads are also recovered batchwise. Cost per unit is ascertained by dividing the total cost of a batch by number of items produced in that batch. Ordinary principles of inventory control are used. Production orders are issued only when the stock of finished goods reaches the

12 | P a g e

ordering level. In case the batches are repetitive, the costing work is much simplified. Since in batch costing production is done in batches and each batch consists of a number of units, the determination of optimum quantity to constitute an economical batch is all the more important. Such a quantity can be fixed on the basis of same formulae and principles as are applicable to economic order quantity of materials. Economic Batch Quantity = 2U x P S Where: U = Annual demand P = Setting up and order placing costs per batch S = Storage or inventory carrying over cost per unit per annum

13 | P a g e

Practical examples Example no 1

Leo Limited undertakes to supply 1,000 units of a component per month for the months of January, February and March 1987. Every month a batch order is opened against which materials and labor cost are booked at actual. Overheads are levied at a rate per labor hour. The selling price is contracted at Rs. 15/- per unit. From the following data, present the cost and profit per unit of each batch order and the overall position of the order for the 3,000 units. Month Batch (Numbers) Output Material Cost Rs. 6,250 9,000 Labor Cost Rs. 2,500 3,000

January 1987 1,250 February1987 1,500

March 1987

1,000

5,000

2,000

14 | P a g e

Labor is paid at the rate of Rs. 2 per hour. The other details are: Month Overheads Total Labor Hours January 1987 February 1987 March 1987 12,000 9,000 15,000 4,000 3,000 5,000

(b) Leo Limited Statement of Cost and Profits Per Unit of Each Batch Januar March y Februar Tota y l (A) Batch Output (Numbers ) RS. Rs. 1,250 . 1,500 Rs Rs . 3,750 1,000

.
15 | P a g e

Cost Accounting (B) Sales 18,750 Value (C) Costs Jan. 87 Rs

22,500 Feb 87 Rs.

15,000

56,250

March 87 Total Rs. Rs.

Material Wages Overheads* Total

6,250 2,500 3,750 12,500

9,000 3,000 3,000 15,000

5,000 2,000 3,000 10,000

20,250 7,500 9,750 37,500

(D) 6,250 Profit/Batch (BC) (E) 10 Cost/Unit (CA) (F) 5 Profit/Unit (DA)

7,500

5,000

18,750

10

10

16 | P a g e

Notes Jan87 (i) Labour Hours (Labour Cost/Labour rate per hour) (ii) Overheads per hour (Total Overhead/ Total Labour hours) (iii) Overhead for the batch (i)(ii) RS 2500/2 =Rs.1,250 Feb87 RS 3000/2 =Rs.1,500 March87 RS 2000/2 =Rs.1,000

RS 12000/4000 RS 3

RS 9000/4500 RS 2

RS 15000/5000 RS 3

Rs.3,750

Rs.3,000

Rs.3,000

Overall position for 3,000 units Sales Value (3,000 units Rs.15) Less: Total Cost (3,000 units Rs.10) Profit
17 | P a g e

Rs. 45,000 30,000 15,000

Example-2
Linda Shaw uses a batch costing system for her drilling and boring business; she uses a cost plus system of price setting and sets a markup of 25% on sales values. Administration costs are absorbed at the rate of 10% of selling price, whereas factory overheads are absorbed at the rate of 12 per direct labor hour for Department C and 9 per direct labor hour for Department L. Batch C-A.RL consists of 1,000 shafts to be drilled and bored, and the following costs have been incurred on it: C 500 direct labor hours at 10 per hour L 750 direct labor hours at 8 per hour Direct materials costing 6,475 have also been used on batch CA.RL. Required: In drawing up a Batch Cost Card show the (a) Total cost and total cost per unit (b) selling price and selling price per unit Solution to batch costing question Batch cost card C-A.RL: 1,000 shafts, drilled and bored Date started: xx/xx/xxxx Date completed: xx/xx/xxxx
18 | P a g e

Materials Labor: dept C 5000 dept L 6000 11000 Factory overheads dept C 6000 dept L 6750 12750 Total factory costs 30225 administration costs 4650 Total costs 34875 Mark up (profit) 11625 Selling price 46500

Total () 6475

Now we know that the total cost of the batch is 46,500 and the cost per unit is 46,500 1,000 units = 46.50 per unit

19 | P a g e

Maths note: Total costs + Mark up (profit) = Selling price And Mark up (profit) = Selling price - Total costs Then 25% = 100% - 75% Putting this into a table now: Total costs 34875 75% of selling price Mark up (profit) 25% of selling price Selling price 100% of selling price So, if total costs = 34,875 = 25% of sales, then (we can drop the % from the calculations now) Selling price = 34,875 75 * 100 = 46,500 So, Mark up = 25% * 46,500 = 11,625 This is where our mark up and selling prices come from! Total costs 34875 75% of selling price Mark up (profit) 11625 25% of selling price Selling price 46500 100% of selling price

20 | P a g e

Example- 3
A jobbing factory has undertaken to supply 200 pieces of components per month for the ensuring six months. Every month a batch order is opened against which materials and labor hours are booked at actual. Overheads are levies at a rate per labor hour. The selling price contracted is 8rs per piece. From the following data represents the cost and profit per piece of each batch order and overall position of the order for 1200 pieces.

month

Batch output 210 200 220 180 200 180 220

Material cost 650 640 680 630 700 630 720

Direct wages 120 140 150 140 150 140 160

Direct labour hour 240 280 280 270 300 270 320

jan feb mar april may june july

21 | P a g e

The other details are

month jan feb mar april may june

Chargeable expenses 12000 10560 12000 10550 13000 12000

Direct labor hours 4800 4400 5000 46000 5000 48000

Solution jan Batch output Sales value Material cost Direct cost Chargeable expenses Total cost
22 | P a g e

feb 200 1600 640 140 672 1452

mar 220 1760 680 150 672 1502

April may 180 1440 630 140 621 1391 200 1600 700 150 780 1630

june 220 1760 720 160 800 1680

Total 1230 9840 4020 860 4145 9025

210 1680 650 120 600 1370

Profit per batch Total cost per unit Profit per unit

310 6.52 1.48

148 7.26 0.74

258 6.83 1.17

49 7.73 0.27

-30 8.15

80 7.64

815 7.34 0.66

-0.15 0.36

Overall position of the order for 1200 units Sales value of 1200 units @ rs 8 per unit Total cost for 1200 units@ rs 7.34 per unit profit 9600

8808 792

23 | P a g e

Economic order quantity

Economic order quantity in batch costing the most important problem is determination of optimum size of the batch (how much to produce) or economic batch quantity.

The determination of economic batch quantity involve two types of costs 1) Set up cost (or preparation cost) 2) Carrying cost If batch size is increased then the carrying cost will also increases but the set up cost per unit decreases and vice versa.

EBQ = ROOT OF 2DS/ IC D = annual demand for the production S = setting up cost per batch C = Carrying cost per unit of production

24 | P a g e

EXAMPLE:

Monthly demand for product Setting up cost per batch Cost of manufacturing per unit Rate of interest Determine the EBQ Solution EBQ =2 DS/IC =2 *500*12*60/0.1*20 =600 UNITS

500 units rs 60 rs 10 10% p.a

25 | P a g e

Conclusion

Thus batch costing is one of the methods of cost accounting. Batch costing is a modified form of job costing. While job costing is concerned with costing of jobs that are executed against specific orders of the customers, batch costing is used where articles are manufactured in definite batches.

In batch costing articles are produced in a lot i:e one unit of product is not produced but a lot of say 500 or 1000 units of such product is produced.

Batch costing is employed by companies manufacturing in batches. It is used by readymade garment factories for ascertaining the cost of each batch of cloths made by them. Pharmaceutical or drug industries, electronic component manufacturing units, radio manufacturing units to use this method of costing for ascertaining the cost of their product.

26 | P a g e