Problem No.

How to calculate raw materials to produce finished product/goods?

A factory uses a particular raw material. There are three processes A, B and C. The data
relating to inputs, outputs and rejections during the month of April are given below:

Inputs (in pieces) Rejections Output

(Including opening W.I.P) (in Pieces) (in pieces)

A 18,000 6,000 12,000

B 19,800 1,800 18,000

C 20,400 3,400 17,000

Determining what should be inputs and Process A when final product transferred from
process C is 1,000 pieces.

Required:

Calculate the cost of raw materials to produce one piece of the finished product when:

(a) the weight of the finished product is 10 gram.

(b) the price of the raw material is $1 per kg.

Solution

(a). Process
No. of Pieces Rejected Pieces

Input Output No. % of output

A 18,000 12,000 6,000 50%

B 19,800 18,000 1,800 10%

C 20,400 17,000 3,400 20%

If 1,000 good pieces should be the output of Process C the input should be 1,000 plus 20%,
i.e., 1,200 pieces. This input of 1,200 units of Process C should be the output of process B.
The percentage of rejection being 10% in process B, the input in process B should be 1,200
pieces plus, i.e., 1,320 pcs. Similarly, 1,320 pcs. should be should be the output of Process A.
The rejection being 50%, the input of process A should be 1,320 plus 50%, i.e., 1,980 pcs. It
can be tabulated as follows:

% Rejection of
Process Input Rejection output Output

A 1,980 660 50% 1,320

B 1,320 120 10% 1,200

C 1,200 200 20% 1,000

1
 Also Check: Receiving and Inspection of the materials

(b) Given:
weight of the finished product = 10 grams per pc.

Assuming that there is no other loss of material, the total material required for 1,980 pcs. of
input of Process A shall be:

1,980 pcs. X 10 gms. = 19,800 gms.

Rate of Material = $1 per kg.
Cost of raw material = (19,800X1) / 1,000 = $19.80
Cost o fraw material per pc.= 19.80 / 1,000 = $0.0198

Problem No. 2

Calculation of Maximum, Minimum and reorder stock levels.

(1). Discuss the consideration that influences the setting of maximum, minimum and reorder
stock levels. Illustrate their computation by using the following information for a component
‘ZYP’.
Normal usage 50 per week

Minimum usage 25 per week

Maximum usage 75 per week

Re-order quantity 300 units

Re-order period 4 to 6 weeks

Solution

(Note: For consideration influencing the stock levels, read the discussion in the previous
pages)

Re-order level = Max. consumption per day / per week etc. X Max. Re-order period
= 75 units X 6 weeks = 450 Units.

Maximum Level = Re-order Level + Re-order Quantity – (Minimum consumption per

day/per week etc. X Minimum time required to obtain supplies)
= 450 units + 300 units – (25 units x 4 weeks)

= 750 units – 100 units = 650 units

Minimum Level = Re-Order level – (Normal consumption per day/per week etc. X
Average Re-order period)
= 450 units – (50 units x 5 weeks)

= 450 units – 250 units = 200 units

(2). Two Components, A and B are used as follows:

2
 Normal usage = 50 units per week each
Minimum usage = 25 units per week each
Maximum usage = 75 units per week each
Reorder quantity A: 400 units
Reorder quantity B: 600 units
Reorder period A: 4 to 6 weeks
Reorder period B: 2 to 4 weeks
What is materiality in accounting information?
September 15, 2019

In accounting, materiality refers to the impact of an omission or misstatement of information in a

company's financial statements on the user of those statements. If it is probable that users of the
financial statements would have altered their actions if the information had not been omitted or
misstated, then the item is considered to be material. If users would not have altered their
actions, then the omission or misstatement is said to be immaterial.

The materiality concept is used frequently in accounting, especially in the following instances:

 Application of accounting standards. A company need not apply the requirements of an

accounting standard if such inaction is immaterial to the financial statements.

 Minor transactions. A controller who is closing the books for an accounting period can ignore
minor journal entries if doing so will have an immaterial impact on the financial statements.

 Capitalization limit. A company can charge expenditures to expense that would normally be
capitalized and depreciated over time, because the expenditures are too small to be worth the
tracking effort, and capitalization would have an immaterial impact on the financial statements.

Thus, materiality allows a company to ignore selected accounting standards, while also
improving the efficiency of accounting activities.

The dividing line between materiality and immateriality has never been precisely defined; there
are no guidelines in the accounting standards. However, a lengthy discussion of the conce pt has
been issued by the Securities and Exchange Commission in one of its staff accounting bulletins;
the SEC's comments only apply to publicly-held companies.

Here are several examples of materiality in accounting information:

 A company encounters an accounting error that will require retrospective application, but the
amount is so small that altering prior financial statements will have no impact on the readers of
those statements.

3
 A controller could wait to receive all supplier invoices before closing the books, but instead
elects to accrue an estimate of invoices yet to be received in order to close the books more
quickly; the accrual is likely to be somewhat inaccurate, but the variance from the actual amount
will not be material.

 A company could capitalize a tablet computer, but the cost falls below the corporate
capitalization limit, so the computer is charged to office supplies expense instead.

 QUESTION
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Question 1.

Multiple Choice. Circle the letter of the answer that best complete the statement or answers the
question (6 marks)

1). Management accounting

a) reports information that has occurred in the past that is verifiable and reliable.
b) Measures, analyzes, and reports financial & nonfinancial information to internal
managers. (correct)
c) Provides information that is generally available only on a quarterly or annual basis.
d) Provides information about the company as a whole
e) Must follow generally accepted accounting principles
2). Financial Accounting
a) Must comply with GAAP (general accepted accounting principles) (Correct Answer)
b) is primarily concerned with profitability analysis
c) Focuses on the future and includes activities such as preparing next year’s operating
budget
d) reports include detailed information on the various operating segments of the business
such as product lines or department
e) is prepared for the use of department heads and other employees

3) Which of the following is a cost object

a) customers (Correct answer)
b) conversion costs
c) indirect labor
d) cost assignments
e) direct materials

4) Prime costs can include

a) conversion costs
b) advertising costs
c) machine set up costs
d) indirect manufacturing labor
e) direct material costs (correct answer)

5) Wages paid to machine operators on an assembly line are an example of which type of
cost

4
a) direct manufacturing overhead costs
b) direct materials costs
c) indirect materials costs
d) direct manufacturing labor costs (correct answer)
e) Indirect Manufacturing overhead costs

6) Which one of the following is a variable cost for an insurance company

a) Property taxes
b) Rent
c) Amortization on the office equipment
d) President’s salary
e) Sales commissions (correct answer)

question 2
eschliman manufacturing company had the following account balances for the quarter
ending September 30, unless otherwise noted
depreciation on manufacturing equipment $88,000
depreciation on office equipment 41,200
direct manufacturing labor 160,000
direct materials used 126,000
finished goods inventory (July 1) 180,000
finished goods inventory (September 30) 170,000
general office expenses 101,000
indirect manufacturing labor 62,000
indirect materials used 28,000
marketing & distribution costs 10,000
miscellaneous plant overhead 45,000
plant utilities 30,800
property taxes on plant building 9,600
property taxes on salespersons’ company vehicles 4,000
work in process inventory (July 1) 46,800
work in process inventory (September 30) 57,000

required: prepare a cost of goods manufactured schedule for the quarter

Eschliman Manufacturing Company
Scheduel of cost of goods Manufactured
For the three months Ended September 30, 2018
Direct materials used $126,000
Direct manufacturing labor 160,000

Manufacturing Overhead
Depreciation of mfg equip 88,000
Indirect mfg. equip 62,000
Indirect materials 28,000
Miscellaneous plant 45,000
overhead
Plant utilities 30,000
Property taxes on building 9,600
263,400
549,400

5
 Add beginning work in 46,800
process inventory
Total manufacturing costs 596,000
Less: ending working in 57,000
process inventory
Cost of goods manufactured $539,200

Sample Bookkeeping Questions

1. Which of the following is an item of working capital?

a. Fixed assets

b. Long-term investments

c. Accounts receivable

d. Bonds payable

For the answer - click here

2. To which account in the Balance Sheet is the net income or net loss

transferred to at the end of the accounting period?

a. Cash

b. Accounts Receivable

c. Inventory

For the answer - click here

Sample Accounts Payable Questions

3. Accounts Payable is classified as a/an ___________ in the _____________.

a. Current asset; Balance Sheet

b. Current liability; Balance Sheet

c. Expense; Income Statement

d. Revenue; Income Statement

For the answer - click here

6
 4. Which of the following documents authorizes the purchase transaction?

a. Credit memo from supplier

b. Invoice or bill from supplier

c. Purchase order

d. Purchase requisition

For the answer - click here

Sample Accounts Receivable Questions

5. Brown Glory Corp. has sales revenue of $150,000, sales discounts of

$12,000, sales returns allowances of $24,000, and cost of goods sold of

$60,000. What would be the net sales revenue of Brown Glory Corp.?

a. $102,000

b. $54,000

c. $90,000

d. $114,000

For the answer - click here

6. What is meant by accounts receivable?

a. Money owed to a company by its debtors

b. Money owed by a company to its creditors

c. Money owed to a company by its employees

d. Money owed by a company to its vendors

7
For the answer - click here

Answers:

1. The correct answer is C.

Explanation: Working capital consists of current assets and current liabilities. For the next question -
click here

2. The correct answer is A.

Explanation: The amount of net income or net loss is transferred to Retained Earnings, which is an
equity account. For the next question - click here

3. The correct answer is B.

Explanation: Accounts payable is a short-term obligation. Hence, it is classified as a current liability in

the Balance Sheet. For the next question - click here

4. The correct answer is C.

Explanation: A purchase order is a buyer-generated document that authorizes the purchase transaction,
and when the seller accepts the terms and conditions indicated therein, it becomes a binding contract
between the seller and the buyer. For the next question - click here

5. The correct answer is D.

Explanation: Net sales revenue is the amount left after deducting sales discounts and sales returns and
allowances from gross sales revenue. Cost of goods sold is deducted from net sales revenue to arrive at
gross profit.

Gross Sales Revenue – Sales Discounts – Sales Returns and Allowances

$150,000 – $12,000 – $24,000 = $114,000. For the next question - click here

6. The correct answer is A.

Explanation: Accounts receivable is defined as money owed to a company by its debtors. When a
company sells goods on credit, it creates a current asset by the name of accounts receivable and books
the corresponding revenue. When the cash is received, the asset is reversed.

Documents Required for Purchasing Stores Routine | Cost Accounting

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8
ADVERTISEMENTS:

The normal process of purchasing, storing, control and issue of materials consists of the
following documents:- 1. Bill of Materials 2. Purchase Requisition 3. Purchase Order 4.
Material Inspection Note 5. Goods Received Note (GRN) 5. Goods Received Note (GRN) 6.
Stores Requisition Note 7. Material Transfer Note 8. Material Return Note 9. Bin Card 10.
Stores Ledger.

Document # 1. Bill of Materials:

Bill of Materials is a comprehensive list of materials, with specifications, material codes and
quantity of each material required for a particular job, process or production unit. It will also
include the details of substitute materials. It is prepared by the engineering or planning
department for submission of quotation and after the receipt of work order. It is a method of
documenting materials required for execution of the specified job work.

Bill of Material acts as an authorization to the Stores Department in procuring the materials
and the concerned department in material requisition from the stores. It is an advance
intimation to the concerned departments of the job, work order to be completed.

ADVERTISEMENTS:

It is circulated to:

(a) Purchase Department,

(b) Stores Department,

(c) Cost Accounts Department, and

ADVERTISEMENTS:

(d) Product Department.

9
Advantages:

(a) It acts as a guide in planning the execution of job, process or product units by
documenting all materials required for that specified work.

ADVERTISEMENTS:

(b) It is a base for action to be initiated by the Stores Department in placing the purchase
requisition with the purchase department.

(c) The information mentioned in the bill of materials act as a standard with which any
deviation can be detected and remedial measures are taken if deviations take places.

(d) It is a good control measure on material cost.

(e) The material cost to be charged to a particular unit, job or process can easily be
determined beforehand.

(f) It helps in submission of tenders and quotations.

(g) It is a planning exercise for the proposed production or work.

(h) It serves as an advance intimation to stores department about the raw material
requirement.

Document # 2. Purchase Requisition:

10
CIMA defines Purchase Requisition as “an internal instruction to a buying office to
purchase goods or services. It states their quantity and description and elicits a
purchase order”.

The manager in-charge of Purchase Department should obtain requisition from the Stores in-
charge, departmental head or similar person requiring goods before placing orders on
suppliers. If the present stock run down to the reorder level, then the stores department send
a Purchase Requisition to Purchase Department, authorizing the department to order further
stock.

The specimen of Purchase Requisition is given below:

Document # 3. Purchase Order:

If the Purchase Requisition received by the Purchasing Department is in order then it will call
for tenders or quotations from the suppliers of materials. It will send enquiries to prospective
suppliers giving details of requirement and requesting details of available materials, prices,
terms and delivery etc. Quotations will then be compared and will place order with those
suppliers who will provide the necessary goods at competitive prices.

The number of copies of routing of Purchase Orders depends on the procedure followed in the
organization. Normally, the copies of the purchase orders will be sent to the Supplier,
Department originating Purchase Requisition, Inspection Department, and Accounting
Department.

The specimen of the Purchase Order is given below:

11
Document # 4. Material Inspection Note:

When materials are delivered, a supplier’s carrier will usually provide a document called
‘delivery note’ or ‘delivery advice’ to confirm the details of materials delivered. When
materials are unloaded, the warehouse staff check the material unloaded with the delivery
note. Then the warehouse staff prepares a Materials Receipt Note, a copy of which is given to
the supplier’s carrier as a proof of delivery.

After receiving the materials the Inspection Department thoroughly inspects whether the
quality of material is in accordance with the purchase order and the quality of material
received and it prepares a note called ‘material inspection note’, copies of which are sent to
the supplier and stores department.

A specimen of material inspection note is given below:

Document # 5. Goods Received Note (GRN):

Once the inspection is completed, GRN is prepared by the stores department, and copies of
GRN is sent to the purchasing department, costing department, accounts department and
production department, which initiated purchase requisition.

A specimen of goods received note is given below:

12
After receipt of GRN from the Stores Department and invoice from the supplier, the accounts
department will check with the purchase order and take necessary steps for making payment
to the supplier.

Document # 6. Stores Requisition Note:

It is also called ‘materials requisition note’. When Production or other departments requires
material from the stores it raises a requisition, which is an order on the stores for the material
required for execution of the work order. This note is signed by the department in-charge of
the concerned department. It is documents which authorize the issue of a specified quantity of
materials.

It will include the cost centre or job number for which the requisition is being
made, a specimen stores requisition note is given below:

13
Any person who requires materials from the stores must submit stores requisition note. The
store keeper should only issue materials from stores against such a properly authorized
requisition and this will be entered in the bin card and stores ledger. A copy of the requisition
will be sent to the costing department for recording the cost or value of materials issued to the
cost centre or job.

Document # 7. Material Transfer Note:

If materials are transferred from one department or job to another within the organization,
then material transfer note should be raised. It is a record of the transfer of materials between
stores, cost centers or cost units showing all data for making necessary accounting entries.

A specimen of ‘material transfer note’ is given below:

Document # 8. Material Return Note:

If materials received from the stores are not of suitable quality or if there is surplus material
remaining with the department, they are returned to stores with a note called ‘material return
note’ evidencing return of material from department to stores.

14
A copy of material return note is sent to the costing department for making necessary
adjustments in accounts.

Document # 9. Bin Card:

A ‘bin card’ indicates the level of each particular item of stock at any point of time. It is
attached to the concerned bin, rack or place where the raw material is stored. It records all the
receipts of a particular item of materials and its issues. It gives all the basic information
relating to physical movements. It is a record of receipts, issues and balance of the quantity of
an item of stock handled by a store.

A specimen bin card is shown below:

Document # 10. Stores Ledger:

15
Stores department will maintain a record called ‘stores ledger’ in which a separate folio is kept
for each individual item of stock. It records not only the quantity details of stock movements
but also record the rates and values of stock movements.

With the information available in the stores ledger, it is easier to ascertain the value of any
stock item at any point of time. The minimum, maximum and reorder levels of stock are also
mentioned for taking action to replenish the stock position.

A specimen stores ledger account is given below:

What are the documents or records used for keeping Store Records?

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ADVERTISEMENTS:

The following documents or records are used “on recording the store items:

A. Bin Card

B. Stores Ledger

ADVERTISEMENTS:

C. Stores Issue Requisition

16
D. Bill of Material

E. Material Transfer Note.

A. Bin Card

ADVERTISEMENTS:

After inspection of materials, the approved materials are received by the keeper. These materials are

stored in bins, racks, almirahs and other equipments provided for the purpose. For systematic storing,

each type of mate kept in different bins, racks, almirahs, etc.

It may be noted that a bin is a place, i.e, a rack, a shelf, an admiral or an op place where goods are

stored. For each bin a card is maintained containing the of materials only and updated by the store-

keeper. Bin card is prepared in dup’!* One card is attached to each bin and the other remains with the

store-keeper.

A bin card is a quantitative record of receipts, issues, and balances of m :‘J in stores. The bin card is

attached to the bin or rack in which materials are sty.

It enables to know the quantity of materials in hand at a glance . Bin card maintained by the store-

keeper. This card is used not only for recording receipts issues of stores but also assists the store-keeper

to c6ntrol the stock. A bin card the store-keeper to prepare purchase requisition to replenish the

exhausted material. It also helps in locating the discrepancy when physical stock verification;

undertaken and the balance compared with bin card.

ADVERTISEMENTS:

It contains particulars such as number, description of material, code number of material, maximum,

minimum, order and danger levels.

Benefits of a Bin Card

Bin card has the following benefits or utilities:

(i) As the most important store record it gives up-to-date record of receipt, sits and closing balances of

items of stores.

ADVERTISEMENTS:

17
(ii) It is helpful in placing requisitions for replenishment as when necessary. Re-ordering quantity is

also available in this card.

(iii) It makes Perpetual Inventory system meaningful by reconciling physical stock with balance shown

in the bin card.

(iv) It helps to control material cost with minimum investment as the storekeeper keeps the stocks

within the prescribed limit.

(v) It discloses at a glance to any one in the stores about the quantity balance of stock. It helps in a

system of internal check as many information relating to store keeping is available from bin card.

ADVERTISEMENTS:

B. Stores Ledger
A stores ledger is a record of materials showings receipts, issues, and balances I of materials in

quantities and value. It is maintained by the Costing Department and is outside the control of store-

keeper. This ledger is maintained in order to ensure correct 1 stores accounting.

This ledger is usually of loose leaf or card type and each account represents an item of materials. The

sheets are numbered serially and initiated by a responsible official so as to avoid the risk of removal or

loss. In some concern, the stores ledger is maintained in bound volumes so as to rule out the possibility

of loss of folios.The specimen of stores ledger is given below:

Benefits of Stores Ledger

The benefits of stores ledger are given below:

(i) It is an account record which provides information about receipt, issue nod balances both in quantity

and value.

(ii) It is maintained centrally in cost office from where consolidated.: information may be made

available.

(iii) It constitutes a. check on the quantity recorded in bin card.

(iv) Frequent overall review of stores balances may be conveniently made with the help of stores

ledger.

18
Difference between a Bin Card and a Stores Ledger

A stores ledger differs from a bin card in the following respects:

Bin Card
(1) Bin card records particulars of materials only in quantities.

(2) It is maintained in the stores by the store-keeper.

(3) It is normally kept inside the stores and it is used for controlling materials.

(4) Entries are posted before the transactions take place.

(5) Entries are posted individually.

(6) Entries are made on the basis of quantity received or issue.

Stores Ledger
Stores Ledger records particulars of materials both in terms of quantity and value.

It is maintained by the cost accounting department by the Accounts Clerk.

It is normally kept outside the stores and it is used to determine the value of materials, i.e., pricing of

materials issues.

Entries are posted after the transactions take place.

Entries are posted periodically.

Entries are supported by material received note and material requisition note.

Two-Bin System
According to this system, a certain quantity of materials termed as reserve stock is set apart which is

not used for daily use. Under this system two bins are used. The first bin is known as “running bin”

which serves the purpose of day-to-day issues. The key second bin which is known as “reserve bin” is

set aside with certain quantity of materials.

19
The reserve stock is set apart by taking into account the time taken by the o supplier to deliver the

materials. When the materials in the running bin exhausts, the materials in the reserve bin is used for

issuing them. This serves as a caution for the store-keeper to place a purchase requisition.

Reconciliation of Bin Card and Stores Ledger

After making necessary entries in the bin card, the receipt and issue document are valued and handed

over to the stores ledger clerk for posting in the ledge Normally, there should be no difference between

the balances disclosed in the twos of records. But in practice difference arises due to the following

reasons:

(i) There may be some arithmetical error in working out the balances.

(ii) There may be posting in the wrong bin card or in the wrong sheet of stores ledger.

(iii) There may be posting of receipt documents in issue column or vice v..

(iv) There may be complete omission of posting a document either in a card or in a stores ledger.

(v) There may be some temporary entry only in bin card or stores ledger. C. Stores Requisition

The store-keeper is required not to issue any material unless he is d; authorized by the competent

authority. “Stores or Material Requisition is authorization to a store-keeper to issue materials or other

stores.” This is use. prepared by the foreman of the production department.

The contents of Stores Requisition are:

(i) Number and date of requisition.

(ii) Name of the section requiring the materials.

(iii) Particulars and code number of materials.

(iv) The quantity of material demanded and its unit of measurement.

(v) The rate at which issue is to be made.

(vi) The total value of materials.

(vii) Authority for requisition.

20
The specimen of stores requisition is given below:

ABC Company Ltd. Stores Requisition Note

D. Bill of Material
A Bill of Material may be defined as, “a document containing a complete list of materials and

components required for manufacturing a particular product or for a particular job, process or work-

order”. It is also known as ‘Specification of materials’,

Bill of material often serves the purpose of Material Requisition as it contains the complete list of

materials required for a particular job. But a Stores Requisition cannot replaces a Bill of Material.

A. bill of material is a schedule of materials required for each job, process or operation. It gives the

details, of materials necessary like material specification, weigh and the quantity of each item. The bill

of material is prepared by production or planning department as soon as the order is received. It is a

requisition to the stores department for supplying the desired materials in proper time.

The specimen of Bill of Material is given below:

ABC Company Ltd Bill of Material

Job Order No.

Prepared by Checked by

Advantages of Bill of Material

(i) It serves the purpose of an advance intimation to all concerned of the order to be executed.

(ii) It acts as an authorization for issue of materials from store.

(iii) It serves the production department as an authority to place material requisition.

(iv) It may be used as a guide for controlling consumption of materials as it provides detailed list of

materials required. >’

(v) It is possible to calculate material cost of all articles before their production.

(vi) It may be used as a basis for passing accounting entries in the stores ledger and cost ledger.

21
E. Material Transfer Note
Material Transfer Note is prepared when materials or equipments are transferred from one sub-store to

another sub-store or from one production section to another or from one job to another in the factory.

Normally inter department transfer is not allowed. However, it may be encouraged in the following

situations:

(a) Where the surplus materials ark of very heavy weight and involves more handling expenses.

Where production is not to be stopped due to want of materials.

Overheads and Its Types [with Accounting Treatment]| Cost Accounting

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Overheads are costs, which are not traced directly to cost units. In other words, overhead is
the total of indirect material costs, indirect labour costs, and indirect expenses. The terms
‘burden’, ‘supplementary costs’, ‘on costs’, and ‘indirect expenses’ are used interchangeably
for overhead. Overheads are aggregated under some account head (e.g. supervisors’ salary,
office lighting, depreciation, and building up-keep) and then assigned to cost units on some
equitable basis.

Overheads are usually classified in terms of functions- factory overhead, administration

overhead, selling overhead, and distribution overhead. The terms factory overhead,
manufacturing overhead, and production overhead are used interchangeably.

Types of Overheads:

1. Manufacturing Overheads:

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Manufacturing overheads are indirect costs associated with the manufacturing process. In a
product manufacturing set-up, we say manufacturing process is the sequence of operations
that begin with supplying materials to workstations and end with the primary packing of the
product.

In the context of producing services, the manufacturing process is the process of performing
activities, concurrently or in sequence, which are directly related to creating the service. E.g.,
in the context of an organisation providing road transport services, manufacturing overheads

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are overheads associated with the operation of the vehicles. Indirect costs incurred in stores
department and in departments providing support services are also included in
manufacturing overhead.

2. Administration Overheads:

Administration overheads are costs of formulating the policy, directing the organization, and
controlling the operations which are not directly related to production, selling, distribution,
and research or development, or any other function.

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Cost of factory administration is a part of manufacturing overhead. Similarly, the cost of

administration of marketing offices is a part of selling overhead.

3. Selling Overheads:

Selling overheads are the costs associated with marketing and selling (excluding distribution)
activities.

4. Distribution Overheads:

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Distribution overheads are the costs associated with the distribution of finished products.
Distribution includes such activities as moving finished goods to central or local storage and
moving finished goods to and from prospective customers as in case of goods on sale or return
basis. In gas, electricity, and water industries, ‘distribution’ means pipes, mains, and services
which may be regarded as equivalent to packing and transportation.

5. Administration Overheads:

Administration overheads are expenses associated with the administration of an undertaking.

Costs of formulating the policy, directing the organization, and controlling the operations of
an undertaking which are not directly related to production, selling, distribution, research or
development activity, or function, are administration overheads.

Thus, administration overheads do not include costs of administering manufacturing

activities. Those costs are treated as manufacturing overhead. E.g., costs of operating a time
office are manufacturing overheads and not administration overheads.

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Examples of administration overheads are as follows- office rents and rates; expenses of office
lighting, heating, and cleaning; depreciation, costs of maintenance, repair, and insurance of
office building, office furniture, and office equipment; salaries to office staff; director’s remu-
neration; office supplies and other expenses; expenses on postage, telephone, and courier
services; printing and stationery; audit fees; legal expenses; and bank charges.

Administration is an independent function and is as important as the other major functions.

Since no direct relationship can be established between administration overhead and
products or jobs manufactured and sold, and because these costs are largely fixed in nature,
they are treated as period costs and charged directly to Costing Profit and Loss Account.

6. Selling and Distribution Overheads:

Selling overheads are costs of creating and stimulating demand and securing and executing
orders. Costs of manufacturing and distributing finished products are excluded from selling
overheads.

Distribution overheads are costs of moving finished products to central and local storage,
moving finished products to the customers, moving finished products to and from the
prospective customers as in the case of goods on sale or return basis, and making empty
packages reusable.

In short, when a product is placed in a saleable condition, production function ends and
distribution function begins. Overheads related to distribution function are termed as
distribution overhead. Many accountants prefer to deal with selling and distribution
overheads together.

Examples of selling overheads are as follows:

Salaries, commissions, travelling expenses of salesmen and technical representatives; sales

office expenses; bad debts; brokerage or third-party commissions; cost of operating the
marketing information system including market research; expenses on advertisement and
publicity; cost of catalogues and price lists; and costs of maintenance of showrooms.

Examples of distribution overheads are the following:

Carriage and freight outwards; depreciation, cost of repair and maintenance, insurance
charges, and operating costs of distribution vehicles; costs of secondary packing; warehousing
expenses; expenses on insurance of finished goods; and wastage of finished goods.

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Selling and distribution overheads are treated as period costs and charged directly to Costing
Profit and Loss Account.

7. Research and Development Costs:

Research is original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding. Development is the application of
research findings or other knowledge into a plan or design for the production of new or
substantially improved materials, devices, products, processes, systems, or services prior to
the commencement of commercial production or use.

An enterprise undertakes research to increase the stock of its scientific knowledge, devices,
and new applications which is expected to create competitive advantage for its business.

Research activities aim at the discovery of new knowledge which can be used in developing
new products, services, processes, and techniques or in improving existing products or
processes. Development starts where research ends. The results of a research cannot be put
directly to commercial use. It requires feasibility study and identifying practical difficulties
which may arise in its applications. Development activities include conceptual formulation,
design and listing of product/process alternatives, development of prototypes, etc.

Research and development costs are likely to benefit future products and, therefore, an
elaborate system of absorbing these costs to products, orders, or process is hardly justified.
Where research has been undertaken at the request of a client, it should obviously be charged
to the customer.

If research is specifically related to an existing product, it should be directly assigned to the

product and considered in analysing the profitability of the product. Research undertaken for
the general interest of the firm should be treated as period cost.

Accounting for Certain Key Items of Overheads:

1. Bad Debt:

There are two approaches for treating bad debt in cost accounts. One view is that bad debt is a
financial loss only and should be excluded from cost accounts. The other view is that bad debt
is similar to other expenses and should not be excluded from cost accounts.

Accordingly, bad debt is considered an item of selling overhead. Abnormally high bad debts
and bad debts of exceptional nature should be excluded from cost accounts. They should be
charged to the Profit and Loss Account.

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2. Advertisement Costs:

Advertisement costs should be allocated and apportioned to various functions. E.g., cost of
advertisement for recruitment should be allocated to the personnel function. Costs of
advertisements to create and retain demand for products and services should be allocated to
selling function. Advertisement cost is an overhead but its accounting depends on its exact
nature.

Advertisement cost which is likely to result in a long-term benefit should be treated as fixed
asset and depreciation on the same should be treated as selling overhead, e.g., the cost of neon
signs.

3. Market Research Costs:

Market research addresses itself to specific marketing problems. This includes the study of
potential markets, customer’s behaviour, competitor’s strategy, etc. It is like a policy cost
because it does not depend on the activity level, but varies with management policy on market
research.

The market research cost is treated as a selling overhead. However, if it is high in a particular
period, it should be treated as a deferred charge. Only a portion of it should be included in the
overhead for the current year and the balance should be carried forward to future years for
inclusion in overhead costs for those years.

4. Royalty and Patent Fees:

Royalty and patent fees may either be based on the units sold or produced, or may take the
form of a periodical payment of a predetermined amount. If royalty and patent fees are fixed
charges in the nature of rent, or are based on the number of units produced, they should be
treated as manufacturing overheads. On the other hand, if they are based on the number of
units sold, they should be treated as selling overhead.

5. After-Sales Services:

It is a common practice to offer continued free support/maintenance services during a

stipulated guarantee period.

Treatment of cost of after-sales services in cost accounts depends upon the cause which has
given rise to the after-sales services. If it is to rectify manufacturing defects, the cost is treated
as manufacturing overhead. If design department is responsible for the defect, the cost is

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allocated to design department. If damage is caused in transit, the cost is treated as
distribution overhead.

The following after-sales service costs are usually treated as selling overhead:

(1) Costs of routine services

(2) Costs of after-sales services rendered only to retain customer’s goodwill, even though such
services are not covered under any agreement.

Appropriate accounting of costs of after-sales services requires a careful analysis of the total
costs. Costs on after-sales services of an exceptional nature should be charged off to Profit and
Loss Account.

E.g., if suddenly an electrical engineering company incurs an abnormally heavy expenditure in

rectifying a defect in a transformer supplied to a customer, inclusion of the same in
production or selling costs would distort costs of production or sales. It is, therefore, logical to
charge such a heavy expenditure to Profit and Loss Account.

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