Cost FINAL

COST ACCOUNTING
UNIT- I
Introduction of Cost Accounting – Meaning and definitions – Difference between

financial and cost accounting – Relationship with Management accounting – Nature
and significance of cost accounting – Installation of Costing system – Characteristics
of ideal costing system – Methods of costing – Elements of costing – cost concept,
fixed cost and variable costs – Preparation of cost sheet.
INTRODUCTION
Meaning of cost, costing and cost accounting
Cost: It means the total of all expenditures incurred on the production of an article.
Costing: It is the techniques and process of ascertaining costs. it enable the management
to know the total cost and each elements of cost of a product. It has been defined by
Weldon as, “the classifying, recording and appropriate allocation of expenditure for the
determination of the costs of products or services, and the presentation of suitably
arranged data for purposes of control and guidance of management.
Cost accounting: It is the accounting system set up for recording costs. It begins with the
recording of income and expenditure and ends with the preparation of statements and
reports of costs.
Object of costing:
The important objects of costing are:-
1. To ascertain the costs.
2. To control the costs by setting standards.
3. To provide the basic for the formulation of policies by the management.
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COST ACCOUNTING
Advantages of costing
The advantages of costing may differ according to the type and efficiency of the
costing system adopted. Some of the important advantages of a good system of costing
are as follows:
1. It helps the management to eliminate the less or unprofitable activities by
disclosing them.
2. It reveals the exact cause of losses or inefficiencies and then, helps to improve the
efficiency.
3. It provides information upon which estimates tender are made.
4 It guides future production policies.
5. It enables the periodical determination of profits or losses without stock taking
6 It helps in controlling costs by providing information for comparison of costs and
the application of standard costing and budgetary control.
7. It provides an efficient check on stores, labour and machine.
8. It guides the management in fixing the prices properly and to take decision
regarding various matter like the profitability (1) purchase or production of a
component, (ii) acceptance of an order below cost, (iii) proposed capital
expenditure, (iv) use of different machine and methods of manufacture.
Necessity of importance of costing:

A good costing system is an invaluable aid to the management”. This statement is
true because the costing system helps the management in carrying out its functions by the
following ways:
1. Classification and subdivision of costs: The costs are collected and collected
and classified into various element which helps the management to ascertain the
profitability of each activity and to control them.
2. Control of materials, labour and overhead costs: The cost accounting helps the
management to excise control over the materials, labour and overhead costs by
the application of various techniques.
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COST ACCOUNTING
3. Business policies: It guides the management in taking decisions regarding various

matters connected with the production and sale of goods.
4. Budgeting: It us a co-ordinate plan of action. it helps to correct inefficiencies
before they enter into the business.
5. Standard costing: It provides the basis for the measurement of efficiency and
future planning.
6. Price determination: It provides the reliable cost data to get maximum output at
minimum cost.
7. Maximum use of resources: It provides the reliable cost data to get maximum
output at minimum cost
8. Expansion programmers: The expansion policies can be decided only on the
basis of cost data.
9. Instrument of control: The costing is an instrument for planning and controlling
the activities of an undertaking to achieves the desired results.
Other factors: It also informs the management about the optimum profitability,
seasonal variations, idle time and capacity etc.
Thus, it is clear from the above that the system of cost accounting in an
organization helps the management in the formulation of policies, their execution and
comparison of actual with the estimated. Such comparison helps to appraise the policies
and to effect changes if necessary. So, it is rightly remarked that costing is an invaluable
said to the management.
Objectives of cost accounting:

1. Unnecessary: Without the help of costing industries prepared in the past. So, it is
argued that the introduction of costing is unnecessary and waste.
2. Inapplicability: There is no separate system of costing applicable to all types of
industries. Hence, it cannot suit the requirements of many industries and
inapplicable to such industries.
3. Defective: It has been proved as a defective system in many cases sine it fails to
produce the desired results.
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COST ACCOUNTING
4. Expensive: It is quite an expensive system. Therefore, big industries alone can

adopted it with advantages.
DIFFERENCE BETWEEN
Financial Accounting Cost Accounting
1. It provides general information about

the profit or loss and financial position of a business 1.It provide information to the
managementfor planning execution
and control of activities
2. These accounts are required by law 2.These accounts are kept voluntarily
3. It classifies and records the expenditure
Accounting 3. It classifies and records the
expenditures accounting to their nature to their purpose
4. It does not provide any type of control. 4. It provides a detailed system of
control.
5. It gives reports usually at the end of the yr. 5. It gives reports as and when
required.
6. It records the total costs. 6. It records the unit costs also.
7. It relates to trading transaction of a business. 7. It relates to manufacturing
transactions.
8. It is based on actual facts and figures. 8. It is mostly based on estimates.
9. It shows all the expenses. 9. It shows only the production
expenses.
10. It reveals the profit or loss of the entire
business. 10. It reveals the profit or loss of a particular line producing
11. In Brief, it is the accounting system
for the whole 11. It is only a part of the financial
business. accounts
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COST ACCOUNTING
Installation of cost accounting

The following steps should be taken at the time of introducing a costing system in
an organization.
1. The nature of business and the process of operations carried on should studied.
2. The costing system should be designed in such a manner to suit the specific
requirements of the business.
3. The degree of accuracy desired and frequency and regularity of supplying cost
data to the management should also be determined before designing the costing
system.
4. The system of costing should be simple and easily understood by the operators.
5. Before it is put into effect, its benefits should be clearly explained to all the
people connected with it to obtain their co-operation.
6. It should be introduced gradually and smoothly without much disturbance to the
existing organization.
7. The relative profitability of the amount to be spent and the benefits to be obtained
from the introduction of a costing system should also be considered.
8. The cost department should function independently. It should have easy access to
the other departments which helps it to understand their problem and to take
corrective action.
Problem in installing a costing system and suggestion to overcome them
1. Lack of support from top management: In most of the cases, this system has
been introduced without the full co-operation of the management. As a result, it
has not been implemented successfully. In order to overcome this difficulty, the
cost accountant must obtain the full support of the management before its
introduction.
2. Resistance from the existing staff: The existing staff may feel that the
introduction of a new system may effect their importance and hence, they cannot
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COST ACCOUNTING
support it. In such cases, the new opportunities that they will get from its
introduction should be well explained to them.
3. Shortage of trained staff: There may be shortage of staff trained in cost
accounting at the time of to introduction. Such shortage can be avoided by giving
proper training to the existing staff.
4. Heavy cost of operation: The cost of operating this system is heavy unless it is
designed accounting to the specific needs of concerns.
5. Proper supervision: After installation of a costing system, there must be proper
supervision. The cost accountant should also take as much effect as possible to
make the system successful and to achieve the desired results.
Method of costing
1. Job Costing: This system is adopted in industries where each job has a separate
identity and are produced against specific orders. The costs are collected for each
job separately under this system. it is also known as lot costing, Specific or
production order.
2. Construct Costing: It is similar to job costing. But requires a long period for
completion. It is applied in industries engaged in construction works. Under this
system, a separate account is opened for each contract and each contract is
considered as a separate cost unit.
3. Batch costing: This method is adopted in industries where the goods are
produced for stock and for sale to the customers in general. Under this method,
the costs are computed for a batch or lot instead of a job in job costing. The unit
cost is calculated by dividing the total cost of a batch by the number of units
produced in that batch. it is suitable for industries producing components and
spare parts for assembling finished products.
4. Process costing: The system adopted to ascertain the cost of each process of
production is known as process costing. It is suitable for industries where a
product passes through different processes for completion. In other words, it is a
system adopted in industries where the finished product of one process is the raw
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COST ACCOUNTING
materials of the next process. This system is suitable for industries like cotton
textile, paper, sugar, chemical and mining.
5. Unit or output or single costing: This method is suitable for industries where
manufacturing is continuous and the units are identical. It is applied in industries
like mines, quarries, oil drilling, breviaries, brick works etc. The unit cost is
determined by dividing the total cost by the number of units produced.
6. Operating costing: This system is employed in undertakings performing service
rather than producing goods like transport and power supply companies, hospitals,
hotels etc. This method is used to ascertain the cost of performing the service.
7. Multiple costing or composite costing: This method is the combination of two
or more costing methods. This is suitable for industries where a number of
component parts are separately produced and subsequently assembled into aa final
product e.g., industries manufacturing cycles, automobiles, radius, typewriters etc.
Type of costing:
1. Uniform Costing: When the same costing principle and practices are used by
several concerns for the common control or comparison of costs, it is known as
uniform costing.
2. Marginal costing: it means the ascertainment of marginal cost by differentiating
between fixed and variable costs and of the effect on profit due to changes in
volume or type of output.
3. Standard costing: It is the preparation of standard costs and applying them to
measure the carnations from standards. It analyses the causes of variations with a
view to maintain maximum efficiency in production.
4. Historical Costing: Under this costing the costs are not predetermined but are
ascertained after their occurrence. Therefore, the costs are not available in time to
correct inefficiencies and to control costs.
6. Direct costing: The practice of charging all direct costs to the products in know
as direct costing. Under this system, the indirect costs are written off against the
profit of the period.
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ELEMENTS OF COSTS
Direct materials: All those materials which can be easily identified as chargeable to a
particular product, job or process, are know as direct materials. Examples: Timber used in
furniture’s, paper used in note books etc.
Direct Labour: All those laborers who can be easily identified as attributable to a
particular job, production process are known as direct labour. The wages given to them
are known as direct wages. Example: Workers directly engaged on production.
Direct or chargeable expenses: All those expenses which are incurred specifically for a
particular job, product or process are known as direct expenses. Examples: Expenses on
drawings, models, design, excise duty, royalty etc.
Overhead: Indirect materials, indirect labour and indirect expenses are collectively know
a “Overhead”
The students are advised to render the chapter “Overhead” for details.
Concept of cost
Cost unit: It is a unit product or service or time in terms of which costs may be
computed, e.g., per tonne in case of coal, per meter in case of cloth etc.
Cost centre: It is a part of an undertaking for which costs may be ascertained. So, it bay
be location like a department or an area or an item of equipment like lathe or a person
like salesman, foreman
CLASSIFICATION OF COSTS
1) According to variability:
1. Fixed costs or period costs are those costs which remains constant
irrespective of the volume of output e.g., factory rent, insurance etc.
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COST ACCOUNTING
2. Variable costs or product costs are those costs which will vary in direct
proportion to the output, e.g., direct materials, direct labour, power etc.
3. Semi-variable costs are those costs which are partly fixed and partly
variable, e.g., telephone charges.
2) Accounting to controllability:
1) Controllable costs are those costs which are not within the control of
management ex., rent of building
3) According to normality
i) Normal cost: It is normally incurred at a given level of output and it forms
part of the of cost production.
ii) Abnormal cost: It is not normally incurred at a given level of output and
therefore, it is charges to costing profit and loss account.
4) According to managerial decision:

i) Marginal cost: It is the total variable cost comprising of prime cost and
variable overheads.
ii) Out of pocket cost: It is a cost which gives rise to cash expenditure.
iii) Differentials cost: It is the change in costs due to change in the level of
activity or method of production.
iv) Sunk costs: It is a cost which cannot be recovered due to the permanent
closure of a plant.
v) Shut down costs: It is the cost incurred on the plants kept idle due to the
temporary suspension of activities.
vi) Imputed costs or notional cost: It is the cost in respect of which no actual
expenditure is incurred e.g., rent of won building, interest on capital etc.
Therefore, it appears only in the cost accounts.
vii) Replacement cost: It is the cost at which an asses can be replaced.
viii) Opportunity cost: It is the cost which may be earned from the alternative
use of a productive capacity.
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COST ACCOUNTING
ix) Avoidable cost: It is the cost which can be eliminated on the

discontinuation of a product or department, e.g., salary of clerks in that
department.
x) Unavoidable cost: It cannot be eliminated on the discontinuation of a
product or department, e.g., salary factory manager.
Expenses and incomes excluded from cost accounts:

The total cost of a product should include only those items of expenses which are
a charge against profits. The other items of expenses which are relating to capital assets,
capital losses, distribution of profits and items of pure financial nature should not form
part of the cost.
The following items of expenses and revenuers are to be excluded from the cost
accounts:
Expenses:
1. Abnormal waste of materialism idle time, bad debts and other abnormal expenses.
2. Interest on capital and borrowings.
3. Loss on sale of capital assets.
4. Discount and commission on issue of shares and debentures.
5. Preliminary expenses.
6. Fines and penalties.
7. Dividend paid.
8. Income –tax and super taxes.
9. Goodwill written off.
10. Charitable donations.
Revenues:
1. Profits from the sale of fixed assets.
2. Transfer fee received.
3. Rent received.
4. Dividends received.
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5. Interest on back deposits.
Cost sheet/Statement of cost/production statement

It is a statement showing the total cost of a product or job in detail. It also shows
the various elements of cost and cost per unit.
Advantages of cost sheet
1. It helps in fixing up the selling price
2. It is useful for determining the estimated prices for tenders or quotations.
3. It enables the manufacturer to control and minimize the cost.
4. It is useful for the formulation of production policies.
Specimen of a cost sheet or statement of cost (and profit) for the period
ending...............
Particular Details Total Cost Cost per unit
Rs. Rs.
Direct material:
Opening stock of raw materials XXX
add purchases
add Purchases expenses XXX
XXX
Less purchases XXX XXX XXX
Direct labour XXX XXX
Direct expenses XXX XXX
Prime cost XXX XXX
Add factory overhead or works overhead
(Factory on cost or works on cost)
...................... XXX
..................... XXX
..................... XXX
XXX
Less Scrap realised XXX
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COST ACCOUNTING
XXX XXX
XXX XXX
Add opening stock of work in progress XXX ---
XXX
Less closing stock of work in progress XXX ---
Factory cost or works cost XXX XXX

Add office and administrative overheads
...................... XXX
..................... XXX
..................... XXX XXX XXX
Cost of production XXX XXX
Add Opening stock of finished goods XXX --
XXX XXX
Less Closing stock of finished goods XXX ---
Cost of goods sold XXX XXX
Add Selling and distribution expenses XXX XXX
Cost of sales or total cost XXX XXX
Profit XXX XXX

Sales XXX XXX
Notes:
1. Unit cost column is to be provided only when it is requires to show t he cost per
unit. Otherwise it is not necessary.
2. Cost per unit is to be calculated for all the figures papering in the total cost
column except the opening and closing stock items.
3. Cost per unit of each item.
Up to cost of production = Cost of the concerned item
No. of units produced
5. Cost/profit per unit from cost of goods sold to sales =
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COST ACCOUNTING
Cost / amount of the concerned items

No. of units sold
When the value of closing stock of finished goods is not given, it is to be calculated in the
following manner:Cost of productionx No of units in closing stock
No. of units produced
6. Meaning of scrap: It is the residue from the materials used in the process of
manufacture. The scrap may be realized without further processing. Such realized
value of scrap is credited to profit and loss account or job account.
7. Meaning of spoilage: The loss due to defective goods which cannot be rectified
economically is known as spoilage. If spoilage is normal, it is treated value of
scrap is credited to profit and loss account or job account.
POINTS TO BE REMEMBERED
➢ Cost means the total of all expenditures incurred on the production of an article
➢ It is the techniques and process of ascertaining costs
➢ is the accounting system set up for recording costs
➢ It helps the management to eliminate the less or unprofitable activities by
disclosing them.
➢ It provides an efficient check on stores, labour and machine
➢ The nature of business and the process of operations carried on should studied
➢ It helps in fixing up the selling price
➢ It is useful for determining the estimated prices for tenders or quotations.
➢ It enables the manufacturer to control and minimize the cost.
➢ It is useful for the formulation of production policies.
EXPECTED QUESTIONS
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COST ACCOUNTING
1. Define Costing.
2. Explain the advantages of Costing
3. Distinguish between Financial Accounting and Cost Accounting
4. Discuss the methods of costing
5. Explain the objectives of cost accounting?
6. What are the importanceof costing?
7. Briefly explain the Installation of cost accounting
8. Explain the classification of costs.
9. What are the elements of costs? Explain
10. Write the specimen for cost sheet.
UNIT- II:
Material classification and coding of material - fixation of maximum,
minimum and reorder level – Economic order quantity – purchase procedure –
storage of materials - Issue of materials – pricing of material issues and returns –
Inventory control – Physical verification – periodical and perceptual inventory –
Analysis of discrepancies – Correction measures.
MATERIALS
Purchasing: It means procurement of materials, supplies machines, tools and services

required for the equipment, maintenance and operation of a manufacturing concern.
Purchasing Procedure
1. Preparation of purchase requisition:
The purchase requisition is prepared by the head of the department in need of
materials and then to the purchasing department. Usually, it contains the name of the
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department requiring materials, description of materials i.e., the quality and quantity,
time and place of delivery.
2. Obtaining quotation: On the basis of purchases requisitions, the purchasing
department should make arrangements for getting quotations from various suppliers.
3. Placing of orders: After comparing the quotations, the order should be placed with
the supplier who offers favorable terms. The order should contain the price, quality,
quantity, time and mode of delivery of goods and the grounds for rejections.
4. Follow up an inspection: Follow up is an act of reminding the supplier in fulfilling
his terms of sale. When materials are delivered, they should be inspected as to their
quality and other specifications continued in the purchase order. If there is any
difference, that should be returned or intimated to the supplier.
Importance of purchasing:
i) The careful purchase of goods will leads to efficient working of the concern.
ii) The purchase of goods at low prices reduces the cost of production which in turn
will increase the sales and profits.
iii) The plant capacity can be utilized fully due to the uninterrupted supply of
materials.
Store – keeping:
In any organization, there is a time gap between purchases and production and
then, production and sales. During that period, the materials or goods should be protected
from fire, theft and obsolescence. For which, they should be kept in a safe place which is
known as store keeping. It also includes issue of materials in proper way. The term stores
refer to the materials, supplies, tools and finished goods.
Duties of store keeper:

1. He should receive the materials and other items required for production from the
purchase manager and the finished goods.
2. He should keep the stores safely and issue them whenever they are required.
3. He should maintain proper records for the receipt and issue of stores.
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4. He should issue the stores only against a properly authorized requisition.
INVENTORY OR MATERIALS CONTROL

Meaning
Inventory control means the safeguarding and maintaining of inventories at
optimum level by taking into consideration the production requirements and the financial
resources of the business. The term inventory includes all materials in stock like raw
materials finished and semi-finished goods, crap etc. the proper control over materials
will reduce the cost of production since it forms major proportion of cost of a product.
This control over materials is normally, exercised over purchases, storage and
consumption of materials.
Objects
1. To ensure minimum utilization of financial resources without affecting the
operational needs.
2. To avoid break down in production due to shortage of materials.
3. To reduce the risk of loss through obsolescence, theft, fire and damage.
4. To make purchases economically.
5. To ensure prompt delivery of finished goods ordered.
6. To submit accurate materials reports to the management in time.
ABC Analysis
The ABC method is an analytical method of stock control. It aims at
concentrating efforts on those items where attention is needed most.
Under this system, the materials stocked may be classified into a number of
categories according to their importance. Their importance is determined on the basis of
their value and frequency of replacement during a period. The first category called as ‘A’
items may consists of only a small percentage of total items handled but of high value.
The second category called as ‘B’ items, may be relatively less important. In the third
category called as ‘c’ items all the remaining items of stock may be included.
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Advantages:
1. Closer and stricter control of those items which represent a major portion of total
stock value.
2. Investment in inventory can be regulated and funds can be utilized in the best possible
manner.
3. Saving in stock carrying costs.
4. Helps in maintaining enough safety stock for ‘C’ category of items.
5. Scientific and selective control helps in the maintenance of high stock turnover.
LEVEL OF INVENTORY
1. Maximum level: It is the level above which the stock of any item should not
generally be allowed to go. The formula for computing this level is as follows:
Maximum level = Re-order level + Re-order quantity – (Minimum consumption x
Minimum re-order period)
2. Minimum level: It is the level below which the stock should not normally be allowed
to fall.
Minimum level = Re-order level – (Normal consumption x Normal re-order
period)
3. Ordering level or re-order level: It is the level of material at which a new order for
material is to be placed.
Re-order level – (Maximum consumption x Maximum re-order period)
4. Danger level: It is the level at which the normal issue of materials should be stopped
and the issuers should be made only under special orders.
Danger level = (Average consumption x Maximum time for emergency
purchases)
5. Average stock level : It can be calculated by adopted the following formula:
Average stock level = Minimum level + Maximum Level
2
or
Minimum level + 1/2 re-order quantity.
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Economic order quantity or Re-order quantity:

It is that size of the order which gives maximum economy in purchasing any
materials and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost.
EOQ = 2AB
CS
EOQ = Economic order quantity
A = Annual Consumption
B = Buying cost per order
C = Cost per unit of material
S = Rate of storage and carrying cost.
Perpetual inventory system

It is a method of recording stores balance after every receipt and issue to facilitate
regular checking to avoid closing down for stock taking. It facilitates the maintenance of
upto date stock records and continuous stock taking.
It is carried out with the following three ways

1. Bin card: A card is attached to each bin, drawer or shelf containing materials. It is
know as Bin card. It shows quantities of materials received, issued and in stock and
other details of materials. It helps easy reference.
2. Stores ledger: This ledger contains and account for each item of materials in stock. It
gives a continuous information of materials received, issued and in hand at any time
in quantity as well as in value.
3. Continuous stock – taking: Under this system, a certain number if items are verified
physically every day. The items for checking should be selected in such a way that
each item of materials gets checked up in a year. The verification will be done by
counting the items actually and comparing them with the bin-cards and stores ledger.
Advantages of perpetual inventory system

1. It avoid the delay and heavy cost involved in stock taking at the end og the yr.
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2. The difference is easily located and rectified.

3. Due to continuous checking, it keeps the staff regular and honest.
4. Since the stocks are kept within the limits, the working capital is not affected or
blocked in stores.
5. Over stocking and under stocking can be avoided.
6. It serves as system of internal check and facilitated the continuous checking of stores.
Turnover of materials or inventory:

It indicates the rate of consumption of materials. It enables to locate the slow or
non moving materials and to avoid the stocking of the same. The following formulas are
to be considered in this respect.
Materials turnover = Materials consumed during the period
Average inventory
Materials consumed = opening stock + purchases – closing stock
Average inventory = opening stock + closing stock

2
Pricing the issue of materials

The materials may be issued at actual cost or at standard cost or at market price.
I Standard cost
The important method by which the materials issues are priced at actual cost are
as follows:
1) Specific cost method: When materials are issued to the jobs for which they have been
purchased, they are priced at the exact cost. Such pricing of materials is know as
specific cost method.
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2) Average cost method: Under this method, materials issues are valued at the average
of the unit cost of materials in the different lots in hand. Although it is a simple
method, it often shows inventories at absurd values.
3) Weighted average method : Under this method, the average price of materials for
pricing the issues is computed in the following manner :
Average price = Value of materials in hand + Value of materials received

Number of units in hand + Number of units received
This method stabiles the costs when the prices fluctuated and therefor it is widely
accepted. But the draw is that it does not reflect the current condition and it requires
detailed clerical work.
4) FIFO method: Under this method, materials issued are priced at the cost of the
oldest consignment of materials on hand as if the materials first purchased are issued
first. Then the quantity issued is not covered entirely by the oldest consignment on
hand then the cost of the next oldest consignment can be used for the uncovered part
of the issue.
It is a simple method and it makes the cost of production fluctuating from to time
and sometimes shows the inventories at higher figures.
The demerit of this is that it makes the cost of production fluctuating from to time
and sometimes shows the inventories at higher figures.
5) LIFO method: Under this method, the issues are priced at the unit cost of the
most recently purchased lot. If such lot is exhausted, the issues are prices at the
unit cost of the immediately preceding lot and so on.
The cost of goods manufactures will represent the current market price. But the
inventories will not represent the current prices. This method may result in increase or
decrease in profit due to the decrease or increase in the price. But the inventories will not
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COST ACCOUNTING
represent the current prices. This method may result in increase or decrease in profit due
to the decrease and increase in the price levels.
5) HIFO Method: Under this method, materials issued are prices at the highest cost of
the materials on hand. This method is not widely accepted.
6) Base stock method: It is a method conjunction with anyone of the above methods.
But in this method, a certain quantity of stock will be kept as base stock and shown in
the balance of each day. In other words, this base stock should be shown as balance
without utilizing it for the issue of materials.
II. Standard cost:
It is a predetermined price fixed for a particular period after taking into account
certain factors like the trend of prices, normal quantity ti be purchased etc. it is only an
estimated price and therefore it should be revised as and when necessary to correspond
with the actual costs.
III. Replace or market cost:

In this case, the material issues are priced at the market rate on the date of their
issues. So it may result in an unrealized profit or loss. The determination of replacement
price is also a difficult task under this case.
Materials loss
1. Wastage: The materials lost in the process of manufacture without any
realizable value is known as wastage. It includes the loss of materials due to
evaporation, shrinkage and unrealizable residues. Examples : Unrealizable
gas, smoke and residue etc. It may be normal or abnormal wastage. For details
about normal and abnormal wastage, refer the chapter ‘Process costing’
2. Scrap : Refer
3. Spoilage : Refer
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4. Defectives: The defective materials which can ne economically rectified are

known as defectives. The expenses incurred for such rectification should be
added with the cost of production.
SPECIMEN FORMS
1. Purchase requisition
It is prepared by the head of the department in need of special materials and by
the stores-keeper for regular materials and then forwarded to the purchasing department.
2. Purchase order
After receiving the purchase requisition, the purchase manager should invite
quotations from different suppliers. Then, he should select a supplier and issue a purchase
order to him in the following form.
3. Goods received note

The goods / materials supplied by the supplier will be received and checking by
the ‘Receiving and Inspection department’ or by the store-keeper. Then, the details of
materials received will be entered in the stores or goods received note
4. Materials or stores requisition

The materials will be issued by the store-keeper only against stores requisitions
prepared and submitted by the production departments in need of materials.
5. Bill of materials
It is a list of various materials required by the production department for a
particular job. At the time of starting a job, all the materials required to complete the job
are listed in this bull and sent to the production department. It is a kind of master
requisition. It serves as a specific materials requisition for a given job.
6. Materials return note
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COST ACCOUNTING
The surplus materials from a job or department will be returned to the store
accompanied by a materials return note. It is similar to stores requisition. Therefore, it is
printed in a different colour paper to identify it.
7. Materials transfer note

When surplus materials of one job are to be transferred to another job, a materials
transfer note should be prepared by the department where there is such surplus.
8. Materials abstract
In order to ascertain the materials cost of each job. All the stores requisition stores
returned notes and materials transfer notes are analyzed at the end of each period. There
documents are classified according to the departments and shown in a separate document.
This document is known as materials analysis sheet or materials abstract
➢ It means procurement of materials, supplies machines, tools and services

required for the equipment, maintenance and operation of a manufacturing
concern.
➢ The careful purchase of goods will leads to efficient working of the concern.
➢ The purchase of goods at low prices reduces the cost of production which in
turn will increase the sales and profits.
➢ The plant capacity can be utilized fully due to the uninterrupted supply of
materials.
➢ Inventory control means the safeguarding and maintaining of inventories at
optimum level by taking into consideration the production requirements and the
financial resources of the business.
➢ To ensure minimum utilization of financial resources without affecting the
operational needs.
➢ The ABC method is an analytical method of stock control.
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COST ACCOUNTING
➢ Investment in inventory can be regulated and funds can be utilized in the best
possible manner
➢ Re-order level – (Maximum consumption x Maximum re-order period)
➢ Maximum level = Re-order level + Re-order quantity – (Minimum consumption
x Minimum re-order period)
➢ Minimum level = Re-order level – (Normal consumption x Normal re-order
period)
➢ Danger level = (Average consumption x Maximum time for emergency
purchases)
➢ Average stock level = Minimum level + Maximum Level
2
➢ EOQ = 2AB
CS
EXPECTED QUESTIONS
1. Explain the Purchasing Procedure.

2. Write short note on Store – keeping.
3. What are the Duties of store keeper?
4. Explain the Objects of inventory control.
5. Write short note on ABC Analysis
6. Explain perpetual inventory system
7. What are the Pricing the issue of materials? Explain
24
COST ACCOUNTING
UNIT – III
Labour: Classifications of labour – Time keeping – Preparation of pay roll –
Wage payment and incentive system – Idle time – Over time – Accounting of labour
cost – Work study – Merit rating – Time and motion study – Labour turnover.
LABOUR
Labour Cost
It includes the following items of expenditure incurred on workers by the
employer.
a) Monetary benefits: It includes basic wages dearness allowance, employer’s
contribution to provident fund and E.S.I. Scheme, production bonus, profit bonus,
pension, and retirement gratuity.
b) Fringe benefits: It includes subsidized food and housing to the workers, subsidized
education to their children, medical facilities, holidays, pay and recreational facilities.
Types of labour
Direct labour: It is the labour directly engaged in the production of goods. It can be
easily allocated to a particular job, product or process. The cost of this labour forms part
of prime cost.
Indirect Labour: It is the labour which indirectly helps the direct labour engaged in
production. Its cost cannot easily be allocated or identified. The cost of this labour will be
included in the overhead. E.g., supervisors, storekeeper, watchmen etc.
Control over labour costs

The ascertainment of cost of production and the recovery of overheads are wholly
based on the labour cost. Therefore, the control of labour cost is an important object of
management. The achievement of this object depends upon the proper employment and
efficient utilization of labour force.
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COST ACCOUNTING
The labour costs are controlled by the co-ordinate efforts of the following
departments:
1. Personnel department which is concerned with the selection, training and placement
of the labour force.
2. Time recording department which is concerned with the recording of time of each
worker for the purpose of time keeping and time booking.
3. Engineering department which maintains control over working conditions and
production methods for each job and department.
4. Pay roll department which prepares and maintains the accounts for labour costs.
5. Cost accounts department which is responsible for the accumulation, classification
and analysis of all labour costs.
Time booking
It means the recording of time spent by a worker on each job or work order during
the period of attendance in the factory. It objects are,
1) To ensure that the time for is properly utilized,
2) To find out the labour cost of each job
3) To ascertain and control the idle time.
The time booking is normally done by the use of, a) Daily time sheet (b) Weekly
time sheets (c) Job tickets or job cards.
Time keeping
It means recording the time of presence of each worker inside the factory. It is
useful for the calculation of wages and for maintaining discipline over the attendance of
workers.
Methods of time keeping

Manual methods:
1) Attendance register or Muster Roll: It is a register kept at the factory gate for
entering the time of arrival and departure of workers. It may be filled up by the
26
COST ACCOUNTING
workers or by the time keeper. It is only a simple method adopted in small factories.
It may lead to dishonest practices.
2) Token or disc method: Under this method each worker is allotted a disc or token
bearing his identification number. All these discs are hung on a board kept at the gate.
As and when every worker enters the gate, he removes his disc and place it in a box
kept for the purpose. The box is removed immediately after the scheduled time. The
late comers will have to report to the time keeping office for recording the exact time
of his arrival. The disc still left on the board represents the absentees. Then, the
attendance is recorded in a register with the help of disc in the back. This method is
also defective and creates the chances of fraud and mistakes.
Mechanical methods:
1. Time’s clock method: Under this system, every worker is identified by a card. The
attendance is recorded by the use of time clocks on the cards.
2. Dial recorder system: Under this system, the time is recorded on an attendance form
by pressing the dial arm into a hole which denotes the number of a particular worker.
3. Key recorder system: Under this system, the attendance is recorded by inserting a
key bearing the number of a worker in the key hole.
Pay roll accounting

It is a part of accounting system in an organization. It is concerned with the
determination of wages for the workers and recording them in the books of accounts. In
large concerns, there is a separate pay roll department for the purpose of computation and
payment of wages. The main function of this department is to prepare the payroll or wage
sheet showing the gross and net wages payable to the workers along with the deduction
made.
Idle time
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COST ACCOUNTING
Idle time may be defined as that time for which wages are paid but no production
is obtained. It represents loss of time due to lack of materials, break down of machinery,
power failure etc.
Causes of Idle Time:

a) Productive cause :
The productive causes which results in idle time are,
i) Machine break down
ii) Power failure
iii) Waiting for the work
iv) Lack of materials and tools
v) Lack of proper instructions
vi) Setting up of machines.
These productive causes can be avoided by way of proper planning in advance.
b) Administrative causes: The surplus capacity of plant and machinery may also results
in idle time.
c) Economic Causes: The seasonal nature of industries is also one of the reasons for
idle time. This isle time cannot be controlled.
Treatment of Idle Time cost:

The normal idle time cost is accounted by the inflation of wages rates. But the
abnormal idle time is charges to the costing profit and loss account.
Labour Turnover
Labour turnover may be defined as the number of workers left during the period
in relation to the average number of workers employed during the period. It denotes the
change in labour force.
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COST ACCOUNTING
Measurement of labour turnover:

a) Separation rate method: Labour Turnover = Number of separations in a period
x100
Average number of workers in the period
b) Replacement rate method:
Labour Turnover = Number of separations in a period x100
c) Flux rate method = Number of separations + Number of replacement x100
Causes of labour turnover:
A minimum labour turnover is common and is good for all industries. But an
excessive or high labour turnover is dangerous. Such labour turnover may be dure to
following reasons.
Avoidable causes
1) Seasonal function.
2) Lack of proper planning
3) Dissatisfaction with the job
4) Lack of proper amenities and benefits to workers.
5) Strained relationship.
Unavoidable causes:
1) Retirement or death
2) Charge of workers for better performance.
Effects of high labour turnover:

The high labour turnover will increase the cost of production by two ways,
1. Preventive cost
2. Replacement cost
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COST ACCOUNTING
Preventive costs refer to all those expenses incurred by a firm to keep the labour
force. Replacement costs refer to all the losses arising due to new labour force and the
cost of recruitment and training of the new workers.
Labour productivity:
The labour productivity indicated the efficiency of workers. It denotes the power
to produce goods. It is normally calculated by dividing the total output by the total man –
hours.
Overtime works:
It is a work beyond the normal working time. And extra payment at double the
rate of normal wages will be given for overtime work. It will increase the cost of
production. Therefore, it should be avoided as far as possible. Generally, overtime cost is
charged to costing profit and loss account.
Casual Labour:
Casual labourers are the temporary workers appointed for short period to,
a) Increase the production temporarily
b) Fill up the vacancies arising out of leave taken by the workers.
Out workers:
These workers perform their work for the factory outside the factory premises.
They get their remuneration on the basis of finished goods produced by them out of the
materials taken from the factory. Therefore, proper control must be exercised on them
regarding the supply of materials, quality of finished goods and delivery of work within
the scheduled time.
Time study
The time study is an art of observing and recording the time required to do each
detailed element of an industrial operation. This analysis involves the following points:
30
COST ACCOUNTING
1) The worker for this purpose should have average efficiency.

2) The standard cost fixed may change and differ from industry to industry.
3) The person who observes the time study must be very careful.
4) The standard cost should include necessary rest, accidental and unavoidable
delays.
The time study finds out the differences between efficient and inefficient workers
and then provides solution for the improvement of inefficient workers.
Motion study
The method employed in determining the best way to handle the work is know as
motion study. There are 17 fundamental motions which are always combines with every
human activity. Such study helps the elimination of unnecessary movements of workers
and avoids the wastage of energy.
Job evaluation
It means scientific assessment of the content of each job and the demands made
by it on a normal worker. In other words, the value of each job depends on certain
factors. Therefore, job evaluation involves the measurement of these factors. The values
assigned to all these factors in each job are added up. On the basic of such values, the
differences in basic wage rate for different types of jobs are determined.
The important methods of job evaluation are as follows:

1) Ranking method: Under this method, the jobs are arranged in the order of importance.
2) Job classification method: this method involves the establishment of job classes or
grades for each grade or classes; there is a different rate of pay.
Advantages of job Evaluation:

1) It provides a rational wages structure.
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COST ACCOUNTING
2) The information collected through job analysis facilitates merit rating, selection,
training, improvement of working conditions and control of labour cost.
3) It simplifies wage administration.
4) It helps to settle the disputes and grievance regarding individual rates of wages.
5) It brings out uniformity in wage rates.
Merit Rating
Merit rating is a systematic evaluation of the personality and performance of each
employee by his supervisors or some other qualified persons. In other words, it rates or
grades employees on their jobs on the basis of an objective by a comparative review of
their individual performances
The following factors are considered for rating the workers.
1) Ability to perform the work assigned.
2) Knowledge about his job, engineering and manufacturing a operations.
3) Work habits and personal characteristics.
4) Special qualities
5) Supervising ability.
Advantages of merit rating:

1. It provides the basic for judging the conduct and performance of each worker.
2. It brings to light the efficient and in efficient workers.
3. It can be used as a fair and scientific basis for transfer promotion and discharge of
workers.
4. To develops a sense of competition among workers which is a right way for
superior achievement.
Methods of labour remuneration

Time rate system
Under this system, wages are fixed and paid to the workers on the basis of time
which may be hourly, daily, weekly or monthly. (Wages = Time Taken x Time rate). This
may be applied under the following methods:
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COST ACCOUNTING
1) Time rates at ordinary levels: Under this system, wages are paid at a rate on the
basis of time irrespective of the work done by the worker.
2) Time rate at high levels: under this system, a time rate which is higher than the rate
prevailing in that area or industry is adopted to provide an incentive to the workers.
3) Graduated time rate: Under this method the wages rate may vary according to the
changes in the cost of living index.
Advantages
1) If gives the workers a sense of security
2) It simplifies the calculation of wages.
3) It ensures the quality of goods produced.
Piece Rate system
Under this system, wages are pais at a fixed rate per unit of production without
taking into account the time taken to complete the work. (Wages = No. of units produced
X rate per unit).
It is of the following types:

1) Straight Piece Rates: Under this method a fixed amount per unit of production is
given to a worker irrespective of time taken by him.
2) Piece Rate with guaranteed day rate: Under this method, a minimum wage is
guaranteed to a worker. Therefore,
Wages = Minimum guaranteed Wages whichever is higher
Or
Piece rate
Differential piece Rates: Under this method the rates of wages vary according to the
level of output.
Advantages
i) It ensures fairness to every worker.
ii) It brings out the efficient and inefficient workers.
iii) The cost of production can easily be calculated.
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COST ACCOUNTING
iv) It does not require strict supervision
Incentives
All those things which may induce the workers to perform their duties efficiently
are called incentives. They may be in the form of money or in kind. Such incentives are
given in addition to the normal wages.
Kinds of Incentives
There are two kinds of incentives. They are explained as follows:
1. Pecuniary or Financial Incentives:

Incentives given in the form of money are called pecuniary incentives. They may
be direct or indirect. The examples for direct pecuniary are additional wages, bonus etc.
2. Non-Pecuniary or Non-financial Incentives:
All the non – monetary benefits offered to the workers to encourage their
activities are called non-pecuniary incentives. Such incentives are important for
motivating the workers to carry out their duties well. For example, provision of welfare
facilities to the worker.
Incentives Plans of Wage Payments

1) Halsey Premium Plan :
This system is a simple combination of time wage and piece wage systems. The
main features of this system are,
a) A minimum wages to all the workers.
b) Standard time is fixed for the completion of a job.
c) Bonus or premium will be given to the workers for the time saved. It is fixed
at certain percentages in between 30% and 50%.
Advantages:
a. It is easy to understand
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COST ACCOUNTING
b. It encourages efficiency
c. It creates a feeling of security among workers.
d. The profit dure to increased efficiency id shard by both employees and
employers.
2) The Rowan plan :

It is slightly different from Halsey plan. Its important features are –
a. A minimum wages to all the workers.
b. Standard time is fixed for the completion of a job.
c. Premium is given on the basis of time saved. But its calculation will differ
from the Halsey plan. here, the bonus or
Premium - Time saved x Time taken x Hourly
Standard Time
Premium = 4/10 x 6 x 2 = Rs. 4.80
Thus, the worker gets 80 paise as excess premium than the Halsey plan.
Advantages:
1. It is more liberal than Halsey plan as it provides a higher premium.
2. It puts an automatic check on production through the formula. The advantages
of Halsey plan also apply to it.
Taylor’s Differential piece Rate system:

The important features of this plan are as follows:
a. Standard output is fixed after a careful study
b. Two or differential piece rates are fixed for the efficient and inefficient
workers.
4) Gant Bonus Plan:

It is otherwise known as Task Bonus System or Progressive Rate System. Its main
features are,
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COST ACCOUNTING
a. It guarantees the day wage to all the workers.

b. Standard task is fixed after a careful study.
c. Bonus is paid to the worker who shows 100% efficiency or more. The bonus
will be in between 20% and 50% of time taken.
5) Emerson’s Efficiency plan:

In this, a standard time is fixed for each job. A daily wages rate is guaranteed and
a certain standard output is fixed as representing 100% efficiency. The daily wages rate is
paid without bonus to those who show less than two third of efficiency or 66.66% of
efficiency. Beyond this, bonus is paid on a graded scale in a fixed ratio to increased
output. For instance, persons who are 90% efficient may be paid a bonus of 10% of the
daily wage persons with 100% efficiency 60% bonus and so on. The merit of this system
is it encourages workers increasing their efficiency.
6) Merrick Differential or Multiple piece Rate system :

Under this system, there will be three piece rates instead of two in the case of
tailor’s scheme. Here, the time wages are not guaranteed but the standard output is fixed.
If a person produces less than 83% of the standard output he will be paid the lowest piece
rate (say 20paise per piece). If a person produces more than 93% and less than the
standard output, he will be paid secured piece rate which is higher by 10% i.e. 22 paise. If
a person reaches the standard or produces more than the standard output. He will be paid
the highest rate. The rate will be 20% higher than the lowest rate i.e. 24paise. Thus under
this system, the efficient workers are paid more and the others are encouraged to improve
their efficiency.
7) Group Incentive plans or collective bonus system:

Under this plan the worker is done by a group of persons and hence the incentives
are provided to the group as a whole. In other words, the premium or bonus is calculated
for the group and disturbed to the individuals on the fair and just basis. It encourages the
spirit of teams work and co-operation. The difficulty is that inefficient and efficient
workers are getting the same. Hence, it fails to satisfy the efficient workers. It also
36
COST ACCOUNTING
encourages shouldering habit which will not conclude the given task. The important
schemes of this plan are priest man scheme. The collective cost premium bonus system,
the town gains sharing system and the scansion plan.
Profit sharing
Profit sharing is an agreement under which the workers get a share in the net
profits of the business. But it is not a method of wages payment. The reason is a share in
the profits is over and above regular wages.
Features:
a. It is paid in addition to the normal wages
b. The worker. Share in the profit is a predetermined one.
c. It is given only out of net profits when the net profit exceeds a certain limit.
d. It is usually given to all types of workers except a few at the top level.
Calculation of wages under various system of wage payment
I Time rate system

1. Normal Time rate system:
Earning or Wages = Time taken x Hourly rate
2. Guaranteed Time Rate System:
Wages = Time wages as above or Guaranteed wages, whichever is greater.
II Scheme of payment by result

A. Piece rate system
1. Normal piece rate system :
Wages = Output x Rate per piece.
2. Guaranteed Piece Rate system :
Wages = Wages as above (or) Guaranteed wages whichever is greater.
B. Bonus or premium or incentive system
1. Halsey Plan:
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COST ACCOUNTING
Wages = Time wages + Bonus

Note:
Time wages = Time taken x Hourly rate
Bonus = 50% of time saved x Hourly rate
Time Saved = Standard time – Time taken
2. Rowan Plan
Wages = Time wages + bonus
Note:
Bonus = Time saved x Time wages
Time allowed
Efficiency or standard Wages
3. Gantt’s Task Bonus Plan
1. Below standard - Guaranteed time wage
2. At standard - 120% x Time wages
(i.e. 100% time wages + 20% bonus)
3. Above standard - Output x High piece rate
4. Emerson’s Efficiency plan
1. Below 66 2/3% Efficiency - Normal time wages

2. 66 2/3% to 100% efficiency - 120% x Time wages
3. Above 100% efficiency - 120% + 1% bonus for every 1%
efficiency
Above 100% efficiency x Time
wages
5. Taylor’s Differential Piece Rate system
1. Below Standard - Low piece rate x Output Law piece
rate
= (83% x Normal piece rate)
2. At and above standard - High piece rate x Output High Piece
rate = (175% x Normal piece rate)
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COST ACCOUNTING
6. Merrick’s differential Piece Rate Plan

1. Below 82 ½ % efficiency - output x Normal piece rate
2. 83 1/3 to 100% efficiency - Output x (110% x Normal piece rate)
3. Above 100% efficiency - Output x (120% x Normal Piece rate)
7. Bedaux Point Premium System

Wages = (Point allowed + 75% of points saved) Rate per point
Note: 1.One pint or ‘B’ + One minute
2. Point saved = Points earned – Points allowed.
Barth Variable Bonus Plan

Wages = Rate per hour x time allowed x time taken
➢ The labour directly engaged in the production of goods

➢ It is the labour which indirectly helps the direct labour engaged in production.
➢ The ascertainment of cost of production and the recovery of overheads are wholly
based on the labour cost.
➢ Time booking means the recording of time spent by a worker on each job or work
order during the period of attendance in the factory.
➢ Time keeping is recording the time of presence of each worker inside the factory.
➢ Payroll is a part of accounting system in an organization.
➢ Idle time may be defined as that time for which wages are paid but no production
is obtained.
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COST ACCOUNTING
➢ Labour turnover may be defined as the number of workers left during the period
in relation to the average number of workers employed during the period.
➢ Overtime is a work beyond the normal working time.
EXPECTED QUESTIONS
1. Define labour and labour cost.

2. What are the types of labour cost?
3. Write short note on payroll system.
4. Explain the types of labour turnover.
5. What are the advantages of job evaluation?
6. Explain about the merit rating.
7. What are the advantages of merit rating?
8. Explain about the piece rate system.
UNIT – IV
Meaning and classifications of Overheads – Classification according to

function – variability and elements – Absorption of overhead cost – Difference
between cost allocation and apportionment and reapportionment – Predetermined
overhead recovery rates – Over absorption and Under absorption – Meaning and
causes – Accounting of under, and over absorbed overheads.
OVERHEADS
The amount appoint by a concern in carrying on day today work except those on
prime cost are known as overheads. It includes indirect materials, indirect labour and
indirect expenses.
40
COST ACCOUNTING
Classification of Overheads
A) According to Function
1. Production or factory overhead: All indirect expenses incurred inside the
factory are treated as factory overheads. It is absorbed on this basis of direct
material, direct wages, prime cost, direct labour hours etc. Example: Repairs,
depreciation, factory rent etc.
2. Administration overhead: All indirect expenses incurred in the office for

planning, directing and controlling the activities of an organization are known
as administrative overheads. Examples: Office rent, office lighting and other
office expenses.
3. Selling overhead: All expenses incurred for the promotion of sales are known
as selling overheads. Examples: Commission, salesman, salaries,
advertisement expenses etc.
4. Distribution overhead: All the expenses incurred for the supply of finished
goods to the consumers are treated as distribution overheads. Example:
Packing expenses. Ware housing expenses, Transportation expenses etc.
B) According to element of cost:

1. Indirect materials: Fuel, Lubricants, tools for general use etc.
2. Indirect wages: Wages for maintenance and repairs, employer’s contribution
of funds.
3. Indirect expenses: Canteen expenses, depreciation, insurance, taxes, rent and
rates etc.
All these three types of overheads are absorbed by or apportioned to various cost
units. But these overheads cannot be allocated.
C) According to Variability to Variability or Behavior:
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COST ACCOUNTING
1. Fixed overheads: The indirect expenses which remain constant up to a

certain level of production are known as fixed overheads. Examples: Office
rent, manager’s salary etc.
However, these expenses will vary after a certain level of production or
due to variation in prices.
2. Variable overhead: The expense which varies according to the level of

production are known as variable overheads. According to the degree of
variability there are three types of variable overheads
i. 100% variable overhead.
ii. Decrease in overhead when production goes up.
iii. Increase in overhead when production goes up.
3. Semi-variable overhead: the indirect expenses which are neither fixed nor
variable in relation to the level of production are known as semi-variable
overheads. In other words, it is fixed as well as variable (e.g) telephone
Charges
Distribution of overheads
The distribution of overheads to various cost centers involves the following
procedure
I. Classification of overheads:
The overheads of similar nature should be grouped and classified in a
convenient manner. For this purpose, a system known as standing order number is
adopted. Such number denotes particular type of overhead. In other words, each type of
overheads is given separate code number or symbol. A list of all standing order number
and their scope and details should be prepared for easy reference.
Examples of Standing order numbers:

S.O No 1. Consumable stores
S.O.No 2. Sundry materials.
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COST ACCOUNTING
II Collection of overheads:
The following are the main sources for which overhead expenses are collected.
a. Stores requisitions: It helps the collection if indirect materials from stores.
b. Job Cards: The job cards facilitate the collection of wages paid to indirect
labours.
c. Vouchers and invoices: The payment to outside parties for the stores or other
service is collected through vouchers and invoices.
d. Cash book and journal entries: Other expenses like rent, interest etc., are
collected normally by examining the journal and cash book.
e. Subsidiary records: The overheads which are adjusted and which do not
involve cash like accrued expenses are collected from theses records.
III Allocation of overheads:

This is allotment of whole item of cost to cost centers or cost units. In other
words, it is a process of charging the full amount of cost to a cost center or a cost unit.
The allocation can be done only when the cost is definitely relates to a particular cost
center.
(e.g.) Indirect materials, indirect labour etc.
IV Apportionment of overheads:
The expenses which cannot be allocated to cost centers are to be apportioned on
some reasonable basis. The determination of a reasonable basis depends upon the
following principles:
a. Service or use: If the service rendered by a particular item of expenses to
different departments is measurable, this method can be adopted.
b. Survey Method: Where the amount of service rendered cannot be measured,
this method can be adopted. The apportionment will be done on the basis of
the survey made.
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COST ACCOUNTING
c. Ability to pay method: this method is usually applied where it is desired that
overhead should be distributed in proportion to the sales ability, income or
profitability of departments, products etc.
The basis adopted for the apportionment of overheads must ensure accuracy as far
as possible. The following are the common overhead distribution bases adopted.
Overhead Cost Bases of distribution

1. Canteen expenses, time keeping, general Number of employees or wages for each
welfare expenses, compensation and other department.
fringe benefits
2. Depreciation of plants, machinery and Capital values.
equipment’s, fire insurance.
3. Electric Light. No. of light pints, floor space, hours used
watts.
4. Electric power Horse power, horse power multiplied by
hours, kwz
5. Steam. Based on a consumption return or on
potential consumption.
6. Heating, air-conditioning, rent, fire Relative areas or volume of departments.
precaution expenses.
7. Delivery expenses. Weight, volume, ton, mile.
8. Tabulation. Hours used number of cards purchased etc.
9. Audit fees Sales or total cost.
1. Simultaneous equation method:

The total expenses of service departments are straight away transfer to production
departments by solving simultaneous equations under this method.
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COST ACCOUNTING
2. Repeated distribution method :

Under this method, service department expenses are distributed to other
departments, production as well as service, on agreed percentages and this process is
repeated until the figures of the service departments comes to zero.
Absorption of overheads
The total overheads expenses of each department will be available often the
apportionment of overheads. The next stage is to find out the suitable basis for the
absorption of proportionate overheads but the products passing through each department.
The following are the usual bases or rates for the absorption of overheads:
1. Direct materials cost percentage rate
2. Direct wages percentage rate
3. Prime cost percentage rate
4. Labour hour rate
5. Cost unit rate
6. Machine hour rate
1. Direct Materials cost percentage rate:

It is calculated by dividing the amount of overhead to be absorbed by the direct
materials cost incurred or expected to be incurred.
Even though this method is simple, it can be adopted where the materials cost
forms major parts of the cost of production and when the materials prices are stanle. The
greatest disadvantage of this method is it ignores the time factor.
2. Direct wages percentage rate:

It is calculated by dividing the overhead to be absorbed by the direct wages to be
incurred.
This rate is suitable where the rates of pay and the grades of labours remain
constant. However this method is not suitable where the labour is not the main factor of
production and where the workers are remunerated on piece wage system.
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COST ACCOUNTING
3. Prime cost percentage rate:

It is calculated by dividing the overheads to be absorbed by prime cost.
It is a simple method and takes into consideration both materials and labour
element. Its disadvantage is it ignores the time factor.
4. Labour hour rate:

It is calculated by dividing the overhead to be absorbed by the labour hours
expected.
It is applicable where labour is the main factor of production. It is an ideal method
for absorption of overheads because it makes use of the time factor. However, it involves
high clerical cost in recording the labour hours spent on each job.
5. Cost unit rate:

It is calculated by dividing the overheads to be absorbed by the number of units
produced.
It is suitable for industries producing a single product.
6. Machine hour rate:

It is calculated by dividing the overhead to the absorbed by the number of hours a
machine is used for a particular job. In other words, it is the cost for running a machine
per hour.
The expenses relating to the machine cost centers are allocated or apportioned on
some reasonable basis. Then, the machine hour rate is computed by dividing the total
overheads for each cost center by the machine hours.
It is the most accurate method of allotting overhead expenses. However, this
method of allotting overhead expenses. However, this method is not applicable where the
operations of machines are limited.
Under or over absorption of overheads
46
COST ACCOUNTING
The overheads absorbed according to predetermined rates may not be equal to the
actual overheads incurred. This will result in the under or over absorption of overheads.
When the actual overheads are more than the absorbed overheads, the overheads
is said to be under absorbed. Similarly, when the actual overheads are less than the
overheads absorbed, the overheads is said to be over absorbed.
Under or ever absorption of overheads may arise due to the following reasons:
1. Error in estimation overhead expenses.
2. Unexpected changes in the level or methods of production.
3. Seasonal fluctuations in the overhead expenses.
The under or over absorbed overheads will be adjusted in any one of the
following ways:
1. Use of supplementary rates:
Under this method, the overhead distribution summary is revised by adding or
deducting the under or over absorbed overheads calculated on the basis of supplementary
rates. The supplementary rate is arrived at by dividing the amount of over or under
absorption by the actual basis i.e., total labour hours, machine hours etc. this method is
adopted when the amount of over or under absorption is large.
2. Write off to costing profit and loss account:

Under this method, the under or over absorbed overheads are written off by
transferring them to the costing profit and loss account. This method is adopted when the
difference in overhead absorption is very small.
3. Carry over to the nest yr’s accounts:

Under this method, the under or over absorbed overheads are carried over to next
year’s accounts. It will be added to the cost of the ext period. Therefore, it is not a proper
method.
47
COST ACCOUNTING
Miscellaneous Topics
Control of Factory Overheads:
The overheads can be controlled by the following procedure:
1. Overheads should be classified and collected according to variability i.e.,
fixed, variable and semi-variable.
2. The overheads must be budgeted for each class of cost and departments.
3. Necessary steps should to take to find out the variation between actual and
budgeted cost. The causes for variation must be analyzed and reported to the
management for corrective action. In order to simplify this process, standard
costing should be introduced.
Capacity cost:
In computing a predetermined overhead, the different levels of activities of a
factory must be determined. All such levels of activity or capacities are collectively
known as capacity costs. The various capacity costs are as follows:
1. Rate or maximum capacity: It is the maximum productivity or capability of a plant
or department. It can be achieved rarely when there is no loss of time in actual
practice. Therefore, it is only an ideal or the theoretical capacity.
2. Practical capacity: It is the maximum capacity less unavoidable losses due to

repairs, breakdown, holidays etc. however, is doesn’t takes into account the abnormal
factors affecting production.
3. Capacity based on sales expectancy: This is the capacity based on the sales
expected and is determined after a careful study of the market conditions.
4. Actual capacity: This is the capacity based on the sales expected and is determined
after a careful study of the market conditions
5. Actual capacity: It is the capacity actually achieved in a particular period
48
COST ACCOUNTING
6. Normal capacity: There are two views regarding normal capacity:

According to one view, it is the long term average capacity based on expected
sales. According to another view, it is the capacity to make or produce.
The abject of normal capacity are:
a. Determination of pre-determined overheads.
b. Setting up of standards.
c. Fixation of budgets.
d. Control of costs.
e. Valuation of inventory.
7. Idle capacity :
Idle capacity is that part of the capacity of a machine or equipment which cannot
be utilized profitably. In other words, it is the difference between the practical capacity
and capacity based on expected sales. For example, if the practical capacity of a machine
is 100 units per hour and it produces only 75units per hour, there is an idle capacity of 25
units per hour.
Causes of idle capacity:

1. Setting up repairs and other adjustments of machines.
2. Lack of power, materials and tools.
3. Strikes and lock outs/
4. Seasonal fluctuations.
Treatment of Idle Capacity cost:

The idle capacity cost is computed by multiplying the idle capacity by the normal
rate. The idle capacity is of two types.
1. Normal or unavoidable idle capacity, the cost of which is normally absorbed in cost
account by the inflation of rates.
2. Abnormal or avoidable idle capacity, the cost of which is charges to profit and loss
account.
Administration overhead
49
COST ACCOUNTING
Administration overheads are the indirect expenses incurred in formulating

polcies, directing and controlling the activities of an organization to achieve its objects.
Examples : Stationery, telephone charges, office salary, postage. Director’s fees,
Auditor’s fees etc.
Treatment of Administration Overhead:

1. Transfer to profit and loss account: Under this method, the administration overhead
is treated as a fixed cost and therefore, transferred to costing profit and loss account
of the period in which it ours. It is based on the principle that the administration
overheads are not directly related with production or sales. The main drawback of this
system is that ir leads to the under estimation of the cost of a product.
2. Apportionment to manufacturing and selling division: Under this, the

administration overhead is divided between the production and sales departments on
some reasonable basis. It is based on the principle that each organization has only two
functions, namely production and sales and all other function are only incidental to
these basic functions. The difficulty in this system is to find out the basis for
apportionment.
3. Treatment as a separate item of cost: In this method, administration overhead is

added separately to the cost of a product. It is based on the assumption that the
administration department in a separate functioning department like production and
sales departments
.
Selling and distribution overheads
Selling overhead:
All expenses incurred for the promotion of sales are known as selling overheads.
Examples: Commission, salesmen salaries, advertisement expenses etc.
Distribution overheads:
50
COST ACCOUNTING
All the expenses incurred for the supply of finished goods to the consumers are
treated as distribution overheads. Examples: Packing expenses, warehouses expenses,
transportation charges etc.
Difference between:
Selling overhead Distribution overhead
1. It promotes sales. 1 It moves the goods to the customer’s
2. Its object is to find and retain 2 place.
customers. Its object is to deliver the goods safely
at the required place.
Absorption of selling and distribution overheads:

These overheads may be absorbed under any one of the following methods:
i. A percentage on the selling price:

A percentage of selling and distribution expenses to sales is determined
and this percentages is added with cost of a product.
ii. A percentages on factory cost:

A percentage of selling and distribution expenses to factory cost is
determined and this percentages id added with the cost of a product.
iii. Estimated rate per unit:

Under this method, the total estimated selling expenses is divided by the
total number of estimated units to be sold and thus the selling and distribution rate per
unit is determined.
Control of Administration, Selling and Distribution Overheads

The control of these overheads is possible by the use of budgets and standards.
These overheads should be classified and collected according to their variability. The
51
COST ACCOUNTING
actual overheads should be compared with their budgeted and standard figures and
standard figures and deviations if any should be reported to the management for
corrective action.
➢ The amount appoint by a concern in carrying on day today work except those on
prime cost are known as overheads.
➢ All indirect expenses incurred inside the factory are treated as factory overheads
➢ All expenses incurred for the promotion of sales are known as selling overheads.
➢ The allocation can be done only when the cost is definitely relates to a particular
cost center.
➢ The expenses which cannot be allocated to cost centers are to be apportioned on
some reasonable basis.
➢ The total overheads expenses of each department will be available often the
apportionment of overheads.
EXPECTED QUESTIONS
1. Define overhead.
2. Explain the Classification of Overheads
3. Explain the distribution of overheads.
4. Explain the Absorption of overheads
5. Discuss about Under or over absorption of overheads
6. Enumerate the Absorption of selling and distribution overheads?
UNIT – V
52
COST ACCOUNTING
Features of process costing – Comparison between Job costing and Process

costing – Process losses – Inter – process Profits - Equivalent Production – Joint –
Products and by products – Distinction between by – products, main products and
joint products. Reconciliation of cost and financial accounts
PROCESS COSTING
The system adapted to certain the cost of each process of production in known as
process costing. It is suitable for industries where a product passes through different
processes for completion. In other words, it is a system adopted in industries where the
finished product of one process is the raw material of the next process. This system is
suitable for industries like cotton textile, paper, and sugar, chemical and mining.
Feature on process costing

1. The production is continuous.
2. The production is uniform.
3. The order of processing a process is specific and pre-determined.
4. The costs are collected process-wise.
5. The finished product of one process will be the raw material for the next process until
the final product is obtained.
Wastage’s or Losses
Normal Wastage or loss: It is an unavoidable loss in the process of manufacture. It may
arise due to evaporation, spoilage etc. the cost of such wastage should be absorbed by the
good units produced. Therefore, no separate treatment is necessary for normal losses in
cost accounts.
Abnormal loss or wastage: The abnormal losses are avoidable but may arise due to
negligence or maladministration. Such wastage’s should be valued as like completed
units and should be charges to costing profit and loss account.
53
COST ACCOUNTING
Abnormal gain
Sometimes, the production may exceed the expected one due to efficient and
careful operation. Such increase in production is known as abnormal gain. It will result
from the reduction in normal loss.
It should also be calculated in the same manner as an abnormal loss but credited
to costing P & L a/c.
JOB COSTING
Job costing
This system is adopted in industries when each job has a separate identity and is
produced against specific orders. The costs are collected for each job separately under
this system. This method is also known as lot costing, specific or production order.
Features
1. The goods are produced against customer’s order and not for stock.
2. There is no uniformity in the process of production.
3. Each job has a separate identity and needs special treatment.
4. The work in progress differs from period to period.
This system is applicable to engineering and printing works.
Advantages:
1. It enables the management to know the profitability of various jobs.
2. It helps the management to know the operating efficiency of different factors of
production by providing the detailed analysis of cost and to control the same.
3. It enjoys the benefits of budgetary control and provides the basis for future
production planning.
4. It helps to reduce spoilage and defective works.
Disadvantages:
1. It is expensive to record the costs for each job.
54
COST ACCOUNTING
2. The jobs costing without budgetary control or standard costing is of no use in

controlling costs because it is only on actual costing or historical costing method.
CONTRACT COSTING
It is similar to job costing. But requires a long period for completion. It is applied
in industries engaged in construction works. Under this system, a separate account is
opened for each contract and each contract is considered as a separate cost unit.
Work Uncertified
When any work done by the contractor has not reached a stipulated stage, the
contractee’s engineers will not certify that work. Such a work which is not so certified is
known as work uncertified. It will not be considered by the contractee while making
payment to the contractor. However, the contractor will record it on the debit side of
work in progress account and credit side of contract account.
Work certified and Retention Money

The contractor receives money from to time on the basis of a certificate issued by
an architect or surveyor about the work completed. Such certified work is known as work
certified.
The value of work certified will not be paid in full to the contractor. A part of it
will be retained as security as security for any defective work which may arise in future.
Such retained amount is known as retention money.
Cost plus contract

It is a contract entered into when into when the cost of materials and labour are
not stable. Under this contract, the contract price is arrived at by adding up a certain
percentage of profit to the cost of work.
Advantages:
55
COST ACCOUNTING
1. There is no risk of loss to the contractor as he is protected from price

fluctuations. He knows the profit expected from a contract in advance.
2. Since the contract price depends on cost, the contractee is ensured or
reasonable price.
Disadvantages:
The contractee cannot ascertain the final price in advance. The contractor will
loose the benefits when the market conditions are favorable to him.
Escalation Clause
It is a clause provided in the contracts to cover up any change in the prices of
materials, labour etc. the object of this clause is to safeguard the interest of both the
parties against unfavorable change in the prices.
Work in Progress:
The work or contact which is incomplete is known as work in progress, in
contract accounts, such work in progress in calculated by deducting the profit kept as
reserve from the cost of certified and uncertified completed work.
Profit on incomplete contracts

To take profit into account on incomplete a contracts, the following precautions
should be taken.
1. Sufficient reserves should be made for contingencies.
2. In case of contracts with government department the possibility of price refund
should be considered.
3. The work which has reached a sufficiently advanced stage of completion alone should
be considered.
Amount or profit to be transferred to profit and loss account

The amount of profit to be transferred to P& L a/c during the contract in progress
will be calculated in the following manner:
56
COST ACCOUNTING
1. When the contract is not reasonably advanced :

The contract is said to be not reasonably advanced when the work verified is less
than ¼ of the contract price. In such certified is less than ¼ of the contract price. In such
case, no profit should be transferred to profit and losses account.
2. When the contract is reasonably advanced :

A contract is said to be reasonably advanced when the work certified is ¼ or more
of the contract price. In this case, the profit to be transferred to profit and loss account
will be calculated by using the following formulas:
1. If the work verified is between ½ and 1.2 of the contract price :
Estimated profit x 1/3 x Cash received

Work certified
2. If it is more than ½ of the contract price:
Estimated profit x Cash received

Work certified
3. When the contract is almost complete:

In this case, the estimated profit is arrived at by debiting all the expenses
9insurred plus the estimated future expenses) to complete the contract and by crediting
the contract price to the contract account. Then, the profit to be credited to profit and loss
account will be calculated by using the following formula:
Estimated profit x Work certified x Cash received

Contract price Work certified
57
COST ACCOUNTING
Notional or Estimated profit

The estimated profit resulting from incomplete contracts in known as notional
profit. Such profits is not an accurate profit since it is arrived at by taking into account the
value of work in progress which is based on estimates. Therefore, the national profit
should not be transferred in full to the costing profit and loss account. A part of it it must
be kept as reserve in order to meet the contingencies.
Difference between Job costing and contract costing
Job Costing Contract costing

1. It is a costing method for jobs which 1. It is costing methods for jobs which
require only jobs which require only a little require huge capital require huge capital
capital and short period for completion and long period for completion.
2. it is suitable for industries like 2. It is suitable for construction works like
engineering, printing etc. construction of buildings and bridges
laying or roads etc.
3. It does not require elaborate accounts 3. It requires elaborate accounts.
4. There is no complication as regards the 4. as regards incomplete contracts, there are
transfer of profit from jobs to profit and number of complications in determining
loss account. the profit to be transferred to profit and loss
account.
Inter-process Profit
This profit may arise then output from pone process to another process is
transferred not at cost price but at cost plus profit. The object is to make each process
stand on its own efficiency and economies. Nut this system involves unnecessary
complication of accounts.
58
COST ACCOUNTING
Joint product
When two or more products of equal impotence are simultaneously produced
from the same raw materials, such products are known as joint products. E.g. : Oil
refining. Therefore, joint products, implies the followings:
1. They are produced from the same raw material.

2. They are comparatively equal importance.
3. They are produced simultaneously by a common process.
4. They may require future process offer the point of separation.
By-Product
By products are products of comparatively small value that are produced
simultaneously with a product of greater value (Main product). Eg.Sugar and Molasses.
Scrape
It is the residue from the materials used in the process of manufacture. The scarp
may be realized without further processing. Such realized value of scrap is credited to
profit and loss account or to the concerned process or job account.
Spoilage
The loss due to defective gods which cannot be rectified economically is known
as spoilage. If spoilage is normal, it is treated as a part of cost of production. If the
spoilage is abnormal, it should be charged to costing profit and loss account.
Equivalent Production
It represents the production in terms of completed units. In other words, it means
converting the incomplete units into their equivalent completed units. Thus, it solves the
problem of balancing work in progress in each process. It came be ascertained by the
following formula:
Equivalent units of work in progress = Actual number of units in process of
manufacture x Percentage of work completed.
59
COST ACCOUNTING
RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
The accounting procedures adopted in financial accounts differ from those

adopted in cost accounts. As a result, the result or profits disclosed by these accounts may
also differ. Therefore, it is become necessary to reconcile their two accounts and to find
out the reasons for the difference. Such reconciliation ensures that no income or
expenditure has been omitted or incorrectly recorded. It also enables to that the accuracy
of cost accounts.
Reasons for disagreement
1. Items recorded in differential accounts only like financial incomes (e.g.) Interest and
dividends in investments and financial expenses (e.g.) interest on lean, damages paid
etc. but these items will not appear in cost accounts.
2. Items recorded in cost accounts but not in financial accounts like rent for own
premises.
3. Under or over absorption of overhead expenses.
4. Adoption of different methods for stock valuation and depreciation,
Accounting procedure
Profit as per cost account XXX

Add : incomes omitted in cost account XXX
Cost accounts only
Under valuation of closing stock and over valuation of opening
Stock in cost accounts XXX
XXX
Less : Incomes stated in cost account only XXX

Expenses under stated or omitted in cost accounts XXX
60
COST ACCOUNTING
Over valuation of closing stock and under valuation of opening stock XXX
XXX
Profit as per financial account XXX
The above statement will be reversed when you will start with profit as per
financial account.
Memorandum Reconciliation Account
When the reconciliation of cost and financial accounts is done in an account form
instead of a statement, such account is known as memorandum reconciliation account. In
this account, the profit worth which it is started should be shown as a first item on the
right side. Then the items to be added with that profit to be deducted should be written on
the left side. The difference between the two sides will be a loss or profit in the account
apposite to the account with which the reconciliation account is started.
➢ The system adapted to certain the cost of each process of production in known as
process costing.
➢ It is an unavoidable loss in the process of manufacture.
➢ The abnormal losses are avoidable but may arise due to negligence or
maladministration.
➢ Such increase in production is known as abnormal gain
➢ This system is adopted in industries when each job has a separate identity and is
produced against specific orders.
➢ Two or more products of equal impotence are simultaneously produced from the
same raw materials; such products are known as joint products.
➢ By products are products of comparatively small value that are produced
simultaneously with a product of greater value.
61
COST ACCOUNTING
➢ The accounting procedures adopted in financial accounts differ from those

adopted in cost accounts.
➢ When the reconciliation of cost and financial accounts is done in an account form
instead of a statement, such account is known as memorandum reconciliation
account.
EXPECTED QUESTIONS
1. Define process costing.

2. Explain the features on process costing.
3. Write short note on abnormal gain and loss.
4. Define job costing.
5. Explain the features on job costing.
6. What are the merits and demerits of job costing?
7. Distinguish between job costing and process costing.
8. Write short note on equivalent production.
9. Write the format for reconciliation statement.
10. Write the format for Memorandum Reconciliation Account
62

Cost FINAL

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COST ACCOUNTING

Introduction of Cost Accounting – Meaning and definitions – Difference between

Necessity of importance of costing:

3. Business policies: It guides the management in taking decisions regarding various

Objectives of cost accounting:

4. Expensive: It is quite an expensive system. Therefore, big industries alone can

Financial Accounting Cost Accounting

1. It provides general information about

Installation of cost accounting

Problem in installing a costing system and suggestion to overcome them

4) According to managerial decision:

ix) Avoidable cost: It is the cost which can be eliminated on the

Expenses and incomes excluded from cost accounts:

5. Interest on back deposits.

Cost sheet/Statement of cost/production statement

Factory cost or works cost XXX XXX

Profit XXX XXX

Cost / amount of the concerned items

Purchasing: It means procurement of materials, supplies machines, tools and services

Duties of store keeper:

4. He should issue the stores only against a properly authorized requisition.

INVENTORY OR MATERIALS CONTROL

Economic order quantity or Re-order quantity:

Perpetual inventory system

It is carried out with the following three ways

Advantages of perpetual inventory system

2. The difference is easily located and rectified.

Turnover of materials or inventory:

Materials consumed = opening stock + purchases – closing stock

Average inventory = opening stock + closing stock

Pricing the issue of materials

Average price = Value of materials in hand + Value of materials received

III. Replace or market cost:

4. Defectives: The defective materials which can ne economically rectified are

3. Goods received note

4. Materials or stores requisition

6. Materials return note

7. Materials transfer note

➢ It means procurement of materials, supplies machines, tools and services

1. Explain the Purchasing Procedure.

Control over labour costs

Methods of time keeping

Pay roll accounting

Causes of Idle Time:

Treatment of Idle Time cost:

Measurement of labour turnover:

Effects of high labour turnover:

1) The worker for this purpose should have average efficiency.

The important methods of job evaluation are as follows:

Advantages of job Evaluation:

Advantages of merit rating:

Methods of labour remuneration

It is of the following types:

iv) It does not require strict supervision

1. Pecuniary or Financial Incentives:

Incentives Plans of Wage Payments

2) The Rowan plan :

Taylor’s Differential piece Rate system:

4) Gant Bonus Plan:

a. It guarantees the day wage to all the workers.

5) Emerson’s Efficiency plan:

6) Merrick Differential or Multiple piece Rate system :