Business Accounting

& Finance
(ACC:501)

Credit Hours- 4 Credits

Hari Dallakoti
 Chapter – Three

Cost
Management
and Reporting
 Cost Concepts
 Cost refers the amount of expenses spent to generate product or
services.
 Cost refers expenditure that may be actual or nominal expenses
incurred to generate output.
 Cost is the value of economic resources used as result of producing
or doing the things.
 Cost has many meaning but in management cost refers the
expenditure not the price.
 As a manager we use cost information for taking decisions and
making plans, programs and policies and strategies.
 Classification of Cost
Basis Costs
Elements  Direct material
 Direct labor
 Direct expenses
 Overheads
Function  Manufacturing costs
 Non-manufacturing costs
Behavior  Variable cost
 Mixed cost
 Fixed cost
Decision Making  Relevant Cost and Irrelevant Cost
 Avoidable and Unavoidable Costs
 Out of pocket costs, Opportunity, Sunk costs
 Period Cost and Product Cost
 Direct and Indirect cost
 Controllable and Uncontrollable Cost
 Incremental Cost and Differential Cost
 Committed fixed cost and Discretionary fixed Cost
 Manufacturing and Non-Manufacturing Costs
 Manufacturing Costs
 Manufacturing costs involves the cost of raw material, labour and
use of equipment to finished goods.
 Composed up of the following elements:
 Direct material
 Direct labour
 Overheads
 Non manufacturing Cost
 Cost other than manufacturing cost that are incurred for sale.
 Non-manufacturing costs are:
 Selling expenses /marketing expenses
 Promotion, or Advertisement costs
 Administrative costs
 Variable Cost
 Variable costs are based on activity.

 They change with changes in activity level in a responsibility center.

 If output is doubled, variable expenses is to be doubled.

 If output increases by 15% the variable expenses also increase by 15%.

 If output is zero, the variable cost also zero.

 Variable costs are usually characterized by:

 Unit cost remains constant.

 Total costs that increase as activity increases.

 Total costs that decrease as activity decreases.

 Total costs changes proportionality with changes in output.

 Fixed Cost
 Fixed cost is also called period cost or capacity cost.
 It does not change in short term period or within a relevant range.
 They accrue primarily with the passage time.
 Fixed costs are caused by holding of assets and other factors of
production in a state of readiness to produce.
 Characteristics of fixed cost are:
 Unit cost increase as activities/outputs decrease.
 Costs that remain constant even activities are decreased or
decreased
 Cost per unit that increases as activity decreases and vice versa
 Total costs that remain constant.
 Contd.
• Committed fixed cost
 Committed cost arises from the ownership, facilities or possession
of assets.
 Committed cost can not be changed by a simple decision.
 Major decisions is required to change.
 Example of Committed fixed cost are: Property tax, Loan
installments, Depreciation, Insurance etc.
• Discretionary fixed Cost
 Arises from management decision.
 Controllable costs.
 Can be easily changed by decisions.
 Examples of Discretionary fixed cost are: Advertisement,
Training costs, Marketing expenses, Promotional expenses etc.
 Step Fixed Costs
 Remains constant over fixed range of activities but jumps to

different amount for the activities levels outside the range

 Semi–Variable Expenses or Mixed Costs
 Semi–variable expenses also changes with changes in output
or activity but not in proportion to changes in activity or
output.

 Semi variable expenses have some of the characteristics of

both fixed and variable costs.

 Semi variable expenses are caused by combined effect of

passage of time, activity or output and management
discretion decisions.
Relevant Cost and Irrelevant Cost
 Costs and expenses which are directly influenced by decision are
relevant costs.
 All future cost are relevant cost.

 They are pertinent and valid costs.

 Relevant costs include all variable costs and additional fixed costs
which are incurred because of the decision being taken.
 Costs that cannot be changed are called irrelevant costs.

 Irrelevant costs include the existing fixed costs which are going to
exist even after the decisions are taken.
 Such costs do not affect the decision.
 Controllable and Uncontrollable Cost
 Controllable and uncontrollable cost depends on the point of
reference.
 Uncontrollable cost at lower level may be controllable at top
level, uncontrollable in short term may be controllable in the long
run. etc.
 A cost is a called controllable at particular level if the level has
power to authorize the cost.
 If it has not, it is called uncontrollable cost.
 Avoidable and Unavoidable
Costs
 Avoidable costs can be saved simply by not doing the alternative
courses of action.
 They are relevant in decision making

 Unavoidable costs are irrelevant cost because they can not be

avoided or eliminated by taking decisions or alternatives.
 If the revenue generated by avoidable cost is high, we have to
take decisions.
 Direct Cost and Indirect Cost
 Direct costs are directly traceable or identifiable to a particular

job or department or product and are controllable.

 Indirect costs are uncontrollable and no-traceable costs.

 Cost may be direct but the same may be indirect depends on the

situation.
Incremental Cost and Differential Cost
 Cost difference between two alternatives.

 If differential costs are increased, it is called incremental cost and

decreased, and called decremental cost.
 Incremental cost refers the only the increased cost from one
alternative to another.
 Differential cost or incremental cost can also be used to analyze
alternatives for decision-making purpose.
 Product Costs and Period Cost
 Product costs are manufacturing costs.

 They are incurred for the manufacturing of goods.

 They include direct material, direct labor, and manufacturing

overheads.
 Example: Direct material, labor cost, manufacturing overhead etc.

 Period costs are not manufacturing cost. However, they are

incurred and paid based on the period
 They are deductible from revenue.

 Example: Rent, salaries, telephone etc.

 Out of Pocket Costs, Sunk Costs, Opportunity Costs
 Out of pocket costs are the expenses incurred for activities for raw
materials, labour overheads etc.
 Sunk costs are the cost incurred a result of past decisions.

 They can not be changed by taking operating decision

 They are irrelevant from decision making.

 Example of Sunk costs are depreciation of assets, lease rent etc.

 Opportunity costs are not recordable in the books of account but are
considered in every decisions of managers.
 It is the amount of benefit that is sacrificed when one alternative is
selected.
 Methods of Cost Segregation

 Engineering analysis

 Accounting analysis

 High Low point methods

 Least Square Regression Analysis

 Engineering Analysis
 Systematic review of costs for product and
services.
 Measuring cost behaviors according to what cost
should be, not by what have been.

Mixed Cost Function = Rs4,000 + Rs.600 X Per Day

 Accounting Analysis
 This is a simple method.
 Segregates cost into fixed and variables based on certain cost
driver.
 Example: A Manufacturing Company produced and sold 80,000
units at Rs. 50 each. The cost for 2014 were as follows:
Particular Fixed Cost Variable Cost
Direct materials - Rs.200,000
Direct labour - 160,000
Manufacturing overhead Rs.440,000 20,000
Selling and admi. expenses 280,000 100,000
Mixed cost function = Rs.720,000 + Rs.6 X units of production
 High Low Point Method
• Under this method, semi variable cost can be segregated into variable and fixed
cost based on the two extreme levels of activities using the following formulas.
• Variable rate (b) = [Cost at high point- Cost at low Point]
[High point –Low point]
• Fixed cost (a) = Total cost – Variable rate  Level of activities
• Therefore, the cost volume formula:
• Total cost = Fixed cost + (Variable rate  levels of activities)
Advantages:
• It is easy and less time consuming.
• Cost behavior is restricted to the relevant ranges.
• It will be more suitable when there are two levels of activities to estimate cost.
Disadvantages
• Use of only two extreme conditions may not be representative of normal
conditions
• It may give the unreliable estimate of fixed cost (a) and variable rate (b).
• It does not specify the fixed cost below and above the two levels of activities.
 Least Square Analysis
 One of the best and widely used methods in cost estimation,
 A statistical procedure for estimating mathematically the average
relationship between the dependent variable (y) and independent
variable (a).
 It includes all the observed data and attempts to find the line of
best fit in estimation of variable and fixed cost.
Y = a + bx
Where, a = Estimated fixed cost i.e. constant
b = Variable rate i.e. slope of regression line
Y = Dependent variable i.e. estimated total cost
X = Independent variable i.e. Level of activity
or units of products, hours etc
Least Square Formula
N  XY   X  Y
b
N  X 2   X 
2

 X  Y   X  XY
2

a  Y  bX 
N  X   X 
2 2

Where
a  fixed cos t
b  var aible rate
X  levels  of  activities
 Example
The details of cost of goods sold at various levels of sales
activities of a manufacturing company have been presented
below.
Production units Cost of goods sold (Rs.)
100 200
200 300
300 400
400 500
500 600
Selling price per unit will be Rs.20 per unit.
Required: Segregation of cost by using least square method.
 Solution
Output (x) Cost of goods x2 xy y2
sold (y)
100 200 10,000 20,000 40,000
200 300 40,000 60,000 90,000
300 400 90,000 120,000 160,000
400 500 160,000 200,000 250,000
500 600 250,000 300,000 360,000
x = 1,500 y = 2,000 x2 = 550,000 xy = 700,000 y2 = 900,000

N  XY   X  Y
b = = = Rs. 1
N  X   X 
2 2

a
 X  Y   X  XY
2

= =
N  X   X 
2 2

= Rs. 100
 Product Cost Determination
 Cost refers the amount of expenses spent to generate product or services.
 It is the value of economic resources used for producing the things.
 The cost of manufacturing a product is called product cost.
 Product costs are taken for inventory valuation so sometimes called
inventory cost and needs to be determined.
 Unless the product cost is determined, a business firm will not be able to
determine the profitability as well.
 Raw material cost, labor cost, manufacturing overhead etc. are example of
a product cost.
 Product cost is the combination of direct cost and indirect cost.
 Direct cost can be traced straightly to the unit of product but indirect cost
can not be traced easily.
 For the purpose of determining the product cost, it is necessary to
calculate and apportion the indirect cost in to per unit of product.
 Contd.
 Manufacturing overhead costs are incurred on an annual basis and paid.
 These costs do not become a physical part of the product and are not
incurred directly to assemble the product.
 It is difficult to determine exactly how much overhead cost is incurred to
make one product as the product is being manufactured.
 Without tracing the overhead in to per unit of product, determination of
product cost is not possible.
 The firm first accumulates overhead costs and then assigns the costs to
the products or services which provides managers cost information for
strategic and other decisions.
 There are two different systems of determining the product cost.
 Traditional Costing System: Based on labor hour or machine hour.
 Activity Based Costing System: Based on Activity pool.
 Traditional Costing System
 Generally, manufacturing companies use the traditional costing system
to assign manufacturing overhead to units produced.
 Make the assumption that the volume metric is the underlying driver of
manufacturing overhead cost.
 Under this costing, accountants assign manufacturing costs only to
products.
 Fails to allocate nonmanufacturing costs associated with the
production, such as administrative expenses.
 Useful for external financial reports because it provides a value for the
cost of goods sold.
 Under this costing system, overheads are determined on the basis of
labour hour or machine hour used.

 Overhead Rate per Labor Hour =

 Overhead Rate per Machine Hour =

 Activity Based Costing System
 Activity Based Costing is an important and improved costing system
under cost accounting system.

 It is a costing system that first accumulates overhead costs for each of

the activities and then assigns the costs to the products or services.

 It is designed to provide managers the cost information for strategic

decisions.

 It is an approach to allocate all direct and overhead costs to cost objects

in order to help management understand critical business information.

 It is ordinarily used as a supplement to the company’s usual costing

system.
 Contd.
 In ABC system, overhead activities are identified and then costs to
perform these activities are traced to the activities using appropriate cost
drivers.
 But in traditional costing system, the portion of total overhead allocated
to a product depends on the proportion of total direct labour hours
consumed in production of product.
 Though complex and expensive, more organizations are adopting ABC
system both in manufacturing and non-manufacturing industry.
 It allocates direct and indirect costs to products and services based on
the level of activities used to create and deliver those products and
services.
 Compared to traditional accounting, activity based costing is a decision
making tool which provides more accurate cost and profit information
and allows management to understand the cost and profit drivers and
improve their business.
 Steps for Design and Implementation of ABC System
 Activity based costing is an approach for allocating overhead
costs.
 ABC system classifies more costs as direct costs than traditional
costing system and ensures greater confidence in the accuracy of
the costs of product or service.
 The following steps will be taken to design and implementation of
ABC system-
 Determine cost objectives, key activities, resources and
related cost drivers.
 Develop a process based map representing the flow of
activities, resources and their interrelationship.
 Collect relevant data concerning costs and the physical flow
of the cost driver units among resources and activities.
 Calculate and interpret the new activity based information.
 Cost Management System
 Cost management system helps to identify how management
decisions affect costs.
 It helps to measure the resources used in performing the activities
and then assessing the effects on costs of changes in those activities.
 Gives importance to activity based management.
 Activity based management is a technique that uses the ABC system
to improve the operation of an organization.
 Activity based management also distinguishes the value-added costs
and non- value- added costs.
 Value- added costs are the costs that can not be eliminated without
affecting a product’s value to a customer.
 Non- value- added costs are the costs that can be eliminated without
affecting a product’s value to a customer.
 Non- value- added costs need to minimize for the better
performance.
 Common Classification System
 ABC costing system provides a structured way of thinking about
relationship between activities and the resources they consume.
 Unit-level activities: Activities performed for each unit of
production.
 Batch-level activities: Activities performed for each of bath of
products.
 Product-level activities: Activities performed in support of an
entire product line.
 Facility-level activities: Activities required to sustain an entire
production process.
 Possible Cost Drivers
 Machine hours
 Direct labor hours
 Number of set-ups
 Number of products
 Number of purchase orders
 Number of employees
 Number of square feet
Difference between Traditional & ABC Method
 In traditional cost accounting it is assumed that cost objects
consume resources whereas in ABC it is assumed that cost
objects consume activities.
 Traditional cost accounting mostly utilizes volume related
allocation bases while ABC uses drivers at various levels.
 Traditional cost accounting is structure-oriented whereas ABC is
process-oriented.
ABC differs from traditional cost accounting in three ways.

Manufacturing costs Nonmanufacturing costs

Mo
st, b

Some
All

not ut
all
Traditional ABC
product costing product costing

ABC does not assign all manufacturing costs to products.

 Just- In- Time Systems
 JIT system is a system in which an organization purchases
materials and other resources and produces goods just when they
are needed.
 It is used to improve profitability of an organization by eliminating
waste and improving quality.
 It helps for improvements result in reducing operating costs and
improving profitability.
 It is for maintaining zero inventory to minimize costs as the
inventory holding costs is non- value- added costs.
 This system gives focus on quality of goods, production cycle
time, production without interruption and flexible production
system.
 This system adopts the cellular manufacturing process which is the
production system in which machines are organized in cells
according to the specific requirements.
 Elements and Objectives of Just- In- Time Systems
 Three important elements must exist for JIT systems to work:
 Dependable suppliers who can delivery on short notice.
 Multi-skilled workforce who can work in work cells or work
stations- One worker may operate several kinds of machines.
 Total quality management- Objective is no defects.
 Objectives of JIT
 Reduction or elimination of inventories
 Enhanced production quality
 Reduction or elimination of rework costs
 Production cost savings from improved flow of goods
through the process.
 Manufacturing Systems
Traditional Progressive
 Just-in-Case: Inventories of  Just in Time: Raw materials
raw materials are maintained arrive just in time for use in
just in case some items are of production and finished goods
poor quality or key suppliers are manufactured just in time
don’t delivery on time. to meet customer needs.
 Push approach manufacturing:  Pull approach manufacturing:
Materials are pushed through Raw materials are not put into
the manufacturing process. the process until the next
department requests them.
 Based on standard costs. Once  Continuous quality
a standard is reached improvement.
improvement ceases.
 Example of Activity Based Costing
The following are the particulars of an industry that manufactures two
products.
Product X Product Y
Output in units- 4,000 6,000
Labour hour per unit- ¾ hour ½ hour
Number of supervision per production run- 4 5
Machine hour per unit- 1.5 hour 1 hour
Production runs- 20 30
The expenses incurred for the realization of the above outputs are as follows-
Production setting- Rs. 25,000
Supervision- Rs. 23,000
Machine operation- Rs. 24,000
Required- Overhead per unit under
i) Traditional Costing and
ii) Activity Based Costing
 Solution
i) Calculation of overhead rate under Traditional Costing:
Production setting- Rs. 25,000
Supervision- Rs. 23,000
Machine operation- Rs. 24,000
Total Overhead Rs. 72,000

Total labour hour used = Units produced × Labour hour per

unit
= (4,000 × ¾) + (6,000 × ½)
= 3,000 + 3,000 = 6,000 hours
Labour hour rate = Total Overhead/ Total labour hour
= 72,000/ 6000 = Rs. 12

Overhead rate per unit = Labour hour rate × Labour hour per unit
For X = Rs. 12 × ¾ = Rs. 9
 Contd.
ii) Calculation of overhead rate under Activity Based Costing-
Calculation of cost driver rate and total costs

Activity Costs Cost Cost driver volume Cost driver Overheads

( in Rs.) driver X Y Total rate X Y
Production Production
setting- 25,000 run 20 30 50 500 10,000 15,000
Supervision- 23,000 No. of
supervision 80 150 230 100 8,000 15,000
Machine Machine
operation- 24,000 hours 6,000 6,000 12,000 2 12,000 12,000

Total Overhead 30,000

42,000

Output in units 4,000

6,000
 Limitations of ABC Costing
 There are five limitations of activity-based costing.
 Implementing an ABC system requires substantial resources.
 ABC systems produce numbers that are at odds with the numbers
produced by traditional cost systems and thus ABC unavoidably faces
resistance.
 This underscores the importance of having top management support and
cross-functional involvement with, the ABC implementation. Most
managers insist on fully allocating all costs to products.
 ABC systems do not automatically identify the relevant costs for
particular decisions; therefore, ABC data can be easily misinterpreted
and must be used with care when making decisions.
 Most organizations use ABC as a supplement to, rather a replacement
for, their existing cost system. Maintaining two cost systems is costlier
than maintaining just one system and it may cause confusion about
which set of numbers is to be relied on.
 When do We Use ABC Costing?
 When one or more of the following conditions are present:
 Product lines differ in volume and manufacturing complexity.
 Product lines are numerous and diverse, and they require
different degrees of support services.
 Overhead costs constitute a significant portion of total costs.
 The manufacturing process or number of products has changed
significantly—for example, from labor intensive to capital
intensive automation.
 Production or marketing managers are ignoring data provided
by the existing system and are instead using “bootleg” costing
data or other alternative data when pricing or making other
product decisions.
 Activity Based Management
 Additional uses of Activity Based Costing.
 Extends the use of ABC from product costing to a comprehensive
management tool that focuses on reducing costs and improving
processes and decision making.
 ABM classifies all activities as value-added or non-value-added.
 Value-added activities increase the worth of a product or service to the
customer.
 Example: Addition of a sun roof to an automobile.
 Non-value added activities don’t.
 Example: The cost of moving or storing the product prior to
sale.
 The sole objective of Activity Based Management is to reduce or
eliminate non-value related activities (and therefore costs).
 Attention to ABM is a part of continuous improvement of operations
and activities.
 Reporting of Net Income Under Different Situation

 A business firm needs to know the profitability situation at the

interval of certain time and thus net income needs to be ascertained.
 The organization needs to report the net income of the firm to its
stakeholders.
 The information relating to the net income provides managers and
other stakeholders supports for strategic and other decisions.

 There two method of preparing income statement :

(a)Absorption costing method and

(b) Variable costing method

 Variable Costing vs Absorption Costing
Variable Costing Absorption Costing
• It is also called marginal costing, direct • Also called traditional costing, conventional
costing, Contribution margin format. costing, full costing.
• Variable costing includes only variable • It treats all production costs as product
production costs in product costs. costs, regardless of whether they are
• Fixed manufacturing overhead is treated as variable or fixed.
a period cost and is charged against income • Under this costing, a portion of fixed
each period. manufacturing overhead is allocated to
• Cost of production per unit will be each unit of product.
calculated as- • Cost of production per unit includes-
Direct materials xx Direct materials
Direct labours xx xx
Variable overheads xx Direct labours
Cost of goods manufactured xx xx
Variable overheads
xx
Fixed Overhead
(Fixed overhead/Normal capacity) xx

Under Variable Costing
Product Costs
Direct Material
Direct Labour
Variable Manufacturing Costs
Period Costs
Fixed manufacturing costs
General & administrative costs
Selling & distribution costs
Contd.
Under Absorption Costing
Product Costs
Direct Material
Direct Labour
Variable Manufacturing Costs
Fixed manufacturing Costs
Period Costs
General & Administrative Costs
Selling & Distribution Costs
 Example
The Boley Company produces a single product. The cost characteristics of the
product and of the manufacturing plant are given below:
Number of units produced each year 6,000
Variable costs per unit:
Direct materials $2
Direct labor 4
Variable manufacturing overhead 1
Variable selling and administrative expense 3
Fixed cost per year:
Manufacturing overhead $ 30,000
Selling and administrative expense 10,000
Required:
1. Compute the, cost of a unit of product under absorption costing.
2. Compute the cost of a unit of product under direct costing
 Calculation of Cost per unit
Direct Costing Absorption Costing
Particulars Amount Particulars Amount

Direct materials $ 2 Direct materials $2

Direct labor 4 Direct labor 4
Variable overhead 1 Variable overhead 1
Total variable production cost 7
Fixed overhead 5
($30,000÷6,000 units of
product)

Total cost per unit $ 7 Total cost per unit $12

 Explanation
Under the Direct Costing Method
• Under the direct costing method, notice
that only the variable production costs
have been added to the cost of units
produced during the period.
• Thus, if the company sells a unit of
product, only $7 will be deducted as
cost of goods sold, and unsold units
will be carried in the balance sheet
inventory account at only $7 each.
Under the Absorption Costing Method
• Under the absorption costing method,
notice that all production costs,
variable and fixed, have been added to
the cost of units produced during the
period.
•Thus, if the company sells a unit of
product and absorption costing is being
used, then $12 (consisting of $7 variable
cost and $5 fixed cost) will be deducted
on the income statement as cost of goods
sold.
•Similarly, any unsold units will be
carried as inventory on the balance sheet
at $12 each.
 Capacity Concept
 Installed capacity - Maximum units that can be produced.
 Normal capacity - Average production level, that is normally below the
maximum capacity.
 Actual capacity - Actual production, it may be more or less than normal
capacity.
 Fixed overhead per unit - Fixed overhead/Normal capacity.
Under/Over Absorption Of Fixed Manufacturing Overhead
 Fixed manufacturing cost is considered as constant cost which is unaffected
due to change into production units.
 The increase or decrease in production volume does not affect the total fixed
cost.
 Thus, fixed manufacturing overhead is allocated to product cost based on
normal level activities.
 It is determined on the basis of normal capacity level of production.
 The differences between normal capacity and actual production create over
absorption or under absorption of fixed manufacturing overhead.
 Advantage of Variable Costing
 More useful for CVP analysis

 Income is not affected by changes in production volume

 Avoids misunderstandings concerning unit product costs

 Fixed costs are more visible

 Understandability

 Facilitates in Control
 Income Statement Under Different Costing Method

Income Statement Under Variable Costing

Particulars Details Amount
Sales revenue (Sales units  SPPU) xxxxxxx
Less- Variable cost of goods sold:
Direct Material @.... .  production units xxxx
Direct Labour @.... .  production units xxxx
Variable Overhead @.... .  production units xxxx
Total Variable Manufacturing Costs xxxx
Add- Opening Stock @.......  units xxxx
Cost of goods available for sale xxxx
Less- Closing Stock @........  units xxxx
Variable Manufacturing Cost of goods sold xxxx
Add – Non Manufacturing variable cost @....  sales units xxxxx
Total Variable Cost of sales xxxxxx
Net Contribution Margin xxxxxx
Less- Fixed Costs
Manufacturing fixed cost xxxx
Non- manufacturing fixed cost xxxx xxxxxx
Net Income before tax xxxxx
 Contd.
Income Statement Under Absorption Costing
Particulars Details Amount
Sales revenue (Sales units  SPPU) xxxxxxx
Less- Manufacturing cost of goods sold:
Direct Material @.... .  production units xxxx
Direct Labour @.... .  production units xxxx
Variable Overhead @.... .  production units xxxx
Fixed Overhead@.... .  production units xxxx
Costs of goods manufactured xxxx
Add- Opening Stock @.......  units xxxx
Cost of goods available for sale xxxx
Less- Closing Stock @........  units xxxx
Cost of goods sold xxxxx
Gross Margin before adjustments- xxxxxx
Less: Under absorption of fixed manufacturing overhead xxx
Add : Over absorption of fixed manufacturing overhead xxx
Gross margin after adjustments xxxxxx
Less: Variable non manufacturing @ . . .  sales units xxxx
Fixed non manufacturing costs xxxx xxxxxx
Net Income before tax xxxxx
 Contd.

Reconciliation statement
Particulars Details Difference
Net profit as per variable costing xxxxxxx

Less: Net profit as per absorption costing xxxxxxx

Difference in Profit xxxxxx

Opening stock in units xxxxxxx

Less: Closing stock in units xxxxxxx

Difference in stock xxxxxx

Fixed manufacturing cost per unit xxx

Different in Profit xxxxx

(Different in Stock X Fixed manufacturing cost per unit)
 Numerical Problem
The Directorium Manufacturing Company produced: 80,000 units of new
products during 2010 and sold 60,000 units at Rs. 50 each. The cost for
2010 were as follows:
Direct materials Rs.200,000
Direct labour Rs.160,000
Variable Manufacturing Overhead Rs.320,000
Fixed Manufacturing overhead Rs.440,000
V. Selling/administrative expenses Rs.80,000
F. Selling and administrative expenses Rs. 280,000
There was no ending work in process inventory.
Required:
a)Income statements for the year 1990 using
(i) direct costing method (ii) Absorption costing method
b) Give the reasons for differences in reported net income or net loss in
requirement a (i) and a (ii).
 Solution
Income Statement Under Contribution Margin Approach
Particulars Amount Amount (Rs)
Sales revenue @ Rs.50 each 3,000,000
Less: Variable manufacturing cost of goods sold:
Direct materials @ 2.5 each 200,000
Direct labour @ 2 each 160,000
Variable manufacturing overhead @ 4 each 320,000
Total variable manufacturing costs 680,000
Add: Opening stock @ 8.5 each Nil
Cost of goods available for sales 680,000
Less: Closing stock @ 8.5 each (20,000 units) 170,000 510,000
Gross contribution margin 2,490,000
Less: Variable selling and administrative 80,000
Net contribution margin 2,410,000
Less: Fixed costs:
Manufacturing 440,000
Selling and administrative 280,000 720,000
Net income 1,690,000
 Contd.

Income Statement Under Absorption Costing

Particulars Amount Amount (Rs)
Sales revenue @ Rs.50 each 3000,000

Less: Manufacturing cost of goods sold:

Direct materials @ 2.5 each 200,000
Direct labour @ 2 each 160,000
Variable manufacturing overhead @ 4 each 320,000
Fixed manufacturing overhead @ 5.5 each 440,000
Total manufacturing costs 11,20,000
Add: Opening stock @ 14 each Nil
1120,000
Less: Closing stock @ 14 each 280,000 840,000
Gross margin 21,60,000
Less: Non-manufacturing costs:
Variable selling and administrative expenses 80,000
Fixed selling and administrative expenses 280,000 360,000
Net income 1800,000
 Contd.

Reconciliation Statement
Particulars Details Difference

Net profit as per variable costing 16,90,000

Less: Net profit as per absorption costing 18,00,000

Difference in profit 110,000

Opening stock in units 0

Less: Closing stock in units 20,000

Difference in stock 20,000

Fixed manufacturing cost per unit 5.5

Difference in profit (Diff. stock x fixed cost per unit) 110,000

 End of the Unit

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