Cost Accounting And Management Accounting

Transcription

1 1 Cost Accounting And Management Accounting Introduction Accounting is a very old science which aims at keeping records of various transactions. The accounting is considered to be essential for keeping records of all receipts and payments as well as that of the income and expenditures.. Cost Accounting helps the business to ascertain the cost of production/services offered by the organization and also provides valuable information for taking various decisions and also for cost control and cost reduction. Management Accounting helps the management to conduct the business in a more efficient manner. The scope of management accounting is broader than that of cost accounting. In other words, it can be said that the management accounting can be considered as an extension of cost accounting. Management Accounting utilises the principles and practices of financial accounting and cost accounting in addition to other modern management techniques for efficient operation of a company. The main thrust in management accounting is towards determining policy and formulating plans to achieve desired objectives of management. Management Accounting makes corporate planning and strategies effective and meaningful. Cost and Management Accounting Summary of transactions:- After recording all transactions, it is essential to prepare a summary of them so as to draw meaningful conclusions. The summary will help in finding out the Profit/Loss of a particular year and also ascertaining Assets and Liabilities on a particular date. In fact, the very purpose of financial accounting is to know the results of a particular year. From this angle, the process of preparing the summary is extremely important. Cost Accounting As compared to the financial accounting, the focus of cost accounting is different. In the modern days of cut throat competition, any business organization has to pay attention towards their cost of production.

2 2 Computation of cost on scientific basis and thereafter cost control and cost reduction has become of paramount importance. Hence it has become essential to study the basic principles and concepts of cost accounting. These are discussed in the subsequent paragraphs. 1-- Cost:- Cost can be defined as the expenditure (actual or notional) incurred on or attributable to a given thing. It can also be described as the resources that have been sacrificed or must be sacrificed to attain a particular objective. In other words, cost is the amount of resources used for something which must be measured in terms of money. For example Cost of preparing one cup of tea is the amount incurred on the elements like material, labor and other expenses; similarly cost of offering any services like banking is the amount of expenditure for offering that service. Thus cost of production or cost of service can be calculated by ascertaining the resources used for the production or services Costing:- Costing may be defined as the technique and process of ascertaining costs. According to Wheldon, Costing is classifying, recording, allocation and appropriation of expenses for the determination of cost of products or services and for the presentation of suitably arranged data for the purpose of control and guidance of management. It includes the ascertainment of every order, job, contract, process, service units as may be appropriate. It deals with the cost of production, selling and distribution. If we analyze the above definitions, it will be understood that costing is basically the procedure of ascertaining the costs. As mentioned above, for any business organization, ascertaining of costs is must and for this purpose a scientific procedure should be followed. Costing is precisely this procedure which helps them to find out the costs of products or services Cost Accounting:- Cost Accounting primarily deals with collection, analysis of relevant of cost data for interpretation and presentation for various problems of management. Cost accounting accounts for the cost of products, service or an operation. It is defined as, the establishment of budgets, standard costs and actual costs of operations, processes, activities or products and the analysis of variances, profitability or the social use of funds Cost Accountancy:- Cost Accountancy is a broader term and is defined as, the application of costing and cost accounting principles, methods and techniques to the science and art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making. If we analyze the above definition, the following points will emerge, A. Cost accounting is basically application of the costing and cost accounting principles. B. This application is with specific purpose and that is for the purpose of cost control, ascertainment of profitability and also for presentation of information to facilitate decision making. C. Cost accounting is a combination of art and science, it is a science as it has well defined rules and regulations, it is an art as application of any science requires art and it is a practice as it has to be applied on continuous basis and is not a onetime exercise.

3 Objectives of Cost Accounting:- Objectives of Cost Accounting can be summarized as under - 1. To ascertain the cost of production on per unit basis, for example, cost per kg, cost per meter, cost per liter, cost per ton etc. 2. Cost accounting helps in the determination of selling price. Cost accounting enables to determine the cost of production on a scientific basis and it helps to fix the selling price. 3. Cost accounting helps in cost control and cost reduction. 4. Ascertainment of division wise, activity wise and unit wise profitability becomes possible through cost accounting. 5. Cost accounting also helps in locating wastages, inefficiencies and other loopholes in the production processes/services offered. 6. Cost accounting helps in presentation of relevant data to the management which helps in decision making. Decision making is one of the important functions of Management and it requires presentation of relevant data. Cost accounting enables presentation of relevant data in a systematic manner so that decision making becomes possible. 7. Cost accounting also helps in estimation of costs for the future Essentials of Costing system:- For availing of maximum benefits, a good costing system should possess the following characteristics. A. Costing system adopted in any organization should be suitable to its nature and size of the business and its information needs. B. A costing system should be such that it is economical and the benefits derived from the same should be more than the cost of operating of the same C. Costing system should be simple to operate and understand. Unnecessary complications should be avoided. D. Costing system should ensure proper system of accounting for material, labor and overheads and there should be proper classification made at the time of recording of the transaction itself. E. Before designing a costing system, need and objectives of the system should be identified. F. The costing system should ensure that the final aim of ascertaining of cost as accurately possible should be achieved Important Terms:- It is necessary to understand certain important terms used in cost accounting. Cost Center :- Cost Center is defined as, a production or service, function, activity or item of equipment whose costs may be attributed to cost units. A cost center is the smallest organizational sub unit for which separate cost allocation is attempted. To put in simple words, a cost center is nothing but a location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. For example, a production department, stores department, sales department can be cost centers. Similarly, an item of equipment like a lathe, fork-lift, truck or delivery vehicle can be cost center, a person like sales manager can be a cost center. The main object

4 4 of identifying a cost center is to facilitate collection of costs so that further accounting will be easy. A cost center can be either personal or impersonal, similarly it can be a production cost center or service cost center. A cost center in which a specific process or a continuous sequence of operations is carried out is known as Process Cost Center. Profit Center :- Profit Center is defined as, a segment of the business entity by which both revenues are received and expenses are incurred or controlled. (CEMA) A profit center is any sub unit of an organization to which both revenues and costs are assigned. As explained above, cost center is an activity to which only costs are assigned but a profit center is one where costs and revenues are assigned so that profit can be ascertained. Such revenues and expenditure are being used to evaluate segmental performance as well as managerial performance. A division of an organization may be called as profit center. The performance of profit center is evaluated in terms of the fact whether the center has achieved its budgeted profits. Thus the profit center concept is used for evaluation of performance Costing Systems:- There are different costing systems used in practice. These are described below. Historical Costing :- In this system, costs are ascertained only after they are incurred and that is why it is called as historical costing system. For example, costs incurred in the month of April, 2007 may be ascertained and collected in the month of May. Such type of costing system is extremely useful for conducting post-mortem examination of costs, i.e. analysis of the costs incurred in the past. Historical costing system may not be useful from cost control point of view but it certainly indicates a trend in the behavior of costs and is useful for estimation of costs in future. Absorption Costing :- In this type of costing system, costs are absorbed in the product units irrespective of their nature. In other words, all fixed and variable costs are absorbed in the products. It is based on the principle that costs should be charged or absorbed to whatever is being costed, whether it is a cost unit, cost center. Marginal Costing :- In Marginal Costing, only variable costs are charged to the products and fixed costs are written off to the Costing Profit and Loss A/c. The principle followed in this case is that since fixed costs are largely period costs, they should not enter into the production units. Naturally, the fixed costs will not enter into the inventories and they will be valued at marginal costs only. Uniform Costing :- This is not a distinct method of costing but is the adoption of identical costing principles and procedures by several units of the same industry or by several undertakings by mutual agreement. Uniform costing facilitates valid comparisons between organizations and helps in eliminating inefficiencies. 9-- Classification of costs for Management decision making:- One of the important functions of cost accounting is to present information to the Management for the purpose of decision making. For decision making certain types of costs are relevant. Classification of costs based on the criteria of decision making can be done in the following manner

5 5 I. Marginal Cost :- Marginal cost is the change in the aggregate costs due to change in the volume of output by one unit. For example, suppose a manufacturing company produces 20,000 units and the aggregate costs are Rs. 50,000, if 20,001 units are produced the aggregate costs may be Rs. 50,020 which means that the marginal cost is Rs. 20. Marginal cost is also termed as variable cost and hence per unit marginal cost is always same, i.e. per unit marginal cost is always fixed. Marginal cost can be effectively used for decision making in various areas. II. Differential Costs :- Differential costs are also known as incremental cost. This cost is the difference in total cost that will arise from the selection of one alternative to the other. In other words, it is an added cost of a change in the level of activity. This type of analysis is useful for taking various decisions like change in the level of activity, adding or dropping a product, change in product mix, make or buy decisions, accepting an export offer and so on. III. Opportunity Costs :- It is the value of benefit sacrificed in favor of an alternative course of action. It is the maximum amount that could be obtained at any given point of time if a resource was sold or put to the most valuable alternative use that would be practicable. Opportunity cost of goods or services is measured in terms of revenue which could have been earned by employing that goods or services in some other alternative uses. IV. Relevant Cost :- The relevant cost is a cost which is relevant in various decisions of management. Decision making involves consideration of several alternative courses of action. In this process, whatever costs are relevant are to be taken into consideration. In other words, costs which are going to be affected matter the most and these costs are called as relevant costs. Relevant cost is a future cost which is different for different alternatives. It can also be defined as any cost which is affected by the decision on hand. Thus in decision making relevant costs plays a vital role. V. Replacement Cost :- This cost is the cost at which existing items of material or fixed assets can be replaced. Thus this is the cost of replacing existing assets at present or at a future date. VI. Abnormal Costs : - It is an unusual or a typical cost whose occurrence is usually not regular and is unexpected. This cost arises due to some abnormal situation of production. Abnormal cost arises due to idle time, may be due to some unexpected heavy breakdown of machinery. They are not taken into consideration while computing cost of production or for decision making. VII. Controllable Costs :- In cost accounting, cost control and cost reduction are extremely important. In fact, in the competitive environment, cost control and reduction are the key words. Hence it is essential to identify the controllable and uncontrollable costs. Controllable costs are those which can be controlled or influenced by a conscious management action. For example, costs like telephone, printing stationery etc can be controlled while costs like salaries etc cannot be controlled at least in the short run. Generally, direct costs are controllable while uncontrollable costs are beyond the control of an individual in a given period of time.

6 6 VIII. Shutdown Cost : These costs are the costs which are incurred if the operations are shut down and they will disappear if the operations are continued. Examples of these costs are costs of sheltering the plant and machinery and construction of sheds for storing exposed property. Computation of shutdown costs is extremely important for taking a decision of continuing or shutting down operations. IX. Capacity Cost : These costs are normally fixed costs. The cost incurred by a company for providing production, administration and selling and distribution capabilities in order to perform various functions. Capacity costs include the costs of plant, machinery and building for production, warehouses and vehicles for distribution and key personnel for administration. These costs are in the nature of long-term costs and are incurred as a result of planning decisions. X. Urgent Costs :- These costs are those which must be incurred in order to continue operations of the firm. For example, cost of material and labor must be incurred if production is to take place Costing Methods and Techniques:- Introduction:- It is necessary to understand the difference between the costing methods and techniques. Costing methods are those which help a firm to compute the cost of production or services offered by it. On the other hand, costing techniques are those which help a firm to present the data in a particular manner so as to facilitate the decision making as well as cost control and cost reduction. Costing methods and techniques are explained below. Methods of Costing:- The following are the methods of costing. Job Costing :- This method is also called as job costing. This costing method is used in firms which work on the basis of job work. There are some manufacturing units which undertake job work and are called as job order units. The main feature of these organizations is that they produce according to the requirements and specifications of the consumers. Each job may be different from the other one. Production is only on specific order and there is no pre demand production. Because of this situation, it is necessary to compute the cost of each job and hence job costing system is used. In this system, each job is treated separately and a job cost sheet is prepared to find out the cost of the job. The job cost sheet helps to compute the cost of the job in a phased manner and finally arrives the total cost of production. Batch Costing :- This method of costing is used in those firms where production is made on continuous basis. Each unit coming out is uniform in all respects and production is made prior to the demand, i.e. in anticipation of demand. One batch of production consists of the units produced from the time machinery is set to the time when it will be shut down for maintenance. For example, if production commences on 1st January 2007 and the machine is

7 7 shut down for maintenance on 1st April 2007, the number of units produced in this period will be the size of one batch. The total cost incurred during this period will be divided by the number of units produced and unit cost will be worked out. Firms producing consumer goods like television, air-conditioners, washing machines etc use batch costing. Process Costing :- Some of the products like sugar, chemicals etc involve continuous production process and hence process costing method is used to work out the cost of production. The meaning of continuous process is that the input introduced in the process I travels through continuous process before finished product is produced. The output of process I becomes input of process II and the output of process II becomes input of the process III. If there is no additional process, the output of process III will be the finished product. In process costing, cost per process is worked out and per unit cost is worked out by dividing the total cost by the number of units. Industries like sugar, edible oil, chemicals are examples of continuous production process and use process costing. Operating Costing :- This type of costing method is used in service sector to work out the cost of services offered to the consumers. For example, operating costing method is used in hospitals, power generating units, transportation sector etc. A cost sheet is prepared to compute the total cost and it is divided by cost units for working out the per unit cost. Contract Costing :- This method of costing is used in construction industry to work out the cost of contract undertaken. For example, cost of constructing a bridge, commercial complex, residential complex, highways etc is worked out by use of this method of costing. Contract costing is actually similar to job costing, the only difference being that in contract costing, one construction job may take several months or even years before they are complete while in job costing, each job may be of a short duration. In contract costing, as each contract may take a long period for completion, the question of computing of profit is to be solved with the help of a well defined and accepted method Technique of Costing:- As mentioned above, costing methods are for computation of the total cost of production/services offered by a firm. On the other hand, costing technique help to present the data in a particular format so that decision making becomes easy. Costing techniques also help for controlling and reducing the costs. The following are the techniques of costing. 1. Marginal Costing :- This technique is based on the assumption that the total cost of production can be divided into fixed and variable. Fixed costs remain same irrespective of the changes in the volume of production while the variable costs vary with the level of production, i.e. they will increase if the production increases and decrease if the production decreases. Variable cost per unit always remains the same. In this technique, only variable costs are taken into account while calculating production cost. Fixed costs are not absorbed in the production units. They are written off to the Costing Profit and Loss Account. The reason behind this is that the fixed costs are period costs and hence should not be absorbed in the production. Secondly they are variable on per unit basis and hence there is no equitable basis for charging them to the products. This technique is effectively used for decision making in the areas like make or buy decisions, optimizing of product mix, key factor analysis, fixation of selling price, accepting or rejecting an export offer, and several other areas.

8 8 2. Standard Costing :- Standard costs are predetermined costs relating to material, labor and overheads. Though they are predetermined, they are worked out on scientific basis by conducting technical analysis. They are computed for all elements of costs such as material, labor and overheads. The main objective of fixation of standard cost is to have benchmark against which the actual performance can be compared. This means that the actual costs are compared with the standards. The difference is called as variance. If actual costs are more than the standard, the variance is adverse while if actual costs are less than the standard, the variance is favorable. The adverse variances are analyzed and reasons for the same are found out. Favorable variances may also be analyzed to find out the reasons behind the same. Standard costing, thus is an important technique for cost control and reduction. 3. Budgets and Budgetary Control :- Budget is defined as, a quantitative and/or a monetary statement prepared to prior to a defined period of time for the policies during that period for the purpose of achieving a given objective. If we analyze this definition, it will be clear that a budget is a statement, which may be either in monetary form or quantitative form or both. For example, a production budget can be prepared in quantitative form showing the target production, it can also be prepared in monetary terms showing the expected cost of production. Some budgets can be prepared only in monetary terms, e.g. cash budget showing the estimated receipts and payments in a particular period can be prepared in monetary terms only. Another feature of budget is that it is always prepared prior to a defined period of time which means that budget is always prepared for future and that too a defined future. For example, a budget may be prepared for next 12 months or 6 months or even for 1 month, but the time period must be certain and not vague. One of the important aspect of budgeting is that it lays down the objective to be achieved during the defined period of time and for achieving the objectives, whatever policies are to be pursued are reflected in the budget.budgetary control involves preparation of budgets and continuous comparison of actual with budgets so that necessary corrective action can be taken. For example, when a production budget is prepared, the production targets are laid down in the same for a particular period. After the period is over, the actual production is compared with the budget and the deviation is found out so that necessary corrective action can be taken. Budget and Budgetary Control is one of the important techniques of costing used for cost control and also for performance evaluation. The success of the technique depends upon several factors such as support from top management, involvement of employees and co-ordination within the organization Cost Sheet Cost Sheet is a statement of cost showing the total cost of production and profit or loss from a particular product or service. A Cost Sheet shows the cost in a systematic manner and element wise. A typical format of the Cost Sheet is given below. Cost Sheet for the period... Production... units Particulars Amount (Rs.) Amount (Rs.) A. Direct Materials Opening Stock + Purchases + Carriage inwards - Closing Stock B. Direct Wages C. Direct Expenses I. Prime Cost ( A + B + C )

9 9 D. Factory Overheads- Indirect materials Loose Tools Indirect wages Rent and Rates ( Factory) Lighting and heating ( F ) Power and fuel Repairs and Maintenance Drawing offi ce expenses Research and experiment Depreciation Plant ( F ) Insurance ( F ) Work Manager s salary II. Factory Cost/Works Cost ( I + D ) E. Office and Administrative Overheads Rent and Rates office Salaries office Insurance of office building and equipments Telephone and postage Printing and Stationery Depreciation of furniture and office equipments Legal expenses Audit fees Bank Charges III. Cost of Production ( II + E ) F. Selling and Distribution Overheads Showroom rent and rates Salesmen s salaries and commission Traveling expenses Printing and Stationery Sales Department Advertising Bad debts Postage Debt collection expenses Carriage outwards Particulars Amount (Rs.) Amount (Rs.) Depreciation of delivery van Debt collection expenses Samples and free gifts IV. Cost of Sales ( III + F ) V. Profit/Loss \ VI. Sales ( IV + V) A glance at the above cost sheet will reveal that it works out the total cost of production/service in a phased manner. In other words, total costs are segregated into elements like Prime Cost,

10 10 Factory or Works Cost, Cost of Production, Cost of Sales and finally the profit/loss is worked out by comparing the total cost with the selling price. Appropriate adjustments are made for opening and closing stock of Work in Progress and also opening and closing stock of finished goods. The format of cost sheet may be suitably changed according to the requirements of each firm but the basic form remains the same Cost Control and Reduction:- One of the important functions of cost accounting is cost control and cost reduction. Cost control implies various actions taken in order to ensure that the cost do not rise beyond a particular level while cost reduction means reducing the existing cost of production. Both these concepts are discussed below. Cost Control :- As mentioned above, cost control means keeping the expenses within limits or control. Cost control has the following features. A. Cost control is a continuous process. It involves setting standards and budgets for deciding targets of different expenses and constant comparison of actual the budgeted and standards. B. Cost control involves creation of responsibilities center with clearly defined authorities and responsibilities. C. It also involves, timely cost control reports showing the variances between standard and actual performance. D. Motivating and encouraging employees to accomplish budgetary goals is also one of the essential aspects of cost control. E. Actually cost control not only means monetary limits on cost but it also involves optimum utilization of resources or performing the same job at same cost. Cost Reduction :- Cost control means attempts to reduce the costs. For example, if the present costs are Rs. 1,000 per unit, attempts can be made to reduce it to bring it down below Rs. 1,000. For doing this, all out efforts will have to be made for achieving this target. The goal of cost reduction can be achieved in two ways, first is reducing the cost per unit and the second one is increasing productivity. Reducing wastages, improving efficiency, searching for alternative materials, and a constant drive to reduce costs, can effect cost reduction. The following tools and techniques are normally used for cost reduction. A. Value analysis or value engineering. B. Setting standards for all elements of costs and constant comparison of actual with standard and analysis of variances.sensitivity analysis, probability techniques, decision tree, ratio analysis etc for planning, control and evaluation. It is futuristic in approach and predictive in nature. Management Accounting system cannot be installed without proper cost accounting system. Management Accounting systems generate various reports which are extremely useful from Management point of view Management Accounting Information and their use

11 11 In the above paragraphs, we have seen the utility of Management Accounting. One of the distinguishing factors between the financial accounting and management accounting is that the management accounting does not have a unified structure. The format in which it is prepared varies widely according to the circumstances in each case and the purpose for which the information is being summarized. The management accounting generates information, which is used for three different purposes. I] Measurement II] Control and III] Decision making [Alternative choice problems] For each of these purposes, management accounting generates vital information. The uses of information for each of the three purposes of management accounting is explained below. I. Measurement: For measurement of full costs, the management accounting system focuses on the measurement of full costs. Full costs are the total costs required for producing goods or offering services. These costs are divided into A] Direct costs and B] Indirect costs. Direct costs are identifiable or traceable to the products or services offered while indirect costs are not traceable to the products or services. Full cost accounting measures not only the total costs [direct plus indirect costs] required for producing products or services but also the full costs required to run other activity like conducting a research project or running a welfare scheme and so on. Thus full cost accounting is not restricted to solely to measure the cost of manufacturing. II. Control: An important aspect of the management accounting information is to provide information, which can be used for Control. The management accounting system is structured in such a manner that information is generated for each Responsibility Center. A responsibility center is an organization unit headed by a manager who is responsible for its operations and performance. Management accounting helps to prepare budget for each responsibility center and also facilitates comparison between the budgeted and actual results. A report is prepared for each responsibility center, which shows the budgeted and actual performance and also the difference between the two. This enables the performance analysis of each responsibility center so that proper corrective action can be taken in this respect. III. Decision Making: Management accounting generates useful information for decision making. Management has to take several decisions in the course of business. Some of the major decisions are, Make or Buy, Accepting or rejecting of an Export Order, Working of second shift, Fixation of selling price, Capital expenditure decisions, Increasing production capacity, Optimizing of Product Mix and so on. For all these decisions, providing of information is necessary and the management accounting generates this information, which enables the management to take such decisions. Material Control Important Issues in Material Procurement: Economic Order Quantity: One important question that is to be answered by the Purchase Manager is how much to purchase at any one time? In other words, how much quantity is to be ordered at any one point of time? Whether there are any costs associated with the ordering quantity apart from the purchase price? It will be noticed that there are costs attached to the ordering quantity. These costs are of two types, the

12 12 first is the ordering cost and the other one is the carrying cost. We will discuss about these costs. Ordering cost is the cost of placing an order. In other words, it can be said that when an order is placed, the company has to incur certain costs at the time of order. These costs include costs like handling and transportation costs, stationery costs, costs incurred for inviting quotations and tenders etc. The more is the frequency of order, the more are these costs.the quantities purchased in different batches. In the periods of price fluctuations this method is useful but if fluctuations are too wide, the method may not be useful. Weighted Average Method:- This method takes into consideration the prices as well as the quantities of materials purchased. Thus weighted average is computed after each receipt by dividing the total amount by the total quantity. The issue is charged at prices arrived at according to this calculation. The main advantage of this method is that it evens out the price fluctuations and reduces the number of calculations to be made. Periodic Average Cost Method:- Under this method, instead of recalculating the simple or weighted average cost every time there is a receipt, periodic average is computed. The average may be calculated for the entire period. The price may be calculated as given below. Cost of Opening Stock + Total Cost of all receipts / Units in Opening Stock + Total Units received during the period. Standard Cost Method:- Under this method, material issues are priced at a predetermined standard issue price. Any difference between the actual purchase price and the standard price is written off to the Costing Profit and Loss Account. Standard Cost is a predetermined cost and if it is set accurately, it can be very effective. However revision of standard cost at regular intervals is required. Replacement Cost [Market Price]:- The replacement cost is the cost at which material identical to that is to be replaced could be purchased at the date of pricing of the issues as distinct from the actual cost price at the date of purchase. The replacement price is the price of replacing the material at the time of the issue of materials or on the date of valuation of closing stock. This method is not acceptable for standard accounting practices as it reflects the price, which has not been paid actually. Next In First Method:- Under this method, the price quoted on the latest purchase order or contract is used for all issues until a new order is placed. Thus this method is a variation of the Replacement Cost Method. Base Stock Method:- Under this method, a certain quantity of materials is always held in stock and any material over and above this quantity is priced according to any other pricing method like First In First Out or Last In First Out or any other method. Thus it will be observed that there are several methods of pricing of issues. Any one of these can be selected. However care should be taken that once a particular method is selected, it should be followed consistently year after year because if frequent changes are made, the results will be not comparable. The following points should be taken into consideration before selecting a particular method.

13 13 Method of production or process Nature of material used Frequency of purchases and issues Economic Batch Quantity Tendency of inflation or deflation Rate of stock turnover Accounting practices acceptable in valuation of inventory Normal losses due to evaporation System of costing prevailing in the organization Objective of charging material cost to production on consistent and realistic basis. Material Losses: One of the main reasons of rising material costs is the loss of material in the production process. It is of paramount importance that there should be rigid control over the material losses failing which it will be very difficult to keep the material costs in check. The material losses can be categorized as given below. Waste:- Waste is a loss of material either in stores or in production due to reasons like evaporation, chemical reaction, shrinkage, unrecoverable residue etc. Wastages may be visible or invisible. It is necessary to take steps to control the material wastage. In cost accounting, the wastage is divided into the following categories. Normal Wastage:- This wastage is such that it cannot be avoided. It is inherent in any production process. The normal wastage is normally estimated in advance and included in the material cost. In other words, the good units should bear the cost of normal wastage. Abnormal Wastage:- Any wastage over and above the normal wastage is the abnormal wastage. In other words it is more than the standard wastage. The cost of the abnormal wastage is not charged to the production, but it is written off to the Costing Profit and Loss Account. Wastage can be controlled by adopting strict quality control measures. Normal allowance of waste can be fixed with technical assessment and past experience as well as by identifying the special features of materials. The causes for abnormal wastages should be studied in detail and responsibility should be fixed for wastage. Better material handling system will also help in controlling the wastage. Scrap:- Scrap is a residual material resulting from a manufacturing process. It has a recovery value and is measurable. The treatment of scrap in cost accounts is normally as per the following details. If the value of scrap is negligible, the good units should bear the cost of scrap and any income collected will be treated as other income. If the value of scrap is considerable and identifiable with the process or job, the cost of job will be transferred to scrap account and any realization from sale of such scrap will be credited to the job or process account and any unrecovered balance in the scrap account will be transferred to the Costing Profit and Loss Account. If scrap value is quite substantial and it is not identifiable with a particular job or process, the amount will be transferred to factory overhead account after deducting the selling cost. This will reduce the cost of production to the extent of the scrap value.

14 14 LABOUR COST Labour cost is a significant element of cost specially in an organisation using more manual operations. It is the cost of human endeavour in the product and requires coordinated efforts for its control. The management objective of keeping labour cost as low as possible is achieved by balancing productivity with wages. Low wages do not necessarily mean low labour cost. Low labour cost is possible by giving substantial increase in wages against corresponding increase in productivity. The gain is reflected both in labour cost as well as in overheads expense per unit, since overheads are distributed over larger volume. Again, the productivity of labour is quite flexible. Given right type of motivation and incentive, it can reach amazing scale. It does not have any limitation like machines. Labour cost is a vital factor not only affecting the cost of production but also industrial relations of the organization. No organization can expect to attract and attain qualified and motivated employees unless it pays them fair remuneration. Employee remuneration therefore influences vitally the growth and profitability of the company. For employees remuneration is more than a means of satisfying their physical needs. Wages and salaries have significant influence on our distribution of income, Consumption savings employment and prices. Thus employee remuneration is a very significant issue from the viewpoint of employer s employees and the nation as whole. CLASSIFICATION OF LABOUR COST The total labour cost can be classified as follows: (a) Direct labour costs; (b) Indirect labour costs. Direct Labour Cost It refers to all labour expended in altering the construction, composition, conformation or condition of the product. The wages paid to skilled and unskilled workers for his labour can be allocated specifically to the particular product or the process as the case may be. In any manufacturing process or department, the workers employed may be of the following two categories: (i) Those who are directly engaged on the production or in the carrying out of an operation or process; (ii) Those who are assisting in the process by way of supervision, maintenance, transportation of materials, etc. The workers coming under the first category constitute direct labour and the wages paid to them are called direct wages. In a factory, where production of a number of products is undertaken or in a jobbing concern, workers are given job cards on which they note the time devoted to each job or product. These job cards are then analysed job wise so that the wages attributable to each job can be computed. Direct labour cost is that portion of wages or salaries which can be identified with and charged to a single costing unit. It can be easily identified with and charged to a single costing unit as there is a direct relationship with the product/process. Direct labour cost can be easily calculated and is quite significant in amount. Indirect Labour Costs It refers to labour expended that does not alter the construction, conformation, composition or condition of the product, but which contributes generally to such work and to the completion of the product and its progressive movement and handling up to the point of dispatch. In other words, labour employed for the purpose of carrying out tasks incidental to goods produced or services provided is regarded as indirect labour. Wages or salaries paid to foremen, supervisors, inspectors, clerks, store-keepers, managers, accountants, salesmen, directors, etc., are examples of indirect labour cost. These costs are not easily identifiable with particular units of cost. Indirect labour cost can be classified as that expended in production departments and that in service departments. (bulk of the labour cost in a production department will be direct). The classification should enable control over such costs and codification of indirect labour accounts. Need for distinguishing between direct and indirect labour cost: The distinction has to be made (a) for calculating accurate labour cost and thus provide a basis for strict control; (b) for facilitating calculation of labour efficiency;

15 15 (c) for proper allocation of overheads; (d) for introduction of incentive schemes; (e) for inter-unit comparison; and (f) for estimating total labour costs. TIME RECORDING Recording of time has two purposes - time-keeping and time-booking. It is necessary for both type of workers: direct and indirect. It is necessary even if the workers are paid on piece basis. Time-keeping is necessary for the purpose of recording attendance and for calculating wages. Time-booking means a record from the utilisation point of view; the purpose is cost analysis and cost apportionment. Record keeping is correct when time-keeping and time-booking tally. TIME-KEEPING The purpose of time-keeping is to provide basic data for: (i) pay-roll preparation; (ii) finding out the labour cost of a job/product/service; (iii) attendance records to meet statutory requirements; (iv) determining productivity and controlling labour cost; (v) calculating overhead cost of a job, product or service; (vi) to maintain discipline in attendance; (vii) to distinguish between normal and over-time, late attendance and early leaving; and (viii) to provide internal check against dummy workers. TIME-BOOKING The objectives of time-booking are: (i) to apportion overheads against jobs; (ii) to calculate the labour cost of jobs done; (ii) to ascertain idle time for the purpose of control; (iv) to find out that the time during which a worker is in the factory is properly utilised; (v) to evaluate labour performance, to compare actual and budgeted time; (vi) to determine overhead rates of absorbing overhead expenses under the labour hour and machine hour methods; (vii) to calculate wages and bonus provided the system of payment depends on the time taken. METHOD OF TIME-BOOKING Different methods used for time booking are: (1) Daily Time Sheets (2) Weekly Time Sheets (3) Job Cards Daily Time Sheets Under this method, a daily time sheet is provided to each worker on which time spent by him on various work orders is mentioned. This method can be conveniently used if the worker works on various jobs of short duration like in maintenance jobs. But this method is disadvantages also as it involves considerable paper work. Weekly Time Sheets In this method time is recorded for all the jobs done during the week instead of recording the work done for a day only. One sheet is allotted to each worker. It involves less paper work. These types of weekly time sheets are useful for intermittent types of jobs like construction work. Job Card

16 16 Job Card is a method of recording details of time with reference to the jobs or work orders undertaken by the workers. This method facilitates the computation of labour cost with reference to jobs or work orders. Job cards may be of two types, one, which is a job order cost card, and contains information regarding material consumption as well as time spent by operators. The other one is, in effect, a job ticket, which is issued to an operator by the supervisor and contains only the operation details. When the operator starts the work, he records the time either manually or through time recording clock on the card. IDLE TIME When workers are paid on time basis there is usually a difference between the time for which the workers are paid and the time actually spent by them in production. The loss of time for which the employer pays but obtains no direct benefit is termed as idle time. In other words, Idle time cost represents the wages paid for the time lost, i.e., time during which the worker was idle. Causes of idle time The causes of idle time can be classified into the following groups: ( (i) According to the controllability classification, the causes are: (a) Normal idle time such as time lost between gate and place of work, time interval between one job and another, rest pauses, tea break, tool setting time, time taken to adjust machines etc. (b) Abnormal idle time due to break downs, scarcity, non-availability of raw materials, negligence of supervision, strikes or lockouts. The idle time may be due to avoidable causes i.e., the causes can be controlled and due to unavoidable causes, i.e., the causes beyond control. Normal idle time occur due to unavoidable causes and abnormal idle time occur due to avoidable causes. The classification according to functions, the functional causes of idle time are analysed as the treatment depends on the causes affecting idle time. The causes can be classified as follows: (a) Productive causes; (b) Administrative causes; and (c) Economic causes. (a) The productive causes can be listed as follows: (i) machine breakdown; (ii) unutilised manpower; (iii) waiting for work; (iv) power cuts; (v) waiting for tools/raw materials; (vi) waiting for instructions. Time lost due to the causes mentioned above can be controlled internally. Proper planning helps control. All engineering organisations should prepare a report showing lost and setting time. The departments in which time was lost can be identified and effective remedial measures taken. It is charged as an item of departmental overhead. (b) Idle time arising due to administrative causes are: (i) Poor planning, (ii) Delayed/unproper instructions, (iii) Unutilised capacity due to management decisions. Idle time arising due to these uncontrollable causes can not be controlled. It is recovered as a part of general works overhead. (c) Idle time arising due to economic causes are: (i) lack of demand resulting in unutilised capacity, (ii) lock outs and strikes,

17 17 (iii) non-dismissal of workers in the off-season in the case of seasonal industries. Such idle time is not a part of cost of production. It is directly transferred to Costing Profit and Loss Account. Accounting Treatment of Idle Time Idle time cost arising due to normal and unavoidable causes should be charged as overheads and those due to abnormal causes should be charged to Costing Profit and Loss Account. Normal idle time such as loss in tool setting etc. can be charged at inflated rate. Jobs are charged at inflated rate. LABOUR TURNOVER It is a common feature in any concern that some employees leave the concern and others join it. Workers change the job either for personal betterment or for better working conditions or due to compulsion. Labour turnover is the ratio of the number of persons leaving in a period to the average number employed. It is the change in the composition of the labour force in an organisation. It can be measured by relating the engagements and losses in the labour force to the total number employed at the beginning of the period. All the losses must be taken into account regardless of the cause for leaving. DIRECT EXPENSES / OVERHEAD Expenses may be defined as the costs of services provided to an undertaking and the notional costs of the use of owned assets. Direct expenses are those expenses which are directly chargeable to a job account. Direct expenses may be defined as those expenses which are easily identifiable and attributable to the individual units or jobs. All expenses other than the direct material or direct labour which are incurred for a particular product or process are termed as direct expenses. Expenses which can be identified with a territory, a customer or product can be considered as direct expenses. Expenses in relation to a department may be direct but are indirect in relation to the product. Nature of Direct Expenses Direct expenses is directly attributed to cost unit/cost center. It includes all direct cost except the direct material and direct labour. Types of Direct Expenses are as under: (i) Royalties if it is charged as a rate per unit. (ii) Hire charges of plant if used for a specific job. (iii) Sub-contract or outside work, if jobs are sent out for special processing. (iv) Salesman s commission if it is based on the value of units sold. (v) Freight, if the goods are handled by an outside carrier whose charges can be related to individual units. (vi) Travelling, hotel and other incidental expenses incurred on a particular contract. (vii) Cost of making a design, pattern for a specific job. (viii) Cost of any special process not forming part of the normal manufacture like water proofing for canvas cloth. Control of Direct Expenses Items under this head are few. They form a small part of the total cost. Such costs are controlled by fixing standards. The actual should be compared with the standard. The causes of variations, if any, should be ascertained and necessary corrective action should be taken. INDIRECT EXPENSES Indirect expenses are expenses other than direct expenses. These refer to those expenses which cannot be directly, conveniently and wholly allocated to cost centres or cost units. E.g. factory rent & insurance, power, general repairs etc.