COST ACCOUNTING AND FINANCIAL MANAGEMENT

Transcription

1 PRACTICE MANUAL Intermediate (IPC) Course PAPER : 3 COST ACCOUNTING AND FINANCIAL MANAGEMENT Part 1 : Cost Accounting VOLUME II BOARD OF STUDIES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA i

2 This practice manual has been prepared by the faculty of the Board of Studies. The objective of the practice manual is to provide teaching material to the students to enable them to obtain knowledge and skills in the subject. Students should also supplement their study by reference to the recommended text books. In case students need any clarifications or have any suggestions to make for further improvement of the material contained herein, they may write to the Director of Studies. All care has been taken to provide interpretations and discussions in a manner useful for the students. However, the practice manual has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees. Permission of the Institute is essential for reproduction of any portion of this material. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA All rights reserved. No part of this book may be reproduced, stored in retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior permission in writing from the publisher. Revised Edition : July, 2013 Website : bos@icai.in Committee / : Board of Studies Department ISBN No. : Price : ` 160/- Published by : The Publication Department on behalf of The Institute of Chartered Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg, New Delhi Printed by : Sahitya bhawan Publications, Hospital Road, Agra July/2013/30,000 Copies ii

3 A WORD ABOUT PRACTICE MANUAL The study material has been divided into two parts, namely, Volume I dealing with conceptual theoretical framework; and Volume II comprising of practice manual. The Study Material has been designed having regard to the needs of home study and distance learning students in mind. The students are expected to cover the entire syllabus and also do practice on their own while going through the practice manual. Volume I of the study material deals with the conceptual theoretical framework in detail. The main features of Volume I are as under: The entire syllabus has been divided into thirteen chapters. In each chapter, learning objectives have been stated. The learning objectives would enable you to understand the sequence of various aspects dealt within the chapter before going into the details so that you know the direction of your studies. In each chapter, the topic has been covered in a step by step approach. The text has been explained, where appropriate, through illustrations and practical problems. You should go through the chapter carefully ensuring that you understand the topic and then can tackle the exercises. A question bank has been included after each chapter in Volume I as well as many questions for practice in Volume II. Volume II of the Study Material comprises the Practice Manual. Main features of Volume II are as under: Compilation of questions appearing during last ten examinations. Important Definition, equation and formulae have been given before each topic for quick recapitulation. Students are expected to attempt the questions and then compare it with the actual answers. Exercises have been given at the end of each topic for independent practice. Aims to provide guidance as to the manner of writing an answer in the examination. Happy Reading and Best Wishes! iii

4 Paper-3 COST ACCOUNTING AND FINANCIAL MANAGEMENT Statement showing topic-wise distribution of Examination Questions along with Marks Topics Nov May 2010 Nov May 2011 Term of Examination Nov May 2012 Nov May 2013 Q M Q M Q M Q M Q M Q M Q M Q M Total Marks Avg. Marks PART-I : COST ACCOUNTING Chapter-1 Basic Concepts 1(i) 2 1(i) 2 6(b)(i) 4 6(b) 4 5(i) 4 5(b) 4 5(a) 4 5(a) (iii) 2 Chapter-2 Material 4(iii) 3 1(iii) 2 1(b) 5 1(c) 5 7(c) 4 7(e) 4 1(d) 5 7(a) Chapter-3 Labour 4(i) 3 4(iii) 3 7(e) 4 1(b) 5 1(b) 5 3(a) 8 1(b) 5 2(b) (c) 4 Chapter-4 Overheads 1(ii) 2 6(b)(ii) 4 2(a) 8 2(a) 8 1(b) 5 2(a) 8 5(b) (ii) 3 7(a) 4 7(a) 4 Chapter-5 Non Integrated 1(vi) 2 1(v) 2 5(a) 8 5(a) 12 4(b) 8 5(a) 4 6(b) 8 7(b) Accounts Chapter-6 Job Costing & Batch Costing Chapter-7 Contract Costing 1(iv) (a) 8 7(c) 4 7(d) 4 2(a) 8 3(b) Chapter-8 Operating Costing 4(ii) 3 3(b) (c) Chapter-9 Process & Operation 3(a) 8 3(a) 8 3(a) 8 3(a) 8 6(a) 8 5(b) 4 3(a) Costing iv

5 Chapter-10 Joint Products & By Products 7(b) (a) Chapter-11 Standard Costing 3(b) (a) 5 6(b) 8 4(a) 8 4(a) 6 1(a) Chapter-12 Marginal Costing 1(v) 2 1(iv) 2 4(b) 8 1(a) 5 7(c)(ii) 2 6(a) 8 1(b) (i) 3 7(d) 4 4(iv) 3 Chapter-13 Budget and Budgetary 1(ii) 2 5(ii) 4 1(a) 5 7(b) 4 6(a) Control 7(e)(ii) 2 Note: Q represents question numbers as they appeared in the question paper of respective examination. M represents the marks which each question carries. The question papers of all the past attempts of IPCC can be accessed from the BOS Knowledge Portal on the Institute s website v

6 CONTENTS COST ACCOUNTING CHAPTER 1 BASIC CONCEPTS CHAPTER 2 MATERIAL CHAPTER 3 LABOUR CHAPTER 4 OVERHEADS CHAPTER 5 NON INTEGRATED ACCOUNTS CHAPTER 6 JOB COSTING & BATCH COSTING CHAPTER 7 CONTRACT COSTING CHAPTER 8 OPERATING COSTING CHAPTER 9 PROCESS & OPERATION COSTING CHAPTER 10 JOINT PRODUCTS & BY PRODUCTS CHAPTER 11 STANDARD COSTING CHAPTER 12 MARGINAL COSTING CHAPTER 13 BUDGETS AND BUDGETARY CONTROL vi

7 1 Basic Concepts BASIC CONCEPTS Classification of Costs 1. Nature of Element BASIC CONCEPTS OF FORMULAE 1.1 Material: Cost of Material used in production 1.2 Labour: Cost of Workers 1.3 Expenses: Costs other than Material and Labour 2. Traceability to Object 2.1 Direct Costs: Which can be allocated directly to the product 2.2 Indirect Costs: Which cannot be directly allocated to the product 3. Functions 3.1 Production Costs Cost of whole process of Production 3.2 Selling Costs: Cost for creating demand of the product produced 3.3 Distribution Costs: Costs starting from packing of the product till reconditioning of empty products 3.4 Administrative Costs: Cost of formulating policy, controlling the organisation, costs not directly related to production 3.5 Development Costs: Development Costs for trial Run 3.6 Pre- Production Costs: Costs starting with implementation of decisions and ending with the commencement of the production process 3.7 Conversion Costs: Cost of transforming direct material into Finished Products 3.8 Product Costs: Costs necessary for production 4. Variability 4.1 Fixed Costs: Cost which remains constant in total

8 1.2 Cost Accounting 4.2 Variable Costs: Costs which changes with production 4.3 Semi- Variable Costs: Costs which are partly fixed and partly variable 5. Controllability 5.1 Controllable Costs: Costs which can be influenced by the action of a specific member of an undertaking 5.2 Uncontrollable Costs: Costs which can not be influenced by the action of a specific member. 6. Normality 6.1 Normal Costs: Costs which are expected to be incurred in normal routine 6.2 Abnormal Costs: Costs which are over and above normal costs 7. Decision Making 7.1 Relevant Costs (Marginal Costs, Differential Costs, Opportunity Costs, Out of Pocket): Costs which are relevant and useful for decision making 7.2 Irrelevant Costs (Sunk costs, Committed costs, Fixed costs): Costs which are not relevant or useful to decision making 8. Cash Outflow 8.1 Explicit Costs: Costs involving immediate payment of cash 8.2 Implicit Costs: Costs not involving immediate cash payment Types of Costing 1. Uniform Costing: Standardised principles and practices of costing are used by a number of different industries. 2. Marginal Costing: Only Variable Costs or costs directly linked are charged to the product or process 3. Standard Costing: Standard Costs are compared with actual costs, to determine variances Historical Costing: Where costs are recorded after they have incurred 5. Direct Costing: Direct Costs are charged to the product or process, Indirect Costs are charged to the profit from the product or process. 6. Absorption Costing: All costs (variable and Fixed) are charged to the product or process Methods of Costing 1. Job costing; Where all costs can be directly charged to a specific job 2. Batch Costing: Where all costs can be directly charged to a group of products (batch)

9 Basic Concepts Contract Costing: Similar to Job costing, but in this case the job is larger than job costing. 4. Single or Output Costing: Cost ascertainment for a single product. 5. Process Costing: The cost of production at each stage is ascertained separately 6. Operating Costing : Ascertainment of Costs in cases where services are rendered 7. Multiple Costing: Combination of two or more methods of costing, used where the nature of the product is complex and method cannot be ascertained Question 1 Enumerate the main objectives of introduction of a Cost Accounting System in a manufacturing organization The main objectives of introduction of a Cost Accounting System in a manufacturing organization are as follows: (i) Ascertainment of cost (ii) Determination of selling price (iii) Cost control and cost reduction (iv) Ascertainment of profit of each activity (v) Assisting in managerial decision making Question 2 Write short notes on any two of the following? (i) Conversion cost (ii) Sunk cost (iii) Opportunity cost (i) Conversion cost: It is the cost incurred to convert raw materials into finished goods. It is the sum of direct wages, direct expenses and manufacturing overheads. (ii) Sunk cost: Historical costs or the costs incurred in the past are known as sunk cost. They play no role in the current decision making process and are termed as irrelevant costs. For example, in the case of a decision relating to the replacement of a machine, the written down value of the existing machine is a sunk cost, and therefore, not considered. (iii) Opportunity cost: It refers to the value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action. For example, a firm financing its

10 1.4 Cost Accounting expansion plan by withdrawing money from its bank deposits. In such a case the loss of interest on the bank deposit is the opportunity cost for carrying out the expansion plan. Question 3 What is meant by cost centre? Cost Centre : It is the smallest area of responsibility or segment of activity for which costs are accumulated. It can be defined as a location; person or an item of equipment or a group of these for which costs are ascertained and used for the purpose of cost control. Cost centres are of two types viz.., personal and impersonal. Personal cost centre: It is a cost centre which consists of a person or a group of persons. Impersonal cost centre: It is a cost centre which consists of a location or an item of equipment or a group of these. In a manufacturing concern there are two types of cost centres viz., production and service cost centres. Question 4 Discuss cost classification based on variability and controllability. Cost classification based on variability Fixed cost These are costs, which do not change in total despite changes of a cost driver. A fixed cost is fixed only in relation to a given relevant range of the cost driver and a given time span. Rent, insurance, depreciation of factory building and equipment are examples of fixed costs where the final product produced is the cost object. Variable costs These are costs which change in total in proportion to changes of cost driver. Direct material, direct labour are examples of variable costs, in cases where the final product produced is the cost object. Semi-variable costs These are partly fixed and partly variable in relation to output e.g. telephone and electricity bill. Cost classification based on controllability Controllable costs Are incurred in a particular responsibility center and relate to a defined time span. They can be influenced by the action of the executive heading the responsibility center e.g. direct costs. Uncontrollable costs Are costs are influenced by the action of the responsibility center manager e.g. expenditure incurred by the tool room are controllable by the foreman in charge

11 Basic Concepts 1.5 of that section, but the share of tool room expenditure which are apportioned to the machine shop are not controllable by machine shop foreman. Question 5 Discuss the essential of a good cost accounting system? Essentials of a good cost accounting system: It should be tailor-made, practical, simple and capable of meeting the requirements of a business concern. The data used by the system should be accurate, otherwise it may distort the output of system. Cost of installing & operating the system should justify the results. Cost accounting system should have the support of top management of the concern. The system should have the necessary support from all the user s departments. Question 6 Explain: (i) Sunk Costs (ii) Pre-production Costs (iii) Research and Development Costs (iv) Training Costs (i) Sunk Costs: These are historical costs which are incurred in the past. These costs were incurred for a decision made in the past and cannot be changed by any decision that will be made in future. In other words, these costs play no role in decision making, in the current period. While considering the replacement of a plant, the depreciated book value of the old plant is irrelevant, as the amount is a sunk cost which is to be written off at the time of replacement. (ii) Pre-production Costs: These costs forms the part of development cost, incurred in making a trial production run, preliminary to formal production. These costs are incurred when a new factory is in the process of establishment or a new project is undertaken or a new product line or product is taken up, but there is no established or formal production to which such costs may be charged. These costs are normally treated as deferred revenue expenditure (except the portion which has been capitalised) and charged to the costs of future production.

12 1.6 Cost Accounting (iii) Research and Development Costs: Research costs are the costs incurred for the discovery of new ideas or processes by experiment or otherwise and for using the results of such experimentation on a commercial basis. Research costs are defined as the costs of searching for new or improved products, new applications of materials, or improved methods, processes, systems or services. Development costs are the costs of the process which begins with the implementation of the decision to produce a new or improved product or to employ a new or improved method and ends with the commencement of formal production of that product by that method. (iv) Training Costs: These costs comprises of wages and salaries of the trainees or learners, pay and allowances of the training and teaching staff, payment of fees etc, for training or for attending courses of studies sponsored by outside agencies and cost of materials, tools and equipments used for training. Costs incurred for running the training department, the losses arising due to the initial lower production, extra spoilage etc. occurring while providing training facilities to the new recruits. All these costs are booked under separate standing order numbers for the various functions. Usually there is a service cost centre, known as the Training Section, to which all the training costs are allocated. The total cost of training section is thereafter apportioned to production centers. Question 7 Enumerate the factors which are to be considered before installing a system of cost accounting in a manufacturing organization. Factors which are to be considered before installing a system of cost accounting in a manufacturing organization are: (i) The objectives of installing a system of cost accounting should be defined, that is whether the system is meant for control of cost or for price fixation (ii) The organization of the company should be studied to understand the authority and responsibilities of the managers. (iii) The technical aspects and flow process should be taken into consideration. (iv) The products to be manufactured should be studied. (v) The marketing set up to be looked into for devising suitable control reports. (vi) The possibility of integrating cost accounting system with financial accounting system should be examined. (vii) The procedure for collection and verification of reliability of the information should be studied.

13 Basic Concepts 1.7 (viii) The degree of details of information required at each level of management should be examined. (ix) The maximum amount of information that would be sufficient and how the same should be secured without too much clerical labour, especially the possibility of collection of data on a separate printed form designed for each process; also the possibility of instruction as regards filling up of the forms in writing to ensure that these would be faithfully carried out. (x) How the accuracy of the data collected can be verified? Who should be made responsible for making such verification with regard to each operation and the form of certification that should be given indicate verification that he has carried out. (xi) The manner in which the benefits of introducing Cost Accounting could be explained to various persons in the concern, specially those in-charge of production department and an awareness created for the necessity of promptitude, frequency and regularity in collection of costing data. Question 8 You have been asked to install a costing system in a manufacturing company. What practical difficulties will you expect and how will you propose to overcome the same? The practical difficulties with which a Cost Accountant is usually confronted with while installing a costing system in a manufacturing company are as follows: (i) Lack of top management support: Installation of a costing system does not receive the support of top management. They consider it as interference in their work. They believe that such, a system will involve additional paperwork. They also have a misconception in their minds that the system is meant for keeping a check on their activities. (ii) Resistance from cost accounting departmental staff: The staff resists because of fear of loosing their jobs and importance after the implementation of the new system. (iii) Non cooperation from user departments: The foremen, supervisor and other staff members may not cooperate in providing requisite data, as this would not only add to their responsibilities but will also increase paper work of the entire team as well. (iv) Shortage of trained staff: Since cost accounting system s installation involves specialised work, there may be a shortage of trained staff. To overcome these practical difficulties, necessary steps required are: To sell the idea to top management To convince them of the utility of the system. Resistance and non cooperation can be overcome by behavioral approach. To deal with the staff concerned effectively.

14 1.8 Cost Accounting Proper training should be given to the staff at each level Regular meetings should be held with the cost accounting staff, user departments, staff and top management to clarify their doubts / misgivings. Question 9 Define Explicit costs. How is it different from implicit costs? Explicit costs: These costs are also known as out of pocket costs. They refer to those costs which involves immediate payment of cash. Salaries, wages, postage and telegram, interest on loan etc. are some examples of explicit costs because they involve immediate cash payment. These payments are recorded in the books of account and can be easily measured. Main points of difference: The following are the main points of difference between explicit and implicit costs. (i) Implicit costs do not involve any immediate cash payment. As such they are also known as imputed costs or economic costs. (ii) Implicit costs are not recorded in the books of account but yet, they are important for certain types of managerial decisions such as equipment replacement and relative profitability of two alternative courses of action. Question 10 What are the main objectives of Cost Accounting? The main objectives of Cost Accounting are as follows: (i) Ascertainment of cost. (ii) Determination of selling price. (iii) Cost control and cost reduction. (iv) Ascertainment of profit of each activity. (v) Assisting management in decision making. Question 11 Explain controllable and non-controllable costs with illustrations. Controllable and non-controllable costs

15 Basic Concepts 1.9 Controllable costs: These are the costs which can be influenced by the action of a specified person in an organisation. In every organisation, there are a number of departments which are called responsibility centres, each under the charge of a specified level of management. Costs incurred in these responsibility centres are influenced by the action of the in-charge of the responsibility centre. Thus any cost that an organisational unit has the authority to incur may be identified as controllable cost. Non-controllable costs: These are the costs which cannot be influenced by the action of a specified member of an undertaking. For example, expenditure incurred by the Tool Room is controllable by the Tool Room Manager but the share of Tool Room expenditure, which is apportioned to the Machine shop cannot be controlled by the manager of the Machine Shop. However, the distinction between controllable and non-controllable costs is not very sharp and is sometimes left to individual judgment to specify a cost as controllable or non-controllable in relation to a particular individual manager. Question 12 Discuss the four different methods of costing alongwith their applicability to concerned industry? Four different methods of costing along with their applicability to concerned industry have been discussed as below: 1. Job Costing: The objective under this method of costing is to ascertain the cost of each job order. A job card is prepared for each job to accumulate costs. The cost of the job is determined by adding all costs against the job it is incurred. This method of costing is used in printing press, foundries and general engineering workshops, advertising etc. 2. Batch Costing: This system of costing is used where small components/parts of the same kind are required to be manufactured in large quantities. Here batch of similar products is treated as a job and cost of such a job is ascertained as discussed under 1, above. If in a cycle manufacturing unit, rims are produced in batches of 2,500 units each, then the cost will be determined in relation to a batch of 2,500 units. 3. Contract Costing: If a job is very big and takes a long time for its completion, then method used for costing is known as Contract Costing. Here the cost of each contract is ascertained separately. It is suitable for firms engaged in the construction of bridges, roads, buildings etc. 4. Operating Costing: The method of Costing used in service rendering undertakings is known as operating costing. This method of costing is used in undertakings like transport, supply of water, telephone services, hospitals, nursing homes etc.

16 1.10 Cost Accounting Question 13 Distinguish between Marginal Costing and Differential Costing Marginal Costing and Differential Costing Marginal Costing is defined as the Ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. Differential Costing is defined as the technique of costing which uses differential costs and/or differential revenues for ascertaining the acceptability of an alternative. The technique may be termed as incremental costing when the difference is increase in costs and decremental costing when the difference is decrease in costs. The main points of distinction between marginal costing and differential costing are as below: (a) The technique of marginal costing requires a clear distinction between variable costs and fixed costs whereas no such distinction is made in the case of differential costing. (b) In marginal costing, margin of contribution and contribution ratio are the main yard sticks for performance evaluation and for decision making whereas under differential costs analysis, differential costs are compared with the incremental or decremental revenue (as the case may be) for arriving at a decision. (c) Differential cost analysis is possible in both absorption costing and marginal costing, where as marginal costing in itself is a distinct technique. (d) Marginal cost may be incorporated in the cost accounting system whereas differential costs are worked out separately. Question 14 any of the following: (i) Explicit and Implicit Costs (ii) Period Costs and Discretionary Costs (i) Explicit and Implicit cost: Explicit costs, which are also known as out of pocket costs, refer to costs involving immediate payment of cash. Salaries, wages, interest on loan etc. are examples of explicit costs. They can be easily measured. The main points of difference between explicit and implicit costs are: Implicit costs do not involve immediate cash payment.

17 Basic Concepts 1.11 (ii) They are not recorded in the books of account. They are also known as economic costs. Period and Discretionary costs There are the costs, which are not assigned to the products but are charged as expenses against the revenue of the period in which they are incurred. All non-manufacturing costs such as general and administrative expenses, selling and distribution expenses are period costs. Such costs are not tied to a clear cause and effect relationship between inputs and outputs. They arise from periodic decisions regarding the maximum outlay to be incurred. Examples are advertising, public relations, training etc. Question 15 Explain Profit centres and investment centres. Profit Centres and Investment Centres: Centres which have the responsibility of generating and maximizing profits are called profit centres. Those centres which are concerned with earning an adequate return on investment are known as Investment centres. Question 16 Briefly discuss how the synergetic effect helps in reduction in costs. Two or more products are produced and managed together. The result of combined efforts is higher than sum of the results of individual products. Analysis of synergetic effect is helpful in cost control. Question 17 What items are generally included in good uniform costing manual? Uniform costing manual includes essential information and instructions to implement accounting procedures. (a) Introduction: It includes objects and scope of the planning. (b) Accounting procedure and planning includes rules, and general principle to be followed.

18 1.12 Cost Accounting (c) Cost accounting planning includes methods of costing, relation between cost and financial accounts and methods of integration. Question 18 Discuss briefly the relevant costs with examples. Relevant costs are those expected future cost which are essential but differ for alternative course or action. (a) Historical cost or sunk costs are irrelevant as they do not play any role in the decision making process. (b) Variable costs which will not differ under various alternatives are irrelevant. Question 19 State the unit of cost for the following industries (a) Transport (b) Power (c) Hotel (d) Hospital Industry Unit of Cost (a) Transport Per passenger k.m. or per tonne. k.m. (b) Power Per Kilo watt (kw) hour (c) Hotel Per room day / or per meal (d) Hospital Per patient day Question 20 Distinguish between product cost and period cost. Product Cost vis-à-vis Period cost Product costs are associated with the purchase and sale of goods. In the production scenario, such costs are associated with the acquisition and conversion of materials and all other manufacturing inputs into finished product for sale. Hence under absorption cost, total manufacturing costs constitute inventoriable or product cost.

19 Basic Concepts 1.13 Periods costs are the costs, which are not assigned to the products but are charged as expense against revenue of the period in which they are incurred. General Administration, marketing, sales and distributor overheads are recognized as period costs. Question 21 Define the following: (a) Imputed cost (b) Capitalised cost (a) Imputed Cost: These costs are notional costs which do not involve any cash outlay. Interest on capital, the payment for which is not actually made, is an example of Imputed Cost. These costs are similar to opportunity costs. (b) Captialised Cost: These are costs which are initially recorded as assets and subsequently treated as expenses. Question 22 What is Cost accounting? Enumerate its important objectives. Cost Accounting is defined as "the process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling costs." The main objectives of the cost accounting are as follows: (a) Ascertainment of cost: There are two methods of ascertaining costs, viz., Post Costing and Continuous Costing. Post Costing means, analysis of actual information as recorded in financial books. Continuous Costing, aims at collecting information about cost as and when the activity takes place so that as soon as a job is completed the cost of completion would be known. (b) Determination of selling price: Business enterprises run on a profit making basis. It is thus necessary that the revenue should be greater than the costs incurred. Cost accounting provides the information regarding the cost to make and sell the product or services produced. (c) Cost control and cost reduction: To exercise cost control, the following steps should be observed: (i) Determine clearly the objective. (ii) Measure the actual performance. (iii) Investigate into the causes of failure to perform according to plan;

20 1.14 Cost Accounting (iv) Institute corrective action. (d) Cost Reduction may be defined as the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impairing their suitability for the use intended or diminution in the quality of the product. (e) Ascertaining the profit of each activity: The profit of any activity can be ascertained by matching cost with the revenue of that activity. The purpose under this step is to determine costing profit or loss of any activity on an objective basis. (f) Assisting management in decision making: Decision making is defined as a process of selecting a course of action out of two or more alternative courses. For making a choice between different courses of action, it is necessary to make a comparison of the outcomes, which may be arrived under different alternatives. Question 23 Write short note on essential factors for installing a Cost Accounting system. Essential Factors for installing a Cost Accounting System Before setting up a system of cost accounting following factors should be studied: (a) Objective : The objective of costing system, for example whether it is being introduced for fixing prices or for insisting a system of cost control. (b) Type of Business: The areas of operation of business wherein the managements action will be most beneficial. For instance, in a concern, which is anxious to expand its operations, increase in production would require maximum attention. On the other hand for a concern, which is not able, to sell the whole of its production the selling effort would require greater attention. The system of costing in each case should be designed to highlight, in significant areas, factors considered important for improving the efficiency of operations in that area. (c) General organisation: The business, with a view of finding out the manner in which the system of cost control could be introduced without altering or extending the organisation appreciably. (d) The Technical Details: Technical aspects of the concern and the attitude and behaviour that will be successful in winning sympathetic assistance or support of the supervisory staff and workmen. (e) Change in operations: The manner in which different variable expenses would be affected with expansion or cessation of different operations (f) Method of maintenance of cost records: The manner in which Cost and Financial accounts could be inter-locked into a single integral accounting system and in which

21 Basic Concepts 1.15 results of separate sets of accounts, cost and financial, could be reconciled by means of control accounts. (g) Information: The maximum amount of information that would be sufficient and how the same should be secured without too much clerical labour, especially the possibility of collection of data on a separate printed form designed for each process; also the possibility of instruction as regards filling up of the forms in writing to ensure that these would be faithfully carried out. (h) Accuracy: How the accuracy of the data collected can be verified? Who should be made responsible for making such verification in regard to each operation and the form of certificate that he should give to indicate the verification that he has carried out? (i) Informative and Simple: The manner in which the benefits of introducing Cost Accounting could be explained to various persons in the concern, especially those in charge of production department and awareness created for the necessity of promptitude, frequency and regularity in collection of costing data. (j) Support: Support of top management and employees are essential for installing a Cost Accounting System in any organisation. Question 24 State the types of cost in the following cases: (i) Interest paid on own capital not involving any cash outflow. (ii) Withdrawing money from bank deposit for the purpose of purchasing new machine for expansion purpose. (iii) Rent paid for the factory building which is temporarily closed (iv) Cost associated with the acquisition and conversion of material into finished product. Type of costs (i) Imputed Cost (ii) Opportunity Cost (iii) Shut Down Cost (iv) Product Cost Question 25 Briefly explain the essential features of a good cost accounting system.

22 1.16 Cost Accounting Essentials of a good Cost Accounting System: The essential features, which a good Cost Accounting System should possess, are as follows: (a) Informative and Simple: Cost Accounting System should be tailor-made, practical, simple and capable of meeting the requirements of a business concern. (b) Accuracy: The data to be used by the Cost Accounting System should be accurate; otherwise it may distort the output of the system. (c) Support from Management: Necessary cooperation and participation of executives from various departments of the concern is essential for developing a good system of Cost Accounting. (d) Cost- Benefit: The Cost of installing and operating the system should justify the results. (e) Precise Information: The system of costing should not sacrifice the utility by introducing meticulous and unnecessary details. (f) Procedure: A carefully phased programme should be prepared by using network analysis for the introduction of the system. (g) Trust: Management should have faith in the Costing System and should also provide a helping hand for its development and success. EXERCISE 1. SV Ltd. Is a manufacturing company which has a sound system of financial accounting. The management of the company therefore feels that there is no need for the installation of a cost accounting system. Prepare a report to the management bringing out the distinction between cost and financial accounting system and the need for the introduction of a sound cost accounting system. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 2 (a) Define the terms cost centre and cost unit. (b) Given below is a list of ten industries. Give the method of costing and the unit of cost against each industry. (a) Nursing Home (b) Road Transport (c) Steel (d) Coal (e) Bicycles (f) Bridge Construction (g) Interior Decoration (h) Advertising (i) Furniture (j) Sugar company having its own sugarcane fields. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 3 Distinguish between

23 Basic Concepts 1.17 (i) (ii) (iii) Cost Unit and Cost Centre Cost Centre and Profit Centre Bill of material from a material requisition note. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 4 (a) Match the following (b) (i) Total fixed cost 1. What cost should be? (ii) Total variable cost 2. Incurred cost (iii) Unit variable cost 3. Increase in proportion to output (iv) Unit fixed cost 4. Cost of conversion (v) Standard cost 5. What costs are expected to be (vi) Period cost 6. Decreases with rise in output (vii) Actual cost 7. Remains constant in total (viii) Labour and overhead 8. Remains constant per unit (ix) Incremental cost 9. Cost not assigned to products (x) Budgeted cost 10. Added value of a new product. Indicate whether the following statements are True or False: (a) (b) (c) (d) (e) (f) All costs are controllable. Conversion cost is equal to direct wages plus factory overhead. Variable cost per unit varies with the increase or decrease in the volume of output. Depreciation is an out of pocket cost. An item of cost that is direct for one business may be indirect for another Fixed cost per unit remains fixed. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 5. List down any eight factors that you will consider before installing a costing system. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 6. Outline the steps involved in installing a costing system in a manufacturing unit. What are the essentials of an effective costing system? Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 7 Distinguish between Controllable costs and uncontrollable costs. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 8. (a) Describe briefly the role of the cost accountant in a manufacturing organisation. (b) Distinguish between: (i) Variable cost and direct cost

24 1.18 Cost Accounting (ii) Estimated cost and standard cost. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 9 Write short notes on Cost Centre Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 10 Name the various reports (Elaboration not needed) that may be provided by the Cost Accounting Department of a big manufacturing company for the use of its executives. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 11 State the unit of cost and method of costing generally used for accounting purpose in the following cases: (i) Brick-works (ii) Bi-cycle (iii) Oil refining mill and (iv) Road transport company Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 12 What is meant by Profit Centre? Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 13 (a) What are the essentials of a Cost Accounting System? (b) Narrate the essential factors to be considered while designing and installing a Cost Accounting System. Refer to Chapter No. 1 i.e. Basic Concepts of Study Material. 14 Specify the methods of costing and cost units applicable to the following industries: (i) Toy making (ii) Cement (iii) Radio (iv) Bicycle (v) Ship building (vi) Hospital Refer to Chapter No. 1 i.e. Basic Concepts of Study Material.

25 2 Materials BASIC CONCEPTS AND FORMULAE 1. Maximum Level: It indicates the maximum figure of inventory quantity held in stock at any time. 2. Minimum Level: It indicates the lowest figure of inventory balance, which must be maintained in hand at all times, so that there is no stoppage of production due to non-availability of inventory. 3. Re-order level: This level lies between minimum and the maximum levels in such a way that before the material ordered is received into the stores, there is sufficient quantity on hand to cover both normal and abnormal consumption situations. 4. Danger level: It is the level at which normal issues of the raw material inventory are stopped and emergency issues are only made. 5. ABC Analysis: It is a system of inventory control. It exercises discriminating control over different items of stores classified on the basis of the investment involved. Items are classified into the following categories: A Category: Quantity less than 10 % but value more than 70 % B Category; Quantity less than 20 % but value about 20 % C Category: Quantity about 70 % but value less than 10% 6. Two bin system: Under this system each bin is divided into two parts - one, smaller part, should stock the quantity equal to the minimum stock or even the re-ordering level, and the other to keep the remaining quantity. Issues are made out of the larger part; but as soon as it becomes necessary to use quantity out of the smaller part of the bin, fresh order is placed. 7. System of budgets: The exact quantity of various types of inventories and the time when they would be required can be known by studying carefully production plans and production schedules. Based on this, inventories requirement budget can be prepared. Such a budget will discourage the unnecessary investment in inventories. 8. Perpetual inventory: Perpetual inventory represents a system of records maintained by the stores department. It in fact comprises: (i) Bin Cards, and (ii) Stores Ledger.

26 2.2 Cost Accounting 9. Continuous stock verification: Continuous stock taking means the physical checking of those records (which are maintained under perpetual inventory) with actual stock. 10. Economic Order Quantity (EOQ): It is the calculation of optimum level quantity which minimizes the total cost of Ordering and Delivery Cost and Carrying Cost. 11. Review of slow and non-moving items: Disposing of as early as possible slow moving items, in return with items needed for production to avoid unnecessary blockage of resources. 12. Input output ratio: Inventory control can also be exercised by the use of input output ratio analysis. Input-output ratio is the ratio of the quantity of input of material to production and the standard material content of the actual output. 13. Inventory turnover ratio: Computation of inventory turnover ratios for different items of material and comparison of the turnover rates provides a useful guidance for measuring inventory performance. High inventory turnover ratio indicates that the material in the question is a fast moving one. A low turnover ratio indicates overinvestment and locking up of the working capital in inventories 14. Valuation of Material Issues: Several methods of pricing material issues have been evolved which are as follows: a) First-in First-out method: The materials received first are to be issued first when material requisition is received. Materials left as closing stock will be at the price of latest purchases. b) Last-in First-out method: The materials purchased last are to be issued first when material requisition is received. Closing stock is valued at the oldest stock price. c) Simple Average Method: Total of unit price of each purchase Material Issue Price = Total Numbers of purchases d) Weighted Average Price Method: This method gives due weightage to quantities purchased and the purchase price to determine the issue price. Total cost of Materials received Weighted Average Price = Total Quantity purchases 15. Various Material Losses a) Wastage: Portion of basic raw material lost in processing having no recoverable value b) Scrap: The incidental material residue coming out of certain manufacturing operations having low recoverable value.

27 Materials 2.3 c) Spoilage: Goods damaged beyond rectification to be sold without further processing. d) Defectives: Goods which can be rectified and turned out as good units by the application of additional labour or other services. Basic Formulas 1. Maximum Level = Reorder Level + Reordering Quantity Minimum Consumption during the period required to obtain delivery. Or RL + RQ MnC Or Safety Stock + EOQ 2. Minimum Level = Reorder Level (Normal usage per period Average delivery time) 3. Average Stock Level = Maximum Level + Minimum Level 2 Minimum Level + ½ Reorder Quantity 4. Reorder Level = Maximum Reorder period Maximum Usage Time) = Normal Usage (Minimum Stock Period + Average Delivery = Safety Stock + Lead Time Consumption 5. Danger Level = Minimum Consumption Emergency Delivery Time 6. EOQ = 7. Ordering Cost = 8. Carrying Cost = Cost inventory 9. Inventory Turnover Ratio = 2 Annual Consumption Buying cos t per order Cost of carrying one unit of inventory for one year Annual usage Fixed Cost per Order Quantity Ordered Quantity ordered 2 Material Consumed Average Inventory Purchase Price for Inventory Carrying expressed as % of average

28 2.4 Cost Accounting 10. Inventory Turnover Period = 365 Inventory Turnover Ratio 11. To decide whether discount on purchase of material should be availed or not, compare total inventory cost before discount and after discount. Total inventory cost will include ordering cost, carrying cost and purchase cost. 12. Safety Stock = Annual Demand 365 (Max. lead time Normal / Average lead time) 13. Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost Note: For calculation of total inventory carrying cost, average inventory should be taken as half of EOQ. Average inventory cost is normally given as a percentage of cost per unit Question 1 How normal and abnormal loss of material arising during storage treated in Cost Accounts? Cost Accounts treatment of normal and abnormal loss of material arising during storage. The difference between the book balance and actual physical stock, which may either be gain or loss, should be transferred to Inventory Adjustment Account pending scrutiny to ascertain the reason for the difference. If on scrutiny, the difference arrived at is considered as normal, then such a difference should be transferred to overhead control account and if abnormal, it should be debited to costing profit and loss account. In the case of normal losses, an alternative method may be used. Under this method the price of the material issued to production may be inflated so as to cover the normal loss. Question 2 Distinguish clearly Bincards and Sores Ledger. Both bin cards and stores ledger are perpetual inventory records. None of them is a substitute for the other. These two records may be distinguished from the following points of view: (i) Bin card is maintained by the store keeper, while the stores ledger is maintained by the cost accounting department. (ii) Bin card is the stores recording document whereas the stores ledger is an accounting record.

29 Materials 2.5 (iii) Bin card contains information with regard to quantities i.e. their receipt, issue and balance while the stores ledger contains both quantitative and value information in respect of their receipts, issue and balance. (iv) In the bin card entries are made at the time when transaction takes place. But in the stores ledger entries are made only after the transaction has taken place. (v) Inter departmental transfer of materials appear only in stores ledger. (vi) Bin cards record each transaction but stores ledger records the same information in a summarized form. Question 3 What is Just in Time (JIT) purchases? What are the advantages of such purchases? Just in time (JIT) purchases means the purchase of goods or materials such that delivery immediately precedes their use. Advantages of JIT purchases: Main advantages of JIT purchases are as follows: 1. The suppliers of goods or materials co-operates with the company and supply requisite quantity of goods or materials for which order is placed before the start of production. 2. JIT purchases results in cost savings for example, the costs of stock out, inventory carrying, materials handling and breakage are reduced. 3. Due to frequent purchases of raw materials, its issue price is likely to be very close to the replacement price. Consequently the method of pricing to be followed for valuing material issues becomes less important for companies using JIT purchasing. 4. JIT purchasing are now attempting to extend daily deliveries to as many areas as possible so that the goods spend less time in warehouses or on store shelves before they are exhausted. Question 4 Discuss the accounting treatment of defectives in cost accounts Accounting treatment of defectives in cost accounts: Defectives refers to those units or portions of production, which do not meet the prescribed specifications. Such units can be reworked or re-conditioned by the use of additional material, labour and /or processing and brought to the point of either standard or sub-standard units. The possible way of treating defectives in cost accounts are as below:

30 2.6 Cost Accounting 1. When defectives are normal and it is not beneficial to identity them job-wise, then the following methods may be used. (a) (b) (c) Charged to good products: The cost of rectification of normal defectives is charged to good units. This method is used when defectives rectified are normal. Charged to general overheads. If the department responsible for defectives cannot be identified, the rework costs are charged to general overheads. Charged to departmental overheads: If the department responsible for defectives can be correctly identified, the rectification costs should be charged to that department. 2. When normal defectives are easily identifiable with specific job the rework costs are debited to the identified job. 3. When defectives are abnormal and are due to causes within the control of the organisation, the rework cost should be charged to the Costing Profit and Loss Account. Question 5 Explain the concept of "ABC Analysis" as a technique of inventory control ABC Analysis: It is a system of selective inventory control whereby the measure of control over an item of inventory varies with its usage value. It exercises discriminatory control over different items of stores grouped on the basis of the investment involved,. Usually the items of material are grouped into three categories viz; A, B and C according to their use value during a period. In other words, the high use value items are controlled more closely than the items of low use value. (i) 'A' Category of items consists of only a small percentage i.e., about 10 % of the total items of material handled by the stores but require heavy investment i.e., about 70% of inventory value, because of their high prices and heavy requirement. (ii) 'B' Category of items comprises of about 20% of the total items of material handled by stores. The percentage of investment required is about 20% of the total investment in inventories. (iii) 'C category of items does not require much investment. It may be about 10% of total inventory value but they are nearly 70% of the total items handled by stores. 'A' category of items can be controlled effectively by using a regular system, which ensures neither over- stocking nor shortage of materials for production. Such a system plans its total material requirements by making budgets. The stocks of materials are controlled by fixing certain levels like maximum level, minimum level and re-order level. A reduction in inventory management costs is achieved by determining economic order quantities after taking into account ordering cost and carrying cost. To avoid shortages and to minimize heavy