COST ACCOUNTING AND COST MANAGEMENT By Mr RS Sardesai

Transcription

1 COST ACCOUNTING AND COST MANAGEMENT By Mr RS Sardesai Syllabus 1. Cost analysis and preparation of cost statement 2. Marginal costing and decision making 3. Standard costing calculation and variances 4. Budgetary control and various functional budgets 5. Job costing and apportionment of service dept s cost 6. Contract costing 7. Process costing 1. Cost Analysis and Preparation of Cost Statement. (a) Cost. Cost is all expenditure incurred to bring the goods or services in the present condition or location. - Implies that all expenditure is not cost - Cost to be calculated with some reference point - There is a change in location or condition or change in both. (i) Raw Material Stock Cost (to be valued at cost) - Supplier s price - Loading Charges - Transportation - Transit insurance - Import duty or octroi etc - Unloading charges - Godown charges - X (a) Godown charges are some times not considered as cost as there is no change in location or condition (b) Godown charges are considered only after the item is shifted from godown. In case of using godown during the transit, the charges are to be included. (ii) Finished Goods Stock - Raw material cost Page 1 of 60 - Cost Management

2 - Wages - Factory expenses (a) Water (b) Electricity (c) Shed rent (d) Depreciation on asset for production (e) Factory taxes - Packing - Excise duty - Sales tax X (not to be included) - Advertising X (iii) Semi finished goods - Raw material - Wages On proportionate basis - Factory expenses Analysis of Costs. There are three methods adopted for cost analysis. 1. Direct and Indirect Costs method. 2. Variable, Fixed and Semi Variable Costs method 3. Production, Admin, Sales & Finance Costs method Direct Cost is the cost which is directly related to a particular activity. In converse way, it is the expenditure which can be avoided if the particular activity is not undertaken. Eg. The raw material used for manufacturing an item. If a particular item is not manufactured, the raw material and consequential cost of raw material is saved/not spent. It is mostly on proportionate basis to the activity level. Indirect Cost is that cost which does not have one to one relation with the activity. It is not directly related to activity. In other words it is the cost which has to be incurred irrespective of activity progressing or not. Such costs normally cover much wider range of activities like Administrative costs. These costs do not have one to one relationship with activity level. Page 2 of 60 - Cost Management

3 Variable Costs are the costs which change in direct proportion with the quantum of activity. In such cases there is direct fixed relation between quantum of activity and the cost incurred. Eg. Fuel expenditure of your car which is directly proportional to the usage of the car. Fixed Costs are the costs which remain constant (subject to a pre-specified maximum limit of activity, after which it will change) irrespective of the quantum of activity. Eg. Depreciation cost of Machinery, Insurance and finance costs of your vehicle which remain constant irrespective whether the machinery/vehicle is run or not. Semi Variable Costs are the costs which do change as the activity level changes but the variation is not in direct proportion to the activity level variation. These costs have a fixed component as well as a variable component. Eg. Hiring of a car which has a fixed daily hiring charges and in addition, per kilometre running charges applicable. Same is the case of mobile post paid charges. Rental charges are fixed costs while per unit call charge is the variable cost. Mathematical Model of Fixed and Variable Costs Sl Item 2000 Units 5000 Units 3000 units Remarks (a) Depreciation Rs 10000/- Rs 10000/- Rs 10000/- Fixed Cost (b) Raw Material Rs 50000/- Rs /- Rs 75000/- Variable Rs25/-per unit (c) Advertisement Rs 20000/- Rs 26000/- Rs 22000/- Semi Variable Fixed Compo Rs 16000/- Rs 16000/- Rs 16000/- Variable unit Rs 4000/- Rs 10000/- Rs 6000/- In case of Fixed costs, unit rate is constant. In case of Variable costs, amount is constant. Example. A factory can produce units per month. The following is their data for Apr and May: - Sl Item Apr (Units) May (Units) (a) Total Production (b) Direct Material Cost Rs /- Rs /- (c) Direct Labour Cost Rs 81000/- Rs /- (d) Depreciation Rs 20000/- Rs 20000/- (e) Production Overheads Rs 35000/- Rs 44000/- (f) Admin Overhead Rs 15000/- Rs 16500/- (g) Sales Overhead RS 30000/- Rs 36000/- Page 3 of 60 - Cost Management

4 The factory is expecting to produce and sell units in Jun at a selling price to earn a profit of 20% on the cost. Prepare a cost statement and selling price for Jun. Cost Analysis Statement Sl Item Apr May Jun (a) Total Production 9000(Units) 12000(Units) 10000(Units) (b) Direct Material Cost Rs /- Rs /- Rs /- (c) Direct Labour Cost Rs 81000/- Rs /- Rs 90000/- (d) Depreciation Rs 20000/- Rs 20000/- Rs 20000/- (e) Production Overheads Rs 35000/- Rs 44000/- Rs 38000/- Fixed cost Rs 8000/- Rs 8000/- Rs 8000/- Variable 3/- Rs 27000/- Rs 36000/- Rs 30000/- (f) Admin Overhead Rs 15000/- Rs 16500/- Rs 15500/- Fixed Cost Rs 10500/- Rs 10500/- Rs 10500/- Variable Rs 4500/- Rs 6000/- Rs 5000/- (g) Sales Overhead RS 30000/- Rs 36000/- Rs 32000/- Fixed Cost Rs 12000/- Rs 12000/- Rs 12000/- Variable Rs 18000/- Rs 24000/- Rs 20000/- Cost Statement for Jun Sl Item Jun Unit Cost (a) Total Production 10000(Units) (b) Direct Material Cost Rs /- Rs 12/- (c) Direct Labour Cost Rs 90000/- Rs 9.00 (d) Depreciation Rs 20000/- Rs 2.00 (e) Production Overheads Rs 38000/- Rs 3.80 (f) Admin Overhead Rs 15500/- Rs 1.55 (g) Sales Overhead Rs 32000/- Rs 3.2 (h) Total Production Cost Rs /- Rs31.55 (j) Profit 20% Rs63100/- Rs 6.31 (k) Selling Price Rs Cost Sheet of a Product 1. Production Cost (a) Direct Cost (Also called Prime Cost) (b) Indirect Cost (Also called Prod n O/H) includes indirect material, indirect labour, power, fuel and depreciation on machinery etc. 2. Admin Cost is also called Admin O/H. Page 4 of 60 - Cost Management

5 3. Selling and Distribution Cost called Selling and Distribution O/H. 4. Financial Costs are called Financial O/H. (Not included in cost sheet as this cost varies between project to project and it is difficult to arrive at a proper figure). But this cost is fully adjusted/factored while calculating selling price of an article or service. Purpose of Preparing a Cost Sheet. 1. To plan cost of a new product 2. To fix selling price 3. To control cost of an existing product 4. To find profitability of a product Cost sheet is a profit and loss account of a product. Principles of a Profit and Loss Account 1. Relate to a period (an account is applicable for a specified period only). 2. Relate to a product (for every individual and specific product) 3. Relate to a level of activity (Production rate). While preparing Cost Sheet of a product, it is necessary to have opening stock of: - (a) (b) (c) Raw Material Work in progress (ie, Stock of semi finished products) Finished products Cost Sheet Model of a Product X Period: Production = 1000 units Sale = 9500 units Sl Item Total Per Unit (a) Direct Material Cost (i) Opening Raw Material stock xx (ii) Add: Purchased during period xx (iii) Less: Closing stock xx Xxxx x (b) Direct Wages Xxxx x 1. Prime Cost Xxxx x Production Overhead Xxxx 2. Factory Cost = production cost of the period Xxxx Add: Opening WIP Stock Xxxx Less: Closing WIP Stock Xxxx 3. Works Cost (Prod n cost of finished product) Xxxx x Admin O/H = Cost of production of Xxxx x Page 5 of 60 - Cost Management

6 units` Add: Opening finished goods stock Xxxx x Less: Closing finished goods stock Xxxx x 4. Cost of Goods Sold Xxxx Selling O/H (Selling & Distribution Expenses) Xxxx x 5. Cost of Sales Xxxx x Profit or Loss Xxxx x 6. Sales (Money realised through sales) Xxxx x Page 6 of 60 - Cost Management

7 Practice Problems Cost Sheet Q1. When the selling price of a product P for the year 2003 was Rs 10/-, the total sales were Rs 1,00,000/-. For the year 2004, the selling price has been increased by 10%. The total sales are expected to increase by 21%. For the year 2003, the materials cost was 40%, labour cost was 30% and total overheads were 20% of sales. For the year 2004, the material rates have increased by 10%, labour rates by 5% and total overheads by Rs 3100/- Prepare the cost sheet for the year 2003 and 2004 and find out the profitability. Solution: - COST SHEET SL NO ITEM TOTAL Derived Information PER UNIT INCREASE PER UNIT TOTAL Sales % Units produced (a) Material Cost Variable Cost % (b) Labour Cost Variable Cost % Prime Cost Variable Cost (c) Over Heads Semi Variable ???? Cost of Sales Selling Price Profit Q2. A Ltd company manufactures and sells electrical ovens. The selling price of the same for the year 2003 was Rs For the year 2003, the material was 40%, labour 30% and total overheads were 30% of the cost of sales. For the year 2004, the material rates have increased by 5 %, labour rates by 10% but no change in overheads. If the management fixes the same selling price of Rs 2500 for the year 2004, there shall be a reduction in the profit of 2004 by 20% of such profits. The management wants you to suggest such a price for 2004 so that same percentage of profit shall be maintained. Page 7 of 60 - Cost Management

8 Sol: - COST SHEET SL NO ITEM % Rs % Rs Material Labour Prime Cost Overheads Cost of Sales Profits Selling Price (See comments on attached excel sheet for sequence of putting the figures in the table) It is seen from above table that cost of sales in 2004 is 5% more than the cost of sales in But it is given that if the selling price is kept same as 2003, Selling price remaining same, increase in cost = Reduction in profits That means 5% of the cost of sales = 20 % Profits. ie Cost of sales = 4 x profits But cost of sales + profit = selling price = 2500 Therefore 4x profits + profit = profits = 2500 Profit = 500 Cost of sales = 4 x 500 = 2000 Percentage of profits = 25% Cost of sales in 2004 = 2100 Therefore Selling price for having same level of profit = 2625 Q3. X Ltd has a capacity to manufacture units per annum. For the year 2003, they produced and sold units in domestic market and the data for same is as under:- Material Rs Labour Rs Production Overheads Rs (50% fixed) Adm Overheads Rs (50% variable) Sales Overhead Rs (75% variable) Cost of sales Rs Profit Rs Sales Rs Page 8 of 60 - Cost Management

9 Additional information is as follows: - Sol: - (a) (b) (c) For 2004, the domestic demand shall reduce by 10%, but the company is expected to utilise 100% of capacity by exporting the units of balance capacity. The rates of all the variable costs shall increase by 10% but the fixed costs are not expected to change. The variable sales overheads rate for the export is expected to be 50% of the similar rate for domestic sale. (d) The company is expected to maintain same level of profit also for (e) Prepare the cost sheet for 2004 and find out what selling price shall be charged for exports if domestic selling price is not expected to change for Prepare a work sheet as follows: - ITEM TOTAL COST UNIT RATE CHANGE Material % 33 Labour % 19.8 Production O/H Fixed NIL Variable % 5.50 Adm O/H Fixed NIL Variable % Sales O/H Fixed NIL Variable Domestic % Variable Export Now Prepare a cost sheet SL ITEM DOMESTIC EXPORT 7000 TOTAL Material Labour Prime Cost Production O/H Fixed Page 9 of 60 - Cost Management

10 Variable Works cost Adm O/H Fixed Variable Cost of Prod n Sales O/H Fixed Variable Cost of sales Profit Sales Page 10 of 60 - Cost Management

11 MARGINAL COSTING Marginal Costing is an important tool for decision making. While arithmetically it is correct to say that if profit on one unit is Rs 10/- then profit on 100 units would be Rs 1000/-, in actual business environment, it is not so. The profit earned on 100 units would rarely be arithmetic calculation of one unit in actual conditions. It could be Rs 500 or Rs Def. Marginal cost is the change in total cost for the change in activity by one unit. In actual scenario, Marginal cost = Variable cost. Therefore, Marginal Costing is a decision making technique by use of calculation of marginal costs. Marginal Cost Table (Very Very Important Table Should be remembered by heart) Per Unit Total Sales X XX (-) Variable Cost X XX Contribution X XX (-) Fixed Costs X XX Profits/Loss X XX Per Unit Total Sales (-) Variable Cost Contribution (-) Fixed Costs Profits/Loss Contribution = Difference in sales and variable cost at any level. = Sales variable cost = Qty x (SP) Qty (Variable cost per unit) = Qty x (SP variable cost per unit) PV Ratio = Profit Volume Ratio = Contribution/Sales Note Contribution and sales should always be taken for the same activity level. Page 11 of 60 - Cost Management

12 PV Ratio does not change due to change in (a) Qty (b) Fixed Costs (c) Change in both in same proportion PV Ratio changes when (a) Selling Price is Changed (Total Sales Revenue is affected due to change in SP. Thus denominator in the ratio changes) (b) Variable Cost changes (Numerator changes due to change in Variable cost) (c) Change in both at differential proportion. Break Even Point The production level at which there is no profit or loss. Contribution at BEP = Fixed Costs Qty = Fixed cost/contribution per unit Qty = 30000/40 = 750 units (Contribution) BEP = Fixed Costs (Divide both sides by (Sales) BEP ) (Contribution) BEP = Fixed Costs (Sales) BEP = (Sales) BEP PV Ratio = Fixed Costs (Sales) BEP (Sales) BEP = Fixed Costs PV Ratio = = Margin of Safety = Actual level BEP = = 250 UNITS Level does not mean only quantity. It could also mean sales = = (Sales Value) Q1. X Ltd sells product P having SP of Rs 150 and variable cost/per unit of Rs 60. The fixed cost for year 2004 is 3,60,000 and the total sales Rs 12 lakhs. (a) Calculate (i) PV Ratio Page 12 of 60 - Cost Management

13 (ii) (iii) (iv) BEP (in Qty and Sales Value) Margin of Safety Profit at present level (b) (c) Calculate profit or loss if activity is 950 units Find out how the activity for (i) How many units to be sold for a profit of Rs (ii) What would be the sales value Sol: - (a) Sales = /150 = 8000 Units Fixed Cost per unit = /8000 = 45 Contribution = SP Variable Cost = = 90 Table Per Unit Total Sales (-) Variable cost Contribution (-) Fixed Costs Profits (i) PV Ratio = Contribution /Sales = 90/150 = 0.60 (ii) BEP Contribution = Fixed Cost (90 x BEP) = BEP = /90 BEP = 4000 units = 150x4000 = Rs (iii) Margin of Safety Actual Level BEP = = (iv) Profit at present level Profit = (SP-Fixed Cost Var Costs)x Qty = ( ) x 8000 = 45 x 8000 = (b) Profit or loss if activity is 950 units Contribution per unit = 90 Total contribution = Contribution per unit x total units 90 x 950 = Page 13 of 60 - Cost Management

14 Loss = Fixed cost contribution = = Profit or loss for sales of Rs Total Contribution = PV Ratio x Sales = 0.60 x = Loss = Fixed cost contribution Loss = = (c) (i) Activity for profit of Rs Total Contribution = Profit + Fixed Costs = = Contribution per unit = 90 Total contribution = No of units x contribution per unit = 90 x X X = 5000 (ii) Contribution = Fixed Cost Loss = = PV Ratio = Contribution / Sales 0.6 = /X X = Q. With above basic data, the management is expecting an increase of Rs in fixed costs with the decrease in selling price by 20% and decrease in Variable cost/unit by 10%. Calculate what would be change in profit/loss. Sol: - The new Selling Price = % = Rs 120 The new Variable Cost = 60 10% = Rs 54 New fixed cost = = Sales (unit SP) = 120 (-) Var Costs = 54 Contribution = (-) Fixed Costs= Profit (New) Profit (Old) Change in profit = New contribution per unit = New SP New Variable Cost = = 66 No of units sold earlier = Earlier Sales/Earlier SP Page 14 of 60 - Cost Management

15 = /150 = 8000 Total Contribution = 8000 x 66 = New profit = New contribution New Fixed Cost = = Reduction in profit = Earlier profit new profit = = Q. Under the new circumstances the management wants to achieve same sales value. How much would be the effect on profits? Sol. Sales Qty = Sales Value/SP per unit = /120 = Units Total Contribution = Contribution per unit x no of units = 66 x = New Profit = New Contribution New fixed costs = = Reduction in profits = Old Profit New Profit = = Q. How much should be the sales level under the changed circumstances to earn the same profit as before? Desired Contribution = Desired Profit + New fixed cost = = Contribution per unit = 66 No of units = /66 = Sales Value = No of units x SP = x 120 = Q. The following are the financial results of X Ltd for the years 2002 and 2003: Sales 20,00,000 25,00,000 Profits 5,00,000 6,50,000 The fixed costs for the year 2003 were higher than that for 2002 by Calculate for both years Page 15 of 60 - Cost Management

16 (a) (b) (c) (d) PV Ratio Fixed Costs Break Even Point Margin of safety Sol Change Sales 20,00,000 25,00,000 5,00,000 - Variable Costs 12,00,000 15,00,000 3,00,000 = Contribution 8,00,000 10,00,000 2,00,000 - Fixed Costs 3,00,000 3,50,000 50,000 = Profit 5,00,000 6,50,000 1,50,000 (To solve this problem, CHANGE has to be calculated and work the figures from there since all the rules of normal Marginal Costing table apply on change figures also. Data in Blue colour, italics and bold is given in the problem. Change in Contribution = Change in Fixed costs + Change in Profits = 50, ,50,000 = 2,00,000 PV Ratio Contribution Fixed Costs Break Even Point Margin of Safety = Change in Contribution /Change in Sales = 2,00,000/5,00,000 = 0.4 = PV Ratio X Sales = 0.4 X 20,00,000 = 8,00,000 (2002) = 0.4 X 25,00,000 = 10,00,000 (2003) = Contribution Profits = 8,00,000 5,00,000 = 3,00,000 (2002) = 10,00,000 6,50,000 = 3,50,000 (2003) = Fixed Costs/PV Ratio = 3,00,000/0.4 = 7,50,000 (2002) = 3,50,000/0.4 = 8,75,000 (2003) = Actual Level BEP = 20,00,000 7,50,000 = 12,50,000 (2002) = 25,00,000 8,75,000 = 16,25,000 (2003) Q. Can BEP be calculated without calculating the fixed costs? Sol: - PV Ratio = Change in total contribution/change in sales Change in sales = Change in total Contribution/PV ratio = Change in Profits/PV Ratio 20,00,000 (Sales) BEP = (5,00,000 0)/0.4 = 12,50,000 Page 16 of 60 - Cost Management

17 (Sales) BEP = 7,50,000 Q. X Ltd has planned the following performance for the year 2004: - Production 20,000 units Sales (In Lakhs) 25 Less cost of sales Raw Mat 06 Labour 03 Production Exp 02 (40% fixed) Admin Exp 02 (90% fixed) Sales Exp (40% variable) Net Profit 07 The company achieved the planned results for the half year ending Jun 04. Due to Union Budget in Jul 04, following changes are expected:- (a) Raw Material rates shall increase by 10%. (b) All variable costs except labour shall increase by 10%. (c) All fixed costs shall increase by 20%. (d) The company has production capacity of units pa. Is it possible to maintain planned profitability for 2004 in the changed circumstances? If so, at what level? Profitability Statement Variable Costs Fixed Costs PerUnit Cost in Rs Total in Lakhs Unit Total in (Rs) Lakhs Sales (20000 units) Labour Production Admin Exp Sales Exp Total Total Contribution Fixed Cost Profit nd Half Page 17 of 60 - Cost Management

18 The planned profits for the year = Profit for 1 st half + expected profits for 2 nd half 7 = (expected profits for 2 nd half) Expected profits for 2 nd half = = 3.5 lakhs Expected Fixed Cost for 2 nd Half Expected Contribution in 2 nd Half = 4/2 x 120% = 2.4 lakhs = Exp Profit + Fixed Costs = = 5.9 lakhs Expected Contribution /unit = Selling Price 125 -Variable Costs Raw Material (30 + 3) 33 Labour 15 Other Expenses (25+2.5) Contribution/unit 49.5 Expected activity for the second half of year = Expected contribution/contribution per unit = 5,90,000/49.5 = units Since the production level required is only units which is less than balance production capacity for the remaining half year ie units, it is feasible to achieve the planned target. Sales Value = x 125 = 14,90,000 Q. What would be minimum selling price that can be fixed for the 2 nd half year to maintain the planned profits? Sol. The minimum SP can be achieved when full capacity ie units is utilised. The expected contribution = 5.9 lakhs as calculated above Contribution per unit = /12500 = 47.2 Variable cost as calculated earlier = 75.5 Selling price = = Q. The management wants to sell units in domestic market and export balance capacity at a selling price lesser by 5% than domestic SP. To earn the same profit what domestic price should be fixed? Sol. The expected contribution = 5,90,000 Expected Variable Costs = x 75.5 = 9,43,750 Expected total sales = 15,33,750 Page 18 of 60 - Cost Management

19 Equivalent Units of Sale Units Wt Equi Units Domestic Export Total Expected Domestic Selling Price = 15,33,750/12375 = Page 19 of 60 - Cost Management

20 APPLICATIONS OF MARGINAL COSTING There are four major applications of Marginal Costing in Management: 1. Priority for profit maximisation (a) (b) Under normal circumstances Under key factor 2. Export Pricing 3. Manufacture Vs Outsource (Make Vs Buy) decision 4. Shutdown point of a factory PRODUCT A B C D E Material Cost Labour Cost Variable Cost Fixed Overheads Total Cost Profit Selling Price Priority by Company III II V IV I Contribution Priority by Me I II III V IV The above priority assessment is when there are no constraints of material, labour, market etc. To maximise the profit, fixed costs remaining constant, the product which facilitates maximum contribution per unit should be given priority. Now suppose that material cost is Rs 5/- Kg and labour cost is Rs 2 per hour. PRODUCT A B C D E Material Cost (Rs 5/- per Kg) Labour Cost (Rs 2/- per Hr) Variable Cost Fixed Overheads Total Cost Profit Selling Price Contribution per unit Consumption - Kg/unit Contribution per Kg Page 20 of 60 - Cost Management

21 Priority per material limitation II III V IV I Consumption - Hours per unit Contribution per Hr Priority with Lab constraints IV I V II III Export Pricing Product P Cost/Unit Export Raw Material (20% Excise duty concession) Labour Total O/H (Only variable taken into a/c) (60% Var) 3 (Special packing cost) Total Cost Domestic Profit 20 (-) 8 (Rebate against FE earnings) Selling Price (Minimum Export Price without any profit) Min Export Price = Additional Cost (Variable Cost) Incentives for Export Make Vs Buy Decision COMPONENT P Q R S T Material Cost Labour Cost Variable O/H Fixed Overheads Total Cost Mkt Price Savings Buy/ Manufacture (Co Decision) M B B B M Var Cost Mkt Price SAVINGS Decision Make Buy Make Make Make (Since Fixed Overheads are sunk cost and will have to be incurred even when purchasing from outside, they are added to the procurement cost from outside for Make or Buy decision. Thus, products R and S which appeared to be profitable when outsourced from market, turn out to be loss making proposition). Other Considerations regarding buy/manufacture decisions: 1. Price Stability in market 2. Quality assurance of supplier Page 21 of 60 - Cost Management

22 3. Criticality of component 4. Loss of contacts with existing suppliers of raw material etc. 5. Assurance regarding timely supply of component. Shut Down Point. Sales 20,00,000 Var Cost 10,00,000 Contribution 10,00,000 Fixed Cost 15,00,000 Loss 5,00,000 If the factory is closed down, 50% of the fixed costs can be saved. Whether factory should be closed? If the factory is not closed, the loss is Rs 5 lakhs as shown above. If the factory is closed: Sales 0 Contribution 0 Fixed Cost 7,50,000 (50% of costs of Rs 15 lakhs) Loss 7,50,000 Therefore, it is better to continue operations. Shut Down point is that point at which the loss if continued is equal to loss if discontinued. Sales Var cost 7.5 (50% of Sales Calculated from given figures) Contribution 7.5 (Calculated ) - Fixed Cost 15.0 (When operational - Given) Loss 7.5 (if discontinued - Given) If the factory is continuing, the expected loss is 7.5 lakhs at shut down point. The fixed cost if continued = 15 lakhs Contribution at Shut down point = Fixed cost loss = 7.5 lakhs Contribution PV Ratio = Sales = 10,00,000 20,00,000 = 0.5 Therefore, Sales at Shut Down Point = Contribution at SD Point PV Ratio = = 15 lakhs Page 22 of 60 - Cost Management

23 STANDARD COSTING Standard Costing is setting of the standard and comparison of the actual with the standards for the purpose of control. It involves taking the remedial measures for the variances or to set or revise the obsolete standards. Calculation of variances Variable Cost Related Fixed Cost Related 1. Raw Material 1. Fixed Overhead 2. Labour 3. Variable Overhead Raw Material Cost Variances Raw Material Price Variance Raw Material Usage Variance The methodology used for calculating the Raw Material Variances is also used for calculating the Labour and Variable Overhead variances. Q. Calculate Raw Material variances: Sol. Standard 1000 units of finished product 2000 Kg of Raw Rs 15/Kg Rs 30000/- Actual 8500 Units of finished goods Kg of Raw 15.50/Kg Rs /- 1. Raw Material Cost Variance = (Actual RM Cost RM cost for actual production at Standard Rates) = x30 = 5400 (Adverse Variance denoted as A ) 2. RM Price Variance = Actual Qty (Actual Price Standard Price) = ( ) = 8400 (A) Page 23 of 60 - Cost Management

24 3. RM Usage Variance = Standard Price (Actual Qty Standard Qty for actual production) = 15 ( x02) = 15 ( ) = 3000 (Favourable Variance denoted as F ) Q. Calculate RM, Labour and Variable Overhead Variances Sol. Standard for 100 Units of Finished Goods RMs 1500 Rs 3/- = Rs 4500/- Labour 600 Rs 4/- = Rs 2400/- Variable Overhead 600 Rs 1.50= Rs 900/- Total Variable Cost for Standard 100 Units = Rs 7800/- Actual for 2500 Units of Finished goods RMs Rs 3.10 = Rs /- Labour Rs 4.15 = Rs 63329/- Variable Overhead Rs 1.40 = Rs 21364/- Total Variable Cost for Actual production = Rs /- Raw Material Cost Variance = Raw Material Rate Variance= Raw Material Usage Variance = Labour Cost Variance = (Actual RM Cost RM cost for actual production at Standard rates) = ( x15) = 2975 (F) = ( ) = 3725 (A) Actual Quantity (Actual Rate Standard Rate) Standard Rate (Actual RM Usage Standard usage for actual production) = 3.0 ( x 15) = 750 (F) (Labour Cost for Actual Production Labour cost for actual production at standard rates) = ( x 6 x 4) = 3329 (A) Page 24 of 60 - Cost Management

25 Labour Efficiency Variance = Standard Labour Rate (Actual hrs Standard Hrs for actual production) = 4 ( x 6) = 1140 (A) Labour Rate Variance = Variable overhead Variance = = (4.15 4) = 2289 (A) Actual Hours (Actual Rate Standard Rate) Actual Variable Overheads Overheads for actual production at standard rates) = ( x 6 x 1.5) = 1136 (F) Variable Overhead Rate Variance = Actual Hrs (Actual Rate Standard Rate) = ( ) = 1526 (F) Variable Overhead Efficiency Variance = Standard Rate (Actual Overhead Hours Hrs required at Standard Rate for Actual Production) Statement of Variances Material Cost Variance Material Price Variance Material Usage Variance = 1.5 ( ) = 1.5 (260) = 390 (A) Rs 2975/- (A) Rs 3725/- (A) Rs 750/- (F) Labour Cost Variance Labour Rate Variance Labour Efficiency Variance Rs 3329/- (A) Rs 2289/- (A) Rs 1040/- (A) Variable Overhead Cost Variance Variable Overhead Rate Variance Variable Overhead Eff. Variance Rs 1136/- (F) Rs 1126/- (F) Rs 390/- (A) (Please note that in all cases, where Rate/price is outside the brackets, it is always STANDARD) Page 25 of 60 - Cost Management

26 Q. Calculate Material, Labour and Variable Overhead Variances from the following data: Standard for units Raw Material Rs 9/Kg Rs /- Labour Rs 3/Hr Rs 9000/- Variable Overhead Rs 1.8/Hr Rs 54000/- Actuals for 9000 Units Raw Material Rs 8.75/Kg Rs /- Labour Rs 3.10/Hr Rs 84506/- Variable Overhead Rs 1.75/Hr Rs 47705/- Sol. Material Cost Variance = (Actual cost Cost at Standard Rates for actual production) = ( x 9 x 9000) = 3375 (F) Material Rate Variance = Actual Mat consumed (Actual Rate Standard Rate) = (9 8.75) = 3375 (F) Material Usage Variance = Standard Rate (Actual Mat consumed Standard material for actual production) = 1.80 ( ) = 000 Labour Cost Variance = Actual Cost Cost at Standard Rate for actual production = x 3 x 3 = 3506 (A) Labour Rate Variance = Actual hrs (Actual Rate Standard Rates) = (3.10 3) = 2726 (A) Labour Eff. Variance = Standard Rate (Actual Hrs Standard hrs for actual production) = 3 ( x 3) = 3 x 260 = 780 (A) Page 26 of 60 - Cost Management

27 Variable Overhead Variance= Actual Overhead Overhead at Standard Rate for actual production = x 3 x 1.8 = = 895 (F) Variable Overhead Rate Variance = Actual Hrs (Actual Rate Standard Rate) = ( ) = 1363 Variable Overhead Eff Variance = Standard Rate (Actual Hrs Standard Hrs for actual production) Statement of Variances Material Cost Variance = 1.8 ( x 3) = 1.8 (260) = 468 (A) Material Price Variance Rs 3375/- (A) Rs 3375/- (A) Material Usage Variance Rs 000/- (-) Labour Cost Variance Labour Rate Variance Labour Efficiency Variance Variable Overhead Cost Variance Variable Overhead Rate Variance Variable Overhead Eff. Variance Rs 3506/- (A) Rs 2726/- (A) Rs 780/- (A) Rs 895/- (F) Rs 1363/- (F) Rs 468/- (A) Page 27 of 60 - Cost Management

28 FIXED OVERHEAD VARIANCES Fixed Overhead Cost Variance Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance Calendar Variance Capacity Variance Efficiency Variance Example 1: Calculate Fixed Overhead Variances from the following details: - Standard Rs Fixed Overhead 2,00,000 Production (Units) 50,000 Hrs 1,00,000 Days 25 Actual Fixed Overhead 2,08,000 Production (Units) 51,200 Hrs 1,02,500 Days 26 Solution Working Notes (Standard) Fixed Overhead per unit = /50000 = Rs 4/- Fixed Overhead per hr = / = Rs 2/- Fixed Overhead per day = /25 = Rs 8000/- Hrs available per day = /25 = 4000 No of Hrs per unit = /50000 = 2 1. Fixed Overhead Cost Variance = Actual Overhead Expenditure Fixed overheads recovered = 2,08, x4 = = 3200 (A) 2. Fixed Overhead Expenditure Variance = Actual Overhead Expenditure Standard Overhead Expenditure = = 8000 (A) Page 28 of 60 - Cost Management

29 3. Fixed Overhead Volume Variance = Fixed Overhead Recovered Standard Fixed Overhead = x = = 4800 (F) 3(a) 3(b) 3(c) Fixed Overhead Calendar Variance = Standard Fixed Overhead per day (Actual Days Standard Days) = 8000 (26 25) = 8000 (F) Fixed Overhead Capacity Variance = Standard Fixed Overhead per hr (Capacity Available Capacity Utilised) = Standard Fixed Overhead per hr (No of days worked x hrs per day Actual hrs utilised) = 2 (26 x ) = 2 ( ) = 2 (1500) = 3000 (A) Fixed Overhead Efficiency Variance = Standard Fixed Overhead per hr (Hrs actually taken Standard Hrs for actual production) = 2 ( x51200) = 2 ( ) = 2 (100) = 200 (A) Fixed Overhead Cost Variance 3200 (A) Fixed Overhead Expenditure Variance 8000 (A) Fixed Overhead Volume Variance 4800 (F) Fixed Overhead Calendar Variance 8000 (F) Fixed Overhead Capacity Variance 3000 (A) Fixed Overhead Efficiency Variance 200 (A) Example 2: Calculate Fixed Overhead Variances from the following details: - Standard Rs Fixed Overhead 5,00,000 Production (Units) 2,50,000 Hrs 4,00,000 Days 25 Page 29 of 60 - Cost Management

30 Actual Fixed Overhead 4,97,000 Production (Units) 2,46,800 Hrs 3,96,500 Days 24 Solution Working Notes Fixed Overhead per unit = / = Rs 2/- Fixed Overhead per hr = / = Rs 1.25 Fixed Overhead per day = /25 = Rs 20,000/- Hrs available per day = /25 = 16,000 No of Hrs per unit = / = Fixed Overhead Cost Variance = Actual Overhead Expenditure Fixed Overheads recovered = 4,97,500 2,46,800 x 2 = 4,97,500 4,93,600 = 3,900 (A) 2. Fixed Overhead Expenditure Variance = Actual Overhead Expenditure Standard Overhead Expenditure = 4,97,500 5,00,000 = 2,500 (F) 3. Fixed Overhead Volume Variance = Fixed Overhead Recovered Standard Fixed Overhead = x = = 6400 (A) 3(a) 3(b) Fixed Overhead Calendar Variance = Standard Fixed Overhead per day (Actual Days Standard Days) = (25 24) = (A) Fixed Overhead Capacity Variance = Standard Fixed Overhead per hr (Capacity Available Capacity Utilised) = Standard Fixed Overhead per hr (No of days worked x hrs per day Actual Hrs Utilised) = 1.25 (24 x ) = 1.25 ( ) = 1.25 (12000) = (F) Page 30 of 60 - Cost Management

31 3(c) Fixed Overhead Efficiency Variance = Standard Fixed Overhead per hr (Hrs actually taken Standard Hrs for actual production) = 1.25 ( x246800) = 1.25 ( ) = 1.25 (1120) = 1400 (A) Fixed Overhead Cost Variance 3900 (A) Fixed Overhead Expenditure Variance 2500 (F) Fixed Overhead Volume Variance 6400 (A) Fixed Overhead Calendar Variance (A) Fixed Overhead Capacity Variance (F) Fixed Overhead Efficiency Variance 1400 (A) Example 3: Calculate Fixed Overhead Variances from the following details: - Standard Rs Fixed Overhead 5,60,000 Production (Units) 14,000 Hrs 70,000 Days 28 Actual Fixed Overhead 6,12,000 Production (Units) 14,900 Hrs 75,000 Days 29 Solution Working Notes Fixed Overhead per unit = /14000 = Rs 40/- Fixed Overhead per hr = /70000 = Rs 8/- Fixed Overhead per day = /28 = Rs 20000/- Hrs available per day = 70000/28 = 2500 No of Hrs per unit = 70000/14000 = 5 1. Fixed Overhead Cost Variance = Actual Overhead Expenditure Fixed Overheads recovered = x 40 = = 16000(A) Page 31 of 60 - Cost Management

32 2. Fixed Overhead Expenditure Variance = Actual Overhead Expenditure Standard Overhead Expenditure = ,60,000= (A) 3. Fixed Overhead Volume Variance = Fixed Overhead Recovered Standard Fixed Overhead = x = = (F) 3(a) 3(b) Fixed Overhead Calendar Variance = Standard Fixed Overhead per day (Actual Days Standard Days) = (29 28) = (F) Fixed Overhead Capacity Variance = Standard Fixed Overhead per hr (Capacity Available Capacity Utilised) = Standard Fixed Overhead per hr (No of days worked x hrs per day Actual Hrs Utilised) = 8 (29 x ) = 8 ( ) = 8 (2500) = (F) 3(c) Fixed Overhead Efficiency Variance = Standard Fixed Overhead per hr (Hrs actually taken Standard Hrs for actual production) = 8 ( x14900) = 8 ( ) = 8 (500) = 4000 (A) Fixed Overhead Cost Variance 16000(A) Fixed Overhead Expenditure Variance (A) Fixed Overhead Volume Variance (F) Fixed Overhead Calendar Variance (F) Fixed Overhead Capacity Variance (F) Fixed Overhead Efficiency Variance 4000 (A) Page 32 of 60 - Cost Management

33 PROCESS COSTING Cost Pursuit in a particular process Further step to cost sheet Conditions: - 1. The whole process should be distinguishable into various identifiable processes 2. The output of earlier process is input for the next process. 3. Various processes are to be conducted in a particular sequence. DR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Rs To wages To Manufacturing Expenses 6000 By Transfer to Process - Rs CR Total Process Loss Loss in weight (No realisable Value) Scrap (There is realisable value) Material Scrap Defective Goods Abnormal Loss Normal Loss Abnormal Gain (Output = 930 units) Eg 5% inputs Output = 955 units = 20 Units Input = = 5 units (Loss beyond 5% = 50 units (Output beyond normal output) normal loss) Normal Output 950 units Normal Loss DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Rs By Normal Loss (5% of 1000 units at Page 33 of 60 - Cost Management

34 Re 1) To wages 6000 By Transfer to Process - Rs To Manufacturing Expenses 4000 Total Abnormal Loss DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Rs By Normal Loss (5% of 1000 units at Re 10) To wages By Abnormal Rs 21 (20000/950) 6000 By Transfer to Process - Rs To Manufacturing Expenses 4000 Total Abnormal Loss A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To process - I A/c By Scrap Value By Profit and Loss A/c 400 Total Abnormal Gain DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Rs By Normal Loss (5% of 1000 units at Re 10) To wages 6000 By Transfer to Process - Rs Page 34 of 60 - Cost Management

35 To abnormal Rs 21 To Manufacturing Expenses Total Abnormal Gain A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Scrap By Process I To Profit and Loss A/c 100 Total Example 1. Product P is manufactured by sequential process I, II, III. From the following information, prepare process I, II, and III A/cs and abnormal loss/gain A/c. ITEM PROCESS - I PROCESS - II PROCESS - III Misc material Wages Mfg Expenditure Normal Loss (% of Input 5% 8% 6% Scrap Value of Normal Loss Rs 8/unit - Rs 12/unit Actual output units were introduced to process Rs 40 per unit. Solution. Working Notes - Process I A/c 1. Normal Quantity = Input Normal Loss = = 950 units 2. Net Cost = Input Cost Scrap Value of Normal Loss = = Cost/unit = Net Cost /Normal Quantity = 87600/950 = Abnormal Loss = Normal Qty Actual Qty = = 25 units Page 35 of 60 - Cost Management

36 Process I A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By Normal Loss (5% of 1000 units at Rs 8) To Misc Material To wages To Manufacturing Expenses 8000 By Abnormal Rs By Transfer to Process - Rs Total Working Notes - Process II A/c 1. Normal Quantity = Input Normal Loss = = 851 units 2. Net Cost = Input Cost Scrap Value of Normal Loss = = Cost/unit = Net Cost /Normal Quantity = /851 = Abnormal Loss = Normal Qty Actual Qty = = 1 unit Process II A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Transferred from process Rs By abnormal Loss (8% of 925 units) 74 0 To Misc Material To wages To Manufacturing Expenses By Abnormal Rs By Transfer to Process - Rs Total Page 36 of 60 - Cost Management

37 Working Notes - Process III A/c 1. Normal Quantity = Input Normal Loss = = 799 units 2. Net Cost = Input Cost Scrap Value of Normal Loss = = Cost/unit = Net Cost /Normal Quantity = /799 = Abnormal gain = Normal Qty Actual Qty = = 06 units Process III Account DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Transferred to Process - Rs By normal Rs 12/- for 6% of 850 units To Misc Material To wages To Mfg Expenses To abnormal By Transfer to finished Total Abnormal Loss A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To process I A/c By scrap Rs 8/ To process II A/c By scrap value 1 NIL By Profit & Loss A/c 2252 Total Abnormal Gain A/c DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To Scrap Value 6 72 By Process III A/c Process I Rs 12 To Profit and Loss A/c Total Page 37 of 60 - Cost Management

38 Example 2. Product P is manufactured by sequential processes X, Y, Z. From the following information, prepare process X, Y, and Z accounts and abnormal loss/gain account. ITEM PROCESS - I PROCESS - II PROCESS - III Misc material Wages Mfg Expenditure % of wages 50% 80% 30% Normal Loss (% of Input 10% 8% 5% Scrap Value of Normal Loss 10% 15% 20% Actual output units were introduced to process Rs 20 per unit. Example 1. A Ltd Co manufactures three chemicals X, Y and Z. Chemical X is manufactured by process I, Chemical Y by processes I & II and chemical Z by process I, II and III. The company sells part of output of each process in market at a profit of 10% above cost. From the following details prepare process accounts I, II and III. ITEM PROCESS - I PROCESS - II PROCESS - III Input material (Kg) Rate per Kg Rs Wages Mfg Expenditure Output (Kg) Qty Sold 1/3 rd Qty Transferred to next Process 2/3 rd The loss of input has no realisable value. *** (Unless abnormal loss or gain is given, normal situation is assumed.) Solution. Working Notes - Process A/c I 1. Output = 9600 Kg 2. Net Cost = Input Cost Scrap Value of Normal Loss = Zero = Cost/unit = Net Cost /Output = / 9600 = Selling Price = Cost + Profit = = Qty Sold = 1/3 x 9600 = 3200 Page 38 of 60 - Cost Management

39 6. Qty Transferred = 2/3 x 9600 = 6400 Process A/c I DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By Loss in Wt ( ) To wages By To Manufacturing Expenses By Transfer to process Rs To Profit and loss 6712 A/c (3200 x 2.09) Total Working Notes - Process A/c II 1. Output = 6800 Kg 2. Net Cost = Input Cost Scrap Value of Normal Loss = Zero = Cost/unit = Net Cost /Output = / 6800 = Selling Price = Cost + Profit = = Qty Sold = Qty Transferred = 3000 Process A/c II DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By Loss in Wt ( ) To units introduced from Process I To wages By To Manufacturing Expenses By Transfer to process Rs Page 39 of 60 - Cost Management

40 26.91 To Profit and loss A/c (3200 x 2.69) Total Working Notes - Process A/c III 1. Output = 3750 Kg 2. Net Cost = Input Cost Scrap Value of Normal Loss = Zero = Cost/unit = Net Cost /Output = / 3750 = Selling Price = Cost + Profit = = Qty Sold = Qty Transferred = 000 Process A/c III DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By Loss in Wt ( ) To units introduced from process II To wages By To Manufacturing Expenses 8000 To Profit and loss A/c (3200 x 2.09) Total Example 2. A Ltd Co manufactures three minerals P, Q and R. Mineral P is manufactured by process I, Mineral Q by process I & II and mineral R by process I, II and III. The company sells part of output of each process in market at specified selling prices. From the following details prepare process accounts I, II and III. ITEM PROCESS - I PROCESS - II PROCESS - III Input material (Kg) Rate per Kg Wages Page 40 of 60 - Cost Management

41 Mfg Expenditure Loss (% of input) 10% 12% 8% Qty Sold (Kg) 1/3 1/2 100 Qty Transferred to 2/3 rd 1/2 000 next Process Selling Price The loss out of process I is Rs 15, Process Rs 20 and Process Rs 25. Solution. Working Notes - Process A/c I 1. Output = % = Loss = 800 Kg 3. Net Cost = Input Cost Scrap Value of Normal Loss = = Cost/unit = Net Cost /Output = / 7200 = Selling Price = Qty Sold = 1/3 x 7200 = Qty Transferred = 2/3 x 9600 = 4800 Process A/c I DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs 50 8,000 4,00,000 By sale of scrap of Normal Loss Rs ,000 To wages To Manufacturing Expenses 1,25,000 By part production Rs 80. 4,200 By Transfer to process Rs ,984 2,400 1,92,000 4,800 3,69,984 To Profit and loss A/c (2400 x 2.92) Total 8,000 5,73,984 8,000 5,73,984 Working Notes - Process A/c II 1. Output = % = Net Cost = Input Cost Scrap Value of Normal Loss Page 41 of 60 - Cost Management

42 = = Loss = Cost/unit = Net Cost /Output = / = Selling Price = Qty Sold = Qty Transferred = 2200 Process A/c II DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By sale of scrap of Normal Loss Rs To units introduced from Process I To wages By part production To Manufacturing Expenses By Transfer to process Rs To Profit and loss A/c (2200 x 16.82) Total Working Notes - Process A/c III 1. Output = % = 2300 Kg 2. Net Cost = Input Cost Scrap Value of Normal Loss = = Loss = Cost/unit = Net Cost /Output = / 2300 = Selling Price = Qty Sold = 2300 Process A/c III DR CR INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To units Rs By sale of scrap of Normal Loss Rs Page 42 of 60 - Cost Management

43 To units introduced from Process II To wages By To Manufacturing Expenses To Profit and loss A/c (2300 x 6.96) Total Process Profit Statement Process I = Rs 6964 Process II = Rs Process III = Rs Rs Page 43 of 60 - Cost Management

44 CONTRACT COSTING Contract Costing. This method is followed in case of construction contracts to find the profitability of the each construction job. It is related to a particular site. Contract Account of Site X (Profit and Loss A/c) Dr Cr Expenditure Income To opening Material Stock By opening reserve for contingencies To opening uncertified work By work certified To material sent to site By uncertified work To wages By materials returned To depreciation on eqpt By closing stock To supervision charges To notional profit By net loss To (profit and loss A/c) To Closing reserve for contingencies By Notional Profit Expenditure Direct 1. Materials Sand, Cement, Bricks, Steel, Water, Wooden Blocks, etc 2. Labour 3. Equipment Depreciation Expenditure Indirect 1. Supervision Charges Case Study- Suppose a project was started on 01 Jan 04. Since the money is paid in case of construction contracts for part job completed (although some money out of the total due is always retained by the person giving contract (contractee) to have some leverage on the contractor so that he does not leave the contract mid way and run away, running bills are submitted for payment according to the percentage of the work completed. Veracity of all such claims of the work completion are usually assessed by a third party who certifies the amount of work completed and his decision is binding on both the parties. The payment is made at a pre agreed rate for the percentage of work certified as completed. Income statement of the Project From to Work Done Claim Certification Date 1 st Running Bill ,00, % Retention Money 10,000 90,000 Cash Paid 2 nd Running Bill ,80,000 (Addl 80,000) Page 44 of 60 - Cost Management