OM SAI RAM COST & MANAGEMENT ACCOUNTING [EXECUTIVE PROGRAMME] VOLUME - 2 get ready to LearN with fun.. 1
INDEX S. NO. TOPIC PAGE NO. 8. INTRODUCTION 3 9. COST SHEET 25 10. CASH FLOW STATEMENT 44 11. FUND FLOW STATEMENT 79 12. RECONCILIATION 91 13. CONTRACT COSTING 99 14. JOINT PRODUCT & BY PRODUCTS 116 15. PROCESS COSTING 126 16. BUDGETARY CONTROL 140 17. OPERATING COSTING 160 18. INTEGRAL & NON INTEGRAL SYSTEMS 170 19. COST ACCOUNTING RECORDS & COST AUDIT 185 PAST TRENDS 192 2
CHAPTER 8 Accounting is a very old science which is considered to be essential for keeping records of all receipts and payments as well as that of the income and expenditures. Accounting can be broadly divided into 3 categories. Categories of Accounting Financial Accounting Cost Accounting Management accounting 1. Financial Accounting aims at finding out profit or losses of an accounting year as well as the assets and liabilities position, by recording various transactions in a systematic manner. 2. Cost Accounting helps the business to ascertain the cost of production/services offered by the organization and also provides valuable information for taking various decisions and also for cost control and cost reduction. 3. Management Accounting helps the management to conduct the business in a more efficient manner. It helps in decision making COST Cost can be defined as the expenditure (actual or notional) incurred on or attributable to a given thing. ICWA, India defines Cost as "measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services". It can also be described as the resources that have been sacrificed or must be sacrificed to attain a particular objective. For example - Cost of preparing one cup of tea is the amount incurred on the elements like material, labour and other expenses. COSTING Costing may be defined as 'The technique and process of ascertaining costs'. Thus costing means determining the cost by any technique or process like memorandum records or formal records based on double entry system. According to Weldon, 'Costing is classifying, recording, allocation and appropriation of expenses for the determination of cost of products or services and for the presentation of suitably arranged data for the purpose of control and guidance of management. If we analyze the above definitions, it will be understood that costing is basically the procedure of ascertaining the costs. 3
It consists of principles and rules which are used for determining: (a) The cost of producing a product, e.g. projector, laptop, car. (b) The cost of providing a service, e.g. educational institute, hospital, transport. (c) The cost of performing an activity, e.g. placing purchase orders, receiving deliveries of materials. COST ACCOUNTING Cost accounting may be defined as A specialized branch of accounting which involves classification, accumulation, assignment and control over cost. Cost Accounting primarily deals with collection, analysis of relevant of cost data for interpretation and presentation for various problems of management. CIMA defined it as, 'the establishment of budgets, standard costs and actual costs of operations, processes, activities or products and the analysis of variances, profitability or the social use of funds'. Thus, Cost Accounting embraces (a) Collecting, classifying, recording, allocating and analyzing the costs. (b) Preparation of periodical statements and reports for ascertaining and controlling costs. (c) Ascertainment of profitability of activities carried out or planned. COST ACCOUNTANCY Cost Accountancy is a broader term and is defined as, the application of costing and cost accounting principles, methods and techniques to the science and art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making. If we analyze the above definition, the following points will emerge, a) Cost accountancy is basically application of the costing and cost accounting principles. b) This application is with specific purpose and that is for the purpose of cost control, ascertainment of profitability and also for presentation of information to facilitate decision making. Cost accountancy is a combination of art and science, it is a science as it has well defined rules and regulations, it is an art as application of any science requires art and it is a practice as it has to be applied on continuous basis and is not a onetime exercise. CLASSIFICATION OF COSTS Classification according to Elements Behaviors Time Nature Function For Decision making An important step in computation and analysis of cost is the classification of costs into different types. Classification helps in better control of the costs and also helps considerably in decision making. Classification of costs can be made according to the following basis. 4
(A) Classification according to elements:- Costs can be classified according to the elements. There are three elements of costing, viz. material, labor and expenses. Total cost of production/services can be divided into the three elements to find out the contribution of each element in the total costs. (B) Classification according to nature:- As per this classification, costs can be classified into Direct and Indirect. Direct costs are the costs which are identifiable with the product unit or cost center while indirect costs are not identifiable with the product unit or cost center and hence they are to be allocated, apportioned and then absorb in the production units. All elements of costs like material, labor and expenses can be classified into direct and indirect. They are mentioned below. 1. Direct and Indirect Material:- Direct material is the material which is identifiable with the product. For example, in a cup of tea, quantity of milk consumed can be identified, quantity of glass in a glass bottle can be identified and so these will be direct materials for these products. Indirect material cannot be identified with the product, for example lubricants, fuel, oil, cotton wastes etc cannot be identified with a given unit of product and hence these are the examples of indirect materials. 2. Direct and Indirect Labour:- Direct labour can be identified with a given unit of product, for example, when wages are paid according to the piece rate, wages per unit can be identified. Similarly wages paid to workers who are directly engaged in the production can also be identified and hence they are direct wages. On the other hand, wages paid to workers like sweepers, gardeners, maintenance workers etc are indirect wages as they cannot be identified with the given unit of production. 3. Direct and Indirect Expenses:- Direct expenses refers to expenses that are specifically incurred and charged for specific or particular job, process, service, cost center or cost unit. These expenses are also called as chargeable expenses. Examples of these expenses are cost of drawing, design and layout, royalties payable on use of patents, copyrights etc, consultation fees paid to architects, surveyors etc. Indirect expenses on the other hand cannot be traced to specific product, job, process, service or cost center or cost unit. Several examples of indirect expenses can be given like insurance, electricity, rent, salaries, advertising etc. It should be noted that the total of direct expenses is known as 'Prime Cost' while the total of all indirect expenses is known as 'Overheads'. (C) Classification according to behavior:- Costs can also be classified according to their behavior. This classification is explained below. 1. Fixed Costs:- Out of the total costs, some costs remain fixed irrespective of changes in the production volume. These costs are called as fixed costs. The feature of these costs is that the total costs remain same while per unit fixed cost is always variable. Examples of these costs are salaries, insurance, rent, etc. 2. Variable Costs:- These costs are variable in nature, i.e. they change according to the volume of production. Their variability is in the same proportion to the production, i.e. the increase is exactly in the same proportion of the production. Another feature of the variable cost is that per unit variable cost remains same while the total variable costs will vary. Examples of variable costs are direct materials, direct labour etc. 5
3. Semi-variable Costs:- Certain costs are partly fixed and partly variable. In other words, they contain the features of both types of costs. These costs are neither totally fixed nor totally variable. Maintenance costs, supervisory costs etc are examples of semi-variable costs. These costs are also called as 'stepped costs'. (D) Classification according to functions:- Costs can also be classified according to the functions / activities. This classification can be done as mentioned below. 1. Production Costs: - All costs incurred for production of goods are known as production costs. 2. Administrative Costs:- Costs incurred for administration are known as administrative costs. Examples of these costs are office salaries, printing and stationery, office telephone, office rent, office insurance etc. 3. Selling and Distribution Costs:- All costs incurred for procuring an order are called as selling costs while all costs incurred for execution of order are distribution costs. Market research expenses, advertising, sales staff salary, sales promotion expenses are some of the examples of selling costs. Transportation expenses incurred on sales, warehouse rent etc are examples of distribution costs. 4. Research and Development Costs:- In the modern days, research and development has become one of the important functions of a business organization. Expenditure incurred for this function can be classified as Research and Development Costs. (E) Classification according to time: - Costs can also be classified according to time. This classification is explained below. 1. Historical Costs: - These are the costs which are incurred in the past, i.e. in the past year, past month or even in the last week or yesterday. The historical costs are ascertained after the period is over. In other words it becomes a post-mortem analysis of what has happened in the past. They can be effectively used for predicting the future costs. 2. Predetermined Cost: - These costs relating to the product are computed in advance of production, on the basis of a specification of all the factors affecting cost and cost data. Pre determined costs may be either standard or estimated. Standard Cost is a predetermined calculation of how much cost should be under specific working conditions. It is based on technical studies regarding material, labour and expenses. On the other hand, estimated costs are predetermined costs based on past performance and adjusted to the anticipated changes. It can be used in any business situation or decision making which does not require accurate cost. (F) Classification of costs for Management decision making: - One of the important functions of cost accounting is to present information to the Management for the purpose of decision making. For decision making certain types of costs are relevant. Classification of costs based on the criteria of decision making can be done in the following manner 1. Marginal Cost: - Marginal cost is the change in the aggregate costs due to change in the volume of output by one unit. For example, suppose a manufacturing company produces 10,000 units and the aggregate costs are ` 25,000, if 10,001 units are produced the aggregate costs may be ` 25,020 which means that the marginal cost is ` 20 Marginal cost is also termed as variable cost and hence per unit marginal cost is always same. 6
2. Differential Costs: - Differential costs are also known as incremental cost. This cost is the difference in total cost that will arise from the selection of one alternative to the other. In other words, it is an added cost of a change in the level of activity. This type of analysis is useful for taking various decisions like change in the level of activity, adding or dropping a product, change in product mix, make or buy decisions, accepting an export offer and so on. 3. Opportunity Costs: - It is the value of benefit sacrificed in favor of an alternative course of action. It is the maximum amount that could be obtained at any given point of time if a resource was sold or put to the most valuable alternative use that would be practicable. Opportunity cost of goods or services is measured in terms of revenue which could have been earned by employing that goods or services in some other alternative uses. 4. Relevant Cost: - The relevant cost is a cost which is relevant in various decisions of management. Decision making involves consideration of several alternative courses of action. In this process whatever costs are relevant, are to be taken into consideration. In other words, costs which are going to be affected matter the most and these costs are called as relevant costs. Relevant cost is a future cost which is different for different alternatives. It can also be defined as any cost which is affected by the decision on hand, Thus in decision making relevant costs play a vital role. 5. Replacement Cost: - This cost is the cost at which existing items of material or fixed assets can be replaced. Thus this is the cost of replacing existing assets at present or at a future date. 6. Abnormal Costs: - It is an unusual or a typical cost whose occurrence is usually not regular and is unexpected. This cost arises due to some abnormal situation of production Abnormal cost arises due to idle time, may be due to some unexpected heavy breakdown of machinery. They are not taken into consideration while computing cost of production or for decision making. 7. Controllable Costs: - In cost accounting, cost control and cost reduction are extremely important. Controllable costs are those which can be controlled or influenced by a conscious management action. For example, costs like telephone, printing stationery etc can be controlled while costs like salaries etc cannot be controlled at least in the short run. Generally, direct costs are controllable while uncontrollable costs are beyond the control of an individual in a given period of time. 8. Shutdown Cost: - These costs are the costs which are incurred if the operations are shut down and they will disappear if the operations are continued. Examples of these costs are costs of sheltering the plant and machinery and construction of sheds for storing exposed property. Computation of shutdown costs is extremely important for taking a decision of continuing or shutting down operations. 9. Urgent Costs: - These costs are those which must be incurred in order to continue operations of the firm. For example, cost of material and labor must be incurred if production is to take place. DISTINCTION BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING Financial Accounting differs from Cost Accounting in the following respects: Basis of Distinction Financial Accounting Cost Accounting Objectives Its objectives is to provide information about overall financial performance and financial position of the business Its objectives is to ascertain cost, to control cost and to provide information for decision- making Analysis of costs and It shows the overall profit/loss of It shows the detailed cost and profits 7
profit the entire organisation. for each product, process, job, contract, etc. Focus on Present/Future Its focus is on historical data. Its focus is on present, past and future data. Legal requirements Financial accounts of companies Preparation of cost records is have to meet requirements of the Companies Act and the Income voluntary, except in a few cases where the law makes it mandatory. Tax Act. Monetary / Nonmonetary information Persons interested Access Decision making Emphasis- Control/Reporting General vs Special reports Only monetary information is recorded in financial records. Virtually the whole world is interested in financial information the top management, workers, the shareholders, lenders, prospective investors the government. Anybody can have access to financial statements of companies Financial accounts are of limited use in decision making Its emphasis is on reporting and not on control It generates general purpose reports like Income Statement, balance Sheet, Cash Flow Statement. Both kinds of information (monetary and physical) are recorded in cost records. Usually internal management at different levels is interested in costing information Outsiders generally have no access to cost records. Cost accounts are basically designed to facilitate decision making in the areas of production, purchase, sales, etc. Its emphasis is on control-control on materials cost, labour cost and overheads. It generates special purpose reports like Report on Defectives, Report on Spoilage, Idle Time Report. MAJOR LIMITATIONS OF FINANCIAL ACCOUNTING AND HOW THESE ARE OVERCOME BY COST ACCOUNTING Major Limitations of Financial Accounting How these are overcome by Cost Accounting Financial Accounting does not provide the The technique of budgeting enables the information required the information required by management for forecasting and planning management to perform the function of forecasting and planning. Financial Accounting does not provide the information required by management for decision making in various areas such as make or buy, shut down or continue, retain or replace etc. Financial Accounting does not provide the information required by the management for control and assessment of the performance of various costs and responsibility centers. The technique of marginal costing enables the management to perform the function of decision making. The techniques of budgeting and standard costing enable the management to perform the function of control and assessment. 8
OBJECTIVES OF COST ACCOUNTING Objectives of Cost Accounting can be summarized as under 1. To ascertain the cost of production on per unit basis, for example, cost per kg, cost per meter, cost per liter, cost per ton etc. 2. Cost accounting helps in the determination of selling price. Cost accounting enables to determine the cost of production on a scientific basis and it helps to fix the selling price. 3. Cost accounting helps in cost control and cost reduction. 4. Cost accounting also helps in locating wastages, inefficiencies and other loopholes in the production processes / services offered. 5. Cost accounting helps in presentation of relevant data to the management which helps in decision making. 6. Cost accounting also helps in estimation of costs for the future. 7. To provide Information for decision-making = Cost Accounting aims at providing information for various managerial decisions like (a) Whether to make or buy a component (b) Whether to retain or replace an existing machine (c) Whether to process further or not (d) Whether to shut down or continue operations. ESSENTIALS OF A GOOD COSTING SYSTEM For availing of maximum benefits, a good costing system should possess the following characteristics. 1. Suitability: The cost accounting system should be suitable to the nature of business. 2. Tailor made system: It should be tailor made to meet the requirements of the business 3. Simplicity: It should be easy to understand and simple to operate 4. Economical: It should be economical to install and operate. Its cost should be justified by the benefits derived 5. Flexibility: It should be flexible to adopt the changing requirements of the business 6. Accuracy: It should provide the accurate information 7. Promptness: It should provide prompt information at regular intervals. 8. Support of staff: It should receive the necessary cooperation and participation of the staff. 9. Cost control: It should ensure cost control over the various fields. 10. Clearly defined Cost Centers: There should be clearly defined cost centers and responsibility centers. ADVANTAGES TO MANAGEMENT IMPORTANCE / ADVANTAGES OF COST ACCOUNTING Helps in Ascertainment of Cost: It helps in the ascertainment of cost of each product, process, job, contract, activity etc. by using different methods of costing such as Job Costing and Process Costing. Helps in Control of Cost: It helps in the control of material costs, labour costs and overheads by using different techniques of control such as Standard Costing and Budgetary Control. Helps in Decisions-Making: It helps the management in making various decisions such as - Whether to make or buy a component Whether to retain or replace an existing machine Whether to process further or not Whether to shut down or continue operations Whether to expand or not 9
Helps in fixing Selling Prices: It helps the management in fixing selling prices of products or services by providing detailed cost information. Helps in Inventory Control: It helps in inventory control by using various techniques such as ABC analysis, Economic Order Quantity, Stock levels, Perpetual Inventory system and Continuous Stock Taking, Inventory Turnover Ratio etc. Helps in Cost reduction: It helps in the introduction of cost reduction programme and finding out new and improved methods to reduce costs. Helps in preparation of Budgets: It helps in the preparation of various budgets such as Sales Budget/Production Budget, Purchase Budget, Man-Power Budget, and Overheads Budget. Helps in Identifying Unprofitable Activities: It helps in identifying unprofitable activities so that the necessary corrective action may be taken. Helps in Identifying Material Losses: It helps in identifying material losses such as wastage, scrap, spoilage and defective through report on material losses so that the necessary corrective action may be taken. Helps in Identifying Idle Time and Labour Turnover: It helps in identifying idle time and labour turnover through the report on idle time and labour turnover so that the necessary corrective action may be taken. Helps in Cost Comparison: It helps in Cost Comparisons such as Comparison with Standard Figures: Comparison of actual figures with standard or budgeted figures for the same period and the same firm; Intra-firm Comparison: Comparison of actual figures of one period with those of another period for the same firm; Inter-firm Comparison: Comparison of actual figures of one firm with those of another standard firm belonging to the same industry; and ADVANTAGES TO EMPLOYEES An efficient costing system benefits employees by introducing incentive plans. As a result both the productivity and earnings increase. ADVANTAGES TO SOCIETY An efficient costing system benefits the society by providing products and services at lower prices due to lower cost of production. ADVANTAGES TO NATIONAL ECONOMY An efficient costing system benefits national economy by achieving higher production, higher productivity because progress of enterprises leads to the progress of the industry which lead to progress of the national economy. ADVANTAGES TO GOVERNMENT, ITS AGENCIES AND OTHERS An efficient costing system helps government, its agencies (like Wage Tribunals) and others (like Chamber 'of Commerce and Industry) by providing required cost information. Such cost information is useful for price fixation, wage level fixation, settlement of industrial disputes, framing various policies etc. 10
COST UNIT CERTAIN IMPORTANT TERMS Meaning of Cost Unit A cost unit is a unit of product, service or time in terms of which costs are ascertained or expressed. It is basically a unit of, measurement like number (per 1000 bricks), weight (per tonne of coal), length (per meter of cloth), volume (per litre of petrol), time (per kilowatt hours of power), area (per square foot of construction). Its selection depends on the nature and type of industry. Purpose of Cost Unit The main purpose of selecting a cost unit is to, express cost per such unit. Types of Cost Unit Cost units are of two types as follows: Types Meaning Examples Units of production These are used in manufacturing A tonne of coal, steel, per 10 gram industries. Units of service These are used in service industries Examples of Cost Unit Some examples of cost unit for different products and services are given below: Product/Activity Cost Unit GOODS Bricks Per 1000 bricks Cars Per car Television Per set Gold Per 10 grams/per gram Iron steel/coal Per tone Paper Per ream/ Per Kilogram Cement Bag / per tone Petrol Per litre Wire Per meter of gold. Passenger km., tonne km., per bed per day SERVICES Power Computers Service Passenger Transport Goods Transport Nursing Home Hotel Per kilowatt hour Per hour Per Passenger per kilometer Per Kilogram / tonne per kilometer Per bed per day Per room per day COST OBJECT Meaning of Cost Object Cost may be defined as anything for which a separate measurement of cost is required. It may be product, service, activity or process etc. Examples of Cost Object Some examples of cost objected are as follows: Cost Object Examples 11
Product Service Process Activity Computer, Mobile Phone, TV, Car Hotel service, Hospital service, Transport service Spinning Process, Weaving Process in a Textile Mill Placing purchases order, Receiving deliveries of materials Inspecting materials, Storing materials in the store. RESPONSIBILTY CENTRE Meaning of Responsibility Centre Responsibility center is unit or function of an organization under the control of a manager who has direct responsibility for its performance. Types of Responsibility Centre For management control purposes, responsibility centers are classified into the following five categories: Responsibility Centers Cost Centre Revenue Centre Profit Contribution Investment Meaning Objective Meaning Objective Meaning Objective Meaning Objective Cost Centre Cost centre is a responsibility centre for which costs are accumulated CIMA, London defines cost centre as a production or service location, function, activity or item of equipment whose costs may be attributed to cost units. For example, a production department, stores department etc. The main objective of cost centre is to minimize the centre s costs and to fix the responsibility of the person in charge of a cost centre for the control of cost of that centre. Revenue Centre Revenue Centre is a responsibility centre for which only revenues are accumulated. CIMA, London defines revenue centre as a centre devoted to raising revenue with no responsibility for production e.g. a sales centre The main objective of revenue centre s is to maximize the centre s revenue Profit Centre Profit Centre is a responsibility centre for which both costs and revenues are accumulated. Thus the profit center concept is used for evaluation of performance. CIMA, London defines profit centre as a part of business accountable for costs and revenues. It may be called a Business Centre, Business Unit or Strategic Business Unit. The main objectives of profit centre is to maximize the centre s profit (i.e., difference between revenues and expenses) Contribution Centre Contribution Centre is a responsibility centre for which variable costs and revenues are accumulated. CIMA, London defines contribution centre as a profit centre whose expenditure is reported on marginal or direct cost basis The main objectives of contribution centre are to maximize the centre s 12
Meaning Objective contribution (i.e., difference between revenues and variable cost of sales). Investment centre Investment Centre is a responsibility centre for which costs, revenues and investments in assets are accumulated. CIMA, London defines investments centre as a profit centre whose performance is measured by its return on capital employed. The main objectives of investment centre is to maximize the centre s Return on investment (ROI) or return on Capital Employed (ROCE) Types of Cost Centre Basically Cost centers are of two types as following: Types Meaning Examples Personal Cost Centre It Consists of person or a group of Machine operator, Driver of a Impersonal Centre Cost persons It Consists of a location or an item of equipment or group of these delivery van, Salesman, Foreman Location: Factory, sales area Equipment: Machine, Delivery van From the functional point view, cost centers may be classified into following two types: Type Meaning Examples Productions Cost It is cost centre where the actual In a Textile Mill, Spinning Centre production work takes place. Department, Weaving Department, Calendaring Department, Dying Department. Service Cost Centre It is a cost centre which renders Power hours, Stores Department services to production cost centers Repairs and maintenance and other cost centers Department, Cost Accounting Department, Purchases Department,Personnel Department. COSTING SYSTEMS There are different costing systems used in practice. These are described below. (A) Historical Costing:- In this system, costs are ascertained only after they are incurred and that is why it is called as historical costing system. For example, costs incurred in the month of April, 2007 may be ascertained and collected in the month of May. Such type of costing system is extremely useful for conducting post-mortem examination of costs, i.e. analysis of the costs incurred in the past. Historical costing system may not be useful from cost control point of view but it certainly indicates a trend in the behavior of costs and is useful for estimation of costs in future. (B) Absorption Costing:- In this type of costing system, costs are absorbed in the product units irrespective of their nature. In other words, all fixed and variable costs are absorbed in the products. It is based on the principle that costs should be charged or absorbed to whatever is being costed, whether it is a cost unit, cost center. (C) Marginal Costing:- In Marginal Costing, only variable costs are charged to the products and fixed costs are written off to the Costing Profit and Loss A/c. The principle followed in this case is that since fixed costs are largely period costs, they should not enter into the production units. Naturally, the fixed costs will not enter into the inventories and they will be valued at marginal costs only. 13
(D) Uniform Costing:- This is not a distinct method of costing but is the adoption of identical costing principles and procedures by several units of the same industry or by several undertakings by mutual agreement. Uniform costing facilitates valid comparisons between organizations and helps in eliminating inefficiencies. COSTING METHODS AND TECHNIQUES Introduction:- It is necessary to understand the difference between the costing methods and techniques. Costing methods are those which help a firm to compute the cost of production or services offered by it. On the other hand, costing techniques are those which help a firm to present the data in a particular manner so as to facilitate the decision making as well as cost control and cost reduction. Costing methods and techniques are explained below. METHOD OF COSTING Job Costing Process costing Contract Costing Batch Costing Operating Costing Methods of Costing:- The following are the methods of costing. (i). Job Costing:- This costing method is used in firms which work on the basis of job work. There are some manufacturing units which undertake job work and are called as job order units. The main feature of these organizations is that they produce according to the requirements and specifications of the consumers. Each job may be different from the other one. Production is only on specific order and there is no pre demand production. Because of this situation, it is necessary to compute the cost of each job and hence job costing system is used. In this system, each job is treated separately and a job cost sheet is prepared to find out the cost of the job. The job cost sheet helps to compute the cost of the job in a phased manner and finally arrives the total cost of production. (ii). Batch Costing:- This method of costing is used in those firms where production is made on continuous basis. Each unit coming out is uniform in all respects and production is made prior to the demand, i.e. in anticipation of demand. One batch of production consists of the units produced from the time machinery is set to the time when it will be shut down for maintenance. For example, if production commences on 1st January 2007 and the machine is shut down for maintenance on 1st April 2007, the number of units produced in this period will be the size of one batch. The total cost incurred during this period will be divided by the number of units produced and unit cost will be worked out. Firms producing consumer goods like television, air-conditioners, washing machines etc use batch costing. (iii). Process Costing:- Some of the products like sugar, chemicals etc involve continuous production process and hence process costing method is used to work out the cost of production. The meaning of continuous process is that the input introduced in the process I travels through continuous process before finished product is produced. The output of process I becomes input of process II and the output of process II becomes input of the process III. If there is no additional process, the output of process III will be the finished product. In process costing, cost per process is worked out and per unit cost is worked out by dividing the total 14
cost by the number of units. Industries like sugar, edible oil, chemicals are examples of continuous production process and use process costing. (iv). Operating Costing:- This type of costing method is used in service sector to work out the cost of services offered to the consumers. For example, operating costing method is used in hospitals, power generating units, transportation sector etc. A cost sheet is prepared to compute the total cost and it is divided by cost units for working out the per unit cost. (v). Contract Costing:- This method of costing is used in construction industry to work out the cost of contract undertaken. For example, cost of constructing a bridge, commercial complex, residential complex, highways etc is worked out by use of this method of costing. Contract costing is actually similar to job costing, the only difference being that in contract costing, one construction job may take several months or even years before they are complete while in job costing, each job may be of a short duration. In contract costing, as each contract may take a long period for completion, the question of computing of profit is to be solved with the help of a well defined and accepted method. Technique of Costing As mentioned above, costing methods are for computation of the total cost of production/ services offered by a firm. On the other hand, costing technique help to present the data in a particular format so that decision making becomes easy. Costing techniques also help for controlling and reducing the costs. The following are the techniques of costing. TECHNIQUES OF COSTING Marginal Costing Standard Costing Budgetary Costing 1. Marginal Costing:- This technique is based on the assumption that the total cost of production can be divided into fixed and variable. Fixed costs remain same irrespective of the changes in the volume of production while the variable costs vary with the level of production, i.e. they will increase if the production increases and decrease if the production decreases. Variable cost per unit always remains the same. In this technique, only variable costs are taken into account while calculating production cost. Fixed costs are not absorbed in the production units. They are written off to the Costing Profit and Loss Account. The reason behind this is that the fixed costs are period costs and hence should not be absorbed in the production. Secondly they are variable on per unit basis and hence there is no equitable basis for charging them to the products. These techniques is effectively used for decision making in the areas like make or buy decisions, optimizing of product mix, key factor analysis, fixation of selling price, accepting or rejecting an export offer, and several other areas. 2. Standard Costing:- Standard costs are predetermined costs relating to material, labor and overheads. Though they are predetermined, they are worked out on scientific basis by conducting technical analysis. They are computed for all elements of costs such as material, labor and overheads. The main objective of fixation of standard cost is to have benchmark against which the actual performance can be compared. This means that the actual costs are compared with the standards. The difference is called as 'variance'. If actual costs are more than the standard, the variance is 'adverse' while if actual costs are less than the standard, the variance is 'favorable'. The adverse variances are analyzed and reasons for 15
the same are found out. Favorable variances may also be analyzed to find out the reasons behind the same. Standard costing, thus is an important technique for cost control and reduction. 3. Budgets and Budgetary Control:- Budget is defined as, 'a quantitative and/or a monetary statement prepared to prior to a defined period of time for the policies during that period for the purpose of achieving a given objective.' If we analyze this definition, it will be clear that a budget is a statement, which may be either in monetary form or quantitative form or both. For example, a production budget can be prepared in quantitative form showing the target production, it can also be prepared in monetary terms showing the expected cost of production. Some budgets can be prepared only in monetary terms, e.g. cash budget showing the estimated receipts and payments in a particular period can be prepared in monetary terms only. Another feature of budget is that it is always prepared prior to a defined period of time which means that budget is always prepared for future and that to a defined future. For example, a budget may be prepared for next 12 months or 6 months or even for 1 month, but the time period must be certain and not vague. One of the important aspects of budgeting is that it lays down the objective to be achieved during the defined period of time and for achieving the objectives, whatever policies are to be pursued are reflected in the budget. 16
MULTIPLE CHOICE QUESTIONS 1. Period costs are- (a) Variable costs (b) Fixed costs (c) Prime costs (d) Overhead costs Ans. (b) Fixed costs PAST EXAMINATION QUESTIONS 2. The management accounting is an extension of - (a) Financial accounting (b) Responsibility accounting (c) Cost accounting (d) All of the above Ans. (d) All of the above 3. Cost is determined before hand under- (a) Standard costing (b) Historical costing (c) Marginal costing ( Ans. (a) Standard Costing 4. Opportunity cost helps in (a) Ascertainment of cost (b) Controlling cost (c) Making managerial decisions (. Ans. (c) Making managerial decisions 5. The costing method in which fixed factory overheads are added to inventory is- (a) Direct costing (b) Marginal costing (c) Absorption costing (d) Activity based costing. Ans. (c) Absorption costing Fill in the Blanks 1. The technique and process of ascertaining cost is termed as costing. 2. The method of costing used in a refinery is Process costing. 3. Costs which are pertinent for decision-making are termed as Relevant Costs. 4. Costs which are ascertained after they have been incurred are known as Historical costs. 5. Operating costing is also known as service costing and it is used where services are rendered but articles are not produced. 6. Cost is a fact whereas price is a Policy. 7. Imputed costs are relevant for Decision Making. 8. A Sunk cost is the cost that has already been incurred and cannot be avoided by decisions taken in the future. 9. A profit centre is a division or organizational unit concerned with controlling both Sales/Revenue and costs. 10. Indirect expenses are excluded from cost. 17
11. Historical costs are not useful for decision making as all past costs are irrelevant. 12. A responsibility centre in which a manager is accountable for costs only is called Cost centre. True and False/Correct and Incorrect Qus 1. Notional costs and imputed costs mean the same thing Ans. Correct. Notional cost or imputed costs appear in the cost account only and do not involve any cash outlay. E.g. Interest on capital, the payment for which is not actually made. These costs are similar to opportunity costs and need to be considered when evaluating alternative proposals. Qus 2. Fringe benefits are charged to Costing Profit and Loss Account. Ans. Incorrect. Expenditure Incurred for factory worker is treated as factory over- head and should be apportioned to all the departments on the basis of the number of workers. Expenses related to office and selling and distribution workers should be treated as office overhead and selling and distribution overhead respectively. Hence, Fringe Benefits are treated in cost accounting in following ways:- a) Directly charged to production by using supplementary rate. b) Charge to particular department overhead. c) Charged as general overhead. Qus 3. Cost Accounting is a branch of financial accounting. Ans. False, Cost Accounting is a branch of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated. Cost accounting system is used to record, summarize and report cost information. Qus 4. Cost reduction is cost control. Ans. False, Cost reduction and cost control are two different approaches. Cost control may be temporary affair and at the cost of quality. Cost reduction implies the retention of the quality. Qus 5. Rent on owned building is included in cost accounts. Ans. True, Rent on owned building is included in cost accounts to calculate the real cost after taking into account the notional rent which would have been paid, if the building had been taken on rent. Qus 6. Rent on own building is not included in cost accounts. Ans. False, Rent on owned building is included in cost accounts to calculate the real cost after taking into account the notional rent which would have been paid, if the building had been taken on rent. Qus 7. Administration overheads are incurred due to management policy and they are easily controllable. Ans. Incorrect, A major part of administrative overhead costs is fixed in nature and are incurred due to management policy. Administration overheads are usually non-controllable cost but still they cannot be allowed to increase beyond limits. Administration overhead can be controlled by adopting the methods i.e. control through budgets, control through standards, etc. 18
Qus 8. A profit centre whose performance is measured by its Return on Investment (ROI) is known as Investment centre. Ans. Correct, The performance of an Investment Centre is measured on the basis of income earned by proper asset utilisation, i.e. Return on Investment. Qus 9. The method of costing used in a refinery is operating costing. Ans. False, The method of costing used in a refinery is process costing. Qus 10. Opportunity cost is recorded in the books of account. Ans. False, Opportunity cost are not recorded in the books of accounts. It is important in decision making and comparing alternatives. Qus 11. Direct cost and variable costs are not necessarily the same. Ans. False, Direct costs are costs that are directly related to a cost centre or cost unit. It is a part of total variable costs, hence, Direct costs and Variable Costs are the same. Qus 12. Sunk cost are not relevant for decision-making. Ans. True, Sunk cost is a cost on equipment or productive resources which has no economic relevance to the present decision making process. Qus 13. 'Costing' and 'cost accounting' are the same. Ans. False, Cost accounting is different from costing in the sense that the former provides only the basis and information for ascertainment of costs. Once the information is made available, costing can be carried out arithmetically by means of memorandum statements or by method of integral accounting. Qus 14. "Opportunity cost is measure of the benefit of opportunity foregone." Comment. Ans. Opportunity Costs refers to the value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action. The opportunity forgone or sacrifice made is usually the net-profit that might have been earned from the rejected alternative. E.g.- a firm financing its 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. Qus 15. Distinguish between 'Job costing' and 'contract costing'. Ans. Job Costing - Under job costing, products are manufactured according to specific requirements of the customer. This method involves the ascertainment of the cost of each job separately. It is ideal where products are dissimilar and non repetitive in nature. It is suitable for printing, interior decoration, ship building, automobile repairing shops and advertising industries. Contract Costing - It is a type of specific order costing in which the cost of each contract is ascertained separately. It is suitable for firms engaged in the civil engineering works, construction of bridges, roads, buildings etc. The main difference between these two Costing are:- 19
The Job Costing, Job refers to any specific work order or assignment where work is performed as per customer specifications and requirements, and duration of a production cycle is usually short, but might extend over a year also. Contract is of long duration, generally extending for more than one accounting year. Each contract is treated as a single cost unit. In job costing, an order, a unit, lot or batch of product may be taken as cost unit. Contract is generally not carried out at the contractor's premises. It is done on the site but job work is generally carried out in the premises. Qus 16. Distinguish between 'Explicit costs' and 'Implicit costs'. Ans. Explicit Costs - These costs involve immediate cash payment. Since, these costs are actually incurred and are recorded in the books of accounts, they are easy to measure. E.g. - salaries, wages, advertisement, etc Implicit Costs - These costs do not involve immediate cash outflow and are otherwise known as economic or notional or imputed costs. They are not recorded in the books of accounts and since they are not actually incurred, they cannot be easily estimated. E.g. - Interest on own capital, salary of proprietor, rent of own premises used or office purposes etc. The major difference between Explicit Costs and Implicit Costs are that explicit costs involves immediate cash outlay whereas, Implicit costs do not involve immediate cash outflow. Explicit costs are recorded in the books of accounts but, implicit costs are not recorded in the books of account. Qus 17. Distinguish between 'imputed costs' and 'common costs'. Ans. Imputed Costs - These costs appears in cost accounts only and do not involve any cash outlay. These costs are used only for the purposes of decision making and performance evaluation. Imputed costs are not recorded in financial accounts. These costs are also known as notional costs. These costs are notional in nature and do not involve any cash outlay. Interest on own capital is an example of imputed cost. In actual, Interest payment is not made but the basic concept is that if the fund had been invested elsewhere they would have earned interest. Thus, Imputed costs are similar to opportunity costs and needs to be considered when evaluating alternative proposals. Common costs - Common costs are incurred collectively for a number of cost centre. These costs are indirect costs which are incurred for more than one product, Job or any other specific costing object. These costs are incurred for the general benefit of a number of departments or for the entire enterprise and which is necessary for present and future operations. Common costs are apportioned, on a suitable basis, for determining the cost of the individual cost centre. Common costs are just the opposite of traceable costs. For e.g., rent of the factory is a common cost to all departments located in a factory. 20
TRAIN UR BRAIN 1. is the process of accounting for cost which begins with the recoding of income and expenditure or the basis on which they are calculated. a) Financial Accounting b) Process Accounting c) Cost Accounting d) Management Accounting 2. Cost accounting system is used to record, summarise and report a) Income information b) Cost Information c) Loss Information d) Capital Information 3. One of the function of cost accounting is proper matching of a) Profits b) Losses c) Overheads d) Costs 4. The main purpose of cost accounting is to provide information to management for - a) Decision making b) Policy making c) Planning 5. One the basis of behaviour of cost, overheads are classified into a) Controllable and Uncontrollable b) Capital and Revenue c) Fixed and Variable d) Normal and Abnormal 6. Total cost of direct material, direct labour, direct expenses and manufacturing expenses are included in a) Selling Costs b) Production costs c) Development Costs d) Distribution Costs 7. costs are directly related to cost centre or cost unit. a) Fixed b) Selling c) Direct d) Indirect 8. The cost which cannot be influenced by the action of a specified member of an undertaking is a) Contrallable Cost b) Opportunity Cost c) Uncontrollable Cost 9. The ascertainment of cost after they had been incurred is known as - a) Historical costing b) Pre-determined costing c) Replacement costing d) Differential Costing 10. One of the most important tool in cost accounting is a) Expenses b) Budget c) Planning 11. is a technique of cost ascertainment and cost control. a) Capital Costing b) Job Costing c) Batch Costing d) Standard Costing 12. The cost of a group of products is ascertained by a) Batch Costing b) Marginal Costing c) Process Costing d) Material Costing 13. costs are hypothetical notional costs. a) Opportunity b) Shut down c) Imputed d) Absolute 14. The method of costing used in job order industries is known as - a) Batch costing b) Job costing c) Direct costing d) Uniform costing 15. Which costs are charged against current income? a) Common cost b) Joint Cost c) Period Cost d) Future Cost 16. cost follows the item into inventory. a) Total b) Period c) Production d) Relevant 17. Increase in variable cost is due to increase in a) Sales b) Production c) Purchase 18. A cost which requires payment to outside parties is known as a) Opportunity cost b) Shut-down cost c) Absolute cost d) Out of pocket cost 19. Salary of sweeper is an example of a) Sunk cost b) Avoidable Cost c) Unavoidable cost 20. Research and development cost is an example of 21