Question 1

AMMI Ltd presents following information for Dec,2018-

Answer: Material cost variance is the difference between the standard cost of materials
allowed for the actual output and the actual cost of materials used. It may be expressed as:

Material cost variance = Standard cost – Actual cost

A favourable variance would result if actual cost is less than the standard cost and vice versa.
The material cost variance is the sum total of material price variance and material usage
variance.

Calculation of material cost variances

Stand
ard Stand Actual Actu
quanti ard quantit al
ty rate Total y rate Total
4400 10 44000 4230.77 12 50769.24
(22000 (4400* (22000/ (4230.77
/5) 10) 5.2) *12)

Material cost variance = Standard cost – Actual cost

= 44000 – 50769.24

= 6769.24 A

Conclusion: Material cost variance is 6769.24 adverse. That shows the actual cost of material
is more than the actual cost of material. Efforts should be made to reduce the cost of
production of material.

Question 2
You have decided to start up a venture for manufacturing gel pens. You plan to discuss
the term cost and the essential elements of cost with your partner so as to find the
suitability of various costs that can be incurred during the production. Design a
presentation to discuss the same with the relevant examples.

Answer: The term cost refers to the amount of resources given up in exchange for some
goods or services. The resources so given up are always expressed in terms of money. For a
firm trading in electrical appliances, the amount paid to purchase table fans will be the cost of
the fans; for a firm manufacturing table fans, the amount paid for the raw material of tin
sheets will be the ‘cost of tin sheets’ and so on. According to the Chartered Institute of
Management Accountants (CIMA), London, the term cost in general means, ‘The amount of
expenditure (actual or notional) incurred on or attributable to a given thing or activity’.
However, the term cost cannot be exactly defined. Its interpretation depends upon:
(a) the nature of business, or industry, and
(b) the context in which it is used.

In a business where selling and distribution expenses are quite nominal, the cost of the article
may be calculated without considering the selling and distribution overheads. In a business
where the nature of the product requires heavy selling and distribution expenses, calculation
of cost without taking into account selling and distribution expenses may prove very costly to
the business. Moreover, cost may be—factory cost, office cost, cost of sales. Even an item of
expense is termed as cost. For example, prime cost includes expenditure on direct materials,
direct labour and direct expenses. Money spent on material is termed as cost of materials, that
spent on labour as cost of labour, and so on. Thus, the use of the term cost without
qualification is also quite misleading. Again, different costs are found out for different
purposes. The work-in-progress is valued at factory cost. (Direct Material + Direct Labour +
Direct Expenses + Factory Overheads) while stock of finished goods is valued at office cost
(Works Cost + Office Overheads). Numerous other examples can be given to show that the
term ‘cost’ does not mean the same thing under all circumstances.

Elements of Cost
There are three broad elements of cost.
1. Material: The substance from which the product is made is known as material. It may be
in raw or semi-manufactured state. It can be direct as well as indirect.
(a) Direct material. All material which becomes an integral part of the finished product and
which can be conveniently assigned to specific physical units is termed as ‘Direct Material’.
The following are some examples of direct material:
(i) All material or components specifically purchased, produced or requisitioned from stores
(ii) Primary packing material (e.g., cartons, wrapping, cardboard boxes, etc.)
(iii) Purchased or partly produced components
Direct material is also described as process material, prime cost material, production material,
stores material, constructional material, etc.
(b) Indirect material. All material which is used for purpose ancillary to the business and
which cannot be conveniently assigned to specific physical units is termed as ‘Indirect
Material’. Consumable stores, oil and waste, printing and stationery material, etc., are few
examples of indirect material.
Indirect material may be used in factories, offices or selling and distribution divisions.
2. Labour: For conversion of materials into finished goods, human effort is needed; such
human effort is called labour. Labour can be direct as well as indirect.
(i) Direct labour. Labour which takes an active and direct part in the production of a
particular commodity is called direct labour. Direct labour costs are, therefore, specifically
and conveniently traceable to specific products.
Direct labour is also described as process labour, productive labour, operating labour, etc.
(ii) Indirect labour. Labour employed for the purpose of carrying out tasks incidental to
goods, or services provided, is indirect labour. Such labour does not alter the construction,
composition or condition of the product. It cannot be practically traced to specific units of
output. Wages and salaries of storekeepers, foremen, time-keepers, directors’ and salesmen,
are all examples of indirect labour costs. Indirect labour may relate to the office or the selling
and distribution divisions.
3. Expenses: Any other cost besides material and labour is termed as expense. Expenses may
be direct or indirect.
(i) Direct expenses. These are expenses which can be directly, conveniently and wholly
allocated to specific cost centres or cost units. Examples of such expenses are: hire of some
special machinery required for a particular contract, cost of defective work incurred in
connection with a particular job or contract, etc. Direct expenses are sometimes also
described as ‘chargeable expenses’.
(ii) Indirect expenses. These are expenses which cannot be directly, conveniently and wholly
allocated to cost centres or cost units. The examples of indirect expenses are rent, rates,
insurance, salaries, lighting charges, etc.

Overheads
Overhead costs are costs which cannot be wholly debited directly to a specific job. They are
neither direct material nor direct wages. They are also not the expenses of a direct nature and
hence cannot enter the cost of manufacture directly. However, they constitute an element of
costs as they have been incurred for manufacturing a commodity or making it ready for sale.
The term ‘overheads’ includes direct material, indirect labour and indirect expenses. Thus, all
indirect costs are overheads. A manufacturing organization can broadly be divided into three
divisions:
(i) Factory or Works where production is done;
(ii) Office and Administration, where routine as well as policy matters are decided; and
(iii) Selling and Distribution where products are sold and finally despatched to the customer.

Overheads may be incurred in the factory or office or selling and distribution divisions. Thus,
overheads may be of three types.
(a) Factory overheads: They include:
(i) Indirect material used in the factory such as lubricants, oil and consumable stores.
(ii) Indirect labour, such as gatekeeper’s salary, timekeeper’s salary and works manager’s
salary.
(iii) Indirect expenses such as factory rent, factory insurance and factory lighting.
(b) Office and Administration overheads: They include:
(i) Indirect material used in the office such as printing and stationery material, brooms and
dusters, and so on.
(ii) Indirect labour such as salaries payable to office manager, office accountant, clerks, and
so on.
(iii) Indirect expenses such as rent, insurance, lighting of the office.
(c) Selling and distribution overheads: They include:
(i) Indirect material used such as packing material, printing and stationery material.
(ii) Indirect labour such as salaries of salesmen and sales manager.
(iii) Indirect expenses, such as rent, insurance, advertising expenses.

Question 3
Bhakti Ltd provides you the following information in relation to the year 2016-17 and
2017-18
2016-17 2017-18
Opening Stock(units) 100 ?
 Value for 2016-17 Rs
25000
Production (units) ? 1800
Fixed Cost Rs 1 lacs Rs 1.5 lacs
Variable Cost 120000 250000
Sales(units) 1900 1100
Selling price (Rs/ per unit) 500 700
Closing Stock( units) 200 ?
Calculate the value of closing stock for the year 2018, using –
a. FIFO basis
b. LIFO basis

Answer:
2016-17 2017-18
Opening Stock(units) 100 200 (w.n.6)
Value for 2016-17 Rs
25000
Production (units) 2000 (w.n.2) 1800
Fixed Cost Rs 1 lacs Rs 1.5 lacs
Variable Cost 120000 250000
Sales(units) 1900 1100
Selling price (Rs/ per unit) 500 700
Closing Stock( units) 200 900 (w.n.7)

a) Value of closing stock as per FIFO for the year 2017-18 is Rs. 200000 (w.n.9)
b) Value of closing stock as per LIFO for the year 2017-18 is Rs. 191555 (w.n.10)

Working notes:
1. Opening stock (rate per unit) = 25000/100 = 250

2. Production (units) = Sales + Cl. Stock – Op. stock

3. Cost per unit for the year 2016-17 = (100000 + 120000)/2000

4. Closing stock (units) as per FIFO (2016-17) = 200 @ 110 = Rs. 22000
5. Closing stock (units) as per LIFO (2016-17) = 100 @ 250 = 25000
100 @ 110 = 11000
36000

6. Opening stock 2017-18 = 200 units (Same as closing stock of 2016-17)

7. Closing stock (2017-18) = Production + Op. stock - Sales

8. Cost per unit for the year 2017-18 = (150000 + 250000)/1800

9. Closing stock (units) as per FIFO (2017-18) = 900 @ 222.22 = Rs. 200000

10. Closing stock (units) as per LIFO (2017-18) = 100 @ 250 = 25000
100 @ 110 = 11000
700 @ 222.22 =155555
191555