Cost Accounting

Theory Compilation
For CMA Inter
Group 1

Important for upcoming CMA Inter Online Exams

In online mock exams, upto 24 marks theory questions are being asked,
out of which 12 marks may be compulsory.
 

Cost Accounting Standards MTP Dec’18/Jun’17/Mock Test Series 5

Q.1 List three items included and two items excluded under the Cost Accounting Standards
for Direct Expenses.

Answer
Items included under CAS 10:
• Any expense directly related to a cost centre or cost object, not being material or labour.
• Cost of patents, royalty payments
• Hire charges of special machinery or plant
• Cost of special patterns, designs or tools.
• Experimental costs and expenditure in connection with models and pilot schemes
• Architects, surveyors and other consultants’ fees
• Travelling expenses to sites
• Inward charges and freight charges on special material.
Exclusions:
• A direct expense which cannot be economically traced to the cost object or cost unit.
• Portion unamortised out of a lumpsum, to be amortised later over its utility period.
• Finance cost incurred in connection with any self generated or procured resources shall
not form part of the direct expenses
• Any subsidy, grant or incentive or any amount received or receivable with respect to any
direct expense shall be reduced
• Penalties/damages paid to statutory authorities shall not form part of the direct expens-
es.

Marginal Costing June 2017/Mock Test Series 5

Q.2 State why and under what conditions will profits under absorption costing
(i) higher than
(ii) equal to and
(iii) lower than the profits under marginal costing.

Answer
Profits as per absorption costing will be:
(i) higher than in marginal costing when closing stock is more than opening stock, since
some overheads will be included in the inventory value under absorption costing while
Marginal Costing considers the full overheads as cost of production,
(ii) equal when the opening and closing stocks are equal,

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(iii) lower when opening stock is more than closing stock.

Since under Marginal Costing, only the current period’s overheads are charged to production,
while under absorption costing, a portion of the earlier period’s overheads will be included in
the opening stock value.

Introduction to Cost Accounting Jun’17

Q.3 Differentiate between Financial Accounting and Management Accounting.

Answer

SL No Financial Accounting Management Accounting
(i) Provides general business Specific information relating to specific problems
information like P& L account, and decision making.
Balance Sheet
(ii) Information for owners and Information for management for optimizing
outside parties decisions.
(iii) Importance is on recording Emphasis is on control like using details of
rather than control materials, labour, etc for standard costing,
budgetary control.
(iv) All commercial transactions Concerned with Internal transaction not involving
between the business and payment or receipt
external parties are recorded
(v) Only those transactions that can Other parameters like cost units,
be measured in monetary terms
are recorded. apportioning bases are also recorded.
(vi) Efficiency of resource utilization Available for corrective action.
men/materials or machine is not
available
(vii) Stocks are valued at cost or Always valued at cost.
market value, whichever is lower.
(viii) Records are maintained as Records are maintained as per Companies
per Companies Act and as per Act only in certain cases, that too as per Cost
Income Tax Act Accounting requirements, but mainly to suit the
management for efficiency and control

Cost Sheet MTP Dec’19/Jun’17/Mock Test Series 5

Q.4 How would you classify costs based on behaviour? Give an example to explain each class.

Answer
Classification of costs based on behaviour:
Fixed Costs:
Costs that do not vary with the change in the volume of activity in the short run. They are not
affected by temporary fluctuation in activity of an enterprise. Example: rent, depreciation, etc.

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Variable Costs:
These costs vary directly with the volume of activity. Variable costs may be direct (like Direct
Material, Direct Labour and Direct Expenses), when they are part of prime cost or they could
be indirect, like selling expenses, variable factory overheads, etc. when they are called variable
overheads.
Semi-Variable costs:
These contain both fixed and variable elements. The variable elements behave like the
Variable Cost and the fixed element behaves like the Fixed Cost. The sum total therefore varies
with change in activity, but not in the same proportion as variable costs. Example: Factory
supervision, maintenance, etc.

Introduction to Cost Accounting MTP Jun’19/Dec’17/Mock Test Series 2

Q.5 “Cost Accounting and Management Accounting are inter-dependent.” Do you agree, dis-
cuss.

Answer
Cost Accounting: In cost accounting, primary emphasis is on cost and it deals with its collection,
analysis, relevance, interpretation and presentation for various problems of management.
Management Accounting: It utilizes the principles and practices of financial accounting
and cost accounting in addition to other management techniques for efficient operations
of a concern. It widely uses different techniques from various branches of knowledge like
Statistics, Mathematics, Economics, Law and Psychology to assist the management in its task of
maximizing profits or minimizing losses. The main thrust in management accounting is towards
determining policy and formulating plans to achieve desired objectives of management. From
the above discussion it may be concluded that cost accounting and management accounting
are inter-dependent, greatly related and inseparable.

Operating Costing MTP Dec’18/Dec’17

Q.6 Differentiate between Operation Cost and Operating Cost.

Answer
Operation Cost: Operation cost is the cost of a specific operation involved in a production
process or business activity. The cost unit in this method is the operation, instead of process.
When the manufacturing method of a concern consists of a number of distinct operations,
operating costing is suitable.
Operating Cost: Operating cost is the cost incurred in conducting a business activity. It refers
to the cost of concerns which do not manufacture any product but which provide services.
Industries and establishments like power house, transport and travel agencies, hospitals,
schools etc. which undertake services rather than the manufacture of products, ascertain
operating costs. The cost units used are Kilo Watt Hour (KWH), Passenger Kilometre and Bed in
the Hospital etc.

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Operation costing method constitutes a distinct type of costing but it may also be classed as a
variant of process cost since costs in this method are usually compiled for a specified period.

Overheads Dec’17/Mock Test Series 2

Q.7 Enumerate the need for predetermined overhead rate.

Answer
Predetermined Overhead Rate is needed for the following reasons:
(i) actual Rate can be determined only after the overheads have been incurred
(ii) to avoid delay in computing cost
(iii) to prepare Quotations in time and quickly
(iv) actual Overhead Rate may fluctuate from period to period. But in case of predetermined
rate, it is not so.
(v) to ensure cost control.
OR
As per study material as under:
Advantages of Predetermined Overhead Rate:
(i) Enables prompt preparation of cost estimates, quotations and fixation of selling prices.
(ii) Cost data is available to management along with financial data.
(iii) In case of Cost-plus contracts prompt billing is possible through predetermined recovery
rate/s.
(iv) In concerns having budgetary control system, no extra clerical efforts are required in
computing the pre-determined overhead rate.

Budget and Budgetary Control MTP Jun’17/MTP Dec’17/MTP Dec’18/

MTP Jun’19/Dec’17/Mock Test Series 2
Q.8 What is Responsibility Accounting? Also state the Principles of Responsibility Accounting.

Answer
It is a system of accounting that recognizes various responsibility centres throughout the
organisation and reflects the plans and actions of each of these centres by assigning particular
revenues and costs of the one having the pertinent responsibility. It is a system in which the
person holding the supervisory posts as president, function head, foreman, etc. are given a
report showing the performance of the company or department or section as the case may
be. The report will show the data relating to operational results of the area and the items of
which he is responsible for control. Responsibility accounting follows the basic principles of any
system of cost control and standard costing. It differs only in the sense that it lays emphasis on

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human beings and fixes responsibilities for individuals. It is based on the belief that control can
be exercised by human beings, so responsibilities should be fixed for individuals.
Principles of Responsibility Accounting:
1. A target is fixed for each department or responsibility centre.
2. Actual performance is compared with the target.
3. The variances from plan are analysed so as to fix the responsibility.
4. Corrective action is taken by higher management and is communicated.

Introduction to Cost Accounting MTP Jun’17/MTP Jun’19/MTP Dec’19/

Jun’18/Mock Test Series 4
Q.9 Differentiate between cost control and cost reduction.

Answer
Cost Control vs. Cost Reduction : Both cost control and cost reduction are efficient tools for
management but their concepts and procedure are widely different. The main differences are
as follows:
Sl No. Cost Control Cost Reduction
(i) Cost control represents efforts made Cost reduction represents the achievement
towards achieving target or goal. in reduction of cost.
(ii) The Process of cost control is to Cost reduction is not concerned with
setup a target, ascertain the actual maintenance of performance according to
performance and compare it with the standards.
target, investigate the variances, and
take remedial measures.
(iii) Cost control assumes the existence Cost reduction assumes the existence of
of standards or norms which are not concealed potential savings in standards
challenged. or norms which are therefore subjected
to a constant challenge with a view to
improvement by bringing out savings.
(iv) Cost control is a preventive function. Cost reduction is a corrective function. It
Costs are optimized before they are operates even when an efficient cost control
incurred. system exists. There is room for reduction
in the achieved costs under controlled
conditions.
(v) Cost control lacks dynamic approach. Cost reduction is a continuous process
of analysis by various methods of all the
factors affecting costs, efforts and functions
in an organization. The main stress is upon
the why of a thing and the aim is to have
continual economy in costs.

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Introduction to Cost Accounting Jun’18

Q.10 Cost accounting has emerged as a specialized discipline due to various factors.

Answer
List out these factors.
The main factors attributable for emerging cost accounting as a specialized discipline are as
under:
(i) Limitations placed on financial accounting.
(ii) Improved cost consciousness.
(iii) Rapid industrial development after industrial revolution and World wars.
(iv) Growing competition among the manufacturers.
(v) To control galloping price rise, the cost of computing the precise cost of product / service.
(vi) To control cost, several legislations passed throughout the World and in India too, such as
Essential Commodities Act, Industrial Development and Regulation Act (IDRA), etc.

Material Costing MTP Jun’19/MTP Jun’20/Jun’18/

Mock Test Series 4
Q.11 What is Economic Order Quantity (EOQ)? State the assumptions underlying EOQ.

Answer
Economic Order Quantity (EOQ): EOQ is the size of the order for which both ordering and carry-
ing costs are minimum.
Assumptions underlying EOQ:
Ordering cost per order and carrying cost per unit per annum are known and they are fixed.
(ii) Anticipated usage of material in units in known.
(iii) Cost per unit of the material is constant and is known as well.
(iv) The quantity of material ordered is received immediately i.e. lead time is zero.

Budget and Budgetary Control June 2018 / Dec 2019/Mock

Test Series 4 & 3
Q.12 What is Principal Budget Factor? Explain with suitable examples.

Answer
Budgets cover all the functional areas of the organisation. For the effective implementation of
the budgetary system, all the functional areas are to be considered which are interlinked. Be-
cause of these interlinks, certain factors have the ability to affect all other budgets. Such factor

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is known as principal budget factor. Principal budget factor is the factor the extent of influence
of which must first be assessed in order to ensure that the functional budgets are reasonably
capable of fulfillment. A principal budget factor may be lack of demand, scarcity of raw material,
non-availability of skilled labour, inadequate working capital etc.
For example, an organisation has the capacity to produce 2,500 units per annum. But the pro-
duction department is able to produce only 1,800 units due to non-availability of raw materials.
In this case, non-availability of raw materials is the principal budget factor (limiting factor). If
the sales manager estimates that he can sell only 1,500 units due to lack of demand, then lack
of demand is the principal budget factor. This concept is also known as key factor, or governing
factor. This factor highlights the constraints within which the organization functions.

Introduction to Cost Accounting MTP Jun’19/MTP Dec’19/Dec

2018/Mock Test Series 1
Q.13 State the advantages of cost control (any five).

Answer
The advantages of cost control are mainly as follows:
(i) Achieving the expected return on capital employed by maximising or optimizing profit.
(ii) Increase in productivity of the available resources.
(iii) Reasonable price of the customers.
(iv) Continued employment and job opportunity for the workers.
(v) Economic use of limited resources of production.
(vi) Increased credit worthiness.
(vii) Prosperity and economic stability of the industry.

Introduction to Cost Accounting Dec’18

Q.14 Describe briefly the main scope of cost accountancy.

A n s w e r
The scope of cost accountancy is very wide and includes the following:
(a) Cost Ascertainment: The main objective of cost accounting is to find out the cost of
product/service rendered with reasonable degree of accuracy.
(b) Cost Accounting: It is the process of accounting for cost which begins with recording of
expenditure and ends with preparation of statistical data.
(c) Cost Control: It is the process of regulating the action so as to keep the element of cost
within the set parameters.
(d) Cost Reports: This is the ultimate function of Cost Accounting. These reports are primarily

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prepared for use by the management at different levels. Cost Reports help in planning
and control, performance appraisal and managerial decision making.
(e) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts and check on the
adherence to the Cost Accounting Plan, its purpose is not only to ensure the arithmetic
accuracy of cost records but also to see the principles and rules have been applied
correctly.

Material Costing MTP Jun’17/MTP Dec’17/ MTP Dec’18/MTP

Dec’19/Dec’18/Mock Test Series 1
Q.15 What is just-in-time (JIT) system? List out its main benefits.

Answer
Just in Time is a production strategy that strives to improve a business return on investment
by reducing in-process inventory and associated carrying costs. Inventory is seen as incurring
costs, or waste, instead of adding and storing value, contrary to traditional accounting. In short,
the just-in-time inventory system focuses on “the right material, at the right time, at the right
place, and in the exact amount” without the safety net of inventory.
The benefits of Just-in-Time system are as follows:
a. Increased emphasis on supplier relationships. A company without inventory does not
want a supply system problem that creates a part shortage. This makes supplier relation-
ships extremely important.
b. Supplies come in at regular intervals throughout the production day. Supply is synchro-
nized with production demand and the optimal amount of inventory is on hand at any
time. When parts move directly from the truck to the point of assembly, the need for
storage facilities is reduced.
c. Reduces the working capital requirements, as very little inventory is maintained.
d. Minimizes storage space.
e. Reduces the chance of inventory obsolescence or damage.

Budget and Budgetary Control Dec’18/Mock Test Series 1

Q.16 Write a brief note on Performance Budgeting describing its main concepts.

Answer
Performance Budgeting is synonymous with Responsibility Accounting which means the
responsibility of various levels of Management is predetermined in terms of output or result
keeping in view the authority vested with them.
The main concepts of such a system are enumerated below:
(a) It is based on a classification of managerial level for the purpose of establishing a budget
for each level. The individual in-charge of that level should be made responsible and held

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accountable for its performance over a given period of time.

(b) The starting point of the performance budgeting system rests with the organisation
chart in which the spheres of jurisdiction have been determined. Authority leads to the
responsibility for certain costs and expenses which are forecasted or present in the bud-
get with the knowledge of the manager concerned.
(c) The cost in each individual`s or department`s budget should be limited to the cost con-
trollable by him.
(d) The person concerned should have the authority to bear the responsibility.

Introduction to Cost Accounting Jun’19/Mock Test Series 6

Q.17 Distinguish between Cost Allocation and Cost Apportionment.

Answer
Cost Allocation: When items of cost are identifiable directly with some products or depart-
ments such costs are charged to such cost centres. This process is known as cost allocation.
Wages paid to workers of service department can be allocated to the particular department.
Indirect materials used by a particular department can also be allocated to that department.
Cost allocation calls for two basic factors –
(i) Concerned department/product should have caused the cost to be incurred, and
(ii) exact amount of cost should be computable.
Cost Apportionment: When items of cost cannot directly be charged to or be accurately
identifiable with any cost centres, they are prorated or distributed amongst the cost centres
on some pre-determined basis. This method is known as cost apportionment. Thus, items of
indirect costs residual to the process of cost allocation are covered by cost apportionment. The
pre-determination of suitable basis of apportionment is very important and usually following
principles are adopted -
(i) Service or use
(ii) Survey method, or
(iii) Ability to bear.
The basis ultimately adopted should ensure an equitable share of common expenses for the
cost centres and the basis once adopted should be reviewed at periodic intervals to improve
upon the accuracy of apportionment.

Introduction to Cost Accounting MTP Jun’19/MTP Jun’20/Jun’19

Q.18 State the main objectives of Cost Accounting.

A n s w e r
The main objectives of cost accounting are as under:
(i) To ascertain the costs under different situations using different techniques and systems
of costing.
(ii) To determine the selling prices under different circumstances.

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(iii) To determine and control efficiency by setting standards for Materials, Labour and
Overheads.
(iv) To determine the value of closing inventory for preparing financial statements of the
concern.
(v) To provide a basis for operating policies of the concern.

Labour Costing Jun’19/Mock Test Series 6

Q.19 List out the various measures to reduce the Labour Turnover (any five).

Answer
Labour Turnover may be reduced by removing its avoidable causes and taking preventive reme-
dial measures. The various measures may be as under:
(i) Efficient, sympathetic and impartial personnel administration.
(ii) Effective communication system to keep the workers informed on matters that affect
them.
(iii) Improving working conditions and placing the right man on the right job.
(iv) Job enrichment to reduce boredom and monotony and to provide job satisfaction.
(v) Introducing fair rates of pay and allowance/s and incentives, pension, gratuity etc.
(vi) Strengthening welfare measures. (vii) Augmenting recreational activities and schemes.

Budget and Budgetary Control June 2019/Mock Test Series 6

Q.20 Write a brief note on Master Budget.

A n s w e r
Master Budget is the budget prepared to cover all the functions of the business organization.
It can be taken as the integrated budget of business concern, that means, it shows the profit or
loss and financial position of the business concern such as Budgeted Profit and Loss Account,
Budgeted Balance Sheet etc. Master budget, also known as summary budget or finalized profit
plan, combines all the budgets for a period into one harmonious unit and thus, it shows the
overall budget plan.
The master budget incorporates all the subsidiary functional budgets and the Budgeted Profit
and Loss Account and Budgeted Balance Sheet. Before the budget plan is put into operation, the
master budget is considered by the management and revised if the position of profit disclosed
therein is not found to be satisfactory. After suitable revision made, the Master Budget is finally
approved and put into action.

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Introduction to Cost Accounting Dec’19/Mock Test Series 3

Q.21 Explain the concept of Opportunity Cost and Imputed Cost with suitable examples.

Answer
Opportunity Cost: Opportunity cost is the value of alternatives foregone by adopting a
particular strategy or employing resources in specific manner. It is the return expected from
an investment other than the present one. These refer to costs which result from the use
or application of material, labour or other facilities in a particular manner which has been
foregone due to not using the facilities in the manner originally planned. Resources (or input)
like men, materials, plant and machinery, finance etc., when utilized in one particular way, yield
a particular return (or output).If the same input is utilized in another way, yielding the same or
a different return, the original return on the forsaken alternative that is no longer obtainable is
the opportunity cost. For example, if fixed deposits in the bank are proposed to be withdrawn
for financing project, the opportunity cost would be loss of interest on the deposits. Similarly,
when a building leased out on rent to a party is got vacated for own purpose or a vacant space
is not leased out but used internally, say, for expansion of the production programme, the rent
so foregone is the opportunity cost.
Imputed Cost: Imputed cost is hypothetical or notional cost, not involving cash outlay and
computed only for the purpose of decision-making. In this respect, imputed cost is similar to
opportunity cost. Interest on funds generated internally, payment for which is not actually
made is an example of imputed cost. When alternative capital investment projects are being
considered out of which one or more are to be financed from internal funds, it is necessary to
take into account the imputed interest on own funds before a decision is arrived at.

Introduction to Cost Accounting MTP Jun’17/MTP Jun’18/Dec’19

Q.22 State the limitations of Cost Accounting System.

A n s w e r
(i) Like any other system of accounting, Cost Accountancy is not an exact science but an
art which has been developed through theories and accounting practices based on rea-
soning and commonsense. Many of the theories cannot be proved nor can they be dis-
proved. They grownup in course of time to become conventions and accepted principles
of Cost Accounting.
(ii) These principles are by no means static, they are changing from day to day and what is
correct today may not hold true in the circumstances tomorrow.
(iii) In cost accounting, no cost can be said to be exact as they incorporate a large number of
conventions, estimations and flexible factors such as :-
(a) Classification of costs into its elements.
(b) Materials issue pricing based on average or standard costs.
(c) Apportionment of overhead expenses and their allocation to cost units/centres.
(d) Arbitrary allocation of joint costs.
(e) Division of overheads into fixed and variable.

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(iv) Cost Accounting lacks the uniform procedures and formats in preparing the cost informa-
tion of a product/ service.
(v) Keeping in view above limitations, all Cost Accounting results can be taken as mere esti-
mates.

Material Costing Dec’19/Mock Test Series 3

Q.23 Describe the main objectives of Material Control System.

A n s w e r
(i) To make continuous availability of materials so that there may be uninterrupted flow of
materials for production. Production may not be held up for want of materials.
(ii) To purchase requisite quantity of materials to avoid locking up of working capital and to
minimise risk of surplus and obsolete stores.
(iii) To make purchase competitively and wisely at the most economical prices so that there
may be reduction in cost of materials.
(iv) To purchase proper quantity of materials to have minimum possible wastage of materials.
(v) To serve as an information centre on the knowledge in respect of materials for prices,
sources of supply, lead time, quality and specification.

Introduction to Cost Accounting MTP Jun’17

Q.24 Cost Absorption

A n s w e r
Ultimately the indirect costs or overhead as they are commonly known, will have to be distributed
over the final products so that the charge is complete. This process is known as cost absorption,
meaning thereby that the costs absorbed by the production during the period. Usually any of
the following methods are adopted for cost absorption - (i) Direct Material Cost Percentage (ii)
Direct Labour Cost Percentage (iii) Prime Cost Percentage (iv) Direct Labour Hour Rate Method
(v) Machine Hour Rate, etc. The basis should be selected after careful maximum accurancy of
Cost Distribution to various production units. The basis should be reviewed periodically and
corrective action whatever needed should be taken for improving upon the accuracy of the
absorption.

Budget and Budgetary Control MTP Dec’19

Q.25 Factors considered in Production Budget

A n s w e r
Next to the sales budget, the main function of a business concern is the production and for
this, a budget is prepared simultaneously with the sales budget. It is the forecast of production

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during the period for which the budget is prepared. It can also be prepared in two parts
viz., production volume budget for the physical units i.e., the number of units, the tonnes of
production etc., and the cost of production or manufacture showing details of all elements of
the manufacture. While preparing the production budget, the following factors must be taken
into consideration:-
(a) Production plan:- Production planning is an important part of the preparation of the
production budget. Optimum utilization of plant capacity is taken by eliminating or
reducing the limiting factors and thereby effective production planning is made.
(b) The capacity of the business concern:- It is to be ensured that the capacity of the
organization will coincide the budgeted production or not. For this purpose, plant
utilization budget will also be necessary. The production budget must be based on
normal capacity likely to be achieved and it should not be too high or too low.
(c) Inventory Policy:- While preparing the production budget it is also necessary to see
to what extent materials are available for producing the budgeted production. For that
purpose, a purchase budget or a purchase plan must also be studied. Similarly, on the
other hand, it is also necessary to verify the extent to which the inventory of finished
goods is to be carried.
(d) Sales budgets must also be considered before preparing production budget because it
may so happen that the entire production of the concern may not be sold. In such a case
the production budget must be in line with the sales budget.
(e) A plan of the sequence of operations of production for effective preparation of a
production budget should always be there.
(f) Last, but not the least, the policy of the management should also be considered before
preparing the production budget.

Labour Costing MTP Dec’18/MTP Dec’17

Q.26 Difference between Job Evaluation and Merit Rating

A n s w e r

Job Evaluation Merit Rating

Job Evaluation is the assessment of relative Merit rating is the assessment of relative
worth of jobs in a business worth of the man behind the job.
Job Evaluation rated the jobs. Merit rating rates the employees.
The objective of job evaluation is to set up aMerit rating provides a scientific basis for
rational wage and salary structure. determining fair wages for each worker based
on his ability and performance
Job Evaluation simplifies wage administration Merit rating helps in determining fair rate of
by rationalizing and bringing uniformity in pay to different workers on the basis of their
the wage rates relative performances.

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Introduction to Cost Accounting MTP Jun’17/MTP Jun’18

Q.27 Cost Centre

A n s w e r
CIMA defines a cost centre as “a location, a person, or an item of equipment (or a group of
them) in or connected with an undertaking, in relation to which costs ascertained and used
for the purpose of cost control”. The determination of suitable cost centres as well as analysis
of cost under cost centres is very helpful for periodical comparison and control of cost. In
order to obtain the cost of product or service, expenses should be suitably segregated to cost
centre. The manager of a cost centre is held responsible for control of cost of his cost centre.
The selection of suitable cost centres or cost units for which costs are to be ascertained in an
undertaking depends upon a number of factors such as organization of a factory, condition of
incidence of cost, availability of information, requirements of costing and management policy
regarding selecting a method from various choices. Cost centre may be production cost centres
operating cost centres or process cost centres depending upon the situation and classification.
In a manufacturing concern, the cost centres generally follow the pattern or layout of the
departments or sections of the factory and accordingly, there are two main types of cost centres
as below:-
(i) Production Cost Centre: These centres are engaged in production work i.e engaged in
converting the raw material into finished product, for example Machine shop, welding
shops...etc
(ii) Service Cost Centre: These centres are ancillary to and render service to production cost
centres, for example Plant Maintenance, Administration...etc The number of cost centres
and the size of each vary from one undertaking to another and are dependent upon the
expenditure involved and the requirements of the management for the purpose of con-
trol.

Cost Accounting Standards MTP Jun’17/MTP Jun’18

Q.28 Cost Accounting Standard on Packing Material Cost

Answer
This standard deals with the principles and methods of determining the Packing Material
Cost. This standard deals with the principles and methods of classification, measurement
and assignment of Packing Material Cost, for determination of the cost of product, and the
presentation and disclosure in Cost Statements. Packing Materials for the purpose of this
standard are classified into primary and secondary packing materials.
The objective of this standard is to bring uniformity and consistency in the principles and
methods of determining the packing material cost with reasonable accuracy.
This standard should be applied to cost statements, which require classification, measurement,
assignment, presentation and disclosure of Packing Material Cost including those requiring
attestation.

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Budget and Budgetary Control MTP Jun’17/MTP Jun’18

Q.29 Standard costing Vs Budgetary Control

A n s w e r
Despite the similarity in the basic principles of Standard Costing and Budgetary Control, the
two systems vary in scope and in the matter of detailed techniques. The difference may be
summarized as follows:
1. A system of Budgetary Control may be operated even if no Standard Costing system is in
use in the concern.
2. While standard is an unit concept, budget is a total concept.
3. Budgets are the ceilings or limits of expenses above which the actual expenditure should
not normally rise; if it does, the planned profits will be reduced. Standards are minimum
targets to be attained by actual performance at specified efficiency.
4. Budgets are complete in as much as they are framed for all the activities and functions
of a concern such as production, purchase, selling and distribution, research and
development, capital utilisation, etc. Standard Costing relates mainly to the function of
production and the related manufacturing costs.
5. A more searching analysis of the variances from standards is necessary than in the case of
variations from the budget.
6. Budgets are indices, adherence to which keeps a business out of difficulties. Standards
are pointers to further possible improvements.

Material Costing MTP Jun’19

Q.30 Advantages of perpetual inventory system

A n s w e r
1. The system obviates the need for the physical checking of all items of stock and stores at
the end of the year.
2. It avoids the dislocation of the routine activities of the organisation including production
and despatch.
3. A reliable and detailed check on the stores is maintained.
4. Errors, irregularities and loss of stock through other methods are quickly detached and
through necessary action recurrence of such things in future is minimised.
5. As the work is carried out systematically and without undue haste the figures are readily
available.
6. Actual stock can be compared with the authorised maximum and minimum levels, thus
keeping the stocks within the prescribed limits. The disadvantages of excess stocks are
avoided and capitalised up in stores materials cannot exceed the budget.

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7. The recorder level of various items of stores are readily available thus facilitating the work
of procurement of stores.
8. For monthly or quarterly financial statements like Profit and Loss Account and Balance
Sheet the stock figures are readily available and it is not necessary to have physical veri-
fication of the balances.

Standard Costing MTP Jun’19

Q.31 Limitations of standard costing:

A n s w e r
1. Establishment of standard costs is difficult in practice.
2. In course of time, sometimes even in a short period the standards become rigid.
3. Inaccurate, unreliable and out of date standards do more harm than benefit.
4. Sometimes, standards create adverse psychological effects. If the standard is set at high
level, its non achievement would result in frustration and build-up of resistance.
5. Due to the play of random factors, variances cannot sometimes be properly explained,
and it is difficult to distinguish between controllable and non-controllable expenses.
6. Standard costing may not sometimes be suitable for some small concerns. Where produc-
tion cannot be carefully scheduled, frequent changes in production conditions result in
variances. Detailed analysis of all of which would be meaningless, superfluous and costly.
7. Standard costing may not, sometimes, be suitable and costly in the case of industries
dealing with non-standardized products and for repair jobs which keep on changing in
accordance with customer’s specifications.
8. Lack of interest in standard costing on the part of the management makes the system
practically ineffective. This limitation, of course, applies equally in the case of any other
system which the management does not accept wholeheartedly.

Marginal Costing MTP Dec’18

Q.32 Difference in profit under Marginal Costing & Absorption Costing

A n s w e r
Difference in profit under Marginal & Absorption Costing:
• No opening and closing stock: In this case, profit/loss under absorption and marginal
costing will be equal.
• When opening stock is equal to closing stock: In this case, profit/loss under two ap-
proaches will be equal provided the fixed cost element in both the stocks is same
amount.
• When closing stock is more than opening stock: In other words, when production
during a period is more than sales, then profit as per absorption approach will be more

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than that by marginal approach. The reason behind this difference is that a part of fixed
overhead included in closing stock value is carried forward to next accounting period.
• When opening stock is more than the closing stock: In other words when production
is less than the sales, profit shown by marginal costing will be more than that shown
by absorption costing. This is because a part of fixed cost from the preceding period is
added to the current year’s cost of goods sold in the form of opening stock.

Introduction to Cost Accounting MTP Dec’17/MTP Dec’18

Q.33 Replacement Cost

A n s w e r
Replacement cost is the cost of an asset in the current market for the purpose of replacement.
Replacement cost is used for determining the optimum time of replacement of an equipment
or machine in consideration of maintenance cost of the existing one and its productive capacity.
This is the cost in the current market of replacing an asset. For example, when replacement cost
of material or an asset is being considered, it means that the cost that would be incurred if the
material or the asset was to be purchased at the current market price and not the cost, at which
it was actually purchased earlier, should be take into account.

Cost Accounting Standards MTP Dec’18

Q.34 How would you treat overtime in cost records as per CAS-7.

A n s w e r
Treatment of overtime in Cost Records :As per CAS-7, Overtime Premium shall be assigned
directly to the cost object or treated as overheads depending on the economic feasibility and
specific circumstances requiring such overtime.
When overtime is worked due to exigencies or urgencies of the work, the basic/normal payment
is treated as Direct Labour Cost and charged to Production or cost unit on which the worker is
employed. Whereas the amount of premium (extra amount) is treated as overhead.
If overtime is spent at the request of the customer, then the entire amount (including over time
premium) is treated as direct wages and should be charged to the job.
When the overtime is worked due to lack of capacity as general policy of the company thenthe
total amount paid is treated as direct wages which is computed at the estimated rate based on
the figures of the previous years.
Overtime worked on account of the abnormal conditions such as flood, earthquake, etc.,
should not be charged to cost, but to Costing Profit and Loss Account if integrated accounts are
maintained.
It will thus be seen that overtime involves payment of increased wages and should be resorted
to only when extremely essential.

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Overheads MTP Dec’17

Q.35 Research and Development Overheads

A n s w e r
Research Cost is defined as the cost of searching for new or improved products, new applications
of material, or new or improved methods, process, systems or services. In the modern days, firms
spend heavily on Research and Development. Expenses incurred on research and development
is known as Research and Development Overheads.
Research may be of the following types:
1. Pure or basic research to gain general know-how regarding the production or market, not
directed towards any particular product.
2. Applied research which applies the basic knowledge in practice. i.e., improvement of ex-
isting products, new process, exploring of new products, improved measures of safety,
etc.
3. Development cost is the cost of the process which begins with the implementation of the
decision to use scientific or technical knowledge to produce a new or improved product
or to employ a new or improved method, process, system, etc. and ends with the com-
mencement of formal production of that product by that method. Development starts
where the research ends. Development cost is the expenditure incurred for putting the
results of research on a practical commercial basis.

Joint Product & By Products MTP Dec’17

Q.36 Difference between Joint products and Co products

Answer
Joint products are frequently confused with co-products. However, there is significant
difference between the two, the former being indivisible and the latter divisible. Common costs
are allocable among products or services performed because each of the products or services
could have been obtained separately. Therefore, any shared cost of obtaining them can be
meaningfully allocated on the basis of relative usage of the common facilities. For example, the
cost of fuel or power may be allocated to products based on production volumes and metered
usage.
Co-products do not always arise from the same operation or raw materials and the quantity
of co-products is within the control of manufacturer. Thus different quantities of car, jeep and
trucks can be produced in car manufacturing industry according to the need of the concern.

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Marginal Costing MTP Dec’17

Q.37 Difference in Profit under Marginal Costing & Absorption Costing

Answer
Difference in profit under Marginal & Absorption Costing:
• No opening and closing stock: In this case, profit/loss under absorption and marginal
costing will be equal.
• When opening stock is equal to closing stock: In this case, profit/loss under two approaches
will be equal provided the fixed cost element in both the stocks is same amount.
• When closing stock is more than opening stock: In other words, when production during
a period is more than sales, then profit as per absorption approach will be more than that
by marginal approach. The reason behind this difference is that a part of fixed overhead
included in closing stock value is carried forward to next accounting period.
• When opening stock is more than the closing stock: In other words when production is
less than the sales, profit shown by marginal costing will be more than that shown by
absorption costing. This is because a part of fixed cost from the preceding period is added
to the current year’s cost of goods sold in the form of opening stock.

Cost Accounting Standards MTP Dec’17

Q.38 Cost Accounting Standard on Cost of Service Cost Centre

Answer
This standard deals with the principles and methods of determining Cost of Service Cost
Centres. This standard deals with the principles and methods of classification, measurement
and assignment of Cost of Service Cost Centre, for determination of the cost of product or
service, and the presentation and disclosure in Cost Statements.
Objective - The objective of this standard is to bring uniformity and consistency in the principles
and methods of determining the Cost of Service Cost Centre with reasonable accuracy.
Scope - The standard should be applied to the preparation & presentation Cost Statements,
which require classification, measurement and assignment, of Cost of Service Cost Centres
including those requiring attestation. It excludes Utilities and Repairs & Maintenance Services
dealt with in CAS-8 and CAS-12 respectively.

Introduction to Cost Accounting MTP Dec’17

Q.39 Cost Classification by Functions and explain any two

Answer
A business enterprise performs a number of functions like manufacturing, selling, research...etc.
Costs may be required to be determined for each of these functions and on this basis functional

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costs may be classified into the following types:-

(i) Production or Manufacturing Costs
(ii) Administration Costs
(iii) Selling & Distribution cost
(iv) Research & Development costs
(i) Production or Manufacturing Costs: Production cost is the cost of all items involved
in the production of a product or service. These refer to the costs of operating the
manufacturing division of an undertaking and include all costs incurred by the factory
from the receipt of raw materials and supply of labour and services until production is
completed and the finished product is packed with the primary packing. The followings
are considered as Production or Manufacturing Costs:-
(1) Direct Material
(2) Direct Labour
(3) Direct Expenses and
(4) Factory overhead, i.e., aggregate of factory indirect material, indirect labour and
indirect expenses.
Manufacturing cost can also be referred to as the aggregate of prime cost and factory
overhead.
(ii) Administration Costs: Administration costs are expenses incurred for general
management of an organization. These are in the nature of indirect costs and are
also termed as administrative overheads. For understanding administration cost, it is
necessary to know the scope of administrative function. Administrative function in any
organization primarily concerned with following activities:-
(1) Formulation of policy
(2) Directing the organization and
(3) Controlling the operations of an organization. But administrative function will
not include control activities concerned with production, selling and distribution
and research and development. Therefore, administration cost is the cost of
administrative function, i.e., the cost of formulating policy, directing, organizing
and controlling the operations of an undertaking (Administrative cost will include
the cost of only those control operations which are not related to production,
selling and distribution and research and development). In most of the cases,
administration cost includes indirect expenses of following types:
(1) Salaries of office staff, accountants, directors
(2) Rent, rates and depreciation of office building
(3) Postage, stationery and telephone
(4) Office supplies and expenses
(5) General administration expenses.

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Labour Costing MTP Dec’19

Q.40 Treatment of Idle Time

A n s w e r
As per CAS-7 (Limited Revision 2017), Idle Time Cost shall be assigned direct to the cost object or
treated as overheads depending on the economic feasibility and specific circumstances causing
such idle time.
Treatment of different categories of Idle Time is as below:-
a) Unavoidable idle time above would be for insignificant periods. In Cost Accounts, this is
allowed to remain merged in the Production Order or Standing Order Number on which
the worker was otherwise employed.
b) Normal Idle Time is booked to factory or works overhead. For the purpose of effective
control, each type of idle time, i.e., idle time classified according to the causes is allocated
to a separate Standing Order Number.
c) Abnormal Idle Time would usually be heavy in amount involves longer periods and
would mostly be beyond the control of the management. Payment for such idle time
is not included in cost and is adjusted through the Costing Profit and Loss Account or
included in Profit and Loss Account, when the accounts are integrated.
d) Tendency to conceal Idle Time should be discouraged. It is a non-effective time and the
resultant loss of profit due to reduced production activity but also increases the cost
per unit of production as the fixed costs continue to be incurred, irrespective of the
reduced quantum of production due to loss of labour time. Idle Time should, therefore,
be highlighted prominently so that action can be taken to remove the causes thereof.
Although for obvious reasons, it is not possible to record minor details, vigilance is
necessary for finding out long-term idleness among the workers

Marginal Costing MTP Dec’19

Q.41 Uses and applications of Break even Analysis

A n s w e r
The important uses to which cost-volume profit analysis or break-even analysis or profit charts
may be put to use are:
a) Forecasting costs and profits as a result of change in Volume determination of costs,
revenue and variable cost per unit at various levels of output.
b) Fixation of sales Volume level to earn or cover given revenue, return on capital employed,
or rate of dividend.
c) Determination of effect of change in Volume due to plant expansion or acceptance of
order, with or without increase in costs or in other words, determination of the quantum
of profit to be obtained with increased or decreased volume of sales.
d) Determination of comparative profitability of each product line, project or profit plan.
e) Suggestion for shift in sales mix.

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Introduction to Cost Accounting MTP Jun’20

Q.42 Difference between Financial Accounting and Cost Accounting

A n s w e r
Financial Accounting Cost Accounting
It provides the information about the business It provides information to the management
in a general way. i.e Profit and Loss Account, for proper planning, operation, control and
Balance Sheet of the business to owners and decision making
other outside partners.
It classifies records and analyses the It records the expenditure in an objective
transactions in a subjective manner, i.e manner, i.e according to the purpose for
according to the nature of expense. which the costs are incurred.
It lays emphasis on recording aspect without It provides a detailed system of control for
attaching any importance to control. materials, labour and overhead costs with
the help of standard costing and budgetary
control.
It reports operating results and financial It gives information through cost reports to
position usually at the end of the year. management as and when desired.
Financial Accounts are accounts of the whole Cost Accounting is only a part of the financial
business. They are independent in nature. accounts and discloses profit or loss of each
product, job or service.
Financial Accounts records all the commercial Cost Accounting relates to transactions
transactions of the business and include all connected with Manufacturing of goods and
expenses i.e Manufacturing, Office, Selling etc services, means expenses which enter into
production.

Marginal Costing MTP Jun’20

Q.43 Advantages of Marginal Costing

A n s w e r
1. Marginal costing system is simple to operate than absorption costing because they do
not involve the problems of overhead apportionment and recovery.
2. Marginal costing avoids, the difficulties of having to explain the purpose and basis of
overhead absorption to management that accompany absorption costing. Fluctuations
in profit are easier to explain because they result from cost volume interactions and not
from changes in inventory valuation.
3. It is easier to make decisions on the basis of marginal cost presentations, e.g., marginal
costing shows which products are making a contribution and which are failing to cover
their avoidable (i.e., variable) costs. Under absorption costing the relevant information
is difficult to gather, and there is the added danger that management may be misled by
reliance on unit costs that contain an element of fixed cost.

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4. Marginal costing is essentially useful to management as a technique in cost analysis and

cost presentation. It enables the presentation of data in a manner useful to different
levels of management for the purpose of controlling costs. Therefore, it is an important
technique in cost control.
5. Future profit planning of the business enterprises can well be carried out by marginal
costing. The contribution ratio and marginal cost ratios are very useful to ascertain the
changes in selling price, variable cost etc. Thus, marginal costing is greatly helpful in
profit planning.

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