UNIT II : ACCOUNTING MECHANICS

____________________________________________________________________

1. INTRODUCTION

The financial accounting has evolved over the no of years into a specialized profession.
The process of accounting starts with recording in the Journal, preparing ledger accounts,
prepare trial balance and final accounts and at the end of this process, the financial
statements are circulated to the stakeholders and shareholders. Proper pricing and
valuation of inventory and adoption and maintenance of sound depreciation policy also
contribute to maximize the earnings of the concern.

2. LEARNING OBJECTIVES

After going through this chapter, the reader is expected to –

1. Understand the accounting cycle that is followed by all the businesses

2. Understand the basic records that every business maintains
3. Understand when revenue is recognized
4. Understand the concept of inventory pricing and valuation
5. Understand how depreciation is calculated and what are the various methods
available for calculating for depreciation.

3. BASIC RECORDS

The American Institute of certified public accountants (AICPA) defined accounting as

“Accounting is the art of recording classifying and summarizing in a significant manner
and in terms of money transactions and events which are in part at least of a financial
character and interpreting the results thereof”.

From the above definition the accounting process is very clear. This process of
recording the transactions in appropriate books, classifying the various accounts and
summarizing in the form of various financial statements and communicating them to all
stock holders and stake holders is known as the accounting cycle.

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 Accounting Cycle

Transaction
!
Recording in either Journal or subsidiary books as the case may be
!
Periodically classifying the various transactions into ledger accounts
!
Preparation of trial balance
!
Preparation of Trading Account
!
Preparation of Profit and Loss Account
!
Preparation of Balance Sheet
!
Circulating the Financial statement to the Stock holders and Stake holders

Journal is known as the original book of entry. It is a book in which a transaction is

recorded for the first time in the form of a journal entry. Whenever a transaction
happens it is immediately recorded in the journal.

Ledger is a book where various transactions are grouped and classified into several ledger
accounts. The closing balances of these accounts give the input for the preparation of
trial balance. Ledger accounts are prepared periodically according to the need.

After ledger accounts are prepared, a statement showing the arithmetic accuracy of the
recording of information is prepared with the help of closing balances of ledger accounts.
This statement is known as a trial balance. This is usually prepared before the
preparation of final accounts. The matching of debit and credit column totals implies that
the recording is accurate.

Once the trial balance is prepared, the next step is preparation of financial statements.
The first statement to be prepared is trading account, which shows the gross profit made
by the concern for the accounting year.

After preparing the trading account, every business has to prepare the profit and loss
account which shows the net profit earned by the company during the current year.

2
The last statement as the Balance sheet is prepared to show the financial position of the
business on any given day, usually the last day of the financial year. This statement
shows the closing balances of various assets and liabilities of the business.

4. PREPARATION OF FINANCIAL STATEMENTS

Every business has to prepare its own financial statements at the end of each accounting
year. Financial statements are the statements that show the operational results of a
business for a given period and also give the financial position of a concern on a given
date. The financial statements prepared by a manufacturing firm include – Manufacturing
account, Trading account, Profit and Loss account and Balance sheet. The financial
statements prepared by a trading firm include – the Trading account, Profit and loss
account and Balance sheet

Trading account is a statement that is prepared for a period of one year. It shows all
manufacturing or factory expenses on the debit side and shows sales revenue and closing
stock on the credit side. The expenses are matched against the revenues and the result
may be Gross profit or Gross Loss. This is carried forward to the Profit & Loss account.

Profit and Loss account is the second statement that is prepared by all the businesses after
the trading account. This account shows all expenses other than manufacturing expenses,
(office and administration expenses, selling and distribution expenses) and both operating
and non-operating losses on its debit side. It shows all incomes and gains, both operating
and non-operating on its credit side. The matching of both expenses & losses with the
incomes & gains gives the operational results for the year. Usually all businesses follow
the mercantile system of accounting (accrual system) while preparing their final accounts.
When expenses are less than the incomes, the resulting figure is known as Net profit and
if the expenses are more than the incomes, then it will result in Net Loss. This net profit
or net loss is carried forward to the Balance sheet to be adjusted against the capital.

Balance sheet is a statement showing the financial position of a business on a given date,
which is usually the last day of the financial year / accounting year. This statement shows
the balances of all liabilities it owes to the outsiders on the debit side and the balances of
assets on the credit side of the statement. All outstanding expenses which belong to the
current year but have not yet been paid will be shown on the liabilities and all expenses
which are paid for the future period are shown on the credit side of the statement.
Similarly, all incomes which belong to the current year, but have not yet been received
will be shown on the credit side of the statement and all incomes which belong to the
future but have already been received in advance are shown on the debit side of the
statement. The general rule is that both the sides must be the same, showing that every
debit has an

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While preparing the final accounts, all the adjustments which have not been made to the
balances must be adjusted.

Illustration

The following trial balance is extracted from the books of Mr.Pillai on 31.03.2002

PARTICULARS DEBIT CREDIT

(Rs) (Rs)
Furniture & Fittings 640 -
Motor Vehicles 6,250 -
Buildings 7,500 -
Capital - 12,500
Bad debts 125 -
Provision for doubtful debts - 200
Sundry debtors & Creditors 3,800 2,500
Stock as on 1.4.2002 3,460 -
Purchases and Sales 5,415 15,540
Bank Overdraft - 2,850
Sales & Purchase returns’ 200 125
Advertising 450 -
Interest on Bank overdraft 118 -
Commission - 375
Cash 650 -
Taxes & Insurance premium 782
General expenses 1,250 -
Salaries 3,300 -
TOTAL 34,000 34,000

Adjustments:

1) Stock on hand on 31.3.2002 Rs.3,250

2) Depreciate Buildings @5% pa, Furniture @ 10% pa, Motor Vehicles @ 20% pa
3) Rs.85 is due for interest on bank overdraft
4) Salaries Rs.300 and taxes Rs.200 are outstanding
5) Insurance premium amounting to Rs.100 is prepaid
6) One third of the commission received is in respect of work to be done next year
7) Write off a further sum of Rs.100 as bad debts from debtors and create provision
for doubtful debts @ 5% on debtors
Prepare a trading and Profit & Loss account and Balance sheet of the company.

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Solution:

Trading and P&L account for the year ended 31st March 2002

Particulars Amount Particulars Amount

To opening stock 3460 By Sales 15,450
To purchases 5475 Less: returns 200 15,250
Less: returns 125 5350 By closing stock 3,250
To Gross profit 9690
To baddebts 125 By Gross profit 9690
(+)Further baddebts By Commission 375
Written off 100 (-)received in advance 125 250
(+)5% provision for
doubtful debts 185
410
(-)old provision for
doubtful debts 200 210

To advertising 450
To interest on Bank
Overdraft 118
(+)outstanding 85 203
To general expenses 1250
To salaries 3300
(+)outstanding 300 3600
To taxes & insurance 782
(+)outstanding taxes 200
982
(-)Prepaid insurance
premium 100 882
To depreciation:
Buildings @ 5% 375
Furniture @ 10% 64
Motor vehicles @ 20% 1250 1689
To Net profit 1656
9940 9940

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 Balance sheet of Mr.Pillai as at 31st March 2002

Liabilities Amount Assets Amount

Capital 12500 Furniture & fixtures 640
(+)Net profit 1656 14156 (-) depreciation 64 576
Sundry creditors 2500 Motor vehicles 6250
Bank overdraft 2850 (-) depreciation 1250 5000
Outstanding salaries 300 Buildings 7500
Outstanding taxes 200 (-) depreciation 375 7125
Outstanding interest on Sundry debtors 3800
bank overdraft 85 (-)baddebts writtenoff 100
Commission received in 125 3700
advance (-)5% new provision 185 3515
Cash 650
Closing stock 3250
Prepaid insurance premium 100
20,216 20,216

Illustration 2

From the following Trial Balance of Evergreen and Company Limited, prepare Trading,
Profit and Loss Account and Balance Sheet.

Trial Balance as on 31-12-1995:

Rs. Rs.
Cash in Hand 2,400
Purchases 2,40,000
Stock as on 1-1-95 70,000
Debtors 1,00,000
Plant & Machinery 1,20,000
Furniture 30,000
Bills Receivable 40,000
Rent & Taxes 20,000
Wages 32,000
Salaries 37,600
Capital 2,00,000
Bills Payable 44,000
Creditors 48,000
Sales 4,00,000
------------ ------------
6,92,000 6,92,000
------------ ------------

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 Adjustments:

(1) Closing inventory as on 31-12-1995 : Rs. 50,000

(2) Outstanding wages : Rs. 5,000
(3) Depreciation on Plant & Machinery at 10% Furniture at 5%

Solution:

Trading and P&L account for the year ended 31st March 2002

Particulars Amount Particulars Amount

To opening stock 70,000 By Sales 4,00,000
To purchases 2,40,000 By closing stock 50,000
To Wages 32,000
Add: outstanding 5,000 37,000
To Gross profit 1,03,000
To depreciation: By Gross profit 1,03,000
Plant & Machinery 12,000
Furniture 1,500
To Rent & Taxes 20,000
To salaries 37,600
To Net profit 31,900
1,03,000 1,03,000

Balance sheet as at 31st March 2002

Liabilities Amount Assets Amount

Capital 2,00,000 Cash in hand 2,400
(+)Net profit 31900 2,31,900 Debtors 1,00,000
Sundry creditors 48,000 Plant & Mach 1,20,000
Outstanding Wages 5,000 Less Dep 12,000 1,08,000
Bills payable 44,000 Furniture 30,000
Less Dep 1,500 28,500
Bills receivable 40,000
Closing stock 50,000
3,28,900 3,28,900

5. REVENUE RECOGNITION & MEASUREMENT

Under accrual system of accounting revenues from the sale of merchandise are
considered to be earned in the accounting year in which the ownership of goods passes

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from the seller to the buyer. As a result even though cash for the sale may not be
collected until the following period, the revenue is recognized as being earned at the time
of sale. Usually the physical delivery of goods occurs at the same time as the sale of the
goods.

Sales revenue is regarded as earned if the following conditions are satisfied.

1) The seller has passed the legal ownership of the goods to the buyer
2) The selling price of the goods has been established
3) The buyer has paid the purchase price of the goods or it is certain that he will
pay the price. If any of these conditions are not fulfilled revenue cannot be
recorded.

6. MATCHIING REVENUES AND EXPNSES

During the process of preparing the trading and profit loss account, the relevant expenses
and revenues are matched to arrive at the operating results of the business i.e. profit or
loss. Expenses may be categorized as manufacturing expenses, office and administration
expenses and selling & distribution expenses. Revenues may arise from sale of products
and services or from sale of fixed assets and income from investments. In trading
account the manufacturing expenses are matched against the sales and closing stock to
arrive at the gross profit or loss. In profit and loss account the office administration
expenses, selling & distribution expenses along with other non-operating expenses or less
are matched against the operating and non-operating incomes arising out of the business.
This results in net profit or net loss. Usually the mercantile system of accounting is
adopted while preparing the financial statements. All the receivables and payables are
considered and shown in the appropriate statements provided they belong to the current
year.

7. INVENTORY PRICING AND VALUATION

Inventories refers to unsold goods purchased or manufactured. According to the

Accounting Standard :2 (Revised), inventories are assets :

(a) held for sale in the ordinary course of business ;

(b) in the process of production for such sale or
(c) in the form of materials or supplies to be consumed in the production
process of in the rendering of services.

Thus, the term inventory include stock of (i) finished goods (ii) work-in-progress and (iii)
raw materials and components. In case of a trading concern, inventory primarily consists
of finished goods while in case of a manufacturing concern, inventory consists of raw
materials, components, stores, work-in-process and finished goods.

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Objectives of inventory valuation

1) Determination of income
2) Determination of financial position

Inventory Systems :

1) Periodic inventory system :

Under this system the merchandise inventory account is updated only

periodically, after a physical count has been made. Usually, the physical
count takes place at the end of the accounting period. Many departmental
stores use this system

2) Perpetual inventory system :

Perpetual inventory system has been defined as ‘ a system of record

maintained by the controlling department, which reflects physical
movement of stocks and their current balances i.e. it is technique of
controlling stock by maintaining stock records, such as bin card in stores
and stores ledger in accounts, in such a manner that the stock balance is
available at any point of time (perpetually)’. Under this system stores
ledger is recorded after each transaction of receipt, issue or transfer. This
facilitates regular stock verification physically which obviates the
stoppage of work for stock taking.

The success of perpetual inventory system depends on (1) maintenance of

bin cards and stores ledger up-to-date (2) reconciliation of quantity
balance as shown by bin cards with that in stores ledger (3) continuous
verification of physical stock with bin card quantity (4) reconciliation of
discrepancies arising out of physical verification, as well as comparison
with stores ledger (5) remedial action to remove the cause of
discrepancies (6) correction of stock records.

Methods of valuation of inventories or Pricing Issues of Material :

Materials issued from stores should be valued at the rate they are carried in stock. The
various methods for pricing material issues from stores are classified as follows :

1) Specific identification method

This method is applicable to materials purchased for a particular job, order

or process, and identified when received either in stores or in the shop
floor directly. Such materials are usually non-standard and actual cost is

9
 charged to the job/order/process concern. No question of difference arises
out of such pricing.

2) First in First Out (FIFO)

This method assumes that materials are used in the order in which they are
received in stores (chronologically). Hence the price of the first lot is
charged to all issues till the stock losts. As a result closing stock will be
valued at latest purchase price.

This method is useful in the slow moving or less frequently used materials
of bulk items and high unit costs.

3) Last In First Out (LIFO)

This method assumes that the last receipt of stock is issued first. Hence
issues are priced at current prices, while stock remains at historical cost.
This method is useful under the inflationary conditions of the market.

This method is useful for materials used less frequently and under
inflationary conditions.

4) Highest in First Out (HIFO)

Under this method issues are valued at their highest price i.e. costliest
items are issued at first, and inventory is kept at lowest possible prices.
Thus a secret reserve is created by undervaluing stock. This method is
complicated to administer if there are numerous purchases within a short
period.

This method is mainly used for monopoly products or cost plus contracts.

5) Base Stock Method

This method assumes that a minimum stock is always carried at original

cost. The issues are priced using one of the conventional method like
FIFO, LIFO, etc, at actual costs.

This method will be suitable for tanning, smelting, oil refineries, etc.
which use basic raw materials like hides, non-ferrous metal, and crude oil
for their products.

6) Next In First Out (NIFO)

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 Under this method issues are valued at the price expected the next
purchase i.e. price of material which has been ordered but not yet
received. Problem may arise if the price ruling at the time of supply
defers from the purchase order price. However this method attempts to
value issues at nearest to current market prices.

7) Weighted Average Price Method

This method gives due importance to quantities received also. Issue prices
are calculated at average cost price of materials in hand i.e. by dividing the
value of materials in stock by the quantities in stock. Weighted average
price remains the same till the next issue is received. Thus issue prices are
derived at the time of receipt and not at the time of issues.

This method is suitable where wide fluctuation of prices occur as it evens

out prices over the accounting period.

8. NET REALISATION VALUE :

According to International Accounting Standard 2 (IAS 2) the Net realizable value means
“ the estimated selling price in the ordinary course of business less costs of completion
and less costs necessarily to be incurred in order to make the sale”.

Under this method, Inventories are to valued at cost or net realizable value whichever is
less.

9. FIXED ASSETS AND DPERECIATION ACCOUNTING

Fixed Assets :

Fixed assets refer to the various tangible and intangible assets used in the business for
producing and selling the products or rendering services to the customers. Fixed assets
are characterized by their long term investment in the business.

Depreciation :

Depreciation is a permanent, continuing and gradual shrinkage in the book value of a

fixed asset due to use, wear and tear, obsolescence or effluxion of time.

Characteristics of Depreciation :

1) It refers to the fall or shrinkage in the true value of an asset

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 2) It refers to a fall in the book value of asset, which may or may not be equal to
the market value or the cost price of the asset.
3) The fall in the book value in a slow and gradual process

Need for providing Depreciation :

1) To ascertain the profits

2) To show the assets at their proper value
3) To create funds for replacement of assets
4) Provision of depreciation is a statutory need u/s 205 of the Indian Companies
Act, 1956.
5) To spread over the cost of the fixed asset
6) To show correct financial position
7) To compute tax liability
8) To determine product cost for managerial decision making

Distinction between depreciation, depletion and amortization :

Depreciation is calculated on fixed, physical and tangible assets.

Depletion refers to the physical exhaustion of natural resources
Amortization refers to writing -off of long term assets or intangible assets. Such as
leaseholds, copy rights, etc.

Causes of Depreciation :

1) Physical deterioration (wear & tear) (erosion, rust, rot and decay)
2) Economic factors (obsolescence & inadequacy)
3) Time factors – (eg. Intangible fixed assets such as patent rights)
4) Depletion

Computation of Depreciation :

1) Depreciation base
2) Useful/Economic life
3) Depreciation method

Methods of Depreication :

1) Fixed installment or Straight line method

2) Diminishing balance or Written down value method
3) Sum of digits method

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 4) Annuity method
5) Depreciation fund/Sinking fund method
6) Insurance policy method
7) Revaluation method
8) Activity method (i) Production unit method (ii) Machine Hour rate method
(iii) Service unit (hrs) method (iv) Depletion’s method.

Illustration

1. A van was bought for Rs.1,86,000 on 1st Jan 2002. Extra partitions and a new counter
were fitted to make use of it as a traveling shop. The additional cost was Rs.18,000.
Repairs during the year amounted to Rs.2,000. The van was depreciated on its capital
cost @ 15%. Pa. show the asset account on 31st Dec 2002

Solution:

Van account

Date Particulars Amount Date Particulars Amount

1st To Bank 2,04,000 31st By Dep @ 15% 30,600
Jan (1,86,000 + Dec By Bal.c/d 1,73,400
2002 18,000) 2002
2,04,000 2,04,000

10. INTANGIBLE ASSETS

Intangible assets refers to those assets which cannot be seen or touched, such as
goodwill. They do not generate goods or services directly. They reflect the rights of the
firm and includes patent rights, copy rights, trade marks and goodwill.

SUMMARY

The financial accounting has evolved over the no of years into a specialized profession.
The process of accounting starts with recording in the Journal, preparing ledger accounts,
prepare trial balance and final accounts and at the end of this process, the financial
statements are circulated to the stakeholders and shareholders. Proper pricing and
valuation of inventory and adoption and maintenance of sound depreciation policy also
contribute to maximize the earnings of the concern.

13
This process of recording the transactions in appropriate books, classifying the various
accounts and summarizing in the form of various financial statements and
communicating them to all stock holders and stake holders is known as the accounting
cycle.

Every business has to prepare its own financial statements at the end of each accounting
year. Financial statements are the statements that show the operational results of a
business for a given period and also give the financial position of a concern on a given
date. The financial statements prepared by a manufacturing firm include – Manufacturing
account, Trading account, Profit and Loss account and Balance sheet. The financial
statements prepared by a trading firm include – the Trading account, Profit and loss
account and Balance sheet

Under accrual system of accounting revenues from the sale of merchandise are
considered to be earned in the accounting year in which the ownership of goods passes
from the seller to the buyer. As a result even though cash for the sale may not be
collected until the following period, the revenue is recognized as being earned at the time
of sale. Usually the physical delivery of goods occurs at the same time as the sale of the
goods.

Sales revenue is regarded as earned if the following conditions are satisfied. – i) The
seller has passed the legal ownership of the goods to the buyer, ii) The selling price of
the goods has been established, iii) The buyer has paid the purchase price of the goods
or it is certain that he will pay the price. If any of these conditions are not fulfilled
revenue cannot be recorded.

The term inventory include stock of (i) finished goods (ii) work-in-progress and (iii) raw
materials and components. In case of a trading concern, inventory primarily consists of
finished goods while in case of a manufacturing concern, inventory consists of raw
materials, components, stores, work-in-process and finished goods.

There are two main objectives to inventory valuation. They are – i) Determination of
income, ii) Determination of financial position

There are two inventory systems. They are – i) periodic inventory system and ii)
Perpetual inventory system.

The various methods of valuation of inventories or pricing issues of material are – i)

Specific identification method , ii) FIFO, iii) LIFO, iv) HIFO, v) Base Stock Method,
vi) Next In First Out (NIFO), vii) Weighted Average Price Method

Depreciation is a permanent, continuing and gradual shrinkage in the book value of a

fixed asset due to use, wear and tear, obsolescence or effluxion of time.

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 Short Questions

1. What is an accounting cycle?

2. Explain the meaning of the term ‘Journal’ and state its significance
3. What is a ledger?
4. What is a trial balance?
5. What are final accounts?
6. When sales revenue is recognized?
7. What do you mean by inventory valuation?
8. Define fixed assets
9. What is depreciation?
10. Distinguish between depreciation, depletion and amortisation
11. What are intangible assets?
12. Define budget and budgetary control
13. Explain the various objectives of depreciation.
14. Distinguish between a master budget and a functional budget

Long Questions

1. Define financial accounting. Explain the process of accounting cycle in depth with an
illustration
2. Mention the various adjustments to be made while preparing the final accounts
3. What is inventory? Explain the various methods of issuing material issues
4. Define depreciation. What are the various methods of calculating depreciation?
5. Explain the concept of budgeting and budgetary control. What are the essentials of
an effective budgetary control system?
6. Explain the concept of budgetary control. What are its merits and demerits. How do
you classify budgets?

Exercises

1. The following are the balances extracted from Nalan on 31-12-1998

Rs.
Capital 30,000
Drawings 5,000
Furniture & Fittngs 2,600
Bank Overdraft 4,200
Creditors 13,800
Business Premises 20,000
Sales Returns 2,000
Discounts (Debtors) 1,600
Discounts (Creditors) 2,000
Taxes & Insurance 2,000

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Stock on 1-1-1998 22,000
Debtors 18,000
Rent from tenants 1,000
Purchases 1,10,000
Sales 1,50,000
General expenses 4,000
Salaries 9,000
Commission (Debtors) 2,200
Carriage on purchases 1,800
Bad debts written off 800

Adjustments

(1) Stock on hand 31-12-1998 : Rs. 20,060

(2) Write off depreciation Business premises : Rs. 300, Furniture & fittings : Rs. 250
(3) Make provision for 5% on debtors for doubtful debts.
(4) Allow interest on capital at 5%.
(5) Carry forward Rs. 200 for unexpired insurance.

2. From the following Trial Balance of KRISHNAN as at 31-12-1987, you are required to
prepare a Trading, Profit and Loss account for the year ended 31-12-1987 and Balance
Sheet as at that date after making necessary adjustments.
Rs. Rs.
Capital 80,000
Drawings 6,000
Plant & Machinery (Balance on 1-1-87) 20,000
Plant & Machinery (Additional on 1-7-87) 5,000
Stock on 1-1-87 15,000
Purchases 82,000
Returns Inwards 1,000
Sundry debtors 20,000
Furniture & Fixtures 5,000
Freight & Duty 2,000
Carriage Outwards 500
Rent, Rates & taxes 4,600
Printing & Stationery 800
Trading expenses 400
Sundry Creditors 10,000
Discounts 800
Sales 1,20,000
Return Outwards 2,000
Posting & telegraph 800
Provision for debtors 400
Subrent for premises upto 30-6-87 1,200

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Insurance charges 700
Salaries & Wages 21,300
Cash in hand 6,200
Cash in Bank 20,500
---------------- ----------------
2,13,400 2,13,400
--------------- ----------------

Adjustments:
(1) Stock on 31-12-87 : Rs. 14,600
(2) Write off Rs. 600 as bad debts
(3) Provision for doubtful debts is to be maintained at 5% on debtors
(4) Create a provision for discount on debtors & reserves fro discount on creditors at
2%
(5) Provision for depreciation on Furniture and fixtures is at 5% per annum and Plant
& Machinery at 20% per annum
(6) Insurance prepaid was Rs. 100
A fire occurred on 25th December 1987 in the godown and stock of the value of Rs. 5,000
was destroyed. It was fully insured and insurance company admitted the claim in full

3. the following Trial Balance of LOVMOON Ltd. And other particulars given, prepare
Trading, Profit and Loss account and Balance Sheet for the year ended 31-12-1995.
Rs. Rs.
Prepaid expenses 1,000 Share Capital 10,00,000
Balance at Bank 1,76,000 Sundry Creditors 2,32,000
Motor Vehicles 1,48,000 Sales 31,60,000
Sundry Debtors 2,96,000 Provision for
Printing & Stationery 6,600 doubtful debts 5,000
Purchases 24,00,000 General reserve 2,00,000
Opening Stock 2,40,000 Last Year P&L
Bad debts 11,400 A/c Balance 1,24,000
Freehold premises
At cost 8,00,000
Repairs to premises 47,600
Mgr.’s Remuneration 20,000
Wages & Salaries 2,29,000
Motor & Delivery exp. 99,000
Administration exp. 1,31,400
Rates & taxes 15,000
Goodwill 1,00,000

----------------- ------------------
47,21,000 47,21,000
---------------- ------------------

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Adjustment:
(1) Stock on hand 31-12-95 : Rs. 2,80,000
(2) Depreciation on Motor vehicles : Rs. 74,000
(3) Sundry creditors include a claim for damages : Rs. 20,000 made last year. This
was settled during this year for Rs. 15,100
(4) Unpaid wages : Rs. 1,600
(5) Rates paid in advance : Rs. 3,000
(6) Provision for bad debts is to be reduced to Rs. 3,500
(7) The item of repairs to premises includes Rs. 20,000 for a new structure
(8) Stock of stationery on hand : Rs. 2,200

4. A company purchased a second hand machine on 1st Jan 2000 for Rs.37,000 and
immediately spent Rs.2,000 on its repairs and Rs.1,000 on its installation. On 1st July
2001, it purchased another machine for Rs.10,000 and on 1st July 2002, it sold off the first
machine purchased in 2000 at Rs.28,000. on the same date, it purchased machinery for
Rs.25,000. The second machine purchased for Rs.10,000 was sold off on 1st July 2003
for Rs.2000.

Depreciation was annually on 31st December provided on machinery @ 10% on the

original cost. In 2001, however, the co changed the method of providing depreciation
and adopted the Written down value method, the rate of depreciation being 15%. Give
the machinery account for the 4 years commencing from 1st January 2000.

TEXT BOOKS FOR THE CHAPTER:

1. S.N.Maheshwari, S.K.Maheshwari, “Accounting for Management”, Vikas

Publishing House Pvt. Ltd, 2006
2. M.A.Sahaf, “Management Accounting – Principles & Practice”, Vikas
Publishing House Pvt. Ltd, 2006
3. M.Y.Khan & P.K.Jain, “Management Accounting”, Tata Mcgraw Hill
Publishing company Ltd, 2007
4. Jawaharlal, “Advanced management accounting”, S.Chand & co ltd, 2003

REFERENCES FOR THE CHAPTER:

1. R.S.N.Pillai & Bagavathi, “Management Accounting”, S.Chand & Co. Ltd, New
Delhi, 2004

2. O.S.Gupta, Pankaj Kothari, “Accounting for Managers”, Frank Bros. Pvt. Ltd,
New Delhi, 2004

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 COST SHEET
Meaning And Scope of Cost Accountancy

The term cost accountancy is wider than the term cost accounting. According
to the Terminology of Management and Financial Accountancy Published by the
Chartered Institute of Management Accountants, London, cost accountancy
means, “the application of costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control. It includes the
presentation of information derived there from for the purpose of managerial
decision making.

Cost Accounting

Cost accounting is the process of accounting for costs. It embraces the

accounting procedures relating to recording of all income and expenditure and
the preparation of periodical statements and reports with the object of
ascertaining and controlling costs. It is thus the formal mechanism by means of
which costs of products or services are ascertained and controlled.

Costing

Costing is “the technique and process of ascertaining costs.” Cost accounting is

different from costing in the sense that the former provides only the basis and
information for ascertainment of cost. Once the information is made available
the costing can be carried out arithmetically by means of memorandum
statements or by method of integral accounting.

However, the two terms costing and cost accounting are often used
interchangeably. No such distinction has also been observed for the purpose of
this book. Wheldon has given an exhaustive definition of costing after
expanding the ideas contained in the definitions of the terms ‘costing and cost
accounting’. According to him costing is, “the classifying recording and
appropriate allocation of expenditure for the determination of the costs of
products or services; the relation of these costs to sales values; and the
ascertainment of profitability”.

Cost Control

According to the Institute of Cost and Works Accountants of India, cost control
means “The act of power of controlling or regulating or dominating or
commanding costs through the application of management tools and techniques

19
to the performance of any operation to most predetermined objectives of
quality, quantity, value and time oat an optimum outlay”.

Objectives of Cost Accounting

The main objectives of cost accounting can be summarized as follows:-

1. Ascertaining Costs: - The first and foremost objective of cost

accounting is to find out cost of a product, process or service. The other
objectives which have been mentioned hereafter scan be achieved only
when the costs have been ascertained.
2. Determining Selling Price: - Business enterprises are run on a profit
– making basis. It is thus necessary that the revenue should be greater
than the costs incurred in producing goods and services from which the
revenue is to be derived. Cost accounting provides information
regarding the cost to make and sell such products or services.
3. Measuring and Increasing Efficiency: - Cost accounting involvers
a study of the various operations used in manufacturing a product or
providing a services. The study facilitates measuring of the efficiency of
the organisation as a whole as well as of the departments besides
devising means of increasing the efficiency.
4. Cost Control and Cost Reduction: - Cost accounting assists in cost
control it uses techniques such as budgetary control, standard costing
etc. for controlling costs. Budgets are prepared will in advance. The
standards for each item of cost are determined, the actual costs are
compared with the standard costs and variances are found out as to
their causes. This greatly increases the operating efficiency of the
enterprise. Besides it, cost is required to be reduced also constant
research and development activities help in reduction of costs without
compromising with the quality of goods or services.
5. Cost Management: - The term ‘Cost Management’ includes the
activities of managers in short-run and long-run planning and control of
costs. Cost management has a broad focus. It includes both cost control
and lost reduction. As a matter of fact cost management is often
invariably linked with revenue and profit planning. For instance, to
enhance revenue and profits, the management often deliberately incurs
additional costs for advertising and product modifications.
6. Ascertaining Profits: - Cost accounting also aims at ascertaining the
profits of each and every activity. It produces statements at such
intervals as the management may require. The financial statements
prepared under financial accounting, generally once a year or half –
year, are spaced too far apart in time to meet the needs of the
management. In order to operate the business at a high level of
efficiency, it is essential for the management to have a frequent review
of production, sales and operating results. Cost accounting provides

20
 daily, weekly or monthly volumes of units produced, accumulated costs
together with appropriate analysis so that quantum of profit and
profitability is known.
7. Providing Basis for Managerial Decision – Making: - Costs
accounting helps the management in formulation operative policies.
These policies may relate to any of the following matters:-
(i) Determination of cost – volume – profit relationship.
(ii) Shutting down or operating at a loss.
(iii) Making or buying from outside supplies.
(iv) Continuing with the existing plant and machinery or replacing
them by improved and economical means.

Cost Accounting Versus Financial Accounting

Accounting may broadly be classified into two categories:-

(a) Financial Accounting and
(b) Management Accounting

Financial Accounting is concerned with recording, classifying and summarizing

financial transactions and preparing statements relating to the business in
accordance with generally accepted accounting concepts and conventions. It is
mainly meant to serve all parties external to the operating responsibility of the
firm such as shareholders and creditors of the firm besides providing
information about the overall operational results of the business while
management accounting is concerned with accounting information which is
useful for the management it is the presentation of accounting information in
such as way as to assist “the management in the creation of policy and day to
day operation of the undertaking.

IMPORTANCE OF COST ACCOUNTING

1. Costing helps in periods of trade depression and trade
competition:-
In periods of trade depression the business cannot afford to have leakages
which pass unchecked. The management should know where economies
may be sought, waste eliminated and efficiency increased. The business
has to wage a wax for its survival. The management should know the actual
cost of their products before embarking on any scheme of reducing the
prices on giving tenders. Adequate costing facilitates this.

2. Aids in price fixation:-

Though economic law & supply and demand and activities of the
competitors, to a great extent, determine the price of the article, cost to

21
 the producer does play an important part. The producer can take necessary
guidance from his costing records.

3. Helps in estimate:-
Adequate costing records provide a reliable basis upon which tenders and
estimates may be prepared. The chances of losing a contract on account of
over – rating or losing in the execution of a contract due to under – rating
can be minimized. Thus, “ascertained costs provide a measure for
estimates, a guide to policy, and a control over current production”.

4. Helps in channeling production on right lines:-

Costing makes possible for the management to distinguish between
profitable and non-profitable activities profit can be maximized by
concentrating on profitable operations and eliminating non-profitable ones.

5. Wastages are eliminated:-

As it is possible to know the cost of the article at every stage, it becomes
possible to chock various forms of waste, such as time, expenses etc. or in
the use of machine, equipment and tools.

6. Costing makes comparison possible:-

If the costing records are regularly kept, comparative cost data for different
periods and various volumes of production will be available. It will help the
management in forming future lines of action.

7. Provides data for periodical profit and loss accounts:-

Adequate costing records supply to the management such data as may be
necessary for preparation of profit and loss account and balance sheet, at
such intervals as may be desired by the management.
It also explains in detail the sources of profit or loss revealed by the
financial accounts thus helps in presentation of better information before
the management.

8. Aids in determining and enhancing efficiency:-

Losses due to wastage of material, idle time of workers, poor supervision
etc., will be disclosed if the various operations involved in manufacturing a
product are studied by a cost accountant. The efficiency can be measured
and costs controlled and through it various devices can be framed to
increase the efficiency.

9. Helps in inventory control:-

Costing furnishes control which management requires in respect of stock of
materials, work-in-progress and finished goods. (This has been explained in
detail under the chapter “Materials”)

22
10. Helps in cost reduction:-
Costs can be reduced in the long run when alternatives are tried. This is
particularly important ion the present day context of global competition
cost accounting has assumed special significance beyond cost control this
way.

11. Assists in increasing productivity

Productivity of material and labour is required to be increased to have
growth and more profitability in the organisation costing renders great
assistance in measuring productivity and suggesting ways to improve it.

ELEMENTS OF COST

There are three broad elements of cost:-

(a) Material
(b) Labour
(c) Expenses

(a) Material: - The substance from which the product is made is known as
material. It may be in a raw or a manufactured state. It can be direct
as well as indirect.

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”.
Following are some of the examples of direct material:-
(i) All material or components specifically purchased produced or
requisitioned from stores.
(ii) Primary packing material (e.g. – cartoon, wrapping, cardboard,
boxes etc.)
(iii) Purchased or partly produced components.

Direct material is also described as raw-material, process material,

prime material, production material, stores material, constructional
material etc.

Indirect Material: - All material which is used for purposes 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 etc. are a few
examples of indirect material
Indirect material may be used in the factory the office or the selling and
distribution division.

23
(b) 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.

Direct labour: - Labour which takes an active and direct part in the
production of a particular commodity is called labour. Direct labour
costs are, therefore specially and conveniently traceable to specific
products.
Direct labour is also described as process labour, productive labour,
operating labour, manufacturing labour, direct wages etc.

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 of store
– keepers, foreman, time – keepers, directors, fees, salaries of salesmen,
etc. are all examples of indirect labour costs.
Indirect labour may relate to the factory the office or the selling and
distribution division.

(c) Expenses: - Expenses may be direct or indirect.

Direct expenses: - These are expenses which can be directly,

conveniently and wholly allocated to specific cost centers 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”.

Indirect expenses:- these are expenses which cannot be directly,

conveniently and wholly allocated to cost centers or cost units.

OVERHEADS:- It is to be noted that the term overheads has a wider

meaning than the term indirect expenses overheads include the cost of
indirect material, indirect labour besides indirect expenses.

Indirect expenses may be classified under the following three categories:-

(a) Manufacturing (works, factory or production) expenses:-

Such indirect expenses which are incurred in the factory and concerned
with the running of the factory or plant are known as manufacturing
expenses. Expenses relating to production management and
administration are included there in. Following are a few items of such
expenses:
Rent, rates and insurance of factory premises, power used in factory
building, plant and machinery etc.

24
(b) Office and Administrative expenses
These expenses are not related to factory but they pertain to the
management and administration of business such expenses are incurred
on the direction and control of an undertaking example are :- office
rent, lighting and heating, postage and telegrams, telephones and other
charges; depreciation of office building, furniture and equipment, bank
charges, legal charges, audit fee etc.

(c) Selling and Distribution Expenses:-

Expenses incurred for marketing of a commodity, for securing orders for
the articles, dispatching goods sold, and for making efforts to find and
retain customers are called selling and distribution expenses examples
are:-
Advertisement expenses cost of preparing tenders, traveling expenses,
bad debts, collection charges etc.
Warehouse charges packing and loading charges, carriage outwards, etc.

The above classification of different elements of cost can be presented

in the form of the following chart:

ELEMENTS OF COST

MATERIAL LABOUR EXPENSES

DIRECT INDIRECT DIRECT INDIRECT INDIRECT

DIRECT

FACTORY FACTORY FACTORY

OFFICE OFFICE OFFICE

SELLING SELLING SELLING

DISTRIBUTION DISTRIBUTION DISTRIBUTION

25
 OR

Elements
of cost

DIRECT MATERIAL DIRECT LABOUR DIRECT EXPENSES OVERHEADS

FACTORY OVERHEADS OFFICE OVERHEADS SELLING & DISTRIBUTION

OVERHEADS

INDIRECT INDIRECT INDIRECT

MATERIAL MATERIAL MATERIAL

INDIRECT INDIRECT INDIRECT

LABOUR LABOUR LABOUR

INDIRECT INDIRECT INDIRECT

EXPENSES EXPENSES EXPENSES

26
Items excluded from cost accounts
There are certain items which are included in financial accounts but not in cost
accounts. These items fall into three categories:-

Appropriation of profits

(i) Appropriation to sinking funds.

(ii) Dividends paid
(iii) Taxes on income and profits
(iv) Transfers to general reserves
(v) Excess provision for depreciation of buildings, plant etc. and for
bad debts
(vi) Amount written off – goodwill, preliminary expenses, underwriting
commission, discount on debentures issued; expenses of capital
issue etc.
(vii) Capital expenditures specifically charged to revenue
(viii) Charitable donation

Matters of pure finance

(a) Purely financial charges:-

(i) Losses on sale of investments, buildings, etc.
(ii) Expenses on transfer of company’s office
(iii) Interest on bank loan, debentures, mortgages, etc.
(iv) Damages payable
(v) Penalties and fines
(vi) Losses due to scrapping of machinery
(vii) Remuneration paid to the proprietor in excess of a fair reward for
services rendered.

(b) Purely financial incomes:-

(i) Interest received on bank deposits
(ii) Profits made on the sale of investments, fixed assets, etc.
(iii) Transfer fees received
(iv) Rent receivable
(v) Interest, dividends, etc. received on investments.
(vi) Brokerage received
(vii) Discount, commission received

Abnormal gains and losses:-

(i) Losses or gains on sale of fixed assets.
(ii) Loss to business property on account of theft, fire or other natural
calamities.

27
 In addition to above abnormal items (gain and losses) may also be
excluded from cost accounts. Alternatively, these may be taken to
costing profit and loss account.

Components of total cost

Prime cost: - It consists of costs of direct material, direct labour and direct
expenses. It is also known as basic, first or flat cost.

Factory cost:- It comprises of prime cost and in addition works of factory

overheads which includes costs of indirect material, indirect labour and
indirect expenses of the factory. The cost is also known as works cost,
production or manufacturing cost.

Office cost: - If office and administrative overheads are added to factory

cost office cost is arrived at this is also termed as administrative cost or the
total cost of production.

Total cost:- Office cost or total cost of production selling and distribution
overheads are added to the total cost of production to get the total cost or the
cost of sales.
Cost of sales or total cost. The various components of total cost can be
depicted through the help of the following chart:-

Components of Total cost

Direct material plus
Direct labour plus Prime cost or Direct cost or First cost
Direct expenses

Prime cost plus works cost or factory or production cost or

manufacturing Works overheads cost

Work cost plus office and

Administrative overheads

Office cost plus selling

And distribution overheads

Adjustments for inventories

28
The following adjustments may have to be made for inventories of raw
materials, work – in – progress and finished goods while computing the different
components of cost:

(i) Direct Opening stock Purchases of Closing stock

Material = of Direct + Direct - of Direct
Consumed material material material
(ii) Works Gross works Opening work - Closing work
– in
= + __
Cost cost in – progress progress

(iii) Cost of production = cost of production + Opening stock Closing

stock
of goods sold of finished _ of
finished good

29
 Particular Details (Rs) Amount (Rs)

Raw material purchased

Add:- Opening stock of raw material
---------------
Raw material for consumption
Less:- closing stock of raw material
---------------
Raw material consumed
Less:- Sale of wastage of materials
-------------
Add:- Direct labour
Add:- Direct chargeable expenses
--------------
Prime cost
Add:- Factory overhead
Rent & Taxes
Factory Power
Experimental charges
--------------
Factory cost
Add:- Administrative overhead:-
Office management salary
Office printing & stationery
---------------
Cost of production
Add:- Opening stock of finished goods
-------------
Goods available for sales
Less:- closing stock of finished goods
-------------
Cost of goods sold
Add:- selling and distribution overhead:-
Salaries of salesman
Commission to traveling agent
--------------
Cost of sales
Profit
--------------
Sales

30
Illustration 1. Calculate prime cost from the following information:-

Direct material - Rs. 40,000, Direct labour - Rs. 30,000 Direct expenses - Rs.
25.000

31
Solution: Prime cost = Direct Material + Direct labour + Direct expenses
= Rs. 40,000 + Rs.30, 000 + Rs. 25,000
= Rs. 95,000

Illustration 2.Calculate prime cost from the following information:-

Opening stock of raw material = Rs. 12,500
Purchased raw material = Rs. 75,000
Expenses incurred on raw material = Rs. 5,000
Closing stock of raw material = Rs. 22,500
Wages Rs. 47,600 Direct expenses Rs. 23,400

Solution: - Calculation of raw material consumed:-

Raw material consumed = Opening stock of material +
purchases of Raw material + expenses incurred on raw
material - closing stock of raw material

= Rs 12,500 + Rs 75,000 + Rs 5,000 – Rs 22,500

= Rs. 92,500 – Rs 22,500
= Rs. 70,000

Prime cost = Raw material consumed + Direct labour + Direct expenses

= Rs 70,000 + Rs 47,600 + Rs 23,400
= Rs 1, 41,000

OR

It can be shown in vertical form such as cost sheet

Particular Details (Rs) Amount (Rs)

Opening stock of raw material 12,500

Add:- Purchase 7,500
Add:- Expenses incurred on purchases 5,000
---------------
Raw material available 92,500
Less :- closing stock of raw material 22,500
---------------
Raw material consumed 70,000
Add:- Direct wages or labour 47,600
Add:- Direct expenses 23,400
--------------

32
 Prime cost 1,41,000

Illustration 3. Calculate works cost or factory cost from the following

details:-

Raw material consumed = Rs 50,000

Direct wages = Rs20, 000
Direct expenses = Rs 10,000
Factory expenses 80% of direct wages
Opening stock of work in progress = Rs 15,000
Closing stock of work in progress = Rs 21,000

Solution: - Calculation of factory cost

Particular Amount (Rs) Amount (Rs)

Direct material consumed 50,000

Add:- Direct wages 20,000
Add:- Direct Expenses 10,000
-------------
Prime cost 80,000

Add:- Factory expenses 16,000

--------------
Current manufacturing cost 96,000
Add:- Opening stock of work in progress 15,000
--------------
Total goods processed during the period 1,11,000
Less:- Closing sock of work in progress 21,000
--------------
Factory cost or work cost 90,000

Illustration 4. Calculate cost of production from the following

information:-
Raw material purchased = Rs 42,500
Freight paid = Rs 5,000
Labour charges = Rs 12,500
Direct expenses = Rs 10,000

33
 Factory overhead 80% of Direct labour charges
Administrative overhead = 10% of work cost

Opening stock Closing stock

Raw material 8,000 10,000
Work in progress 7,500 9,000

Solution: - Calculation of cost of production:-

Particular Amount (Rs) Amount (Rs)

Material purchased 42,500

Add:- freight 5,000
-------------
Total cost of material purchased 47,500
Add:- Opening stock of Raw material 8,000
------------
Material available for consumption 55,500
Less:- Closing stock of Raw material 10,000
------------
Raw material consumed 45,500
Add:- Direct labour charges 12,500
Add:- Direct expenses 10,000
Prime cost 68,000
Add:- Factory overhead 10,000
------------
Current manufacturing cost 78,000
Add:- Opening stock of work in progress 7,500
------------
Total goods processed during the period 85,500
Less:- Closing stock of work in progress 9,000
------------
Factory cost 76,500
Add:- Administrative overhead 7,650
------------
Cost of production 84,150

Illustration 5. Prepare cost sheet from the following particular in the book
of B. M. Rehman
Raw material purchased = Rs. 1, 20,000
Paid freight charges = Rs 10,000
Wages paid to laborers = Rs 35,000
Directly chargeable expenses = Rs 25,000
Factory on cost = 20% of prime cost

34
 General and administrative expenses = 4% of factory cost
Selling and distribution expenses = 5% of production cost
Profit 20% on sales
Opening stock Closing stock
Raw material 15,000 20,000
Work in progress 17,500 24,000
Finished goods 20,000 27,500

Solution:-
Book of B. M. Rehman
Cost sheet

Raw material purchased 1,20,000

Add:- freight charges 10,000
---------------
Total cost of raw material purchased 1,30,000
Add:- opening stock of raw material 15,000
---------------
Cash of raw material available 1,45,000
Less:- closing stock of raw material 20,000
--------------
Raw material consumed 1,25,000
Add:- wages paid to labours 35,000
Add:- Directly chargeable expenses 25,000

35
 --------------
Prime cost 1,85,000
Add:- Factory overhead 20% of prime cost 37,000
---------------
Current manufacturing cost 2,22,000
Add:- Opening stock of work in progress 17,500
---------------
Total goods processed during the period 2,39,500
Less:- closing stock of work in progress 24,000
---------------
Factory on work cost 2,15,500
Add:- General & administrative expenses 4% of factory 8,620
cost ---------------
Cost of production 2,24,120
Add:- opening stock of finished goods 20,000
--------------
Goods available for sales 2,44,120
Less:- closing stock of finished goods 27,500
--------------
Cost of goods sold 2,16,620
Add:- selling and distribution expenses 5% of 11,206
production cost --------------
Cost of sales 2,27,826
Add:- Profit 56,956.50
---------------
Sales 2,84,782.50

Illustration 6. Prepare cost sheet in the book of M. B. Rehman from the

following particulars.

Opening stock: - Raw material = Rs 5,000

Finished goods = Rs 4,000
Closing stock: - Raw material = Rs 4,000
Finished goods = Rs 5,000
Raw material purchased = Rs 50,000
Wages paid to laboures = Rs 20,000
Chargeable expenses = Rs 2,000
Rent and Taxes = Rs 7,400
Power = Rs 3,000
Experimental expenses = Rs 600
Sale of wastage of material = Rs 200
Office management salary = Rs 4,000
Office printing & stationery = Rs 200
Salaries to salesman = Rs 2,000
Commission to traveling agents = Rs 1,000

36
 Sales = Rs 1, 00,000

Solution:-
Book of B. M. Rehman
Cost sheet

Particular Details (Rs) Amount (Rs)

Raw material purchased 50,000

Add:- Opening stock of raw material 5,000
---------------
Raw material for consumption 55,000
Less:- closing stock of raw material 4,000
---------------
Raw material consumed 51,000
Less:- Sale of wastage of materials 200
------------- 50,800
Add:- Direct labour 20,000
Add:- Direct chargeable expenses 2,000
--------------
Prime cost 72,800
Add:- Factory overhead
Rent & Taxes 7,400
Power 3,000
Experimental charges 600
-------------- 11,000
Factory cost 83,800
Add:- Administrative overhead:-
Office management salary 4,000
Office printing & stationery 200
--------------- 4,200
Cost of production 88,000
Add:- Opening stock of finished goods 4,000
-------------
Goods available for sales 92,000
Less:- closing stock of finished goods 5,000
-------------
Cost of goods sold 87,000
Add:- selling and distribution overhead:-
Salaries of salesman 2,000
Commission to traveling agent 1,000
-------------- 3,000
Cost of sales 90,000
Profit 10,000

37
 --------------
Sales 1,00,000

Illustration 7. The cost of sale of production ‘A’ is made up as follows:-

Material used in manufacturing Rs 5,500

Material used in packing material Rs 1,000
Material used in selling the product Rs 150
Material used in the factory Rs 175
Material used in the office Rs 125
Labour required in production Rs 1,000
Labour required for supervision in factory Rs 200
Expenses direct factory Rs 500
Expenses indirect factory Rs 100
Expenses office Rs 125
Depreciation of office building Rs 75
Depreciation on factory plant Rs 175
Selling expenses Rs 350
Freight on material Rs 500
Advertising Rs 125

Assuming that all products manufactured and sold, what should be the selling
price be fixed to obtain a profit of 20% on selling price.
Solution
Cost Sheet

Particular Amount (Rs) Amount (Rs) Amount (Rs)

Direct material:-
Material used in manufacturing 5,500
Material used in Packing material 1,000
Freight on material 500
------------- 7,000
Direct wages:-
labour require in production 1,000
Direct expenses:- Direct factory 500
------------
Prime cost 8,500
Add:- Factory overhead
Indirect material used in factory 75
Indirect labour required for supervision 200
Indirect factory expenses 100
Depreciation factory 175
------------- 275

38
 ------------- 550
Factory on works cost 9050
Add:- office & administrative expenses
Indirect material 125
Indirect expenses office 125
Indirect depreciation 75
------------ 200
------------- 325
Total cost of production 9375
Add:- selling and distribution overhead:-
Indirect material 150
Indirect expenses 350
Advertisement 125
------------ 475
------------- 625
Cost of sales 10,000
Profit 2,500
-----------
Sales 12,500

Illustration 8.
Prepare a statement of cost from the following trading and P/L account for
the year ending March 31, 2008

Particular Amount (Rs) Particular Amount (Rs)

To opening stock material 12,000 By sales 2,00,000

Finished goods 40,000 By closing stock 20,000
material
To purchases 1,20,000 Finished goods 50,000
To cost of moulds 3,000
To salary of factory manger 1,000
To depreciation of machine 800
To gross profit 63,200
-------------- ---------------
2,70,000 2,70,000
-------------- -------------
To office salary 9,000 By Gross profit 63,200
To salesman salary 6,000 By interest from 800
bank
To insurance of office building 1,000 By dividend received 200
To godown expenses 800 By rent received 900
To directors fees 2,000

39
To telephone charges 700
To showroom expenses 1,200
To delivery van expenses 1,500
To preliminary expenses 2,000
To interest on deb. 700
To market research exp. 600
To net profit 39,000
-------------- --------------
65,100 65,100
-------------- --------------

Solution
Statement of cost
(For the year ending 31st March 2008)
Particular Details (Rs) Amount (Rs)

Direct material:-
Raw material purchased 1,20,000
Add:- opening stock of raw materials 12,000
---------------
Raw material for consumption 1,32,000
Less:- Closing sock of raw materials 20,000
---------------
Raw material consumed 1,12,000
Add:- Direct labour 30,000
---------------
Prime cost 1,42,000
Add:- Factory overhead:-
Cost of moulds 3,000
Factory manager salary 1,000
Depreciation on machinery 800
--------------- 4,800
---------------
Factory cost 1,46,800
Add:- office and administrate overhead
Salary 9,000
Insurance 1,000
Directors fees 2,000
Telephone charges 700
--------------- 12,700
-------------
Cost of production 1,59,500
Add:- Opening stock of finished goods 40,000
--------------
Goods available for sales 1,99,500
Less:- Closing stock of finished goods 50,000
--------------
Cost of goods sold 1,49,500

40
Add:- selling & distribution ext:-
Salesman’s salary 6,000
Insurance (godown) 800
Showroom expenses 1,200
Expenses of delivery van 1,500
Market research expenses 600
------------- 10,100
----------------
Cost of sales 1,59,600
Profit 40,400
----------------
Sales 2,00,000

Illustration 9.
The following inventory data relate to Nazia Ltd.

Inventories
Opening Closing
Finish goods Rs 1,100 Rs 950
Work in progress Rs 700 Rs 800
Raw materials Rs 900 Rs 950

Additional information:-
Cost of goods available for sales = Rs 6840
Total goods processed during the period = Rs 6540
Factory on cost = Rs 1670
Direct material used = Rs 1930

Requirements:-
(i) determine raw material purchase
(ii) determine the direct labour and cost incurred
(iii) determine the cost of goods sold

Solution

(i) Raw material purchased:-

Raw material consumed = opening stock + purchases – closing
stock
OR Rs 1,930 = Rs 900 + Purchases – Rs 950
OR Rs 1,930 + Rs 50 = purchases
Rs 1,980 = Raw material purchased

(ii) Direct labour cost:-

Cost of goods processed during the year = Rs 6,540
Less: - Opening work in progress = Rs 700

41
 ---------------
Rs 5,840
Less: - Factory overheads = Rs 1,670
---------------
Prime cost = Rs 4,170
Less: - Raw material consumed = Rs 1930
--------------
Direct labour cost = Rs 2,240

(iii) Cost of goods sold:-

= cost of goods available for sales – closing stock finished goods
= 6840 – 950 = Rs 5890

Illustration 10.
Mr. Zia furnishes the following data related to the manufacture of a standard
product during the month of August 2008

Raw material consumed - Rs 15,000

Direct labour - Rs 5,000
Machine hours worked - Rs 900
Machine hour rate - Rs 5
Administration overheads = 20% of works cost
Selling overheads - Rs 0.50 per unit
Unit produced - Rs 17,100
Unit sold - 16,000 @ Rs 4 per unit

You are required to prepare a cost sheet from the above showing:-
(a) The cost per unit
(b) Cost per unit sold and profit for the period
Solution
Book of Zia
Cost sheet
(For the month of August 31, 2008)

Particular Amount (Rs) Amount (Rs)

Direct material consumed 15,000 0.878

Direct labour 5,000 0.292
Direct expenses 4,000 0.233
-------------- --------------
Prime cost 24,000 1.403
Factory overheads
(900 hours @ Rs 5 per hour) 4,500 0.263
-------------- ---------------

42
 Work cost 28,500 1.666
Administrative overheads
@ 20% of works cost 5,700 0.333
-------------- ---------------
Cost of production 34,200 2,000
Less:- closing stock on August 31, 2008
(1100 units @ Rs 2 per unit) 2,200 -----
----------- --------------
Cost of goods sold 32,000 2.000
Selling overheads @ Rs 0.50 per unit for 8,000 0.50
16000 ----------- -------------
Cost of sales 40,000 2.50
Profit 24,000 1.50
------------ ------------
Sales (1600 unit) 64,000 4.00

* Closing stock = unit produced - units sold

= 17100-16000
= 1100 units

Exercise Questions.

Theoretical Questions:-

1) Explain the meaning of cost accountancy

2) Define
a) Direct materials
b) Direct wages
c) Direct expenses

3) What is cost accounting? Discuss briefly its important functions in a

business firm
4) Explain the important objectives of cost accounting?
5) Distinguish between:-
a) Direct expenses and indirect expenses?
b) Direct labour and indirect labour?
c) Direct materials and indirect materials?
6) Distinguish between ‘costing’ and ‘cost accounting’
7) What is financial accounting? How it is different from cost-accounting?
8) Mention the elements of cost
9) Explain the classification of direct labour
10) How the overheads are different from the expenses?
11) State at least five each type of overheads
a) Factory overheads
b) Administrative overheads
c) Selling and distribution overheads

43
 12) What are the components of direct cost?
13) Write the formula of calculating the raw material consumed
14) Explain the meaning of cost of goods sold and cost of sales
15) Explain the meaning of
a) First cost
b) Works cost and works on cost
c) Cost of production and goods available for sales

Practical problems (Short Answers)

1. Opening stock of raw material - Rs 15,000

Closing stock of raw material - Rs 20,000
Material purchased - Rs 1, 20,000
Find raw material consumed
(Ans. 1, 15,000)

2. Raw material consumed - Rs 1, 02,000

Raw material for consumption - Rs 1, 10,000
Raw material purchased - Rs 1, 00,000
Find opening & closing stock of raw material (Ans. Rs 10,000 and Rs
8,000)
3. Prime cost - Rs 1, 85,000
Current manufacturing cost - Rs 2, 22,000
Total goods processed during the period - Rs 2, 39,500
Works cost - Rs 2, 15,000
Find factory overheads, opening and closing stock of work in progress
(Ans. Rs 37,000, Rs 17,500 and Rs 24,000)

4. Cost of production - Rs 11,206

Goods available for sales - Rs 12,206
Cost of goods sold - Rs 10,831
Cost of Sales - Rs 11, 391
Sales - Rs 12,000
Find opening and closing stock of finished goods, selling expenses and
profit or loss (Ans. Rs 1,000, Rs 1,375, Rs 560 and Rs 609 profit)

5. Direct material consumed - Rs 60,000

Direct labour 50% of material consumed
Direct expenses - 33¹/³% of direct labour
Factory overheads - 40% of direct labour
Office overheads - on cost 66²/³% of works
Find office cost (Ans. Rs 1, 20,000)

44
PRACTICAL PROBLEMS

1. From the following particulars prepare a cost sheet showing the total
cost per tone for the period ended 31st December 1998

Rs Rs

Raw material 33,000 Director’s fees (office) 2,000

Productive wages 35,000 Factory cleaning 500
Direct expenses 3,000 Sundry office expenses 200
Unproductive wages 10,500 Estimating 800
Factory rent and terms 7,500 Factory stationery 750
Factory lighting 2,200 Office stationery 900
Factory heating 1,500 Factory insurance 1,100
Motive power 4,400 Office insurance 500
Haulage 3,000 Legal expenses 400
Director’s fees (works) 1,000 Rent of warehouse 300
Depreciation of Unkeeping of delivery vans 700
- plant and machinery 2,000 Bank charges 50
- office building 1,000 Commission on sales 1,500
- delivery vans 200 Loose tools written off 600
Bad debts 100 Rent and taxes (office) 500
Advertising 300 Water supply 1,200
Sales department 1,500
salaries

The total output for the period has been 10,000 tones.

(Ans. Prime cost Rs 71,000 works cost Rs 1,08,050 office cost Rs 1,13,600 total
cost Rs 1,18,200 cost per tone Rs 11.82)

2. Prepare a cost sheet to show the total cost of production and cost per
unit of goods manufactured by a company for the month of July 1994.
Also find out the cost of sales.

Rs Rs

Stock of raw materials 3,000 Factory rent & rates 3,000

1-7-1994
Raw materials purchased 28,000 Office rent 500
Stock of raw materials 4,500 General expenses 400
31-7-1994
Manufacturing wages 7,000 Discount on sales 300
Depreciation on plant 1,500 Advertisement 600
Loss on sale of a part of 300 Expenses to be charged 2,000
plant fully income tax paid

45
The number of units produced during July 1994 was 3,000
The stock of finished goods was 200 and 400 units on 1-7-1994 and 31-7-1994
respectively. The total cost of units on hand on 1-7-1994 was Rs 2,800. All
these had been sold during the month.

(Ans. Prime cost Rs 33,500 factory cost Rs 38,000 cost of production Rs 38,900
cost of sales Rs 37416)

3. The following particulars relating to the year 1994 have been taken from
the books of a chemical works manufacturing and selling a chemical
mixture:

Rs Rs

Stock on 1st Jan. 1994

Raw materials 2,000 2,000
Finished mixture 500 1,750
Factory stores ------ 7,250
Purchases
Raw materials 1,60,000 1,80,000
Factory stores ------ 24,250
Sales
Finished mixture 1,53,050 9,18,000
Factory scrap ------ 8,170
Factory wages ------ 1,78,650
Power ------ 30,400
Depreciation of machinery ------ 18,000
Salaries
Factory ------ 72,220
Office ------ 37,220
Selling ------ 41,500
Expenses
Direct ------ 18,500
Office ------ 18,200
Selling ------ 18,000
Stock on 31st December 1994
Raw material 1,200
Finished mixture 450
Factory stores ------ 5,550

The stock of finished mixture at the end of 1994 is to be valued at the factory
cost of the mixture for that year. The purchase price of raw–materials
uncharged throughout 1994.

46
Prepare a statement giving the maximum possible information about cost and
its break up for the year 1994.

(Ans. Prime cost Rs 3,77,800 factory cost Rs 5,16,200 cost of production of

finished mixture sold Rs 5,71,852 cost of sales Rs 6,31,352)

4. Calculate
a) Value of raw-materials consumed
b) Total cost of production
c) Cost of goods sold and
d) The amount of profit from the following particulars:

Rs Rs

Opening stock Power 2,000

Raw – materials 5,000 Factory heating and 2,000
lighting
Finished goods 4,000 Factory insurance 1,000
Closing stock Experimental Expenses 500
Raw – materials 4,000 Sales of wastage of 200
materials
Finished goods 5,000 Office management 4,000
salaries
Raw – materials 50,000 Office printing and 200
purchased stationery
Wages paid to labourers 20,000 Salaries of salesmen 2,000
commission of traveling
agent
Chargeable expenses 2,000
Factory rent, rates & 5,000 Sales 1,00,000
taxes

(Ans. (a) Rs 50,800, (b) Rs 87,500, (c) Rs 89,500, (d) Rs 10,500)

[Hint sales of raw-materials wastage of Rs 200 has been deducted from the cost
of raw-materials]

5. The cost of the sale of product ‘X’ is made up as follows:

Rs

Materials used in manufacturing 10,20

Materials used in packing materials 2,500

47
Materials used in selling the product 350
Materials used in office 75
Materials used in factory 125
Labour required in producing 2,500
Salary paid to works manager and other principal officers of the 450
factory
Expenses – indirect office 250
Expenses – direct factory 1,000
Bad debts 300
Packing expenses 150
Lighting and heating charges of the factory 200
Expenses – indirect factory 125

Assuming that all the products manufactured are sold, what should be the
selling price to obtain a profit of 20% on cost price?

Illustrate in a chart fork for presentation to your mange, the division of costs of
product ‘X’

[Ans. Prime cost Rs 16,200, works cost Rs 17,100 cost of sales Rs 18,225 sales
Rs 21,870]

6. Calculate the prime cost, factory cost, total cost of production and cost of
sales from the following particulars:

Rs.

Raw materials consumed 12,000

Directly chargeable expenses 500
Wages paid to labourers 2,500
Grease, oil, cotton waste etc. 25
Salary manager and clerks 1,750
Insurance of stock of raw materials 300
Consumable stores 400
Printing and stationery:
Factory 50
Office 200
Sales deptt. 100
----------- 350

Rent of office building 150

Depreciation :
Factory premises 200
Office furniture 50
Delivery vans 75
--------- 325

48
Power and fuel 500
Contribution to provident fund of factory employees 1,000
Salaries of administrative directors 100
Bank charges 75
Cost of samples 250
Salaries of sales manger 300
Advertising 500
Packing material 350
Storage in stocks of finished goods 20

[Ans. Prime cost Rs 15,000, factory cost Rs 19225 total cost of production Rs
19,800 cost of sales Rs 21,395]

7. Calculate
a) Value of raw-materials consumed
b) Total cost of production
c) Cost of goods sold and
d) The amount of profit from the following particulars:

Rs

Opening stock:
Raw materials 1,350
Finished goods 2,500
Closing stock:
Raw-materials 750
Finished goods 1,500
Raw materials purchased 20,000
Wages paid to labourers 8,000
Direct expenses 1,250
Experimental expenses 450
Factory printing and stationery 350
Rent :
Factory 250
Office 120
-------- 370
Wages of fireman 1,000
Lighting – office 125
Audit fees 150
Telephone expenses 500
Advertising 1,250
Market research expenses 550
Salary of godown – keepers 175
Traveling expenses 750
Commission of traveling agent 500
Sales 50,000

49
[Ans. (a) value of raw – materials consumed Rs. 20,600 (b) Total cost of
production Rs 32,795, (c) cost of goods sold Rs 33,795, (d) profit Rs 12,980]

8. Prepare a statement of cost from the following trading and profit and
loss account for the year ending 31st March, 1995.

Particulars Rs Particulars Rs

Opening stock: Sales 1,00,000

Materials 8,000 Closing stock:
Finished goods 25,000 Materials 15,000
Purchase of materials 70,000 Finished goods 30,000
Direct labour 10,000
Grease, oil etc. 500
Salary of storekeeper 700
Power & fuel 800
Gross profit c/d 30,000
------------- -------------
1,45,000 1,45,000
------------- -------------
Lighting: Gross profit b/d 30,000
Office 500 Dividends received 2,000
Sales deptt. 650 Interest on loan 600
Depreciation: Transfer fees 1,450
Office premises 1,000 Received
Delivery vans 750
Fees of office manager 2,000
Bank charges 1,500
Selling expenses 1,500
Sales commission 500
Preliminary expenses 3,000
Packing expenses 1,100
Dividends paid on 1,000
Share capital of company
Discount on debentures 500
Net profit 20,000
------------ -----------
34,000 34,000

[Ans. Prime cost Rs 73,000, works cost Rs 75,000, total cost of production Rs
80,000 cost of goods sold Rs 75000 cost of sales Rs 79,000 profit Rs 21,000]

50
9. The following data relate to the manufacture of standard product during
the four week ending on 28th Oct. 1994.

Raw materials consumed Rs 20,000

Direct wages Rs 12,000
Machine hr worked 950 (hrs)
Machine hour rate Rs 2.00
Office overhead 15% on works cost
Selling overhead Rs 0.37 per unit
Units produced 20,000
Units sold @ Rs 2.50 each 18,000
Prepare a statement from the above showing:
(a) The cost of production per unit, and
(b) The profit for the period

[Ans. (a) Rs 1,949 (b) Rs 3,258

10. A firm has purchased a plant to manufacture a new product, the cost
data for which is given below:

Estimated annual sales 24,000 units

Estimated costs:
Material Rs 4.00 per unit
Direct labour Rs 0.60 per unit
Overheads Rs 24,000 per year
Administrative expenses Rs 28,800 per year
Selling expenses 15% of sales
Calculate the selling price if profit per unit is Rs 1.02

[Ans. Rs 9.20]

11. Prepare a cost sheet from the following data to find out profit and cost
per unit:

Raw materials consumed Rs 1,60,000

Direct wages Rs 80,000
Factory overheads 20% of direct wages
Office overheads 10% of factory cost
Selling overheads 12,000
Unit produced 4,000
Units sold 3,600
Selling price Rs 100 per unit

[Ans. Prime cost Rs 2,40,000, factory cost Rs 2,56,000, cost of production Rs

2,81,600, cost of sales Rs 2,65,440, profit Rs 94,560]

51