UNIT I

COST ACCOUNTING
INTRODUCTION
The function of any accounting system is to make available necessary information accurately for all
parties who are concerned with the welfare of organization-owners, employees, creditors, prospective investors
& management. The requirements of majority of them are satisfied by means of profit & loss a/c & balance
sheet. The management however requires for more detailed information than what the conventional financial
statements can offer.
For a businessman, who manufactures goods or renders service, cost accountancy is a useful aid. It is an
extension of financial accounting & it was developed on account of limitations of financial accounting to meet
ever-growing needs of the management.
Q: WHAT DO YOU MEAN BY COST, COSTING, COST ACCOUNTING &
COST ACCOUNTANCY? (2/5 MARKS)
COST (EXPENDITURE)
 ‘Cost is the amount of expenditure (actual or national) incurred or attributable to, a given thing’ – ICMA
 ‘Cost is the price paid for something’ – Oxford dictionary.
 ‘Cost represents the resources that have been or must be sacrificed to attain a particular objective’ –
Gordon shilling law.
 ‘A cost is the value of economic resources used as a result of producing or doing a thing costed’ – W.A.
Harper.
COSTING
The term costing signifies the “techniques and process of ascertaining costs”. The term “techniques” consists
of a “body of principles and rules” by which the cost is ascertained. It is the classification, recoding and
appropriate allocation of expenditure for the determination of the cost of the product or services.
COST ACCOUNTING
It is the method of accounting for cost. J.M. Fremgiv in his book ‘Accounting for managerial analysis’
states that “Cost accounting is the process of recording, classifying, allocating and reporting various cost
incurred in the operations of an enterprise”.
COST ACCOUNTANCY
ICMA has defined cost accountancy as “The application of costing and cost accounting principles,
methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It
includes the presentation of information derived there from form the purpose of managerial decision making”.
SCOPE OF COST ACCOUNTING
Q: EXPLAIN THE SCOPE OF COST ACCOUNTING. (5 MARKS)
 The term scope here refers to field of activity. Cost accounting is concerned with ascertainment and
control of costs. The information provided to the management is helpful for cost control and cost
reduction through functions of planning, decision making and control.
 In the initial stages of evolution, cost accounting confined itself to cost ascertainment and presentation
of same with the main objective of finding the product cost. With the development of business activity
and introduction of large scale production, the scope of cost accounting was broadened and providing
information for cost control and cost reduction has assumed equal significance along with finding out
cost of production.
 In addition to enlargement of scope, the area of application of cost accounting has also widened.
Initially cost accounting was applied in manufacturing activities only. Now, it is applied in service
organizations, government organizations, local authorities, farms, extractive industries, etc.

OBJECTIVES OF COST ACCOUNTING

Q: EXPLAIN THE OBJECTIVES OF COST ACCOUNTING. (5 MARKS)
The object of cost accounting is to ascertain the true cost of every operation through a close watch – cost
analysis and allocation. The main objectives are as follows:
 Ascertainment of cost: It enables the management to ascertain the cost of production or product, job,
contract or service or unit of production so as to develop cost standard. Costs may be ascertained.
Under different circumstances, using one or more types of costing principle standard costing, marginal
costing, uniform costing etc.
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  Fixation of selling price: Cost data are useful in the determination of selling price or quotations or
tenders. Apart from cost ascertainment, the cost accountant analyses the total cost into fixed cost and
variable cost. This will help the management to fix the selling price sometimes, below the total cost but
above the variable cost. This will increase the volume of sales, more sales than previously thus leading
to maximum profit.
 Cost control: The object is to minimize the cost of manufacturing comparison of actual cost with
standards reveals the discrepancies variances. If the variances are adverse, the management enters into
investigation so as to adopt corrective action immediately.
 Matching revenue with cost: The determination of profitability of each product, process, department,
etc., is the important object of costing.
 Special cost studies and investigations: It undertakes special cost studies and investigations and these
are the basis for the management in decision making or policies. This will also include pricing of new
products, contraction or expansion programmes, closing down or continuing a department, product mix,
price reduction in depression, etc.
 Preparation of financial statement, profit and loss A/c and balance sheet: To prepare these
statements, the value of stock, work-in-progress, finished goods etc., are essential; & in the absence of
costing department, when we have to close the accounts it rather takes too much time. But a good
system of costing facilitates the preparation of statements, as figures are easily available; they can be
prepared monthly or even weekly.

METHODS AND TECHNIQUES OF COSTING

Q: EXPLAIN THE VARIOUS METHODS & TECHNIQUES OF COST ACCOUNTING. (10 MARKS)
Following are the various methods of costing which are applicable to different industries.
 Job costing: ICMA England defines it as “that form of specific order costing, which is applied where
work is undertaken to customers’ specific requirements”. It is applied in such industries which produce
definite articles against individual orders from customers. Each job is separately identified and a job
card is prepared for each job for cost accumulation. This method is applicable to printers, machine tool
manufacturers, general engineering work etc.
 Batch costing: A batch is a cost unit which consists of a group of identical items. Costs are determined
for the entire batch and total cost of batch is divided by number of item it consists. It is used in biscuit
manufacturing, garment making, pharmaceutical industry spare parts manufacture etc.
 Process costing: process costing is designed to show the cost of each process through which raw
materials pass in their conversion to the saleable product. The cost of every unit resulting from a
particular batch processed is deemed to the uniform. This system, of costing is suitable for industries
like chemical manufacture.
 Operating costing: This method is used to ascertain cost of services rendered by concerns like
transports, power supply municipal services, hotels, hospitals, water supply etc. Composite units of cost
such as Kilowatt – hour (electricity), ton – km or passenger – km (transport), patient day (hospital), are
used for ascertaining cost.
 Unit or output costing: This method aims at finding cost/unit of output and is suitable for industries
where production is continuous and units are identical. A cost sheet is prepared for a period by taking
material, labour and other cost and total expenditure is divided by the number of units produced.
 Multiple costing: Multiple costing systems is adopted in business producing a variety of articles each of
which differs from the other as to price, materials used and manufacturing process. The principal
characteristic of multiple costing is that a separate method of costing may be employed in respect of
each article. This type of costing is in force in industries where cycles, ratios, typewriters and other
complex items are produced.
 Contract costing: It is a method of costing applied in such concerns where the job is big and is spread
over long period of time. For each job or contract work, a separate contract account is maintained. This
method is used by builders’ civil engineering contractors etc.
 Operation costing: This also known as single or output or unit costing. The method of costing is
applied in such concerns where the process of production is continuous and the units produced are
identical. This method is applied in industries like, mines, quarries, brick works etc.

The following are the main types of costing applied for cost ascertainment.

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  Historical costing: It is the ascertainment of cost after they have been incurred. It aims at ascertaining
the cost incurred on the work done in the past. Batty defines it as “the ascertaining and recording of
actual cost when, or after, they have been incurred.
 Marginal costing: This techniques bifurcates total cost of a product or operation into two classes, viz.,
(i) fixed cost which do not change but remain constant for any level of production, and (ii) variable cost
which vary proportionately to the change in the volume. This approach is useful in cost-volume-profit
analysis in guiding the management in its task of decision-making.
 Absorption costing: It is also known as total cost approach. It is defined as “the practice of charging
all costs, both variable and fixed, to operations, processes or products”. It is useful in submitting
traders, preparing job estimates.
 Standard costing: A standard costing is a predetermined cost. Standard costing is the ascertainment of
the standard cost and its comparison with the actual cost in order to ascertain variations if any.
 Uniform costing: The use by several undertakings of the same costing principles and or practices” –
ICMA.

ESSENTIAL CHARACTERISTIC OF GOOD COSTING SYSTEM

Q: EXPLAIN THE ESSENTIAL CHARACTERISTICS OF GOOD COSTING SYSTEM. (10 MARKS)
An ideal system of cost accounting must posses some characteristics which will bring all the advantage
to the business. The main features of an ideal costing system are:
 Simplicity: It must be simple, flexible and adaptable to the changing conditions. And it must be
understandable to the personnel. The information provided must be in proper order, at the right time
and to the right persons so as to be utilized fully.
 Flexibility and adaptability: the costing system must be flexible to adjust to the changing conditions
and circumstances. The expansion, contraction or changes must be adopted in the existing system with
minimum charges.
 Economy: The costing system must suit the finance available. The expenditure must be less than the
benefit derived from the system adopted.
 Comparability: the management must be able to compare the facts and figures with past figures,
figures of other concerns or other departments of the same concerns.
 Suitability to the firms: Before accepting a costing system, the nature, requirements, size, conditions of
business, etc., must be carefully considered. The system must be capable to prompt and accurate
reporting to different levels of management according to their requirements.
 Minimum changes in the existing set up: When introducing a costing system, it must cause minimum
disturbance to the existing system of business.
 Uniformity of forms: Forms of different colours can be used to distinguish them. Forms must be
uniform in size and quality. Forms should contain instruction to fill, to use and for disposal.
 Less clerical work: Printed forms will involve less labour to fill in, as the workers may be a little
educated. They may not like to spend much time in filling the forms.
 Efficient material control and wage system: There must be proper procedure for recording the time
spend on different jobs, by worker for payment of wages. A systematic method of wages system will
help in the control of labour cost. Since the cost of material forms a greater proportion to the total cost
there must be an efficient system of stores control.
 Sound plan: There must be proper and sound plan to collect, to allocate, to apportion overhead
expenses on each job or each product in order to find out the cost accurately.
 Reconciliation: The system of costing and financial accounting must be facilitated to reconcile in the
easiest manner.
 Overall efficiency of cost accountant: The work of the cost accountant under a good system of costing
must be clearly defined as his duties and responsibilities to the firm are very essential.

ADVANTAGES OF COST ACCOUNTING

Q: WHAT ARE THE ADVANTAGES OF COST ACCOUNTING? (10 MARKS)
Cost accounting is a very valuable tool of planning and control. It offers a number of advantages to the
management. The following are the important advantages of cost accounting.

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 Helps in decision making: Cost accounting helps in decision making. It provides vital information
necessary for decision making. For instance, cost accounting helps in deciding:
 Whether to make a product or buy a product?
 Whether to accept or reject an export order?
 How to utilize the scarce materials profitably?
 Formulation of future plans:
Cost accounting is not a post-morterm examination. It is a system of foresight. On the basis of past
experience, it helps in the formulation of definite future plans in quantitive terms. Budgets are prepared and
they give direction to the enterprise.
 Helps in fixing prices:
Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the
aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basic
information for the preparation of tenders, estimates and quotations.
 Highlights causes:
The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting.
For instance, it is possible for the management to know whether profits have decreased due to an increase in
labour cost or material cost or both.
 Reward to efficiency:
Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the
organization. These plans and systems reward efficient workers and improve the productivity as well
improve the morale of the work force.
 Avoidance of wastage:
Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage,
inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided.
 Facilitates control:
Cost accounting includes effective tools such as inventory control, budgetary control and variance
analysis. By adopting them the management can notice the deviation from the plans. Remedial action can be
taken quickly.
 Preparation of final accounts:
Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit
and loss account and balance sheet without physical stock verification.
 Improvement in profitability:
Cost accounting reveals unprofitable products and activities. Management can drop those products and
eliminate unprofitable activities. The resources released from unprofitable products can be used to improve
the profitability of the business
 Prevention of fraud:
Cost accounting envisages sound system of inventory control, budgetary control and standard costing.
Scope for manipulation and fraud is minimized.
LIMITATIONS OF COST ACCOUNTING
Q: WHAT ARE THE LIMITATIONS OF COST ACCOUNTING? (5 MARKS)
 It is expensive:
Many people raise objections against cost accounting on the basis that involves a considerable amount
of expenditure in the introduction stage. Double scat of accounts books have to be maintained and it is not
economical for small concerns. In the installation stage, it consumer a good amount of finance.
 It is unnecessary:
It is argued that costing is only recently originated and that many industries have prospered well and are
still prospering with out cost accounting, therefore, the system is unnecessary.
 Matter of routine forms and statement:
Reporting of the costing information to the management to the management involves the use of a
number of forms. As such, filling of forms becomes a stereo type mechanical reporting of cost data and is
monotonous issue. There is unnecessary paper work.
 Failure of costing system:
It is claimed that costing system has failed to bring good or desired results in many cases. Therefore, it
is defective.
 Not applicable to many industries:
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 Modern method of costing cannot be applied to certain types of industries.
 It is not reliable:
It is stated that cost accounting is based one estimates and therefore cannot be relied upon. There is lack of
support and interest from the employees, executives and the top management. Lack of cost consciousness
among the production personnel and shortage of trained staff and non-co-operation and resistance from the
personnel.
Q: WRITE SHORT NOTES ON (A) COST UNITS, (B) COST CENTRE, (C) PROFIT CENTRE,
(D) COST CONTROL, (E) COST REDUCTION AND (F) COST AUDIT. (2 MARKS)
COST UNIT
A cost unit is a unit of product, service or time in relation to which cost may be ascertained. Since
costing is measuring, the unit of measurement must be clearly defined and selected before the process of cost-
finding can be started; equity in cotton spinning mill cost may be calculated in terms of the meter; in colliery
the cost may be calculated in terms of metric tonne of coal etc.
The main purposes of cost accounting is the cost accumulation and the sub-divisions in order to allocate
the same to the selected cost units or cost centre, and this will enable one to know the total cost. The unit
adopted must be practicable i.e., the unit of production should neither be too small nor too large. The unit of
production means, the unit in which the commodity or service in dividend. The cost of a unit should be one
adaptable to the industry, readily understood and accepted by all the persons concerned.
COST CENTRE
“A cost centre is a location, person or item of equipment (or group of these) for which cost may be
ascertained and used for the purpose of cost control”. The cost centre may be a department or a machine or a
plant or a salesman or a particular work, etc. In certain cases the cost unit and cost centre may be the same.
Each cost centre is given charge under personnel for controlling the cost, accumulation of cost and its
allocation.
The sub-division of cost centre is:
 The personal cost centre: If consists a person or group of person; cost like work manger, store-keeper,
sales manager, etc., may be accumulated.
 Impersonal cost centre: It consists of a location or items of equipment.
 Operation cost centre: It consists of machine and / or persons carrying out similar operation e.g., machines
and people engaged in welding, turning, machinery, etc.
 Process cost centre: It consists of a specific persons or a continuous sequence of operations. The cost
accumulated by each of these categories of department is a production or a service which can be considered
as a cost centre.
PROFIT CENTRE
A profit centre is that segment of activity of a business which is responsible for both revenue and
expenses and discloses the profit of a particular segment of activity profit centres and created to delegate
responsibility to individuals and measure their performance. Profit centre is different from cost centre.
Cost control:
Cost control is defined as “the guidance and regulation by executive action, by costs of operating an
undertaking”. Cost control plays its part at the discretion of the management, who wish to maintain the cost
within a specified limit. It aims to improve performance or efficiency to achieve the target. Cost control can be
secured through.
 Setting up standards for expenses and production.
 Finding out differences of actual against standards.
 Analyzing the differences (variances) with reasons.
 Taking up corrective measures to eliminate variations.
Cost reduction:
Cost reduction is concerned with reducing costs. It is concerned with reduction programme which is a
continuous process; it strives to achieve permanent reduction which starts where control ends cost; cost can be
reducing on account to savings in cost.

Cost audit:
“Cost audit is the verification of cost accounts, and a check on the adherence to the cost accounting
plan” – ICMA. The first function is the verification of the accuracy of cost account, statements and reports.
Secondly, it is checking whether the costing principles, procedures and conventions have been adhered to. It

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reveals error, frauds, malpractices committed in cost accountant. The auditor gives suggestions for
improvement.
FUNCTIONS OF COST ACCOUNTING
Q: EXPLAIN THE FUNCTIONS OF COST ACCOUNTING. (5 MARKS)
Cost accounting is of very much help especially to management. The device is designed to effect cost
control and cost reduction. The utility of cost accounting are listed below.
 It helps in optimum utilization of men, material and machines.
 Cost accounting identifies the areas that require corrective action.
 It helps management in the formulation of policies.
 It helps in the formation of cost centre and responsibility centre to exercise control.
 It helps in fixing prices of products and services.
 Costing facilitates use of specialized techniques like cost prediction, value analysis etc.
 Costing focuses attention on the profitability of each product and service unlike financial accounting,
which presents profitability of a company as a whole
 It provides appropriate solution to the various problems of management.
 Costing helps management in making short-term decisions by the use of techniques like managerial
costing, standard costing etc.
 It provides useful data for the preparation of final accounts by giving cost of closing stock of raw
materials, work-in-progress and finished products.
 It provides a data-base for reference to government, wage tribunals, trade unions etc.
 It enables comparison of performance and results between different period and different firms.
Q: WHAT IS INSTALLATION OF COST ACCOUNTING SYSTEM? (2 MARKS)
There is no uniform method of costing applicable to all industries. A method of costing should be
designed for an industry keeping in mind the items produced, the method of manufacture, the cost elements
involved etc., the installation of costing system requires careful consideration of the following factors:
 The introduction of costing should not disturb the existing system as far as possible.
 Introduction of the system of costing should be gradual and smooth.
 The benefits attainable should over weight the expenditure likely to be incurred.
 Over-elaboration of records should be avoided, but essential records should be maintained.
 It should be simple and practicable.
 It should be tailor-made to the requirements of the organization.
 Active co-operation and participation of executives from different departments will promise best
system.
STEPS FOR INSTALLATION OF COSTING
Q. WHAT ARE THE STEPS FOR INSTALLATION OF COSTING? (10 MARKS)
It is difficult to prepare a uniform method of costing applicable to each and every kind of industry. The
basis principles are fairly definite, but practical application varies from industry to industry because of the
nature of industries. The installation of a costing system requires careful consideration of the following.
 Determination of objectives
The first and important step is to clearly lay down the objectives of the costing system. If the
objective is only to ascertain the cost, a simple system will be sufficient. If the objective is to get
information for decision making, planning and control, a name elaborate system of costing is
necessary.
 Study of the nature of business
The nature of the business and other technical aspects like nature of the products, method and
stage of production cycle should be carefully analysed. It is necessary to decide the method of costing
to be adopted.
 Study of the nature of the organization
The costing system should be designed to meet the requirement of the organization.

 Deciding the structure of cost accounts

The cost office with adequate staff must be located as close as possible to the factory cost
accountant must have the necessary authority to discharge his duties effectively.
 Introducing the system
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 Introducing of the system is an existing organization should be done gradually. Before introducing
the feature of the system, its advantages must be explained to the concern employees to secure their
co-operation.
 Determination of accounting system
Determination of unit of cost, classification of operating expenses, coding system of material,
developing the measures of inventory control, cost control, budgetary control, presentation of cost to
managerial level of making decisions are the general problem to be dealt with.
 Elasticity and economy
The system we adopt must be capable of being flexible and adoptive to the charging
circumstances. The system should not be complicated and expensive.
 Regularity
Cost data and costing information must reach the person concern regularity and promptly.
Otherwise significance of the costing system will be lost.
PROBLEMS OF INSTALLING A COSTING SYSTEM
Q: EXPLAIN THE PROBLEMS OF INSTALLING A COSTING SYSTEM.
The management may face additional difficulties in the installation of costing system, and they are:
 Lack of support and interest and interest from the employers, executives and the top management.
 Lack of cost consciousness among the production personnel.
 Shortage of trained staff.
 Non co-operation and resistance from the personnel.
STEPS TO OVERCOME PROBLEMS IN INSTALLING A COSTING SYSTEM
Q: WHAT ARE THE STEPS TO OVERCOME PROBLEMS IN INSTALLING A COSTING
SYSTEM? (5 MARKS)
 Broad of the system is to be explained to all the employees.
 The cost accountant would have to explain the advantages of the system to the management and employees.
 The introduction and filling up of forms and various cost statements have to be made easy.
 Frequent meetings should be convened to remove any doubts and difficulties the employees have.
DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING
Q: DISTINGUISH BETWEEN FINANCIAL AND COST ACCOUNTING. (10 MARKS)
Financial accounting Cost accounting
Objective The main objective of financial The main objective of cost
accounting is to prepare profit and accounting is to provide cost
loss account and balance sheet to information to management for
report to owners and outsiders. decision making.
Legal Financial records are maintained as Cost accounts are maintained to
requirement per the requirement of Companies fulfill the internal requirement of
Act and Income Tax Act the management as per
conventional guidelines.
Classification Financial accounting classifies Cost accounting records and
of transaction records and analysis transactions in analyses expenditure in an
a subjective manner I.e. according objective manner viz., according to
nature of expenses. purpose for which costs are
incurred.
Stock In financial accounts, stocks are In cost accounts stock are valued at
valuation valued at cost or realizable value, cost.
whichever is less.
Analysis of In financial accounts the profit or Cost accounts reveal profit or loss
profit& cost loss of the entire enterprise is of different products, departments
disclosed. separately.
Accounting Financial reports are prepared Cost reports are of continuous
period annually. process and are prepared as per the
requirements. Of managements
may be daily, weekly, monthly,
quarterly or annually.

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 Emphasis Emphasis is laid on the recording of Cost accounting lays emphasis on
transactions and control aspects is ascertainment of cost and cost
not given importance control
Nature Financial accounts are maintained Cost accounts maintained on both
on the basis of historical records. historical and predetermined costs.
DIFFERENCE BETWEEN COST ACCOUNTING AND MANAGEMENT ACCOUNTING
Q: DISTINGUISH BETWEEN COST ACCOUNTING AND MANAGEMENT ACCOUNTING.
Cost accounting Management accounting
It is mainly concerned with ascertainment of It is concerned with all such matters which assists the
cost and profitability management in formulation of policies and
improvement of productivity, profitability etc.
In cost accounting only quantitative It uses both quantitative and qualitative information.
transactions are taken which can be expressed
in figures
It is evolved out of financial accounting It is evolved out of cost accounting
In cost accounting certain principles and No specific rules and procedures are followed in
procedures are followed for recording cost of reporting in management accounting.
different products
Cost accounting uses both past and present It is generally concerned with the projection of figures
figures for future. The policies and plans are prepared for
providing future guidelines.
Q: WRITE SHORT NOTES ON (A) PRIME COST, (B) WORK COST, (C) COST OF PRODUCTION,
(D) TOTAL COST, (D) SELLING PRICE AND (F) WORK-IN-PROGRESS. (2 MARKS)
 Prime cost: Prime cost of any product comprises of all direct costs viz., direct material, direct labour and
direct expenses especially attributable to a job. Price cost is also known as flat cost (or) first cost or direct
cost.
 Work cost: It represents the total of all items of expenses incurred in the manufacturing of an articles, viz.,
direct material, direct labour, direct expenses and factory expenses. In short, it is desired as prime cost plus
work on cost. It is also known as factory cost or cost of manufacture.
 Cost of production: It means and represents the factory cost plus administration expenses; i.e., prime cost
plus works cost plus administration expenses. Is equal to cost of production, It is also known as office cost.
 Total cost: It means the sum of all items of expenditure incurred in producing, manufacturing and selling
and distribution. It comprises of cost of production plus selling and distribution expenses prime cost and
work cost and administration cost plus selling and distribution expenses = total cost (final cost).
 Selling price: It is the price which includes cost of sales plus a margin of profit or minus loss if any.
 Work-in-progress: It means units of production on which work has been done are not yet completely
finished. Work-in-progress is valued on prime cost (or) work cost basis but the latter is preferred.
Q: WRITE SHORT NOTE ON DOWN COST, SUNK COST, OPPORTUNITY AND IMPUTED COST?
Shutdown cost: It refers to the costs which continue to occur even after the shutting down of the plant or the
temporary stoppage of production activities such as salary of watchmen, rent, depreciation etc.
Sunk cost: A cost which was incurred or sunk in the past and is not relevant to the particular decision. Making
is a sunk cost or sunken loss. It may be variable or fixed both. It is only historical cost and as such irrelevant
for decision making.
Opportunity: By opportunity cost we mean the expected return or benefit forgone in rejecting one course of
action for another. When rejecting one course of action, the rejected alternative becomes the opportunity cost
for the alternative accepted.
Imputed cost (Hypothetical cost): This type of cost is neither spent nor recorded in the books of account. For
example, interest on capital rent of freehold premises etc., are of notional costs.

ELEMENTS OF COST
Q: DISCUSS THE VARIOUS ELEMENTS OF COST. (10 MARKS)
ELEMENTS OF COST

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 Material Labour Other Expenses

Direct Indirect Direct Indirect Direct Indirect

Overheads

Factory Administrative Selling Distribution

Overheads Overheads Overheads Overheads
Elements of cost:
 Materials: “The materials cost is the cost of commodities supplied to an undertaking” – ICMA. Materials
cost is sub-divided into:
 Direct material cost or direct materials, and
 Indirect materials cost or indirect materials
 Direct materials: It is the materials that can be directly identified with each unit of the finished product.
Direct material is that material which becomes a part of the product. Raw material, semi-finished materials,
components, etc., which become part and parcel of the product are known as direct materials. E.g. cloth in
garments, leather in shoe-making, spare parts in assembling of radio, Television , cycle, scooter, etc.
 Indirect materials: Materials which do not form part of a product are indirect materials. E.g., consumable
stores, lubricants, cotton waste, chemicals added in production process, store required by service and
maintenance departments. The direct material which is of very small value may also be treated as “indirect
material”. E.g. thread in dress, in wooden box etc.
 Labour: “Labour cost is the cost of remuneration / (wages, salaries, commission, bonus etc.) of employees
of an undertaking” – ICMA.
 Direct labour: The labour services that can be conveniently identified & associated to a particular output or
job is known as direct labour. The cost of such labour services is the direct labour cost. Thus direct labour
cost can be allocated directly to the cost of production.
 Indirect labour: All human effort which is not directly spent in the manufacture of a product or output
comes under this category. Wages paid to persons who facilitate or assist the direct labour in manufacturing
process are known as indirect labour cost. Indirect labour cannot be identified with a job, process or
operation.
 Expenses: “The cost of services provided to an undertaking and the notional cost of the use of owned
assets” – ICMA. Expenses are of two types viz.,
 Direct expenses: Expenses other than direct material or direct labour which are specifically incurred for a
particular product or process are known as direct expenses or chargeable expenses. They can be identified
with and allotted to cost unit or cost centre. According to ICMA. London, direct expenses are defined as
“Costs other than material or labour which can be identified in a specific product or saleable service”.
 Indirect expenses: Expenses which are not directly related to product or service are known as indirect
expenses. These cannot be allocated conveniently and wholly to any product or process but are only
apportioned to or absorbed by cost units or cost centre. Expenses like insurance premium, rent, power,
advertisement etc., are indirect expenses
Overheads:
All expenses other than the direct material cost, direct wages and direct expenses are known as indirect
expenses or overhead. According to wheldon, overhead means “the cost of indirect materials, indirect labour
and such other expenses including services as cannot conveniently be charged direct to specific cost units”.
 Production overhead or work overhead: They refers to all indirect expenses incurred on processes or
operations, which commence from the receipt of work order till its completion, ready for delivery to the
customer or to the finished goods store.

9
 Administrative overhead: It consists of all expenses incurred in formulating the policies, directing the
organization and controlling the operations of an undertaking which are not directly connected to
production, selling and distribution, research and development activities.
 Selling overhead: It is the cost of seeking to create and stimulate demand and of securing order. In other
words, all expenses in securing and retaining customers for the products are selling expenses since they
have been spent in creating and maintaining demand for the product.
 Distribution expenses: These are the expenses concerned with the delivery and dispatch of finished goods
to customers. In other words, it is an expenditure incurred from the time the product is completed until it
reaches its destination.
CLASSIFICATION OF COST
Q: EXPLAIN THE CLASSIFICATION OF COST. (10 MARKS)
Cost classification is the process of grouping the item of cost under different categories based on
common characteristics. In order to that similar transactions get similar treatment, it is essential that cost items
should be divided into different groups with each group containing similar items. The basis of classification of
cost depends on managerial requirement. The following are the major classification of costs:
 Classification according to nature or elements:
Cost are divided into three categories i.e., material, labour and expenses. Material cost means cost of
commodities supplied to an undertaking. Labour cost or wages means the cost of remuneration such as
wages, salaries, bonus, etc., of the employees of the undertaking. Expenses means cost of service provided
to an undertaking and notional cost of the use of variable assets i.e., depreciation etc.
 Classification according to functions: Under this, costs are classified according to the purpose for which
they are incurred. They are production cost, administrative cost, selling cost and distribution cost.
 Classification according to variability: Costs are also classified into fixed, variable and semi-variable cost
on the basis of variability of cost in the volume of production.
 Fixed cost: Fixed cost means the cost tends to be unaffected with the volume of output. Fixed cost
depends upon the passage of time and does not vary directly with the volume of output.
 Variable cost: Variable cost tends to vary directly with the volume of output. It varies almost in direct
proportion to the volume of production.
 Semi-variable cost: Semi-variable costs are those costs which are partly fixed and partly variable.
 Classification according to controllability: Costs are classified as controllable and uncontrollable costs.
“A cost which can be influenced by the action of a specified member of an undertaking” is known as
controllable costs. “A cost which cannot be influenced by the action of a specified member of an
undertaking” is known as uncontrollable cost.
 Classification into direct and indirect costs: On the basis of relationship, costs can be classified into
direct and indirect. Direct costs are those which can be identified with the cost centre or cost unit, and can
conveniently be wholly connected with any cost unit, where as indirect cost cannot be identified with, but
can be apportioned to or absorbed by cost centre or cost unit.
 Classification according to capital & revenue: Capital costs are those costs incurred in the acquisition of
assets either to earn income or increase the earning capacity of the business e.g., cost of plant & machinery.
Revenue costs are those costs incurred to maintain the earning capacity of the firm. In costing only revenue
expenditure is taken into accounts while capital cost is ignored.
 Classification according to normality costs: Normal cost is a cost which is normally incurred at a given
level of output in the conditions in which the level of output is normally attained. Abnormal costs are not
normally incurred at a given level of output in the conditions in which that level of output is normal.
Normal cost is taken as an item cost of production; but it excludes abnormal cost from cost of production.
 Classification according to decision making:
 Opportunity cost: It is defined by the terminology of ICMA, England as “The value of a benefit
sacrificed in favour of an alternative course of action”.
 Shut down cost: This is the cost which continues to occur after shutting down the plant or temporary
stoppage of production.
 Suck cost: It is the cost incurred in the past and has not effect on future decision making.
 Differential cost: Difference in cost between a particular level of activity or a particular course of
activity and another is known as differential cost.
 Imputed (notional) cost: Those cost which appear only in cost accounting are notional costs.
 Replacement cost: It is a cost replacing a material for asset in the current market price.

10
  Conversion cost: It refers to the cost changing direct materials into partly or fully finished products or
from one stage of production to the next. In conversion cost the cost of raw material is left out.
Therefore conversion cost is the sum of direct wages direct expenses and overhead expenses of
converting raw material into finished products.
MEANING OF COST SHEET
Q: WHAT IS A COST SHEET? DEFINE COST SHEET.
A cost sheet is a statement prepared to show the different elements of cost. Preparation of cost sheet is
one of the functions of cost accounting.
DEFINITION OF COST SHEET
A cost sheet may be defined as a “detailed statement of the elements of cost incurred in production,
arranged in a logical order under different heads such as materials, labour and overhead, prepared at short
intervals of time”. In strict sense, cost sheet does not include sale proceeds and profit earned. If they are
included, it is known as a statement of production.
PURPOSE OF PREPARING COST SHEET
Q: WHAT ARE THE PURPOSE OF PREPARING COST SHEET?
 It gives the break up figures of the total cost under different elements.
 It gives the total cost as well as cost per unit
 It facilities comparisons.
 It helps in the preparation of cost estimates (for tenders or quotations).
 It helps in fixing selling price.
 It facilities cost control by disclosing inefficiencies by comparing with the previous year’s figures.
Q: EXPLAIN TENDER (OR) QUOTATION? WHAT ARE THE ITEMS ARE TO BE ANALYZED
WHILE PREPARING TENDER? (5 MARKS)
TENDER OR QUOTATIONS
Frequently a manufacturer of capital goods, consumer durable goods etc., is required to quote the price
at which he can supply a particular articles. The price, at which the supplier offers his goods for sales, is known
as tender or quotation. A tender has to be prepared very carefully and must be competitive as the receipt of
order depends upon the acceptance of price supplied. To prepare a tender the following details are carefully
analyzed:
 Cost of materials, Cost of work overhead, Cost of direct labour and chargeable expenses
 Cost of office overhead, Cost of selling overhead and estimated profit.
Generally, overhead are estimated as percentage, for example.
Factory Overhead
For % of factory overhead to direct wages = X 100
Direct Wages
Office Overhead
For % of office overhead to work cost = X 100
Work cost
Selling Overhead
For % of Selling overhead = X 100
Work cost
Estimated costs are developed on the basis of costs in previous period by giving due regard to likely
charges in the above costs. If any increase or decrease on any cost is anticipated, the same should be added or
deducted.
Estimating of profit for a tender (or) quotation:
Some time profit is given as percentage of cost. In that case profit for the tender is ascertained as given below:
Profit percentage
Profit = Cost of sales X
100
If profit is to be ascertained as a percentage of selling price of the tender, the profit is to be calculated as given
below:
Cost of sales X Rate of profit on sale
Profit =
100 - Rate percentage on sales

11
 SPECIMEN OR PREPARATION OF COST SHEET

Particulars ` `
Opening stock of direct materials XXX
Add: Purchase of direct materials XXX
Expenses, taxes and duties on material purchased XXX
Material purchased XXX
Less: Closing stock of direct material XXX
Direct material scrap sold XXX XXX
Cost of raw material consumed XXX
Add: Direct wages XXX
Direct (or) chargeable expenses XXX
Prime cost XXX
Add: Factory overhead:
Fuel, Power, gas, coal, wastes etc (factory) XXX
Indirect material XXX
Wages of foreman & other indirect wages XXX
Factory rent, taxes, insurances etc. XXX
Lighting, heating (factory) XXX
Drawing office, work office expenses XXX
Depreciation on plant and equipments XXX
Repairs of plant, machinery etc XXX XXX
XXX
Add: Opening work-in-progress XXX
XXX
Less: Closing work-in-progress XXX
Work cost (or) factory cost XXX
Add: Administrative overhead:
Office salary XXX
Office rent, insurance, taxes, lighting XXX
Telephone, postage, printing, stationery XXX
Audit fees, legal expenses etc XXX
Directors remuneration XXX
Depreciation of office building, office equipment, furniture XXX
General managers salary XXX
Gas, water, fuel etc., (office) XXX
Counting houses salaries XXX XXX
Cost of production XXX
Add: Opening stock of finished goods XXX
XXX
Less: Closing stock of finished goods XXX
Cost of production of goods sold XXX
Add: Selling and distribution overhead:
Salesman salaries and commission XXX
Godown rent or warehouse rent XXX
Bad debts or discount etc. XXX
Showroom expenses XXX
Advertising XXX
Delivery expenses XXX
Carriage outwards XXX
Depreciation of delivery van etc. XXX XXX
Cost of sales XXX
Add: Profit / loss XXX
Sales XXX

12
 COST SHEET
PROBLEM NO: 1 (Simple cost sheet)
The following information relates to AG manufacturing company for the 3 months ending 31-3-2012.
Direct materials consumed 36,000 Factory overheads 12,000
Direct labour paid 24,000 Administrative overheads 9,000
Direct expenses 8,000 Selling & distribution overheads 5,000
1,000 units of toy gun are produced during the period and all the units produced are sold at `55 per unit.
Prepare a cost sheet showing (a) Prime cost, (b) Factory cost, (c) Cost of production, (d) Cost of sales and (e)
Profit or loss.

PROBLEM NO: 2
You are required to compile a statement showing cost and profit from the information given, showing clearly:
(a) Material consumed, (b) Prime cost, (c) Work cost, (d) Cost of production, (e) Cost of sales, (f) Profit and (g) Sales.
Material purchased 4,00,000 Opening stock of materials 80,000
Wages 2,00,000 Closing stock of material 1,20,000
Direct expenses 40,000
Factory overhead is absorbed at 20% on wages. Administration overhead is 25% on the works cost. Selling
and distribution overhead are 20% on the cost of production. Profit is 20% on sales.

PROBLEM NO: 3
During the year 2012, X Ltd., produced 50,000 units of a product. The following were the expenses:
Stock of raw materials on 1-1-12 10,000 Direct expenses 25,000
Stock of raw materials on 31-12-12 20,000 Factory expenses 37,500
Purchases 1,60,000 Office expenses 62,500
Direct wages 75,000 Selling expenses 25,000
You are required to prepare a cost sheet showing cost per unit and total cost at each stage.

PROBLEM NO: 4(Cost sheet – With details of overheads)

The following information has been obtained from the cost records of Modern Works Ltd., for three months
ending 31st March, 2012 during which 100 units are produced and all the units are sold @ `3,000 per unit.
Stock of raw materials on 1-1-2012 18,000 Indirect labour 9,000
Stock of raw materials on 31-12-2012 21,000 Direct labour 28,000
Material Purchases 1,62,000 Depreciation on furniture 3,000
Carriage paid on purchase 3,000 Printing & stationery 1,500
Depreciation on plant 6,000 Office salaries and allowances 14,500
Repairs to plant 2,000 Warehouse rent 2,400
Factory rent, taxes and insurance 7,000 Advertising 2,000
Indirect materials 11,000 Salesmen’s salary and commission 2,600
Prepare statement showing the following information: (a) Prime cost, (b) Work cost, (c) Cost of production, (d)
Cost of sales and (e) Profit.

PROBLEM NO: 5
The following details have been obtained from the cost records of Raja sekhar Ltd.,
Stock of raw materials on 1-12-12 75,000 Depreciation of plant and machinery 3,500
Stock of raw materials on 31-12-12 91,500 Expenses on purchases 1,500
Direct wages 52,500 Carriage outwards 2,500
Indirect wages 2,750 Advertising 3,500
Sales 2,11,000 Office rent and taxes 2,500
Work-in-progress 1-12-12 28,000 Traveler’s wages and commission 6,500
Work-in-progress 31-12-12 35,000 Stock of finished goods 1.12.12 54,000
Purchases of raw materials 66,000 Stock of finished goods 31.12.12 31,000
Factory rent, rates and power 15,000
Prepare a cost sheet giving the maximum possible break up of costs and profit.

PROBLEM NO: 6
13
From the following particulars prepare cost sheet:

Particulars `
Direct Materials 8,000
Direct Wages 6,000
Direct Expenses 2,500
Administrative Overheads 5,000
Factory Overheads 40,000

PROBLEM NO: 7
The following cost data are available from the books for the year ended 31.12.1995
Particulars `
Direct Material 9,00,000
Direct Wages 7,50,000
Profit 6,09,000
Selling and Distribution overheads 5,25,000
Administrative overheads 4,20,000
Factory overheads 4,50,000
Prepare a cost sheet indicating the prime cost, works cost, production cost, cost of sales and sales value.

PROBLEM NO: 8
You are required to compile a statement showing cost and profit from the information given, showing clearly:
a) material consumed b) Prime cost c) Works cost d) Cost of production e) Cost of sales f) Profit and g) Sales.
Particulars `
Materials purchased 2,00,000
Wages 1,00,000
Direct expenses 20,000
Opening stock of materials 40,000
Closing stock of materials 60,000
Factory overheads are absorbed at 20% on wages. Administration overhead is 25% on the works cost.
Selling and distribution overhead are 20% on the cost of production. Profit is 20% on sales.

PROBLEM NO: 9
Prepare a cost sheet from the following data:
Particulars ` `
Direct material consumed 50,000
Direct wages paid 40,000
Chargeable expenses 10,000
Indirect materials:
Used in factory 8,000
Used in office 12,000
Used in selling 6,000
Used in distribution 4,000 30,000
Indirect Labour:
In factory 15,000
In office 20,000
In selling 18,000
In distribution 12,000 65,000
Indirect expenses:
Relating to factory 6,000
Relating to office 3,000
Relating to selling 1,000 10,000
You are required to prepare a cost sheet showing cost per unit and total cost at each stage.

PROBLEM NO: 10
14
Draw a statement of cost from the following particulars:
Particulars `
Opening Stock (1) Materials 2,00,000
(2) Work in Progress 60,000
(3) Finished goods 5,000
Closing Stock (1) Materials 1,80,000
(2) Work in Progress 50,000
(3) Finished goods 15,000
Materials purchased 5,00,000
Direct wages 1,50,000
Manufacturing expenses 1,00,000
Sales 8,00,000
Selling and distribution expenses 20,000

Cost sheet – with details of Overheads:

PROBLEM NO: 11
Calculate 1) Prime Cost 2) Factory Cost 3) Cost of Production 4) Cost of Sales and 5) Profit from following
particulars.
Particulars `
Direct materials 1,00,000
Direct Wages 25,000
Direct Expenses 5,000
Wages of foremen 2,500
Electric power 500
Lighting:
Factory 1,500
Office 500
Rent:
Factory 5,000
Office 2,500
Salaries to Salesmen 1,250
Advertising 1,250
Income Tax 10,000
Sales 1,89,500

PROBLEM NO: 12
Form the following particulars you are required to prepare a statement showing:
 The cost of materials consumed
 Prime cost
 Works cost
 Total cost and
 Cost of sales and profit.
Particulars `
st
Stock of finished goods on 31 Dec 1993 73,000
Stock of raw materials on 31st Dec 1993 35,000
Purchases of raw materials 7,60,000
Productive wages 5,20,000
Stock of finished goods on 31st Dec 1994 82,500
Stock of raw materials on 31st Dec 1994 37,500
Sales of finished goods 15,45,800
Works overhead charges 1,30,200
Office and general charges 69,700

PROBLEM NO: 13
15
A company is manufacturing Washing Machines and the following details are furnished:
Particulars ` `
Work in progress at the beginning:
At Prime cost 51,000
Manufacturing expenses 15,000 66,000
Work in progress at the end:
At Prime Cost 45,000
Manufacturing expenses 9,000 54,000
Stock of raw materials 2,25,000
Purchases of raw materials 4,75,000
Expenses on purchases 2,000
Manufacturing expenses 84,000
Direct Labour 1,71,000
Stock of raw materials at the end 2,04,000
Administrative expenses 1,05,000
Selling & distribution expenses 35,000
Sales 9,75,000
On the basis of the above data, prepare a statement of cost and profit.
PROBLEM NO: 14
The accounts of Z Manufacturing Company for the year ended December 2009 show the following:
Particulars ` Particulars `
Factory office salaries 6,500 Travelling expenses 2,100
General office salaries 12,600 Travelling salaries
Carriage outward 4,300 & Commission 7,700
Carriage on purchases 7,500 Productive wages 1,26,000
Bad debts written off 6,500 Depreciation – plant Machinery
Repairs of plant, Machinery and Tools 6,500
and tools 4,100 Depreciation – Furniture 300
Rent, rates, taxes & Insurance Directors fees 6,000
- Factory 8,500 Gas and water – factory 1,200
- Office 2,000 - Office 400
Sales 4,61,100 Managers salary (3/4 Factory
Stock of materials – and ¼ Office) 10,000
31st Dec 2008 62,800 General expenses 3,400
st
31 Dec 2009 48,000 Income tax 2,500
Materials purchased 1,85,000 dividend 2,000

Prepare statement giving the following information:

1) Materials consumed 2) Prime Cost 3) Factory Cost 4) Cost of Production 5) Total Cost 6) Net profit.

PROBLEM NO: 15
The following details have been obtained from the cost records of Raja Sekhar ltd:
Particulars `
st
Stock of raw materials on 1 Dec 1994 75,000
Stock of raw materials on 31st Dec 1994 91,500
Direct wages 52,500
Indirect wages 2,750
Sales 2,11,000
Work in progress 1st Dec 1994 28,000
Work in progress 31st Dec 1994 35,000
Purchases of raw materials 66,000
Factory rent rates and power 15,000
Depreciation of plant and machinery 3,500
Expenses on purchases 1,500
Carriage outwards 2,500

16
 Advertising 3,500
Office rent and taxes 2,500
Traveller’s wages and commission 6,500
Stock of finished goods (1st Dec 1994) 54,000
Stock of finished goods (31st Dec 1994) 31,000
Prepare a cost sheet giving the maximum possible break up of costs and profit.

PROBLEM NO: 16
Mr Gopal furnishes the following data relating to the manufacture of standard product during the month of
April.

Raw materials consumed `15,000

Direct Labour charges ` 9,000
Machine hours worked 900
Machine hour rate ` 5
Administrative overheads 20% on works
cost
Selling overheads ` 0.50 per unit.
Units produced 17,100
Units sold 16,000 at ` 4 per unit
You are required to prepare a cost sheet from the above showing:
 The cost per unit
 Profit per unit sold and profit for the period.
Classify the above expenses under the various elements of cost showing separately the total expenditure under
each element.

PROBLEM NO: 17
The following information was obtained from the costing records of a manufacturing concern for the month of
March 2004:
1.3.2004 31.3.2004
Particulars `
(`) (`)
Raw materials 1,00,000 1,23,500
Finished goods 71,500 42,000
Work in progress 31,000 34,500
Other Expenses:
Purchase of Raw material 88,000
Direct Wages 70,000
Indirect Factory Wages 2,500
Work Expenses 37,000
Administration Expenses 13,000
Sale of Scrap 2,000
Selling and Distribution Expenses 15,000
Sales 2,84,000
Prepare a Cost Sheet.

PROBLEM NO: 18
Prepare production statement giving the maximum break-up of cost and profit.
Particulars 1-4-12 30-4-12 Particulars 30-4-12
Stock of raw materials 26,000 15,000 Expenses: Direct 18,500
Work-in-progress 15,000 10,000 Indirect 16,200
Finished goods 40,000 51,000 Depreciation: Plant & Machinery 14,000
Purchase of raw materials 1,74,000 Office Building 12,000
Wages: Direct 73,000 Delivery van 7,500
Indirect 17,000 Income tax 4,500
Rent & Rates: Factory 24,800 Dividend 6,000

17
 Office 18,750 Debenture interest 5,400
Warehouse 10,500 Sales 5,80,000
Salaries: Factory 55,500
Office 50,250
Salesmen 47,750

PROBLEM NO: 19
The cost of sale of Product A is made up as follows:
Material used in manufacturing 5,500 Indirect expense (factory) 100
Material used in packing material 1,000 Expenses (office) 125
Material used in selling the product 150 Depreciation – office building 75
Material used in the factory 75 Depreciation – factory 175
Material used in the office 125 Selling expenses 350
Labour required in producing 1,000 Freight 500
Labour required for supervision – factory 200 Advertising 125
Direct expenses (factory) 500
Assuming that all the products manufactured are sold, what should be the selling price to obtain a profit of 25%
on selling price?

PROBLEM NO: 20
The following particulars have been extracted from the books of manufacturing Co., Ltd., Kolkatta year ended
31st March 2012.
Stock of raw materials on 31-3-11 47,000 Rent, rates and taxes (office) 1,000
Stock of raw materials on 31-3-12 50,000 Traveling expenses 3,100
Material Purchases 2,08,000 Traveler’s salaries and commission 8,400
Drawing office salaries 9,600 Production wages 1,40,000
Counting house salaries 14,000 Depreciation on machine, plant & tools 7,100
Carriage inwards 8,200 Depreciation on furniture 600
Carriage outwards 5,100 Directors’ fees 6,000
Cash discounts allowed 3,400 Gas and water charges (factory) 1,500
Bad debts written off 4,700 Gas and water charges (office) 300
Repairs of plant, machinery and tools 10,600 General charges 5,000
Rent, rates and taxes (factory) 3,000 Manager’s salary 12,000
Out of 48 working hours in a week, the time devoted by the manager to the factory and office was on an
average 40 hours and 8 hours, respectively, throughout the accounting year. Prepare a statement giving the
following information.
 Prime cost
 Factory overhead and the percentage on production wages
 Factory cost
 General overheads and percentage on factory cost and total cost.

TENDER (OR) QUOTATION

PROBLEM NO: 21
Material used `62,600; Direct Labour charges `55,400; Work overhead `72,000; Establishment expenses
`24,000; Selling expenses `9,000. Calculate: (a) Total cost, (b) Percentage of works cost to price cost, (c)
Percentage of administration overheads on works cost, (d) Percentage of selling overheads on work cost.

PROBLEM NO: 22
The accounts of a machine manufacturing company disclose the following information for six months ending
31st December 1978.
Particulars `
Materials used 1,50,000
Direct wages 1,20,000
Factory overheads 30,000
Administrative expenses 15,000

18
Prepare cost sheet for the half year and calculate the price which the company should quote for the manufacture
of a machine requiring materials valued at ` 1,250 and expenditure in productive wages ` 750, so that the price
might yield a profit of 20% on the selling price.

PROBLEM NO: 23
The accounts of ABC Co., Ltd., show the following
Material used 7,00,000 Works overheads expenses 1,62,000
Direct wages 5,40,000 General expenses 1,12,160
Prepare a statement showing the following: (a) Works cost, (b) Total costs, (c) Percentage of works overhead to
direct wages and (d) Percentage of general overheads to works cost. What price should the company quote to
manufacture a machine which will require an expenditure of `1,000 on materials and `800 as wages, so that it
will yield a profit of 20% on the sale price?

PROBLEM NO: 24
The accounts of a machine manufacturing company disclose the following information for six months ending
31st December 1993.
Particulars `
Materials used 1,50,000
Direct wages 1,20,000
Factory overheads 24,000
Administrative expenses 17,640
Prepare a cost sheet of the machine and calculate the price which the company should quote for the manufacture
of a machine requiring materials valued at ` 1,250 and expenditure in productive wages ` 750, so that the price
may yield a profit of 20% on the selling price.

PROBLEM NO: 25
The following particulars relate to the manufacture or electric fans for a period of 3 months ending 31.3.2001.
Particulars `
Completed stock on 1.1.2001 NIL
Completed stock on 31.3.2001 30,000
Stock of raw materials 1.1.2001 5,000
Stock of raw materials 31.3.2001 3,500
Direct wages 74,000
Factory overhead 8,000
Administration overhead 4,000
Purchases of raw materials 32,500
Sales 1,12,500
The number of fans manufactured during the month was 2,000. Prepare a statement showing the cost per fan
and the price to be quoted for 750 fans to realize the same percentage of profit as was realized during the 3
months referred to above assuming the same condition.

PROBLEM NO: 26
The following figures relate to the costing to time sheets manufactured for a period of three months for
industrial use.
Stock of materials – 1st Jan. 5,500 Sales 1,41,500
Stock of materials – 31st March 3,500 Indirect expenses 13,000
st
Factory wages 83,000 Completed stock 1 Jan. Nil
Materials purchased 61,500 Completed stock 31st March 29,000
The number of sheets manufactured during three months is 2,200. Find the price to be quoted for 648 sheets in
order to realize the same percentage of profit as for the period under review assuming no alterations in the rates
of wages and cost of materials. Prepare a statement of cost for the manufacture of 2,200 sheets and quotations
for 648 sheets.

19
PROBLEM NO: 27
A company has received an enquiry for the supply of 5,000 steel pipes. The costs are estimated as follows:
Raw materials 1,00,000 kgs at `1.00 per kg
Direct wages 10,000 hours at `4.00 per hour
Variable overheads: Factory `2.40 per Labour hour
Selling and distribution `16,000
Fixed overheads: Factory `6,000
Selling and distribution `14,000
Prepare a statement showing the price to be quoted which will result in a profit of 20% on selling price.

PROBLEM NO: 28
BPL Television Company find that in 2001, the cost of manufacture 200 T.V. sets was `6, 16,000 which it sold
at `4,000 each. Cost was made up of:
Materials 2,00,000 Factory expenses 60,000
Director wages 3,00,000 Office expenses 56,000
For 2012, it estimates that
 Each Television will require materials of the value of `1,000 and wages `1,500
 Absorb factory expenses on the basis of direct wages. Absorb office expenses on the basis of works cost.
Prepare a statement showing the profit it should make per unit if it enhances the price of television by `80.

PROBLEM NO: 29
From the following data prepare a cost and production statement of Zenith stove manufacturing Co., for the
year 2012.
Stock of materials on 1-1-12 35,000 Establishment expenses 10,000
Stock of materials on 31-12-12 4,900 Completed stock on hand 1-1-12 Nil
Purchase of materials 52,500 Completed stock on hand 31-12-12 35,000
Factory wages 95,000 Sales 1,89,000
Factory expenses 17,500
The number of stoves manufactured during the year was 4,000. The company wants to quote for a contract for
the supply of 1,000 electric stoves during the year 2013. The stoves to be quoted are of uniform quality and
make, and are similar to those manufactured in the previous year; but the cost of material has increased by 15%
and cost of factory labour by 10%. Prepare a statement showing the price to be charged or quoted to give the
same percentage of net profit on turnover as was realized during the year 2012 assuming that the cost per unit
of overhead charge will be the same as in the previous year.

PROBLEM NO: 30
In respect of a factory the following figures have been obtained for the year 2012. Cost of materials `6,00,000;
Direct wages `5,00,000; Factory Overheads `3,00,000; Administrative overhead `3,36,000; Selling overhead
`2,24,000; Distribution overheads `1,40,000 and profit `4,20,000.
A work order has been executed in 2013 and the following expenses have been incurred.
Materials `8,000; Wages `5,000. Assume that in 2013, the rate of factory overheads has increased by 20%,
administrative and selling overheads have gone up by 12.5% and distribution expenses have gone down by
10%.
At what price should the product be sold so as to earn the same rate of profit on selling price as in 2012?
Factory overhead is based on direct wages, while all other overheads are based on works cost.

UNIT II
MATERIAL MANAGEMENT / MATERIAL OR STOCK CONTROL
INTRODUCTION
The basic objective of cost accounting is cost control. This objective is attained by an effective control
on each element of cost. Out of the three elements- material, labour and expense – the material element is the
biggest or the highest proportion of the total cost or production. It is also defined as “providing the right
quantity of material of the right quality at the right time and place at the minimum cost”. The quality of
finished goods is also governed by the quality of raw materials, which are used in the production. Hence
material control is an important function of the management.
20
Q: EXPLAIN THE MEANING & DEFINITION OF MATERIAL OR STOCK CONTROL.
(2/5MARKS)
MEANING
The material means and include raw material, spare parts, components, factory supplies, packing
material etc., the term material control means the regulation of an organization relating to procurement, storage,
and usage of material in such a way as to maintain an even flow of production without excessive investment in
material stock.
DEFINITION
Material control can be defined as “a systematic control over purchasing, storing and consumption of
material, so as to maintain a regular and timely supply of material, at the same time avoiding over-stocking”.
There are mainly three stages where material control is exercised viz., at the time of purchase of material,
storage of material, and issue of materials to different jobs.

OBJECTIVES
Q: WHAT ARE THE OBJECTIVES OF MATERIAL CONTROL? (2/5MARKS)
As a major portion of cost of production consists of material cost, the cost accounting system can be
effective only when there is an efficient material control. The following are the objectives of material control.
 Ensuring supply of adequate quantity of materials: sufficient quantity of material should be made
available for all the activities and departments in the organization so that uninterrupted production can
be carried on and work does not stop due to non availability of material.
 Optimum investment in materials: keeping the amount invested in materials under control is a central
objective of material control. Locking up of funds in stocks results in mismanagement of working
capital. Overstocking should be avoided in view of its disadvantages. Excessive investment and over
stocking can be avoided by fixing maximum stock level for all major items of materials.
 Favourable terms of purchase: the purchase price and other terms of purchase should be maximum
advantage to the firm. At the same time, quality and specifications of the materials should be as per
requirements.
 Control of wastage: watage of materials during storage and handling on the production floor should be
fixed for wastage and efforts can be made to keep the actual wastage below the standard level.pilferage,
theft etc., should be minimized to keep material cost within control.
 Proper reporting to management: management has to be informed frequently about stock of raw
materials so that production is planned. This is possible only if there is proper reporting system and
updating of record by the store keeper.
 Prevention of misappropriation of materials: proper internal check of receipts issues and
consumption of raw materials helps in prevention of misappropriation of materials by the employees.
 Proper control system for settlement of invoices: suppliers invoice is to be paid only after verifying
the physical receipt of materials to avoid excess payment to the suppliers.

FEATURES
Q: WHAT ARE THE SALIENT FEATURES OF MATERIAL COST CONTROL? (OR) WHAT ARE
THE ESSENTIALS OF GOOD SYSTEM OF MATERIAL CONTROL? (5 MARKS)
To achieve maximum managerial control on materials:
 There should be co-operation & co-ordination among the department dealing with material – purchasing,
receiving, testing, storage, and production planning of material.
 Purchasing material should be centralized under expert, personnel, who have been trained.
 All items in the store should be codified, classified and standardized.
 Proper forms should be used for dealing of store items, issues, transfer, return of material etc.,
 Material storage should be carefully planned to avoid losses from theft, deterioration, damage, evaporation,
pilferage etc.,
 Store control measures, like ABC analysis and stock verification, should be introduced.
 Stock at different level should be fixed to ensure that there is no shortage and overstocking of material.
21
 Purchasing quantity should be fixed to reduce the orderly costs and carrying costs.
 Material & supplies should be properly stored.
 Requisitions & stock must be priced on a suitable basis in order to ensure reliable costs.
 Receiving and inspection procedure must be chalked out.
 Regular reports on material purchased, issued, obsolete, spoiled defective etc., are be submitted to the
management.
ADVANTAGES
Q: EXPLAIN THE ADVANTAGES OF MATERIAL CONTROL. (5 MARKS)
An effective material control system
 Ensures availability of material for production.
 Reduces wastage of raw materials.
 Achieves economy of buying and storage cost.
 Reduces pilferage, theft, obsolescence and other material losses.
 Avoids excessive investment in stocks.
 Helps in maintaining perpetual inventory system to furnish information to management regarding materials.
 Helps in ascertaining value of jobs, processes and others.

TECHNIQUES
Q: WHAT ARE THE TECHNIQUES OF INVENTORY CONTROL? (5 MARKS)
Various techniques commonly used for inventory control are listed below:
 ABC techniques.
 Minimum, maximum and re-order levels
 Economic Order Quantity
 Proper purchase procedure
 Proper storage of material
 Inventory turnover ratio to overview slow and non-moving material
 Perpetual inventory system
 Fixation of material cost standards
 Preparation of material budgets.

PURCHASE CONTROL / PURCHASING DEPARTMENT

Q: WHAT IS PURCHASE CONTROL? WRITE SHORT NOTES ON PURCHASE DEPARTMENT.
DESCRIBE THE PROCEDURE OF PURCHASING MATERIAL FROM OUTSIDE. WHAT IS BILL
OF MATERIALS? (10 MARKS)
Purchase control:
An effective material control requires a good amount of attention to the purchasing procedure of
material as to its cost. Quality, volume, timely delivers etc. Low cost material will reflect in the finished
product causing more wastage, resulting in high cost and sub-standard articles. Lack of proper purchase
interrupts the production. Purchase control is one of the aspects of material control; it generally starts with
initiation of purchase requisition and ends with receipt of material by the stores and payment of the bill.
Generally, the following procedures are adopted, in most of the concerns.

Purchase department:
In small concerns, all the purchases of raw materials are done by the owner himself. But in large firms,
job of purchasing is entrusted to an efficient purchasing department headed by a purchase manager or chief
buyer.
Centralized Vs. Decentralized purchasing:
Whether purchasing should be centralized or decentralized is a matter of policy after consideration of a
number of factors. Centralized purchase means that all the purchases are made by the specialized department.
Decentralized purchase means that the purchases are made by the individual departments. The centralized
purchasing system has many advantages and is preferred.

PURCHASE PROCEDURE / BILL OF MATERIALS

Purchase procedure:
22
 Bill of material (specification of materials):
It is a complete schedule of material & components needed for a particular work order. The buying
department is informed through the bill of material as to the quality, quantity and other specifications of the
material required for a particular work. The advantages are:
 The purchasing department is able to collect quotations, select suppliers & make quick purchase when
the indent is received.
 If stock is exhausted, initiate purchase requisition.
 Cost of a job can be fixed in advance.
 The bill is prepared in five copies, one for each of the following: (a) Purchasing department, (b) Stores,
(c) Production section, (d) Cost office, and (e) Office copy which is retained for reference.
 Purchase requisition (indent for material):
A purchase requisition is a formal request, initiated by the store-keeper for the materials required to
replenish the stock of items. Sometimes, the purchase requisition is also initiated by other department.
Generally printed forms are sued for this purpose. It is a basis on which the purchasing department is to
make the purchase.
 Selection of supplier:
After the receipt of purchase requisition, the source of material supply is to be selected. Generally, the
purchasing department keeps a list of suppliers for all needed items. The quotation will be called for, by
keeping in view the benefits to the concern-lowest price better quality, quick delivery, reliable supplies
according the specifications etc. After receiving the quotations, they are opened at the time prescribed and a
comparative statement is prepared.
 Goods received note & inspection of materials:
When the ordered goods arrive at the factory door, the clerk concerned verifies the goods with the help
of the delivery. Note and the copy of the purchase order. In big concerns, an inspector is there who
inspects all the materials and makes out a material inspection report.
 Passing the bill:
Having checked all the items, the bills is passed and sent to the accounts section, which makes the
payment by accepting a stamped receipt.

VARIOUS STOCK LEVELS

Q: EXPLAIN THE TERMS ‘MINIMUM LEVEL’, ‘MAXIMUM LEVEL’ AND ‘ORDERING LEVEL’
WITH REGARD TO MAINTENANCE OF STOCK. (10 MARKS)
One of the objectives of material control is to maintain the stock of raw material as low as possible and
to ensure the availability of material as and when required. Over stocking and under stocking lead to
unnecessary blocking up of working capital and under stocking may interrupt production. The object of fixing
stock levels for each items of material is to maintain required quantity of material in the store and there by the
expenses may be reduced.
The different stock levels:
 Maximum stock level:
It is the stock level above which stock should not be allowed to rise. This is the maximum quantity of
stock of raw material which can be had is the stock. If it goes above, it will be overstocking and it will lead
to the following disadvantages.

Demerits of over stocking:

 Capital is blocked.
 More space is needed
 Deterioration of stock is possible.
 There will be loss due to obsolescence.
 There is the danger of depreciation in value.

The maximum level is fixed by taking into account the following factors:
 Availability of capital.
 Space available in stores
 Rate of consumption
 Re-order level
 Delivery time to obtain fresh stock
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  Change in price
 Cost of maintaining the stock
 Possibility of change in fashion
 Seasonal nature of supply.
 Restriction imposed by goods
 Economic order quantity.
Formula:
Maximum stock level = Re-order level + Re-ordering quantity – (Minimum consumption X Minimum re-
order period)

 Minimum stock level:

It represents the minimum quantity of an item of material to be kept in the store at any time. Material
should not be allowed to fall below this level. If the stock goes below this level, production may be held up
for want of material. This stock is also known as safety stock level or buffer stock. In determining the
minimum level the following factors are to be considered.
 Lead time i.e., time required for getting fresh delivery of material.
 Date of consumption of material during the lead time.
 Availability of substitute and re-order level.
Formula:
Minimum stock level = Re-order level – (Normal consumption X Normal re-order period)
 Re-order level:
It is the point at which the storekeeper should initiate purchase requisition for fresh supply. This level
lies between the maximum level and minimum level. The re-ordering point is fixed slightly higher than the
minimum stocks in such a way that the difference between minimum level & re-ordering level is sufficient
to meet the demand for production up to the time of fresh supply. The level depends upon the lead time,
state of consumption and economic order quantity.
Formula:
Re-order level (or) Ordering level = Minimum level + Consumption during the time required to get
fresh supply (or)
Re-order level (or) Ordering level = Maximum consumption X Maximum re-order period.
 Danger level:
This level is below the minimum quantity. It is level at which normal issues of the material are stopped,
but issued under special instructions. When the material reach below the minimum level i.e., danger level,
the storekeeper must make special arrangements to get fresh issues so that production may not be held up
for want of material.
 Average stock level:
This stock level shows the average quantity of material kept in the store. This is regarded as the average
of maximum and minimum stock levels.
Formula:
Maximum level + Minimum level
Average stock level =
2
If maximum level is not available:
Average stock level = Minimum level + ½ Re-order quantity.
ECONOMIC ORDER QUANTITY
Q: WHAT DO YOU UNDERSTAND BY ECONOMIC ORDER QUANTITY? (5 MARKS)
Economic order quantity refers to the quantity of material to be purchased at one time to optimize the
cost thereon. At this point of quantity the total of carrying costs and ordering costs will be the lowest. It is
known by different names like ‘Optimum quantity’, (or) ‘Ideal quantity’ of purchase etc.
Ordering costs are the expenses incurred for the placement of purchasing order and other related
expenses. More quantities of material ordered at one time reduces the ordering costs and if the quantity
ordering is less, more frequent purchases are to be made and the ordering cost will increase.
Carrying cost are the expenses incurred for preserving the purchased material. It includes, interest on
money invested in material, storage cost like insurance, lighting, rent, salaries of the staff employed in store
etc., higher quantities of material purchased increase the carrying cost and vice versa.

24
 Both ordering cost & carrying cost move in opposite direction. At a particular quantity of material
purchased the total of both carrying cost & ordering cost will be the lowest, and this level of quantity is called
EOQ.
Determination of EOQ:
Formula:

Economic Order Quantity (EOQ )=

√ 2AB
CS
A= Annual usage; B = Buying cost/order; C = Cost/unit; S = Storage & carrying cost / unit.

BIN CARD AND STORES LEDGER - MEANING

Q: WHAT IS BIN CARD, DOUBLE BIN SYSTEM & STORES LEDGER? DISTINGUISH BETWEEN
BIN CARD & STORES LEDGER? WHAT ARE THE ADVANTAGES OF BIN CARD? SPECIMEN
OF BIN CARD & STORES LEDGER (2/5 MARKS)
Bin is a place where materials are kept in. It may be a rack, container, shelf or space where stores are
kept. Bin card is a document showing the particulars of material kept in the bin. It is a document attached to
the bin disclosing the quantitative details of material received, issued and the closing balance. A bin card is
used for each item of material each receipt and issue is recorded on the bin card in a chronological order & the
latest balance is shown after each receipt & issue.
Bin card is maintained by the store keeper. It indicates information like different stock levels. No,
name of materials, material code number, stores ledger folio no, quantity of material received issued and the
balance in hand.
SPECIMEN OF BIN CARD
Material: Maximum level:
Code No.: Minimum Level:
Bin No.: Re-order level:
Stores ledger folio No.: Re-ordering Quantity:
Receipts Issues
Balance
Date M.R. note Remarks
G.R. note no. Quantity Quantity quantity
no.

Advantages of bin card:

 It enables the store-keeper to plan the receipts and issues of material & keep the stocks within the minimum
& maximum levels.
 It provides up-to-date record of material received, issued & balance in stock. This helps in the successful
operation of a perpetual inventory system.
 By seeing the bin card, the storekeeper can send the material requisition of the purchase of material in time.
Double bin system:
The bin will be divided into two parts, one part usually the smaller part contain the minimum level of
stock from which issues are made. The other part of the bin contains the remaining quantity of material. Issues
will be made from this portion only when the minimum quantity in the small part is finished.

Stores ledger:
A stores ledger is a record of stock both in quantity and value. It consists of the same column as a bin
card; but in addition, there is the amount column in which the values are entered. The ledger shows the balance
in hand at any time.
SPECIMEN OF STORES LEDGER
Material: Maximum level:
Code No.: Minimum Level:
Bin No.: Re-order level:
Stores ledger folio No.: Re-ordering Quantity:
Date Receipt Issue Balance
G.R.N. Quantity Rate Amount M.R. Quantity Rate Amount Quantity Rate Amount
25
 No. No.

DIFFERENCE BETWEEN BIN CARD & STORES LEDGER

Bin card Stores ledger

It is a record of quantity only It is a record of both quantity and value
It is maintained by the storekeeper It is maintained by the cost clerk.
It is attached to the bin It is kept in the cost office
Entries are made by the storekeeper Entries are made by the cost clerk.
Entries are made on the basis of actual quantity Entries are made on the basis of documents like goods
received & issued received note, material requisition note etc.,
Posting are made before the transactions Posting are made after the transactions.
Individual transaction are recorded Transactions are periodically recorded.
Inter departmental transfer are not shown Inter departmental transaction are recorded for costing
purpose.
Facilitates physical verification of closing stock Facilitates valuation of closing stock.

PERPETUAL INVENTORY SYSTEM - MEANING

Q: WHAT IS PERPETUAL INVENTORY SYSTEM? WHAT ARE ITS MERITS? / EXPLAIN ITS
OPERATION. (5 MARKS)
The perpetual inventory system is also known as automatic inventory system. The ICMA defines the
perpetual inventory system as, “A system of records maintained by the controlling departmental which reflects
the physical movement of stocks and their current balance”. According to Weldon, “Perpetual inventory
system is a method of recording stores balances after every receipt and issue, to facilitate regular checking and
to obviate closing down for stock taking”.

Merits of perpetual inventory system:

 It is not necessary to stop production to carry out stock taking.
 The long and costly stock-taking (periodic) is avoided.
 Discrepancies are detected easily and quickly.
 Bin cards & stock ledger give ready figures.
 It facilitates the preparation of final account, even at short notice
 Stock levels can be revised from time to time in order to avoid under or overstocking.
 A detailed and reliable check on the stores is facilitated.
 Since it is a regular work, experts can be appointed.
 Deterioration, obsolescence etc., can be avoided.
 The balance of stock is always correct, because checking is done on random basis, selecting certain items;
but the storekeeper does not known which items will be checked, therefore he keeps all the stock always
correct.

OPERATIONS
 The entries for receipt or issue of the material are made in the bin card and store ledger account and the
balance is ascertained.
 Store received but not inspected are not mixed up with regular stocks.
 Stock taking is done continuously. The stores records are compared & entered in stock verification report
for suitable treatment.

PERIODICAL AND CONTINUOUS STOCK TAKING- MEANING

Q: WHAT IS PERIODICAL AND CONTINUOUS STOCK TAKING? / WHAT ARE THE MAIN
FEATURES OF CONTINUOUS STOCK TAKING? (2/5 MARKS)
Periodical inventory system:
26
 Under this system, stock taking is undertaken at the end of the accounting year. As the stock taking
involves verifying the physical quantities of stores in hand, some firm temporarily suspend plant operations
when this is done. This is because it is rarely feasible to take stocks while production continues. Thus, the
annual stock taking should be organized well in advance to minimize production hold ups.
Continuous stock taking:
In any perpetual inventory system, the book balance as shown by bin cards and store ledger should
agree with actual physical balance is store. This is best done by continuous stock taking, which is an integral
part of the perpetual inventory system. The primary objectives of continuous stock taking are to confirm that
the perpetual inventory system is functioning properly and that to bring records into line with the physical
stocks.

FEATURES
 A few items are physically counted daily or at frequent intervals
 All items are checked within a definite period such as, one month or two months, so that each item is
checked a specific number of times in each year.
 The checking is carried out by special staff, having no other responsibility for physical stocks or stocks
records.
 All differences are recorded in appropriate reports.

DISTINCTION BETWEEN CONTINUOUS STOCK TAKING AND PERIODICAL STOCK TAKING

Q: DISTINGUISH BETWEEN CONTINUOUS STOCK-TAKING & PERIODICAL STOCK-TAKING.
(5 MARKS)

Continuous stock taking Periodical stock taking

Permanent personnel are required Persons from other departments or temporary
committee can be appointed.
Held throughout the year Generally held once in a year
Normal and routine work will not be affected All work will be paralyzed
Discrepancies can be rectified without delay There is delay in taking actions
All items are not checked. Items are selected at All items are checked
random and selection of items is kept secret
It is a costly affair It is a cheaper method

Q: WRITE SHORT NOTES ON: (A) JUST-IN TIME INVENTORY (JIT), (B) VED ANALYSIS, (C)
AUTOMATIC ORDER SYSTEM, (D) ORDERING CYCLE METHOD, (E) MINI-MAX METHOD, (F)
INVENTORY TURNOVER RATIO AND (G) INPUT-OUTPUT ANALYSIS. (2/5 MARKS)
Just-in time inventory (JIT):
Business concerns are giving maximum attention to reducing stock levels by establishing cardial
relationship with supplies to arrange for frequent delivery of quantities. This is called JIT purchasing. The
objective of JIT purchasing is to obtain delivery of material immediately before their use. This is possible with
the co-operation of the supplier.
VED analysis:
It is device intended for control of spare parts. On the basis of the relative importance, spare parts may
be classified into three category viz., V for vital, E for essential & D for desirable. ‘Vital’ spare parts are those
whose non availability may lead to stoppage of production. Therefore every effort should be taken to ensure
the availability of these spare parts at any time. Production may not be interrupted due to the non-availability
of ‘Essential’ spares for one hour or one day, beyond which production will be stopped and thus these items are
very essential. ‘Desirable’ spare parts are those spares which are needed but their absence for a week or so
many not lead to stoppage of production.
Automatic order system:
This method of inventory control is done with the help of computers. Orders for fresh purchases are
automatically placed when the inventory reaches ‘Order Point Quantity’ (OPQ). For each type of material
records are maintained by data processing in the form of receipts and issues. When the records show order
point the staff concerned place order for necessary quantity. This system ensures the materials are always
promptly replaced.

27
Ordering cycle method:
In this method, the review of material held in stock is done in regular cycle. The length of cycle
depends on the nature of material. Materials which are expensive and essential have a shorter review cycle and
non-vital materials have longer review cycle. At the time of review order is placed to bring the inventory to the
desired level.
Min-max method:
The demand & supply method is an improvisation of min-max method. In the min-max method each
item of material is fixed with its maximum & minimum levels. When the quantity reaches minimum level, an
order is placed for such a quantity as would make the inventory reach in maximum level.
Inventory turnover ratio:
Inventory turnover is also called as material turnover it is a ratio of the value of material consumed
during a period to the average value of inventory during the period. A high ratio is an indicator of fast moving
stock, and a low ratio indicates locking up of working capital in undesirable items.
Formula:
Value of material consumed
Stock turnover ratio =
Average value of material kept during the period

Value of material consumed may be determined as:

Opening stock of material + material purchased during the period – closing stock of material
Opening stock + Closing stock
Average stock =
2
Stock turnover ratio may be determined in days also by using the formula:
Days during the period
Turnover in days =
Inventory turnover ratio
Input-output analysis:
Input output ratio is the ratio of the quantity of material to production and standard material content of
the actual output. This is possible in industries where the production and raw material are being expressed in
same quantitative measurement such as kilogram, metric tones.

The ratio is obtained as given below:

Standard cost of actual quantity
Input-output ratio =
Standard cost of standard quantity

PRICING OF MATERIAL ISSUES

Q: WHAT IS THE VARIOUS METHODS OF PRICING OF MATERIAL ISSUE? (10 MARKS)
When materials are issued for any production work or any job, they have to be valued in the costing
department. If materials are purchased for any particular job, the total cost of the material can be charged to
that job. But generally raw materials are purchased in anticipation and issued whenever they are needed for
production, assuming that the rate of raw material is the same. But this is not the case always. Price of
everything change on the prevailing condition of the market.

FIFO, LIFO, SIMPLE AVERAGE AND WEIGHTED AVERAGE METHOD

 Actual price method:
 First in first out method (FIFO):
Under this system, materials are issued in the order in which they are received in the store. The material
received first will be issued first. “First come first served”. In other words old stocks are issued first and new
stock will be issued afterwards. As a result of this system, when we value the closing stock of material that will
be at the latest price.
Advantages:
 The method is simple & easy to operate
 Closing value of material will reflect to current market price.
28
  This system is good for slow moving materials.
 When prices are falling, this method gives better result.
 “First come, first served” is a logical system.
 Deterioration and obsolescence can be avoided.
Disadvantages:
 When price fluctuate, calculation becomes complicated.
 Complicated calculation will invite clerical errors.
 Under fluctuating prices, material charged to different but similar jobs vary, leading to non-
comparison.
 When prices fall, jobs are charged with higher price of earlier material; the quotations are less
competitive.
 When materials are returned to the stores, they are treated as new purchase, for the purpose of next
issue.

 Last in first out method (LIFO):

This method is opposite to FIFO. Here, material received last are issued first. Issues are made from the
latest purchases. The issues are priced at the unit cost of the latest lot or the most recent purchase. The issues
are not in chronological order, and cost of material reflects current market price.
Advantages:
 Material cost represents current price.
 It facilitates complete recovery of material cost.
 It is most suitable when pricing are rising.
 There is better matching of cost & revenue.
Disadvantages:
 It involves considerable clerical work.
 Due to variation of prices, comparison of cost of similar jobs in non-comparable.
 Stock of material shown is balance sheet will not reflect market prices.
 This system is not accepted by IT authorities.
 Specific price method (Identical cost):
This is the price actually paid for the material for a particular job or work or contract. Under this
method, material purchased for specific jobs, are kept separately and when issued, the job is charged with the
actual price paid. Material of special nature, costing items etc., when used for specific work, are priced at the
actual price & charged to the work. This method is good on individual jobs, contracts etc., against specific
orders.
Advantages:
 True or actual price is charged.
 It is suitable when the items are costly.
Disadvantage:
 Separate records have to be kept, when involves clerical work.
 Base stock method:
In almost all concerns, a minimum quantity of stock is always kept in store. A fixed minimum stock of the
material is always maintained and is known as ‘safety’ or ‘base stock’. This stock is valued at a price at which
the first lot of material is received. The stock should not be issued until emergency arises. The quantity in
excess of this base stock may be valued either FIFO or LIFO method.

 Highest in first out method (HIFO):

Under this method materials of the highest price are issued first. According to this method the closing
stock will be of the minimum price or as low as possible. In short, material purchased at the highest price will
be first issued, irrespective of the order of purchase; when the whole lot of the highest price is exhausted,
material purchased at the next higher price are issued. This method is suitable for cost plus contracts, but is not
common. It rather operates similar to FIFO & LIFO.
 Average price method:
 Simple average method:

29
 Issue prices of raw material are fixed at the calculated average unit price. When new purchases are made at
different rates, the average changes. This method of simple average is not generally followed, because it fails
to recover the cost price of material. For example:
Issue price = total of unit price of material in stock / number of prices
Advantages:
 It is easy to operate.
 It reduces clerical work
 When there are slight fluctuations in price, it gives good result.
Disadvantages:
 Costs are not fully recovered.
 This system is not generally followed.
 Weighted average method:
This method gives weightage, a part from the price, to the quantity also. Weighted average price is a
price obtained by dividing the total cost of material in the stock by the total quantity of material in the stock;
and issues are priced accordingly.
Formula:
Weighted average price = value of material in stock / quantity in stock
Advantages:
 It will smooth out fluctuation.
 It facilitates recovery of the cost paid for material
 It is accepted by all.
Disadvantages:
 When a large number of purchases are made at different rates, the calculation is tedious.
 Periodic simple average price:
The simple average rate is calculated, for a particular period, ignoring the rate of opening stock. The
computation of the issue rate is found out by totaling the unit prices of all purchases of opening stock. The rate
thus computed is used for all issues of the period & for valuing the closing stock.
Advantages:
 Calculation is easy, as the rate is to be computed only once at the end of the period.
 The issue price of material does not change during the period.
 Comparison of similar jobs in respect of material is easy.
Disadvantages:
 Delay is involved.
 Closing stock will not be in true value.
 Periodic weighted average price:
Like the weighted average method, the rate is found out by computing the total cost paid for the material
and dividing it by the total quantities purchased during a period, say a month, ignoring the opening stock. The
rate thus calculated is used for issue as well as for closing stock of material.
Advantages:
 This method is superior to the above.
 Price fluctuations have been removed.
Disadvantages:
 The rate is calculated at the end of the period.
 Pricing of material is delayed.
 Other methods:
 Standard price method: This is a method of valuing the issues on a pre-determined price. The standard
price of the material is decided, taking into account the quantity purchased, market conditions, future trend of
the prices and all other matter connected with the material. Under such circumstances, the cost of the issue of
the material will neither be at the cost price not at the market price.
Advantages:
 It is simple in working.
 Material cost can be fixed in advance.
 Comparison of jobs becomes easy.
 Control over purchase is possible.
Disadvantages:
 Sometimes, it fails to recover the cost of material.

30
  It will reflect the market price.
 Price variance account has to be created, in addition.
 Market price method (Replacement price method): This is based on the principle that material issued to
any job on a particular day, should be charged at the rate prevalent in the market. In other words, materials
issued are valued at a price at which they can be replaced. After the issue, the closing stock is adjusted to
the net value.
Advantages:
 Latest price is reflected
 Comparison is easy
Disadvantages:
 Lost of production varies with the market trends.
 It is not easy to know the latest price.
 Difference in value arises (purchase price & issue price), and needs adjustment.
 Profit or loss may arise on account of rise and fall in price of raw material.
 Inflated prices: When purchases are made, looking at the invoice, one is able to understand that the seller
charges the cost of the material and the expenses like packing, forwarding, freight, etc. then, after
purchasing additional expenses – sorting, preservation, issuing etc., are there.
Q: WHAT ARE THE DIFFERENCE BETWEEN DIRECT AND INDIRECT MATERIAL? (2 MARKS)
Materials, which form part of a finished product, are known as direct material. In other words, direct
material can be conveniently and accurately allocated to a particular unit of cost.
Indirect material, on the other hand cannot be treated as part of the finished product because it cannot be
conveniently and accurately allocated to a particular unit of product.

STOCK CONTROL
Q: WRITE A NOTE ON STOCK CONTROL. (2 MARKS)
Inventory control/stock control is a system which ensures the maintenance of required quantity of
inventories of the required quality at the required time with minimum amount of investment. The term
inventory includes raw materials, stores, supplies, spare parts, tools, components; assemblies partly finished
goods & finished goods.
Q: WHAT DO YOU UNDERSTAND BY ABC ANALYSIS? WHAT ARE ITS ADVANTAGES?
(2/5 MARKS)
ABC ANALYSIS (CONTROL ACCORDING TO VALUES)
ABC analysis is also known as proportional past value analysis. Under this method (always better
control) efficient control of store is required to give more case on cost items. As such, on the basis of the value
of different material, items are grouped into three categories:
 High priced material (A)
 Medium priced material (B)
 Low priced material (C)
The material, which are costly and form a small part of the total inventory, can be taken in storing and in the
use of such items market “A”. For this category of material, high price has to be paid and the number of items
is small. On the other hand, certain materials do not require much investment, and the number of such items is
usually large, market “C”. The materials which have moderate value may be marked “B”.
Advantages of ABC analysis:
 Ensures strict control over such items having a sizable investment in them.
 We could be put to use in a better way.
 Helps in maintaining enough safety stock for ‘C’ category store items.
ECONOMIC ORDER QUANTITY
PROBLEM: 1
Calculate Economic Order Quantity from the following information: Annual usage: 600 units; Cost of
placing an order: `12; Price of material per unit: `20; Cost of storage: 20%.
PROBLEM: 2
From the following data, find out economic order quantity: Annual usage 6,000 units; Cost per unit
`0.30; Buying cost `7 per order; Carrying cost 15% of average inventory holding.

31
PROBLEM: 3
A manufacturer buys certain equipment from outside suppliers at `30 per unit. Total annual needs are
800 units. The following further data are available: Determine the economic order quantity. Annual return on
investments 10%; Rent, insurance, taxes per unit per year `1; Cost of placing an order `100.
PROBLEM: 4
A factory requires 1,500 units of an item per month, each costing `27. The cost per order is `150 and the
inventory carrying charges work out to 20 per cent of the average inventory. Find out the Economic Order
Quantity and the number of orders per year.
PROBLEM: 5
Calculate the economic order quantity from the following information. Also state the number of orders
to be placed in year. Consumption of material per annum 10,000 kg.; Order placing costs per order `50; Cost
per kg. of raw materials `2; Storage costs 8% on average in inventory.
PROBLEM: 6
A company uses 10,000 units per year of an item costing `5 each. The cost of processing a purchase
order is `100 and the stock holding cost amounts to 20% per year of the money value of the inventory. How
much should the company buy at a time (in a single order) in order to minimize the inventory costs?
PROBLEM: 7
From the following information, find out the economic order quantity and the number of orders placed
in the year:
Annual consumption 120 units; Buying cost per order `20; Price per unit `100; storage and carrying cost as a
percentage of average inventory 12%
PROBLEM: 8
From the following data, you are required to determine the economic order quantity. Annual usage
8,000 units; Cost per unit `0.30; Buying cost `7 per order; Storage and carrying cost as percentage of average
inventory holding 15%.

PROBLEM: 9
Find out the economic order quantity and order schedule for raw material and packing materials with the
following data given to you
Cost of ordering Raw material `1,000 per order
Packing materials `5,000 per order
Cost of holding inventory Raw materials 1 paisa per unit p.m.
Packing materials 5 paise per unit p.m.
Production rate 2,00,000 units per month
PROBLEM: 10
An engineering company consumes 50,000 units of a component per year. The ordering, receiving and
handling cost are `3 per order while the transport costs are `12 per order. Further details are as under: Interest
`0.06 per unit per year. Deterioration cost `0.005 per unit, per annum. Storage cost `1,000 per annum for
50,000 units. Calculate the economic order quantity.
PROBLEM: 11 (Input-output ratio)
From the following, compute input-output ratio: Cost per kg. of material `9.
Particulars Standard Actual
Input of material 5 kg. 1,000 kg.
Output of raw material in final 4.5 kg. 800 kg.
product
PROBLEM: 12 (Inventory turnover ratio)
The following information is related to Material ‘X’ for the year ended 2008. The value of material is
`1 per kg. Stock at the beginning 1,000 kg.; Purchases 20,000 kg.; Stock at the end 500 kg.;
Calculate the material turnover ratio and express in number of days the average inventory held.
PROBLEM: 13
Calculate material turnover ratio for the year 2008 form the following: Determine the fast moving
material.
32
 Particulars Material Material B
A
Opening stock 15,000 28,000
Closing stock 28,000 17,500
Purchases 2,25,000 1,35,000

PROBLEM: 14
Calculate inventory turnover from the following: Minimum stock level 2,000 units; Maximum stock
level 6,000 units; Re-order quantity 4,000 units; Issues 12,000 units.
PROBLEM: 15 (Various stock levels)
From the following information, calculate: a) Maximum stock level; b) Minimum stock level; 3) Re-
order level.
Minimum 240 units per day Re-order quantity 3,600 units
consumptions 300 units per day Re-order period 10 to 15 days
Normal consumption 420 units per day Normal order period 12 days
Maximum consumption

PROBLEM: 16
From the following particulars, calculate: a) Maximum level; b) Minimum level; c) Re-order level.
Normal usage 100 units per day Economic order 5000 units
Minimum usage 60 units per day quantity 25 to 30 days
Maximum usage 130 units per day Re-order period

PROBLEM: 17
From the following data for last 12 months compute stock levels for component A. Maximum usage in
a month 300 units; Minimum usage in a month 200 units; Average usage in a month 225 units; Time lag for
procurement of material: Maximum 6 months, minimum 2 months, reordering quantity 750 units.
PROBLEM: 18
Calculate the minimum stock level, maximum stock level and re-order level from the following
information. Minimum consumption 100 kg per day; Maximum consumption 150 kg per day; Normal
consumption 120 kg per day; Re-order period 10-15 days; Re-order quantity 1,500 kg; Normal re-order period
12 days; Time for emergency supplies 3 days.
PROBLEM: 19
Two components A and B are used as follows: Normal usage 50 units each per week; Minimum usage
25 units each per week; Maximum usage 75 units each per week; Re-order quantity A: 300 units, B: 500 units,
Re-order period A 4 to 6 weeks; B 2 to 4 Weeks. Calculate for each component: a) Re-order level; b)
Minimum level; c) Maximum level; d) Average stock level.

PROBLEM: 20
In manufacturing its products, a company uses three raw materials A, B and C in respect of which the
following particulars are given:
Delivery
Raw Usage per unit Re-order Price per Order Minimum
period
material of product (kg) quantity (Kg) kg. (paise) level (kg.) level (Kg.)
(weeks)
A 10 10,000 10 1 to 3 8,000 --
B 4 5,000 30 3 to 5 4,750 --
C 6 10,000 15 2 to 4 -- 2,000
Weekly production varies from 175 to 225 units, averaging 200. Calculate (a) Minimum stock of A, (b)
Maximum stock of B, (c) Re-order level of C, (d) Maximum level of A and (e) Average stock of A.

PROBLEM: 21
The particulars relating to inventory are given below:
Annual consumption (360 days) 12,000 units

33
 Cost per unit `2
Ordering costs `12 per order
Cost of carrying inventory 10%
Normal lead time 18 days
Safety stock 30 days consumption
You are required to find out: (1) The quantity to be ordered each time, (2) When should the order be placed? (3)
What should be the ideal inventory immediately before receipt of the ordered material?

PROBLEM: 22
Sai Santhosh enterprises manufacture a special product “ZED”. The following particulars were
collected for the current year: Monthly demand of Zed – 1,000 units; Cost of placing an order `100; Annual
carrying cost per unit `15. Normal usage 50 units per week.; Minimum usage 25 units per week; Maximum
usage 75 units per week; Reorder period 4 to 6 weeks. Compute from the above: (a) Reorder quantity, (b)
Reorder level, (c) Minimum level, (d) Maximum level and (e) Average stock.
PROBLEM: 23
From the information given below, calculate the re-order level, maximum level and minimum level.

Re-order quantity 4,000 units Maximum stock level 20 weeks

Minimum stock level to allow for emergencies 5 weeks Average rate of consumption 250 units
Average delivery time for suppliers 4 weeks Minimum consumption in 4 800 units
weeks.

PROBLEM: 24 (Methods of pricing issues – FIFO)

From the following details, prepare the store ledger account by adopting FIFO method. What would be
the value of stock at the end of the period?
Date Particulars Date Particulars
Dec. 1 Opening stock 1,000 units @`2.00 Dec. 5 Issued 1,200 units.
each
Dec. 3 Purchased 800 units at `2.10 each Dec. Purchased 1,600 units at `2,10
12 each.

PROBLEM: 25
From the following particulars, prepare stores ledger adjustment account under FIFO method.
Date Particulars Unit ` P.U. Date Particular Units `
s s P.U.
Mar. 2 Purchases 200 200 Mar. 18 Issued 220 --
Mar.4 Issued 150 -- Mar. 24 Purchases 150 230
Mar. 6 Purchases 200 220 Mar. 25 Issued 190 --
Mar.10 Issued 100 -- Mar. 28 Issued 30 --
Mar. 16 Purchases 200 210

PROBLEM: 26
The stock in hand of a material as on 1st September was 500 units at `10 per unit. The following
purchases and issues were subsequently made. Prepare the store ledger account showing how the value of the
issue would be recorded under FIFO method.
Date Particulars Units ` Date Particular Units
P.U. s
Sep. 6 Purchases 100 11 Sep. 9 Issues 500
Sep. 20 Purchases 700 12 Sep. 22 Issues 500
Sep. 27 Purchases 400 13 Sep. 30 Issues 500
Oct. 13 Purchases 1,000 14 Oct. 15 Issues 500
Oct. 20 Purchases 500 15 Oct. 22 Issues 500
Nov. Purchases 400 16 Nov. 11 Issues 500
17

34
PROBLEM: 27 (Last in first out – LIFO)
Priya who newly set up a factory uses cost price as the basis for charging out materials to jobs. The
receipts side of the store ledger account shows the following particulars.
500 articles bought at `3.00 each.
700 articles bought at `3.10 each. Successive issue of 300 and 600 articles were made.
At what price should each of these issues be made under LIFO method?

PROBLEM: 28
The stock of a material as on 1 st April 2009 was 200 units at `2 each. The following purchases and
issues were made subsequently. Prepare store ledger account showing how the value of the issues would be
recorded under LIFO method.

Date Particulars Units ` P.U. Date Particulars Units

April 5 Purchases 100 2.20 April 7 Issues 100
April Purchases 150 2.40 April 12 Issues 100
10 Purchases 180 2.50 April 28 Issues 200
April Issues 150 --
20
April 2

PROBLEM: 29
From the following particulars write up the priced store ledger under LIFO

Date Particulars Date Particulars

Dec. Stock in hand 500 units at Dec. Issued 300 units
1 `20 6 Returned to store 10 units (issued on 4th Dec.)
Dec. Issued 200 units Dec. Issued 100 units
3 Purchased 150 units at `22 6 Issued 50 units
Dec. Issued 100 units Dec.
3 Purchased 200 units at `25 7
Dec. Dec.
4 8
Dec.
5

On 10th it was noticed that there is a shortage of 10 units.

PROBLEM: 30 (Simple Average method)

The following particular have been extracted in respect of material X. Prepare ledger account showing
receipts and issue pricing material issued on the basis of simple average method.

Date Particular Units ` P.U. Date Particulars Units

s
Oct. 3 Purchases 500 4 Oct. 5 Issues 400
Oct. 13 Purchases 900 4.3 Oct. 15 Issues 600
Oct. 23 Purchases 600 3.8 Oct. 25 Issues 600

PROBLEM: 31 (Weighted average method)

The following particular have been extracted in respect of material X. Prepare ledger account showing
receipts and issue pricing material issued on the basis of weighted average method.

Date Particular Units ` P.U. Date Particulars Units

s
Oct. 3 Purchases 500 4 Oct. 5 Issues 400
35
 Oct. 13 Purchases 900 4.3 Oct. 15 Issues 600
Oct. 23 Purchases 600 3.8 Oct. 25 Issues 600

PROBLEM: 32 (Base stock method)

From the following particulars write up the priced store ledger card: The following particular have been
extracted in respect of material X. Prepare ledger account showing receipts and issue pricing material issued on
the basis of simple average method.

Date Particular Units ` Date Particular Units `

s P.U. s P.U.
Jan. 1 Purchased 500 2.00 Jan. 25 Issued 300 --
Jan. 10 Purchased 300 2.10 Jan. 27 Purchased 500 2.10
Jan. 15 Issued 600 -- Jan. 31 Issued 200 --
Jan. 20 Purchased 400 2.20
Adopt base stock method of issue and ascertain the closing stock. Base stock 200 tons.

PROBLEM: 33 (Standard price method)

The purchases and issue of material X in the month of January 2010 were as follows:
Date Particulars Units ` P.U. Date Particulars Unit `
s P.U.
Jan. 3 Purchased 800 20 Jan. 17 Purchased 800 20
Jan. 8 Purchased 700 18 Jan. 25 Purchased 500 25
Jan. 9 Issued 600 -- Jan. 31 Issued 1,000 --
Jan. Issued 800 --
11
The standard price per unit of material is `20 fixed for the year 2010. Show the store ledger entries and
determine the price variance for the month of January 2010.

PROBLEM: 34 (Periodic simple average)

The following particulars are furnished in respect of a material:
Date Particulars Units ` P.U. Date Particular Units `
s P.U.
Jan. 1 Stock on hand 100 2 Jan. 31 Purchases 100 3.40
Jan. 5 Purchases 200 3 Feb. 10 Issues 300 --
Jan. Issues 120 -- Feb. 15 Purchases 200 3.60
10 Purchases 250 3.20 Feb. 20 Issues 150 --
Jan. Issues 150 -- Feb. 25 Purchases 100 4
16
Jan.
20
Draw up store ledger account for this material using periodic simple average (for each month).

PROBLEM: 35 (Periodic weighted average)

Prepare a store ledger for the following receipts and issues under periodic weighted average system:

Date Particular Units ` Date Particulars Units

s P.U.
April 1 Purchases 6,000 7 April 4 Issues 2,000
April 10 Purchases 4,000 5.5 April 12 Issues 3,500
April 15 Purchases 3,000 8.00 April 18 Issues 2,500
April 20 Purchases 2,000 8.50

PROBLEM: 36 (Highest in first out method – HIFO)

Laxmi and Co., has purchased and issued material D as under.

36
 Date Particulars Units ` Date Particulars Unit `
P.U. s P.U.
May 1 Opening stock 2,000 5 May 15 Purchased 200 7
May 3 Purchased 500 6 May 18 Issued 400 --
May 5 Purchased 700 6.50 May 25 Purchased 200 9
May 10 Issued 800 -- May 28 Purchased 150 8.50
May 11 Purchased 300 8 May 30 Issued 200 --
Ascertain the closing stock value under HIFO method of price of issues.

UNIT III
LABOUR COST
INTRODUCTION:
Labour is one of the three elements of cost. The human effort required to perform an activity is termed
as labour. The remuneration payable to the labour is called wages. The term labour cost (wages) generally
includes the monetary benefits like wages, dearness allowance etc., paid to workers. According to Alfred
Marshall “Labour is any exertion of mind or body undergone partly or wholly with a view to derive benefit
other than the pleasure derived from it”

Q: WHAT DO YOU MEAN BY DIRECT & INDIRECT LABOUR? (2 MARKS)

DIRECT LABOUR- MEANING

Accounting to ICMA “Direct labour cost is that cost which can be identified with & allocated to cost
centers or cost unit”. Again “The cost of remuneration for employee’s efforts and skill is applied directly to a
product or a saleable service”. The labour spends in altering the construction, composition of the product is
known as direct labour. The direct labour cost can easily be identified and allocated to cost units. It varies
directly with production, thus creating closeness to production.
INDIRECT LABOUR – MEANING
Indirect labour, on the other hand, cannot be conveniently identified with cost unit or cost centre.
ICMA defines indirect wages as “cost other than direct wages cost”. Therefore indirect labour cost is the
amount of wages paid to workmen, who are not engaged in the production of goods or services, but at the same
time, indirectly help the direct labour. In short, wages paid to such workers cannot be identified with any
particular work.
IMPORTANCE OF LABOUR COST
Q: WHAT ARE THE IMPORTANCE OF LABOUR COST? (5 MARKS)
 Reduction of labour turnover
 Absorption of overhead by using direct labour as a basis.
 To find out the correct amount of overhead by ascertaining the indirect labour cost.
 To estimate the correct labour cost of order, jobs and processes to ascertain the cost of each job, process
or order.
 To increase the efficiency of labour by taking direct labour cost as a guideline.

VARIOUS METHODS OF LABOUR COST CONTROL

Q: STATE THE VARIOUS METHODS OF LABOUR COST CONTROL. (5 MARKS)
The control of labour is very important, engaging unfit person in the factory; result in poor output at
high cost of production in the product find no place in the market or fetches less profits, and a time arrives
when the industry has to be closed down. Therefore the management takes measures for an effective control on
the labour. Labour cost includes monetary benefits and frig benefits.
Methods of labour cost control:
 The scientific methods of selection of personnel.
 Imparting training to them
 A good system of incentives
 Production planning made in advances.
 Time and motion studies which help to determine standards of time required for each job.
 A proper system of job evaluation.

37
  Introducing mechanical devices in labour costing.
 A good system of control over idle time and over time.
 A control labour turnover ratio.
 Co-ordination and co-operation among the workers of the concern.

Q: WRITE SHORT NOTES ON: (A) METHOD STUDY, (B) TIME STUDY, (C) MOTION STUDY
AND (D) WORK STUDY. (5 MARKS)
 Method study:
It is defined as a systematic procedure by which a detailed analysis of study is conducted, by eliminating
the unnecessary work and movement, and arranging the remaining work in the best order and forming a
standardization of doing the work. This study aims to ascertain the easiest and best method of performing a
job.
 Time study: (A device of work measurement)
“Time study may be defined primarily as the art of observing and recording the time required to do each
detailed element of an industrial operation”. It facilitates in fixing a “standard time” for a job. It is the basis
on which wages rates, incentives schemes etc., are fixed. To be effective, an organization worker may be
studied and not fast or slow workers.
 Motion study: (A device of work improvement)
Gilbert defines it as “The science of eliminating wastefulness resulting from unnecessary, ill-directed
and inefficient motions”. In other words, it is the study of the movements of an employee (or a machine) in
doing an operation for the purposes of eliminating unnecessary and inefficient motions (movements).
 Work study:
Work study is study of technical aspects of production. It involves a detailed study of processes,
operations, evaluation and analysis of jobs and work measurement. Therefore, work study involves method
study, motion study and time study.

JOB EVALUATION – MEANING

Q: WHAT DO YOU MEAN BY JOB EVALUATION? (2 MARKS)
Breach defines job evaluation as “Method of determining the relative worth of job on some scale usually
by an analysis of the content of jobs under classified headings”. ICO states that “Job evaluation may be defined
as an attempt to determine and compare the demand which the normal performance of the workers concerned”.
Thus job evaluation is a systematic and orderly process of determining the worth of job in relation to other jobs.

ADVANTAGES OF JOB EVALUATION

Q: WHAT ARE THE ADVANTAGES OF JOB EVALUATION? (5 MARKS)
 It helps in job classification and work simplification.
 It helps in bringing uniformity in wage structure.
 It facilitates cost control.
 It simplifies wage administration by bringing about uniformity in wage rates.
 There develops good relationship between employee and the employer as no scope is left for personal
bias of the employer.
 It helps is avoiding anomalies, confusion, unrest etc.,
MERIT RATING – MEANING
Q: WHAT IS MERIT RATING? (2 MARKS)
Merit rating may be defined as a systematic evaluation of an employee’s performance on the job in
terms of the requirements of the job. Merit rating aims at evaluating the employee’s actual performance of a
job. The main object of merit rating is that an employee is to be rewarded suitably, on the basis of merits.
Higher wages naturally fetch sense of responsibility and trust worthiness in the minds of the workers. The
relative worth of each job is ascertained carefully, studying the characteristics required for each workers.
MERITS AND DEMERITS OF MERIT RATING
Q: STATE THE MERITS AND DEMERITS OF MERIT RATING. (5 MARKS)
Merits:
 Promotion and wages rate are determined on sound basis.
 The employees are encouraged through a good system of reward and effort; thus further improvement is aimed at.
38
  It simplifies wages structure.
 Labour turnover is reduced.
 A sense of competition in the minds of workers is developed.
 Promotion or demotions or transfers are justified.

Demerits :
 The worker may be rated high based on a single trait. The rater may ignore the other traits in which the
worker may not be good.
 The different of opinion between the members of merit rating committee may lead to unsatisfactory
evaluation.
 The men doing the rating may be influenced by their personal ill feting towards particular workers
which may lead to unsatisfactory rating.
REMUNERATION
Q: WHAT IS MEANT BY REMUNERATION AND INCENTIVES? (2 MARKS)
Total wages earned by the employees is termed as remuneration. Time wages or piece wages earned
plus other financial incentives constitute the earnings of employees.
Incentives:
Good wage system along with effective incentive system will encourage the labour force to give their
best to the employer. Moreover attractive pay package will reduce labour turnover. In addition to monetary
incentives non monetary incentives also encourage employees to improve their productivity. Non monetary
incentives include promotional opportunities training schemes etc.
ESSENTIAL OR FEATURES OF GOOD WAGES SYSTEM
Q: WHAT ARE THE ESSENTIAL FEATURES OF GOOD WAGES SYSTEM? (5 MARKS)
Remuneration to labour is the most complex problem, especially in a country like India, because there is
no simple method of solution that is acceptable to both. Employees want wages rise and employers want to
keep down wage rate. Such situations conflict each other. There must be a wages system which increases the
efficiency and at the same time brings satisfaction to the workers.
Therefore, an ideal wages system should possess the following:
 The wage system adopted must be simple so that the workers may be able to understand it.
 The system must ensure satisfaction to both the employees and the employer.
 It should be based upon scientific time and motion study.
 It should guarantee a minimum wage at satisfactory level.
 It should enable an efficient worker to earn more.
 It should reduce labour turnover.
 It must be accepted by trade unions.
 It must increase the morale of the employees.
 It should be according to the capacity to pay.
 It should be flexible to adjust to the changes in the cost of living.
 The cost of the scheme must be minimum level.
 It should encourage productivity.
METHODS OF WAGE PAYMENT
Q: EXPLAIN THE METHODS OF WAGE PAYMENT. (10 MARKS)
For convenience, the various method of remuneration may be divided as follows:
I) Time rate system or day rate or flat rate:
This is the simplest, oldest and the most common method of wages payment. Under this method the wages
are calculated on the basis of time spend on a job irrespective of the volume of output. The time may be an
hour, a day, a week or a month. Total amount of wages is calculated by multiplying time rate with the time
spend.
Formula: Wages = Time worked X Rate of wages
 Time rate at ordinary level:
Under this method payment is made on the basis of time, which may be an hour, day, week or a month,
irrespective of the output. It means that a definite amount of payment is guaranteed for the specified period.

Formula: Earnings = Hours worked X Rate per hour

39
 Time rate at high level:
In this case the time rate is fixed at a level higher than the rate prevailing in the locality for similar
employment. Consequently a high standard of efficiency and output are fixed for the workers. If any
worker cannot attain that level of efficiency, he is excluded from the scheme and is paid only ordinary time
rate.
 Guaranteed time rate:
Under this system payment is at time rates, but adjusted to cost of living. Merit awards for personal
qualities, skill, ability, punctuality, etc., are also considered. The employer is not losing but compensates, it
by increasing the price of the products.
 Differential time rate:
Under this system different time rates are fixed for different level of efficiency. A percentage of
efficiency is fixed, up to which a worker gets normal time rate. If he crosses that percentage of efficiency
his time rate shall increase step by step.
Advantages of time rate system:
 Simplicity:
An important advantage of time rate system is its simplicity. It is very easy to measure the time spent
on the job and to calculate the amount of wages earned.
 Security to workers:
It gives the worker a feeling of security as he known in advance what will be his total remuneration at
the end of the period. This will give him an assurance and he can plan his own expenditure accordingly.
 Equality of wages:
All workers doing similar jobs get the same rate of wages and a sense of equality prevails among the
workers. This sense of equality among the workers helps in the smooth working of the organization.
 Better quality:
There the quality of products is more important than quantity, time rate is more advantageous.
 Less wastage:
Under this time rate, the workers need not speed up their operations to earn higher wages. So there will
be less wastage of material and les wear and tears of tools and machinery.
 Adaptability:
This system can be adapted to all kinds of work. Even if a worker does a variety of jobs, he can be
compensated on time wages basis.
 Acceptable to trade unions:
Labour unions always prefer time wages since this form of payment does not make any discrimination
between efficient and inefficient workers. This method ensures stable income to all the employees.
Disadvantages of time rate system:
 Inefficiency:
This system does not check employees’ inefficiency as there is no link between wages and productivity.
The workers may deliberately show down the pace of work.
 Lack of motivation:
This system does not provide any incentive of efficiency. Both efficient and inefficient workers are
treated alike.
 Increased supervision:
Time rate system leads to lower productivity so; strict supervision is required to ensure better
productivity.
II) Piece rate system (payment by result):
Here speed is the basis of payment, instead of time. This system is opposite to time wage system according
to this system, the volume of work done is the basis for payment of wages to workers. Efficiency is recognized
in this system. The worker gets payment according to his speed, ability, efficiency etc. A specific rate is fixed
per unit of output, and the worker is paid accordingly, irrespective of the time taken by him.
This method is applicable where:
 Quality of the work is not important.
 Work is of a repetitive nature.
 Job rate can easily be fixed.
 There is good demand and Job is standardized one.
Merits:
40
  The output is increased.
 The system works as an incentive to workers.
 Efforts and rewards are correlated.
 Efforts and rewards can be made confidentially and accurately.
 Supervision work is low.
 Breakage of machine will reduce wages; hence machines are handled with care.
 Idle time has no place.
 The worker develops skill and zeal to work.
 The rate of fixed overhead is reduced.
Demerits:
 Workers are always in hurry, hence accidents may happen.
 Quality of the products will be examined, as workers are interested in quantity; as a result overhead cost
increase.
 In efficient workers will be thrown out.
 High speed work is injurious to the health of the workers.
 In order to maximize production, it is possible that machines are used recklessly.
 Breakdown of machine or power failure may disappoint the workers.
 When there is less demand, over production may arise.
 Fixation of a satisfactory piece rate is a difficult task.
 It is possible that material may be wasted or spoiled, as the workers are only anxious about speed.
Types of piece rate system:
 Straight piece rate:
Under this system the workers gets a flat rate per unit of output. His earnings i.e.,
Formula: Piece working earnings = Rate per unit X Unit produced
 Piece rate with guaranteed time rate:
Under this system a worker gets a fixed amount of wages and he is also paid for the performance
beyond a prescribed limits.
 Differential piece rate:
Under this scheme, the rate per piece is increased, as the output level is increased. That is, there is more
than one piece rate system. In other words, the increase in rates may be proportionate to the increase in
output. By this system, inefficient workers are encouraged to earn more.

 Taylor’s differential piece rate system:

F.W. Taylor, the father of scientific management, introduced this system. According to this system.

o There are two piece rate systems – one is lower and the other one is higher.
o Lower price rate is the output below standard and a higher piece rate is for the output above the
standard.
o For each job standard time is stipulated.
o Usual rate as 83% for output below standard and 175% for output above standard.

 The Merrick’s differential piece rate (or) multiple piece rate system:
It is a modification of Taylor system, in order to reduce penalization of slow workers. Thus these
people are encouraged. Therefore, he introduced three rates in place of two. They are:

Level of efficiency Piece rate

Up to 83% Ordinary piece rate
83% to 100% 110% of ordinary piece rate
Above 100% 120% of ordinary piece rage

 Gantt task and bonus plan:

41
 This is combination of time, bonus and piece rate plan based on the differential piece rate principles. A
bonus of 20% of time rate is paid when output is achieved, thereafter high piece rate are paid. A standard is
set and remuneration is calculated as follows.
 When output is below standard – Payment at time rate
 When output is at standard - payment at time rate plus 20% bonus.
 When output is above standard – payment a high piece rate.
DIFFERENCE BETWEEN TIME & PIECE RATE SYSTEM
Q: DISTINGUISH BETWEEN TIME RATE SYSTEM AND PIECE RATE SYSTEM. (5 MARKS)

Time rate system Piece rate system

It is simple to calculate and easy to understand The rate have to be carefully fixed so as to avoid
possible loss to management.
This pertains to hours of work This pertains to output
General supervision is needed Careful supervision is needed
It does not promise efficiency It promise efficiency in working
Individual efficiency is not looked upon Individual efficiency is measured and accounted for
Cost reduction is not possible Cost reduction is possible
Benefit of efficient worker goes to the employer Benefit of efficient workers is shared by the worker
and the employer
There arises more idle time There is no chance of idle time

VARIOUS INCENTIVES SCHEMES OR BONUS METHODS

Q: EXPLAIN THE VARIOUS INCENTIVE OF PAYMENT TO WORKERS. (5/10 MARKS)
An incentive may be defined as a benefit either monetary or otherwise offered to stimulate effort. An
incentive may be either monetary or non-monetary. It may be given either individually to every worker or
collectively to a group of workers. The object is to induce the worker to produce more and to earn more.
Before the introduction of incentive plant,
The following factors may be taken into consideration.
 It must be simple and understandable to workers.
 It must be fair to both – employer & employee.
 The standard should be fixed by time and motion study.
 Standard once fixed may not be altered.
 The cost of operating the scheme should be minimum.
 The work must be repetitive by nature.
 The workers should not raise objections.
 The system must be permanent; once introduced should not be discounted.
 The system should also benefit the indirect workers.
 It must reduce labour turnover.
 Employer – employee – customers are to be benefited.
Advantages:
 Increase in production with corresponding reduction in cost. Cost is reduced because of reduction in
overhead cost per unit.
 Labour turnover is reduced as the labour morale is boosted because of better payment.
 More efficient workers may be attracted as there is a chance of earning more wages.
 Consumers are benefited because of lower selling price due to low cost of production.
Disadvantages:
 It is difficult to establish performance level and fixing rates.
 It is difficult to withdraw the scheme once it is introduced.
 Trade unions usually object to the introductions of the scheme.
 Some schemes are complicated and expensive to administer.
1) Halsey premium plan:
42
 This system is also known as split bonus plan or fifty-fifty plan. The plan was introduced by F.A.
Halsey, an American engineer. In the plan, the task time is decided on the basis of past experience and
scientific studies are set. Under this plan a standard time is fixed for the performance of each job, and the
worker is paid the agreed rate per hour for the time spend thereon plus a fixed percentage (may be 50%) of
the time be saved on the standard.

Formula:
Total earnings = (Time rate X Time taken) + 50% of (Time saved X Time rate) (or) Time wages +
50% of time saved X Time rate

Time saved = Standard time – Actual time

Merits:
 It is simple to understand and easy to calculate.
 Standard time is fixed for each job or operation.
 Both employer and employee get equal benefit from time saved by the workers.
 It can be easily introduced in any modern industry.
 It provides incentive to efficient workers, at the same time below – average. Workers are not penalized.
 Savings in time reduce both labour cost and overhead expenditure.
 The system is based on time saved and not on output; thus prevents over production.
Demerits:
 Fixation of standard is very difficult.
 If wages rate is low, incentive value may be low.
 Careful supervision is necessary.
 Earnings are reduced at high level efficiency.

2) Halsey weir plan:

This is more or less the same as Halsey premium bonus system. Here also time wages is guaranteed.
1
33 %
Under the Halsey-weir scheme a worker is entitled to bonus equal to his time wages for 3 (often 30%)
of the time saved. Thus basically these are no difference between the Halsey scheme and the Halsey-weir
1
33 %
scheme except to the condition that for the calculation of bonus to employees only 3 of the time saved
is considered.
1 2
33 % 66 %
This is also known as 3 : 3 scheme.
3) Rowan system:
This is similar to the Halsey system in many respects, but it differs in the method of calculating bonus.
The bonus is equal to the percentage of time saved over the standard time allowed multiplied by the time
wage. Thus total wages under Rowan scheme:

Time allowed - Time taken

Earnings = Time taken X Time rate + X Time taken X Time rate
Time allowed
(or )
Time saved
Earnings = Time wages + X Time wages
Time allowed
Advantages:
 Standard time is fixed; the basic rate is not changed.
 It assures the minimum time wages to workers.
 It is suitable to the beginners.
 The employers also are benefited with the employees.
 The employer is protected even if the rate is not properly fixed.
 It plays higher bonus to workers compared to Halsey plan.

43
  As bonus decline, at higher level of efficiency, the workers are not tempted to rush work; thereby
reducing the chance of over production.
Disadvantages:
 It is difficult to understand and calculate.
 Efficiency beyond certain point is not rewarded.
 It is more complex and expensive.

Q: DISTINGUISH BETWEEN HALSEY PLAN AND ROWAN PLAN. (5 MARKS)

Halsey plan Rowan plan
It guarantees minimum time wages It assures minimum time wages
Bonus increase steadily with increase in Bonus increase up to a certain stage and starts
efficiency decreasing
Bonus is wages of 50% of the time saved Bonus is in that proportion of time taken, which the
time saved bears to the standard time.
Gains of efficiency are shared by employer and Gains of efficiency are not shared equally.
employee equally (1:1)
It the time saved in more than 50% of the If the time saved is less than 50% of the standard time
standard time, this plan is better plan is better.

4) Barth variable sharing plan:

This is a premium bonus system designed to provide incentive to the beginners and developing workers
to improve their performance. Time wage is not guaranteed and the incentive is provided to low task only.
If does not provide enough incentive to the skilled and efficient workers.

Formula:
Wages under barth plan = Time Rate X √Standard time X Actual time
5) Emerson efficiency bonus plan:
It is similar to piece rate system but provides a guaranteed time rate. Incentive bonus paid at both low
and high task level.

Level of efficiency Piece rate

Below 66 2/3% No bonus (only time wages)
66 2/3% to 100% Bonus increase in steps and rises to 20% at 100 % efficiency
Over 100% 20% bonus plus 1% bonus for cash increase of 1% inefficiency

6) Bedaux point premium system:

It is a premium bonus system which uses minimum as the point and the standard time allowed is known
as Bedaux point. Each job is allowed a number of points based on the standard time determined by means
of time and motion study. Time rate is guaranteed and in addition a bonus equivalent to 75% of the points
saved is allowed.
Formula:
Bonus = 75% (Standard points – Actual points) X Rate per min.

 Accelerating premium bonus plan:

Under this plan bonus is paid to workers at an increased rate according to more and more time saved
instead of as a fixed percentage under Halsey plan and as a decreasing percentage under Rowan plan. This
provides a great inducement to workers to achieve the goal of higher production.

 Group bonus system:

These systems are employed to provide incentive to a group of workers whose individual efforts are
difficult to measure or have little effect on the output of the group. The bonus payable is determined on the
basis of collective output of the group and is shared in equal proportions by the workers of the group.

44
 IDLE TIME – MEANING
Q: WHAT IS IDLE TIME? EXPLAIN THE TYPES OF IDLE TIME. (2/5 MARKS)
When workers spend their whole time at different jobs, then the time booked for jobs must agree with
the gate time. Ordinarily the time booked for job does not agree with the gate time. It so happens, because of
reasons like, waiting for material, machine breakdown, waiting for instruction, power failure etc., reconciliation
of gate time with time booked is facilitated by preparing on idle time card. The idle time card shows the time
which has been lost and the reasons thereof.
Types of idle time: Idle time is of two types.
Normal idle time:
Normal idle time (or) the time wasted by the worker cannot be avoided. This must be borne by the
employer.
Abnormal idle time: It is the wasted time, which can be avoided.

REASONS OR CAUSES
Q: WHAT ARE THE CAUSES FOR IDLE TIME? (5 MARKS)
Reasons or Causes of idle time:
 Power failure
 Waiting for work
 Waiting for instruction
 Waiting for tools
 Machine breakdown.
 Bad planning of work
 Accidents, strikes etc.,
 Time worked in changing from one job to another
 Seasonal nature of industry
 Time taken to reach the department form gate.
Control of idle time:
Following steps are suggested to control idle time.
 Vigilance must be exercised to control and eliminate idle time.
 The instruction to the workers should be given in advance so that workers need not wait.
 Plant and machine should be maintained properly so that their breakdown can be avoided.
 The causes of the idle time should be found out and the root cause must be removed.
 Regular and timely supply of raw material must be made available through a good system of storing
materials.
RECORDING OF LABOUR TIME AND IDEAL TIME
Q: EXPLAIN THE PROCEDURE FOR RECORDING OF LABOUR TIME AND IDEAL TIME.
(2/5/10 MARKS)
Time keeping:
Time keeping is the recording of each worker’s time of coming in and going out of the factory for the
purpose of attendance and wage calculations.
The objects of time keeping are:
 The wages of time workers can be correctly calculated.
 The record of attendance meets the statutory requirements.
 It ensures punctuality and discipline.
 The waste of time or idle time of workers can be known.
 Cost of labour chargeable to the job, product or process can be ascertained.
 In certain cases, it helps in charging of overheads on the basis of wages.
Methods of time keeping:
 Manual methods: The manual methods of time keeping are as follows:
 Attendance register or muster roll:
This is an old system of time keeping. At the factory gate or department, attendance register is kept
under the custody of the time keeper. The register contains name of the workers, identification number,
time of arrival and departure. The employees may be required to sign the register both at the time of
entering and leaving the factory, noting down the time in and time out.

45
  Token or discs method:
Under this method, each worker is allotted a token or disc bearing his identification number. All such
tokens or discs are hanged on a board near the main gate in a serial order. As and when the worker enters,
he removes his token from the board and puts it in a box kept nearby. The box is removed after the grace
period. Late comers will have to give their tokens to the time keeper personally, so that the exact time of
arrival may be noted. The tokens still left on the board represent the absentee workers. With the help of the
token in the box, the time keeper records the attendance in a register.
 Mechanical methods: The mechanical methods of time keeping may be as follows:
 Card time recorder:
Each worker is given a clock time card bearing his identity number and other details. The machine may
be installed at the factory gate. There will be a rack placed inside as well as outside gate. The clock time
cards are serially arranged and kept in outer rack. When a worker enters the factory, he takes his card and
inserts it into the machine which marks the exact time of his arrival. Late arrivals are marked in red ink.
Then, the card is deposited in the inside track. While going out, the same procedure is repeated.
 Ideal time recorder:
This recorder has a clock like face with several holes (about 150) around it. Each hole is serially
numbered and each worker is allotted one hole. There is an arm at the centre of the dial. When the worker
enters into the factory, he has to press the dial arm after placing it in the hold allotted to him. His incoming
time is recorded along with his number on the paper roll kept inside the machine. Similarly, outgoing times
are recorded.
Time booking:
A worker is not paid for his mere attendance in the factory. He is paid for the work he does or the time
he works. The process of recording the time spent by a worker on different jobs is known as time booking.
Objects of time booking:
 To ascertain the labour cost of each job;
 To ensure that the time for which the worker has been paid is properly utilized;
 To ascertain the idle time so as to control it;
 To provide basis for the apportionment of overhead expenses to various jobs;
 To compare the actual time taken and time allowed for a job so as to know the efficiency of workers and
to pay bonus.
Methods of time booking:
 Daily time sheet:
In small concerns, a daily time sheet is allotted to each worker. In it, he enters daily the time spent by
him on each job and hands it over to the foreman for verification and signature.
 Weekly time sheet:
The purpose of this time sheet is the same as that of daily time sheet. Weekly time sheet is allotted to
each worker for a week. In it, he enters the time spent by him on each job during the week. A specimen
form of a weekly time sheet is given below.
 Job card:
Under this system a separate card is issued for each job. The card contains columns to record the time
spent by a worker on each job. It helps to ascertain the labour cost of each job. It also contains instructions
for doing the job.
ACCOUNTING TREATMENT
Q: HOW DO YOU TREAT IDLE TIME IS COST ACCOUNTS? (5 MARKS)
Normal idle time: The cost of labour of normal idle time can be treated in two ways.
 A worker has to work for 8 hours a day’s but he actually puts in only 7 ½ hours on job and half an hour
is wasted. The labour cost of the normal idle time (here half an hour), may be charged to factory on cost
and 7 ½ hours to the job concerned.
 The hourly rate may be raised and the cost of complete labour may be charged to the job concerned.
This is preferred.
Abnormal idle time: Abnormal idle time expenditure or cost should not be included in cost. Such labour cost
on account of abnormal nature may be debited to costing profit and loss account.
Q: WHAT IS OVERTIME? HOW IS IT TREATED IN COST ACCOUNTS?
STATE THE METHOD OF CONTROL OF OVERTIME WORK? (2/5 MARKS)
Overtime:
46
 When a workers works above his normal working hours, he is said to be working overtime, and
according to factories Act, 1948, Overtime has to be paid at double the normal rate, if a worker work more than
9 hours on any day or 48 hours in a week, the workers is entitled for overtime payment.
Overtime work should be avoided as far as possible due the following reasons:
 Overtime leads to excessive labour cost and will reduce profit.
 It leads to unusual strain on plant and machinery
 Expenses like lighting, cost of supervision etc., will also increase considerable.
 Workers start doing regular work slow to secure overtime work.
 Quality suffers because workers are tired.
Overtime may arise in the department due to any one of the following reasons:
 To complete the work within a specified time.
 To make up any shortfall in production caused by abnormal circumstances such as fire, flood, strike, etc.
 To increase the production to meet the huge demand for the product in the market.
Treatment of overtime in cost accounts:
 If the overtime is paid on the instruction of a customer then the additional amount is charged directly to
the job.
 The extra amount may be charged to the department which is responsible for the delay.
 The extra amount may be charged to prime cost, if there is rush of seasonal work.
 If there are any abnormal reasons, then the overtime premium may be charged to costing profit and loss
account.
Control of overtime:
To keep the cost of production to the minimum, the control of overtime is essential. The following steps
must be taken to control overtime work.
 All the overtime work should be duly authorized by works manager in advance.
 There must be proper flow of work to the workers, so that their time is not lost.
 There must be proper instructions to the workers, so that they need not wait for instructions.
 Regular maintenance of plant, regular supply of raw materials of standard quality have a good effect in
reducing the waste of time or idle time.
LABOUR TURNOVER – MEANING
Q: WHAT IS LABOUR TURNOVER? (2 MARKS)
Labour turnover may be defined as the rate of change in the labour force, i.e., it denotes the percentage
of change in the labour force of an organization. In other words, it is a term used to describe the movement of
shifting into and out of an organization by the employees.
METHODS OR MEASUREMENT OF LABOUR TURNOVER
Q: EXPLAIN THE METHOD OF MEASURING LABOUR TURNOVER. (5 MARKS)
Methods of measuring labour turnover:
 Separation method:
Under this method, labour turnover for any period is measured by dividing the total number of
separation by the average number of workers on the roll, then multiply by 100.

Formula:
Number of separation during a period
Labour turnover = X 100
Average number of workers during the period
 Replacement method:
Under this method only the actual replacement of labour during a period is taken into account
irrespective of the number of workers leaving.

Formula:
Number of replacement in a period
Labour turnover = X 100
Average number of workers in the period
When new recruitment is there for expansion purpose they should be excluded from the number of
replacement.

47
 Flux method:
Labour turnover is obtained by dividing the total number of separations and replacement by the
average number of workers.
Formula:
Numer of additions + Number of separations
Labour turnover = X 100
Average number of workers during the period
REDUCTION OF LABOUR TURNOVER
Q: EXPLAIN THE METHOD OF REDUCING LABOUR TURNOVER. (5 MARKS)
Following measures are suggested to management to maintain a happy and contented labour force.
 Better working conditions may be provided to workers.
 Selection of candidates must be made on the basis of scientific principles and workers must be placed on
appropriate jobs.
 Well organized programmes must be chalked out to increase their efficiency.
 There must be a cordial relation between employer and employees.
 There must be job security and opportunities for career advancement.
 A good wages policy and incentive plans must be devised.
 An efficient grievance procedure is to be adopted.
 Labour participation in management must be encouraged.
 A good working condition conducing to health and efficiency should be provided.
 The personal department must prepare a periodical reports relating to causes of labour turnover and suggest
remedies.
CAUSES AND EFFECTS OF LABOUR TURNOVER
Q: ENUMERATE THE CAUSES AND EFFECTS OF LABOUR TURNOVER. (5 MARKS)
The causes can be broadly divided into two categories.
 Avoidable causes:
 Dissatisfaction with job
 Dissatisfaction with wages.
 Poor working condition.
 Unsuitable working hours.
 Non-cooperative attitude
 Lack of promotions.
 Unfair method of promotion
 Unsympathetic attitude of management
 Inadequate protection.
 Weakness (employee – employer relations).
 Unavoidable causes:
 Quitting the job (due to inefficiency)
 Lack of work
 Retirement or death
 Accident of illness.
 Marriage
 Disliking a job
 Personal department
 Worker’s roving nature.
 National service.
 Effects of labour turnover:
 Fall in production.
 Increased in cost, selection, training etc.
 Dislocation of even flow of production.
 Increase of scrap, defective work, additional supervision etc.
 Higher accident rate.
 Mishandling of machines.
 Instability of labour & their low team spirit.

48
 COST OF LABOUR TURNOVER
Q: EXPLAIN COST OF LABOUR TURNOVER. (2 MARKS)
 Preventive cost:
These costs are incurred to prevent the labour turnover. They include administration cost, cost of health
care facilities, cost of welfare facilities, old age facilities etc.
 Replacement cost:
These costs include recruitment and training cost, cost of machine break down, spares, tools etc.
LABOUR TURNOVER
PROBLEM: 1
The extracts from the payroll of Mr. Santhosh & Bros. is as follows: calculate labour turnover by
applying.
 Separation method
 Replacement method
 Flux method

Number of employees at the beginning of 2005 150

Number of employees at the end of 2005 200
Number of employees resigned 20
Number of employees discharged 5
Number of employees replaced 20

PROBLEM: 2
The following information relates to the personnel department of a factory for the month of April 1996.
Calculate labour turnover by applying.
 Separation method
 Replacement method
 Flux method

Number of worker on April 1, 1996 1,900

Number of worker on April 30, 1996 2,100
Number of workers who quit the factory in April 20
Number of workers discharged in April 60
Number of workers engaged in April 280
(including 240 on account of expansion scheme)
PROBLEM: 3
The personnel department of a concern gives you the following information in respect of labour.
Number of employees on 1st January – 1,800; Number of employees on 31 st January – 2,200. During the month
20 persons quit and 80 persons are terminated. 300 workers are needed. Of these, 50 workers are recruited in
the vacancies and the rest were engaged in the expansion scheme. Calculate the L.T.R.
PROBLEM: 4
From the following particulars supplied by personnel department of a company, calculate labour turnover
by applying.
 Separation method
 Replacement method
 Flux method
Total number of employees at the beginning 2,010
Total number of employees at the end 1,990
Number of employees resigned 30
Number of employees discharged 50
Number of employees replaced 40

LABOUR COST
PROBLEM: 5

49
From the following particulars, you are required to prepare a statement of labour cost showing the cost per day
of 8 hours.
a) Monthly salary `200
b) Leave salary 5% of salary
c) Employer’s contribution to Provident fund 8% of (a) and (b)
d) Employer’s contribution to State Insurance 2.5% of (a) and (b)
e) Pro-rata expenditure on amenities to labour `17.95 per head, per month
f) No. of working hours in a month 200
PROBLEM: 6
From the following particulars, calculate labour cost for a day of 8 hours.

a) Basic wages `5 per day

b) Dearness allowance 25 paise for every point over 100 costs of living
indeed. Present cost of living index 800 points
c) Leave pay 5% of (a) and (b)
d) Employer’s contribution to Provident Fund 8% of (a) and (b)
e) Employer’s contribution to State Insurance 5% of (a), (b) and (c)
f) No. of working days in a month 25 days of 8 hours each

PROBLEM: 7
Find out the wages per hour based on the following information.

Wages per year `2,400

Annual bonus 25% of wages
Contribution to provident fund 10% of wages
ESI contribution 5% of wages
Total leave permitted during the year 60 days
Cost of labour welfare activities including canteen subsidy `8,000
Number of workmen 200
Normal idle time 80 hours
Working days per annum 320 days of 8 hours

How will you treat, if a worker had lost 60 hours on some days on account of failure of power supply.

NORMAL AND OVERTIME WAGES

PROBLEM: 8
Calculate the normal and overtime wages payable to a workman from the following data:

Days Hours worked Days Hours worked Days Hours worked

Monday 8 hours Wednesda 9 hours Friday 9 hours
Tuesday 10 hours y 11 hours Saturday 4 hours
Thursday

Normal working hours – 8 hours per day; Normal rate – `1 per hour; Overtime rate – Up to 9 hours in a day a
single rate and over 9 hours in a day at double rate or up to 48 hours in a week at single rate and over 48 hours
at double rate whichever is more beneficial to the workman.
TIME WAGES AND PIECE WAGES
PROBLEM: 9
The output of a worker X is 100 units in 40 hours per week. Graduated time rate is `4 per hour.
Ordinary piece rate is `2 per unit. Show the earnings of the worker under piece rate and time rate system.

PROBLEM: 10
The output of the worker A is 60 units in a 40 hour week. Guaranteed time rate is `5 per hour. Ordinary
piece rate is `2 per units. Show the earnings of worker A under time rate and piece rate system.
50
PROBLEM: 11
The standard time taken to complete a product is 12 hours at 25 paise per hour. Time wages are allowed
to workers taking more than the time allowed. But workers who complete the job in standard time or less
received a straight piece work rate plus 10% bonus i.e., 12 hours at `0.275.
Calculate the wages earned by A, B, C and D who complete the job in 15, 12, 10 and 8 hours respectively.
What will be their effective hourly rate?

TAYLOR’S DIFFERENTIAL PIECE RATE SYSTEM

PROBLEM: 12
With the help of the following information ascertained the wages paid to the worker X and Y Taylor’s
Differential piece rate system. Standard time allowed: 40 units per hour; Simple time rate: Rs.4 per hour.
Differential piece rate to be applied: 75% of piece rate – When below standard; 125% of piece rate – When at
and above standard. The workers have produced in a day of 8 hours as follows: X – 300 units, Y – 420 units.
MERRICK DIFFERENTIAL PIECE RATE SYSTEM
PROBLEM: 13
Calculate the earning of workers A, B and C under Merrick’s differential piece rate system when basic
piece rate is guaranteed below standard and the workers get 108% of basic piece rate between 100% to 120%
efficiency and 120% of basic piece rate above 120% efficiency.
Given: Basic piece rate = 50 paise per piece; Production of worker A = 2,000 Numbers per day; B = 1,800
Number per day; C = 2,400 Numbers per day; standard production per day = 1,920 Numbers.
PROBLEM: 14
Calculate the earnings of workers A, B and C under straight piece rate system and Merrick’s multiple
piece rate system form the following particulars: Normal rate per hour `1.80; Standard time per unit 1 minute;
Output per day of 8 hours is as follows: A – 360 units; B – 420 units; C – 540 units.
GANTT’S TASK BONUS PLAN
PROBLEM: 15
The following are the particular applicable to a work process: Time rate `5 per hour; High task 40 units
per week; Piece rate above the high task `6.5 per unit.
In a 40 hour week, the production of the worker was as follows: A – 35 units; B – 40 units; C – 41 units; D – 52
units. Calculate the wages of the workers under Gantt’s task bonus plan.
PROBLEM: 16
The standard job cards of the three workers contain the following particulars:
Time rate: `5 per hour or `200 per 40 hour week.
Standard production: 40 units per week; piece rate above standard output: `6 per unit; Output for the week: P
– 32 units; Q – 37 units; R – 42 units. Calculate the wages of each worker under the Gantt’s task bonus plan.

PROBLEM: 17
Following are the particulars relating to three workers, A, B and C
Normal rate per hour `80; Piece rate per piece `0.60; Standard output 2 unit per hour
In a 40 hour week, the production of the workers is as follows: A – 50 units; B – 80 units; C – 120 units.
Calculate the earnings of the worker under:
 Taylor’s differential piece rate system;
 Merrick multiple piece rate system;
 Gantt’s task bonus system.

HALSEY PLAN
PROBLEM: 18
A worker is paid at 25 paise per hour for completing a work within 8 hours. If he completes the work
within 6 hours, calculate his wages under Halsey plan when the rate of premium is 50%. Also ascertain the
effective hourly rate of earning by the worker.
PROBLEM: 19

51
 A worker is paid at `1.00 per hour for completing a work within 8 hours. If he completes the work
within 6 hours, calculate his wages for 6 hours and 8 hours under Halsey plan when the rate of premium is 50%.
HALSEY-WEIR PLAN
PROBLEM: 20
Calculate earnings of a worker under Halsey-weir scheme. The bonus is 33.33% of time saved. Time
allowed – 48 hours; Time taken – 36 hours; Rate per hour – `10.

PROBLEM: 21
Calculate the earning of a worker under Halsey – weir plan. Time allowed 48 hours; Time taken 40
hours; Rate per hour `10.
ROWAN PLAN
PROBLEM: 22
The following particulars apply to a job: Standard time – 10 hours; Time taken – 8 hours; Time rate – `2
per hour; calculate the earnings under Rowan plan.
PROBLEM: 23
Calculate the wages due under the Rowan plan with the following details: Standard time – 9 hours;
Time taken – 6 hours; Normal rate – 0.75 paise per hour. Overhead recovered 150% of the direct wages.
PROBLEM: 24
Calculate the earnings of a worker under the following method:
 Time rate
 Piece rate
 Halsey plan
 Rowan plan
Information given: Standard time – 30 hours; Time taken – 20 hours; Hourly rate of wages is `1 per hour plus
dearness allowance at 50 paise per hour worked.
PROBLEM: 25
Calculate the earnings of a worker A under (a) Halsey plan, (b) Halsey-weir plan and (c) Rowan plan
form the following data: Time allowed – 48 hours; Time taken – 40 hours; Rate per hour – Re.1.

PROBLEM: 26
A worker takes 80 hours to do a job for which the time allowed is 100 hours. His daily rate is `2.50 per
hour. Calculate the works cost of the job under the following methods of payment of wages:
 Time rate
 Piece rate
 Halsey plan
 Rowan plan.
Additional information: Material cost `120; Factory overhead 125% of wages.
BEDAUX POINT SCHEME
PROBLEM: 27
Standard time allowed for a job is 20 hours, time taken for completion 16 hours. Rate per hour is `20.
Find total earnings as per Bedaux scheme.

BARTH VARIABLE SHARING PLAN

PROBLEM: 28
Calculate earnings of a worker under Barth plan if the time allowed is 48 hours, time taken is 40 hours
and rate per hour is `10.
EMERSON’S EFFICIENCY PLAN
PROBLEM: 29
Standard output per day of 8 hours is 16 units. Actual output of a worker for 8 hours is 20 units. Rate
per hour is `10. Calculate the wages payable to the workers according to the Emerson’s efficiency plan.
PROBLEM: 30

52
 Standard output per day of 8 hours is 16 units. Actual output of a worker for 8 hours is 20 units. Rate
per hour is `2.50. Calculate the wages payable to the worker according to the Emerson’s efficiency plan.

UNIT IV
OVERHEADS
INTRODUCTION:
Cost relating to a cost center or cost units consists of direct cost and indirect cost. Direct cost can easily
be identified with cost units. Generally speaking, any expenditure incurred over and above prime cost is known
as overhead. It has been defined as the aggregate of indirect material, indirect wage and indirect expenses. The
terms ‘indirect’ here means that which cannot be allocated, but which can be apportioned to, or absorbed by
cost centers or cost unit. Overhead is also known as ‘overhead cost’, ‘overhead charges’, ‘nonproductive cost’,
‘burden’, ‘loading’, ‘on cost’, ‘supplementary cost’ etc.,

DEFINITION
Q: DEFINITION OF OVERHEAD. (2 MARKS)
Wheldon says, overhead may be defined as “the cost of indirect material, indirect labour and such other
expenses including services as cannot be conveniently charged to a specific unit. Alternatively, overhead are all
expenses, other than direct expenses”.
Broker and weltmer defined “Overhead costs are operating costs of a business enterprise, which cannot
be traced directly to a particular unit of output. Further, such costs are invisible or unaccountable”.

CLASSIFICATION
Q: EXPLAIN THE VARIOUS CLASSIFICATIONS OF OVERHEADS. (5/10 MARKS)
There are various methods of classifying or grouping overhead which greatly depend upon the
objectives of classification, the type or size of the firm. Generally, the following is the classification according
to: Overhead

Nature Function Variability Control Normality

 According to nature:
 Indirect material: The cost of material which cannot be allocated to a particular unit and does not form
part of the finished product is termed as indirect material.
 Indirect labour: A labour charge which cannot be allocated to a particular unit of cost is called indirect
labour or wages.
 Indirect expenses: Most items of expenditure are classified as indirect since they are incurred for the
business as a whole, rather than is regard to a particular product.
 According to function:
 Manufacturing overhead: They are also called work overhead or factory overhead. It is aggregate of
indirect expenses of operating the manufacturing division of a concern and includes all expenses
incurred by the concern from the time of the receipt of the order till its completion ready for despatch.
 Administration overhead: It is the cost of formulating the policy, directing the organization and
controlling the operation of an undertaking which is not related to production, selling and distribution,
research and development activity or function”.
 Selling overhead: It means the cost of seeking to create demand and stimulate demand in securing
orders for the product.
 Distribution overhead: It means expenses connected with or incurred from the stage the production is
completed in the works till the product reaches its destination.
 According to variability:
 Fixed overhead: They are constant or called period cost and remain fixed in nature and do not vary
with changes in the volume of output.
 Variable overhead: Variable or fluctuation overhead is a cost which, in the aggregate, tends to vary in
direct proportion to changes in the volume of output or turnover.
 Semi-variable overhead: This type of overhead varies with a change in the volume of output, but not in
such a proportion as the output changes.

53
 According to normality: They are normal and abnormal overhead. Normal overhead expenses are
expected to be incurred in attaining a given output. These are unavoidable. These can be included in
production cost. Abnormal costs are those which are not expected to occur in attaining a given output.
 According to control: It is known as control-wise classification. It may be controllable costs. Controllable
costs are those costs which can be controlled by an efficient management.
TYPES OF DEPARTMENT
Q: WHAT ARE THE DIFFERENT TYPES OF DEPARTMENTS? (2/5/10 MARKS)
 Production department:
Where actual activity is undertaken in these department the raw material are converted into finished
goods with the help of manual and machine operations. The number and nature of such department depends
on the type of the industry.
 Service department:
Where there is not production activity but they render service for the benefits of other department.
 Partly producing departments:
The nature of work done by these departments is such that is not possible to place them into a particular
category of either production or service.
COST ALLOCATION
Q: WHAT IS THE MEANING OF COST ALLOCATION? (2 MARKS)
Cost allocation may be defined as the allotment of whole items of cost of cost centers of cost unit. The
nature of expenses is such that it can easily be identified and allocated to accost centre. For example, salary
paid to the sales manager is allocated to the sales department.
APPORTIONMENT OF OVERHEAD-MEANING
Q: GIVE THE MEANING OF APPORTIONMENT OF OVERHEAD. (2 MARKS)
Charging a fair share of overhead to each cost centre is termed as apportionment. I.C.M.A., London
defined it as “the allotment to two or more cost centre’s of proportions of common items of cost on estimated
basis of benefit received”. If an item of overhead cost cannot be allocated to cost centres, it has to be
apportioned. For apportionment suitable basis has to be selected so that overheads are equitable disturbed
between various cost centres.
Q: WHAT ARE THE PRINCIPLES OF APPORTIONMENT? (2/5 MARKS)
After collecting indirect expenses such as electricity, rent, insurance etc., they are to be apportioned on
the suitable basis to the various cost centres. Selection of a suitable base is important and the following
principles are useful in dealing with them:
 Service or use method: Under this system, the overhead costs are shared by the departments on the basis of
services or benefit received these from.
 Ability to bear: This principle is on the basis of earning profits among the departments. A department,
which produces costly goods or earn higher profits, share larger part of the cost of the service department by
deliberate decision of the costing department.
 Survey method: In certain cases, a survey method has to be used in order to understand the benefits
received by different departments.
DIFFERENCE BETWEEN COST ALLOCATION AND APPORTIONMENT OF OVERHEADS
Q: DISTINGUISH BETWEEN COST ALLOCATION AND APPORTIONMENT OF OVERHEAD.
(5 MARKS)
Cost Allocation Apportionment of overhead
It is the allotment of whole item of cost to cost centres It is the allotment of proportion of items of cost to cost
or cost units centres or cost units
There is no need of a basis for the allocation of There is the need of some suitable basis for the
overhead to departments apportionment of overhead.
The items of overhead are directly attributable to The items are shared by two or more departments. So,
particular department or cost centre. So, they are they are indirect in nature.
direct in nature
Cost control is more easy as overhead are identified Cost control is difficult as overhead are not identified
with each department with specific department.

54
 PROCEDURE OF LINKING OVERHEAD TO COST UNITS
Q: EXPLAIN THE PROCEDURE OF LINKING OVERHEAD TO COST UNITS? (5 MARKS)
In order to arrive at the total cost of production, overhead is added to the prime cost. The overhead,
being common /general costs incurred for number of units / cost centres, is to be allocated and apportioned to
various departments are then to cost centres and finally absorbed by cost units. Thus procedure involved for the
final absorption is as under
 Collection of overhead
 Classification of overhead
 Allocation of overhead
 Apportionment of overhead
 Absorption of overhead by cost units.

PRIMARY AND SECONDARY DISTRIBUTION-MEANING

Q: WHAT IS PRIMARY & SECONDARY OVERHEAD DISTRIBUTION SUMMARY (OR) WHAT IS
RE-APPORTIONMENT? (2/5 MARKS)
Primary distribution of overhead:
Primary distribution of overhead is the process of allocating and apportioning the costs on suitable basis
to all the departments or cost centres. Primary distribution is done without distinction between production and
service departments.
Secondary distribution of overhead:
Secondary distribution is the process of redistribution of service department cost to production
departments. This is done as output or jobs pass through one or more production cost centres only. This kind
of distribution is called secondary apportionment. Suitable bases have to be adopted for redistribution of
service department cost of production department.

Basis of apportionment:
Service cost center Basis of apportionment among the production
departments
Stores department Number of material requisitions, direct material of
each department.
Labour welfare department, canteen service, Number of employees each year.
recreation facility.
Building maintenance department. Relative area of each department.
Internal transport service department, personal Weight, weight and distance traversed no.of
department, time keeping department, payroll employees in each department labour / machine
department. hours.

METHODS OF SECONDARY DISTRIBUTION OF OVERHEAD OR REAPPORTIONMENT OR

REDISTRIBUTION OF OVERHEADS
Q: EXPLAIN THE VARIOUS METHODS OF SECONDARY DISTRIBUTION OF OVERHEAD.
(2/5/10 MARKS)

 Direct distribution:
A service department renders service to production department and other service department. This
method ignores the service rendered by one service department to another service department. So overhead
expenses of service department are directly allocated to production department. This method is simple, but
unscientific.

 Step method:
Under this method the cost of the most serviceable department is first apportioned to the other
production as well as the service departments. Therefore, a sequence of apportionment must be chosen.
After apportioning to the first service department, the next service department is taken up. Thus the service
departments are apportioned off one after another.

55
 Reciprocal service method:
When there are two or more service department, it is recognized that they render services to each
other. These inter departmental service are taken with consideration and are not ignored in redistributing
expenses of the service department. There are mainly three methods.
 Simultaneous equation method: The total overhead cost is ascertained with the help of simultaneous
equations. The result obtained through the help of simultaneous equation is redistributed to the
production department on the basis of given percentage.
 Repeated distribution method: The overhead expenses, according to primary distribution summary,
are written against the respective departments, one after another. The expenses of service departments
are redistributed to the production department as well as service departments on the basis of agreed
percentage. The process is repeated unit the figures of the service departments are exhausted or become
too small to matter.
 Trial and error method:
In this method the cost of service centre (S1) is apportioned to another service centre (S2). Then the
cost of another service centre is a gain apportioned to the first service centre. This process is repeated
till the amount becomes zero or negligible.

SERVICE DEPARTMENT COST – MEANING

Q: WHAT IS THE MEANING OF SERVICE DEPARTMENT COST? (2 MARKS)
Service department cost is an ancillary and is not directly engaged in production though its existence is
very essential for smooth and efficient running of production department. Such departments are not directly
engaged in the conversion of raw materials into finished goods. Such departments enter particular types of
service for the benefits of other department. A number of departments in a factory and the name to be assigned
to them depend upon size of the factory, nature of industry and the nature of service entered.

ABSORPTION OF OVERHEAD – MEANING

Q: WHAT DO YOU MEAN BY ABSORPTION OVERHEAD? DISCUSS THE DIFFERENT
METHODS FOR THE ABSORPTION OF FACTORY OVERHEAD? (2/5/10 MARKS)
The amount of overhead allocated and apportioned to cost centres should be finally borne by all cost
units passing through each cost centre. The process by which factory overhead is allocated to cost units is
known as overhead absorption or overhead recovery or overhead levy. The ICMA, UK defines overhead
absorption as “allotment of overhead to cost units”. A simple method of overhead recovery can be adopted if
the products are identical in nature and the manufacturing processes are not complex. But, if there a product of
different nature involving many processes, an appropriate method of overhead absorption is required.

TYPES OR METHODS OF ABSORPTION OVERHEAD

For changing or absorbing overhead to cost units, overhead rates have to be determined on an
appropriate basis. This requires computation of an overhead absorption rate. “Overhead absorption rate is the
sets at which overhead is charged to cost units, jobs or products”
 Percentage on direct materials: In this method the cost of direct material used in the manufacture of a
product is used as the base in absorption of factory overhead. The overhead rate is calculated on the basis
of the following formula:
Factory overhead
Overhead rate = X 100
Direct material cost
 Percentage on direct wages: Under this method the absorption rate is expressed as a percentage of direct
wages. The rate is calculated as below:
Estimated factory overhead for the budget period
Overhead rate = X 100
Estimated direct labour cost for the normal output
 Percentage of prime cost: According to this method, overhead absorption rate is expressed as a percentage
of prime cost. The rate is calculated as follows:
Estimated factory overhead fot the budget period
Overhead rate = X 100
Estimated prime cost for normal output
 Unit of production basis: The unit of production method is a simple method of charging factory overhead.
The unit of production may be one or a dozen or a Kg. or liter or any other municipal measure used for the
output. The unit rate of recovery of factory overhead is calculated as follows:
56
 Factory overhead
Units of production =
Estimated number of units
 Direct labour hour rate: Labour hour rate is a commonly used method of overhead recovery in
manufacturing concerns where ‘labour’ is the dominant factor of production. In many factories, the time
spent by workers on each job is recorded most reliably. If the data relating to overhead are readily available
the rate can be calculated as follows:
Factory overhead
Direct labour hour rate =
Direct labour hours

CALCULATION OF MACHINE HOUR RATE – MEANING

 Machine hour rate: The cost of running a machine per hour can be called machine hour rate. A separate
rate for each machine or groups of machines can be established, which can be related to overhead costs
of the production department the actual or pre-determined rate of manufacturing overhead (factory
overhead) absorption is computed by dividing the manufacturing cost to be absorbed by the number of
hours for which a machine or a group of machines are operated or expected to be operated. Thus
Factory overhead
Machine hour rate =
Machine hours during a given period
Types or Methods of machine hour rate:
 Ordinary machine hour rate:
Direct machine expenses are taken into account when calculating ordinary machine hour rate.
Machine expenses are two categories:
 Machine expenses which are proportional to the operating time of the machine, and
 Machine expenses which have no relation to operating time.
 Composite machine hour rate: In this method, machine expenses and other general overhead of the
department like supervision, rent, lighting and heating, insurance on building, etc., are taken into account
and they are known as standing charges (departmental overhead). These are to be apportioned to each
machine as a suitable basis. These standing charges apportioned to each machine are divided by the number
of working hours of that machine during the period. We can get composite machine hour rate by adding
this rate with the ordinary machine hour rate, thus:
Composite machine hour rate = Ordinary machine hour rate + Machine hour for standing charges.
MERITS
 It is a scientific and logical method, where the time factor is taken into account
 We can compare the relative efficiencies and cost of operating different machines.
 The difference between the usefulness of machine work and manual work can be known by the
management.
 It reveals the idle time of machine (under-absorption)
DEMERITS
 It leads to more clerical work in finding out the working hours of machines.
 Expenses which are not proportional to the working hours of machines are not taken into account.

COMPUTATION OF MACHINE HOUR RATE

 Each time or group of machines is treated as a cost centre in order to identify overhead expenses.
 Machine overhead are of two type – standard charged (fixed) and machine expenses (variable or running).
 The standing charges e.g., rent, rates, supervision etc., remain constant and do not vary with the use of
machine. Theses standing charges are estimated for a given period for every machine. The estimated
figures divided by the total working hours of the period will show an hourly rate for standing charges.
 The machine expenses e.g., power, depreciation, repairs, etc., are variable with the use of machines.
These machinery expenses are estimated separately and then divided by the normal working hours to
give hourly rate for each item. Normal working hours are calculated by giving allowance for idle
time, for maintenance, for setting up etc.
 The sum of standing charges rate and the machine expenses rate will give the machine hour rate.

57
The following are suitable basis of apportionment of different expenses for calculating of machine hour
rate:
Overhead cost Basis of apportionment
Rent and rates Floor space occupied by each machine
Lighting and heating Floor area, number of points, plus cost of special
lighting or heating any machine
Supervision According to time spent on each machine
Consumable stores and lubricating oil As per stores requisition slip
Insurance Capital value of the machine
Miscellaneous expenses (variable or running) Cost of machine-scrap value
Depreciation Life in terms of machine hour
Power House power (HD) of each machine
Repair Cost of repairs life in terms of machine hours.

BASES OF APPORTIONMENT
PROBLEM: 1
Mention the bases of apportionment of the following expenses of departments.
Rent Canteen expenses
Lighting Welfare expenses
Power Staff recreation
Depreciation of Plant & Machinery Stores overheads
Insurance of Plant & Machinery Indirect materials
Insurance of stock Indirect wages
Repairs of plant Time-keeping
Material handling charges Municipal taxes
Supervision Advertising

PRIMARY APPORTIONMENT OF OVERHEADS

PROBLEM: 2
Kumaresh Ltd., has three production departments A, B and C and two service departments D and E. The
following figures are extracted from the records of the company:
Rent and rates 5,000 General lighting 600
Indirect wages 1,500 Power 1,500
Depreciation of 10,000 Sundries 10,000
machinery
The following data are also available in respect of five departments:
Particulars Production departments Service dep.
A B C D E
Floor space in square 2,000 2,500 3,000 2,00 500
feet 10 15 20 0 5
Light points 3,000 2,000 3,000 10 500
Direct wages (`) 60 30 50 1,50 -
H.P of machines 60,000 80,000 1,00,000 0 5,000
Value of machinery (`) 10
1,50
0
Apportion the cost to the various departments on the most equitable basis by preparing a primary departmental
distribution summary.
PROBLEM: 3
Krishna producing concern is divided into four departments. A, B and C production department and D is a
service department.
Rent 10,00 Supervisory expenses 15,000
Repairs to plant 0 Fire insurance (on stock) 5,000

58
 Depreciation to plant 6,000 Power 9,000
Lighting expenses 4,500 Employers liability for insurance 1,500
1,000
The following information is available in respect of the four departments.

Production departments Service dep.

Particulars
A B C D
Area (Sq. ft.) 1,500 1,100 900 500
Number of lights 75 11 9 5
Number of employees 200 150 100 50
` ` ` `
Total wages 60,000 40,000 30,000 20,000
Value of plant 2,40,000 1,80,000 1,20,000 60,000
Value of stock 1,50,000 90,000 60,000 --
Apportion the cost to the various departments on the most equitable method.
PROBLEM: 4
Y Ltd., has four departments, A, B, C and D. A, B and C are production departments and D is a service
department. The actual cost for the period are given below:
Rent 4,00 Insurance of stock 1,500
Repairs 0 Supervision 4,500
Depreciation 2,40 Power 2,700
Lighting 0
1,35
0
300
The following data are also available in respect of the four departments.
Particulars Dept. A Dept. B Dept. C Dept. D
Area Sq. ft. 300 220 180 100
No. or 36 24 18 12
workers `24,000 `18,000 `12,000 `6,000
Value of plant `15,000 `9,000 `6,000 --
Value of stock
Apportion the cost to the various departments on the most equitable method.
PROBLEM: 5
Shiva industries Ltd., has four departments. A, B and C are production departments and D is the service
department. The actual expenses for a month were as follows:
Rent 6,000 Supervision 9,000
Repairs to plant 3,600 Insurance of stock 3,000
Depreciation 2,700 Power 5,400
Lighting charges 600 Employee’s insurance employer’s liability 900
The following information is also available:
Particulars Dept. A Dept. B Dept. C Dept. D
Area Sq. ft. 300 220 180 100
No. or 48 2 24 16
workers `8,000 `6,000 `4,000 `2,000
Total wages `24,000 `18,000 `12,000 `6,000
Value of plant `15,000 `9,000 `6,000 --
Value of stock
Apportion the costs to four departments on the most equitable method.
SECONDARY APPORTIONMENT – DIRECT APPORTIONMENT
PROBLEM: 6
K Ltd., has three production departments and four service departments. The expenses of these departments as
per primary distribution summary were:
59
 Production department: Service department: Stores 2,000
J 15,000 Time-keeping 1,500
K 13,000 Power 800
L 12,000 Canteen 500
The following additional information is available in respect of production department:
Particulars J K L
Horse power of 300 300 200
machines 20 15 15
Number of workers `5,00 `3,00 `2,00
Value of stores used 0 0 0
Apportion the costs of the service departments to the production departments on an appropriate basis.
PROBLEM: 7
Calculate the overhead allocable to production department A and B from the following:
There are two service departments X and Y. X renders service to A and B in the ratio of 3:2 and Y renders
service to A and B in the ratio of 9:1. Overhead as per primary overhead distribution is: A – `49,800; B –
`29,600; X – `15,600; Y – `10,800.
PROBLEM: 8
The following data were obtained from the books of Arun Engineering Company for the half-year ended 30 th
September. Prepare an overhead distribution summary and compute the departmental overhead rate for each of
the production department assuming that overhead is recovered as a percentage of direct wages.
Production departments Service departments
Particulars
A B C X Y
Direct wages ` 7,000 6,000 5,000 1,000 1,000
Direct material ` 3,000 2,500 2,000 1,500 1,500
No. of 200 150 150 50 50
workers Kwh. 8,000 6,000 6,000 2,000 3,000
Electricity No. 10 15 15 5 5
Light points ` 50,000 30,000 30,000 10,000 10,000
Asset values Sq. ft. 800 600 600 200 200
Area occupied
The expenses during the period were:
Stores 400 Depreciation 6,000
overhead 1,500 Repairs and maintenance 1,200
Motive power 200 General overheads 10,000
Lighting 3,000 Rent and taxes 600
Labour welfare
Apportion the expenses of department X in the ratio of 4:3:3 and that of department Y in proportion to direct
wages to department A, B and C respectively.

REPEATED DISTRIBUTION METHOD

PROBLEM: 9
You are supplied with the following information. Calculate overhead hourly rate in respect of production
department A, B and C. The primary overheads are:
Production department: Service department:
A 7,810 X 4,000
B 12,54 Y 2,600
C 3
4,547
Expenses of service departments X and Y are apportioned as under:
A B C X Y
X 30 40% 20 -- 10%
Y % 20% % 20% --
10 50
% %
60
Estimated working hours are: A – 1,000; B – 2,500; C – 1,400.

PROBLEM: 10
In a factory, there are two service departments I and II and three production departments A, B and C. In April
1992, the departmental expenses were:
Production Service department:
department: 6,50,000 I 1,20,000
A 6,00,000 II 1,00,000
B 5,00,000
C
The Expenses of the service departments are allocated on a percentage basis as follows:
A B C I II
I 30% 40% 15% -- 15%
I 40% 30% 25% 5% --
I
Prepare a statement showing distribution of the expenses of the two service departments on a percentage basis
by repeated distribution method.

PROBLEM: 11
A company has three production department A, B and C and two service departments X and Y. The expenses
incurred in the departments are given below:
Production department: Service department:
A 80,00 X 23,400
B 0 Y 30,000
C 70,00
0
50,00
0
The expenses of the service departments are apportioned as follows:
A B C X Y
X 20 40% 30 -- 10%
Y % 20% % 20% --
40 20
% %
Apportion the expenses of department X and Y to production departments using repeated distribution method.

STEP METHOD
PROBLEM: 12
Bombay industries has two production departments and three service departments. The total overheads of the
departments are:
Production department: Service department:
A 24,00 Time office 8,000
B 0 Stores 10,000
16,00 Maintenance 6,000
0
Details relating to the departments are:
Time office Store Maintenance A B
s
Number of workers 7 20 10 40 30
Number of stores requisitions -- -- 6 24 20
Machine hours -- -- -- 2,400 1,600

Prepare overhead distribution summary by step method.

RECIPROCAL SERVICES METHOD – SIMULTANEOUS EQUATION METHOD

61
PROBLEM: 13
You are supplied with the following information and are required to work out the secondary distribution of
service department overheads under simultaneous equation method.
Production departments Service departments
Particulars
X Y Z P Q
Primary distribution 7,810 12,543 4,547 4,000 2,600
`
Expenses of service departments P and Q re apportioned as under:
X Y Z P Q
P 30 40% 20 -- 10%
Q % 20% % 20% --
10 50
% %

TRIAL AND ERROR METHOD

PROBLEM: 14
A company has three production departments A, B and C and two service departments X and Y. The expenses
incurred by them during the month are:
A B C X Y
80,000 70,000 50,000 23,400 30,000
The expenses of the service departments are apportioned to the production departments on the following basis:
A B C X Y
X 20% 40% 30% -- 10%
Y 40% 20% 20% 20% --
Show clearly as to how the expenses of X and Y departments would be apportioned to A, B and C departments
under Trial and Error method.

PROBLEM: 15
The following particulars relate to a manufacturing company with three production departments A, B and C and
two service departments S1 and S2. The following are details of overheads distributed to the departments as
per primary distribution summary.
A B C S1 S2
6,300 7,400 2,800 4,500 2,000
A technical assessment for apportionment of service departments is as under:
A B C S1 S2
S 40% 30% 20 -- 10%
1 30% 30% % 20% --
S 20
2 %
Find out the overheads of production departments on the basis of (i) Simultaneous equation method, (ii)
Repeated distribution method, (iii) Trial and error method and (iv) Step method.
ABSORPTION OF OVERHEAD
PROBLEM: 16
Calculate labour hour rate from the following:
Total number of workers 100 Idle time 5%
Working days in a year 300 Factory overheads `11,40,00
No. of hours per day 8 Gift to workers. 0
worked `7,000
PROBLEM: 17
The following details pertain to the production department of a factory
Material consumed 60,000 Labour hours worked 27,000
Direct wages 36,000 Factory overheads 54,000
Machine hours 18,000 Output during the year 9,000

62
Calculate overhead absorption rate under different methods possible from the above data.

PROBLEM: 18
From the budgeted figures of Madras Chemicals Ltd:
a) Prepare normal overhead application rates using: (i) Direct labour hour method, (ii) Direct labour cost
method and (iii) Machine hour rate method. Budgeted figures for the year:
Estimated factory overhead `58,000 Estimated direct labour cost `97,80
Estimated direct labour hours 1,34,60 Estimated machine hours 0
0 50,500
b) Prepare a comparative statement of cost showing the result of application of each of the above rates of
batch No.243 from the data given below:
Direct material consumed `4 Direct labour `3
Direct labour 2 hours 0
`4 Machine hours `2
5 0

PROBLEM: 19
The following information relates to the activities of a production department for a certain period in a factory:
Material used `72,00 Labour hour worked 24,000
Direct wages 0 Overhead chargeable to the department
Hours of machine `60,00 `48,00
operation 0 0
20,000
On one order carried out in the department during the period, the relevant data were:
Materials used `4,00 Direct wages `3,30
Labour hours 0 Machine hours 0
1,650 1,200
Prepare a comparative statement of cost of this order by using the following three methods of recovery of
overheads: (a) Direct labour – hour rate method; (b) Direct labour – cost rate method and (c) Machine hour rate
method.
UNDER OR OVER ABSORPTION OF OVERHEADS
PROBLEM: 20
During the year ended 31st March 1993 the factory overhead costs of three production departments of an
organization are as under: X – `48,950; Y – `89,200; Z – `64,500. The basis of apportionment of overhead is
given below: Department X: `5 per machine hour for 10,000 hours; Department Y: 75% of direct labour cost of
`1,20,000; Department Z: `4 per piece for 15,000 pieces. Calculate department wise under or over absorption of
overheads and present data in a tabular form.
MACHINE HOUR RATE
PROBLEM: 21
Calculate the machine hour rate for machine A.
Cost of machine `16,000
Estimate scrap value `1,000
Effective working life 10,000 hours
Running hours for a 4 weekly period 160 hours
Average repairs and maintenance for a 4 weekly period `120
Standing charges allocated to machine A for a 4 weekly period `40
Power 4 units per hour at a cost of 25 paise per hour.

PROBLEM: 22
Compute the machine hour rate from the following data:
Cost of machine 1,00,000
Installation charges 10,000
Estimated scrap value after life time (15 years) 5,000
Rent and rates for the month 2,000
Lighting charges per month 3,000
Insurance per annum 960
63
 Power consumption 10 units per hour @ 60 paise per
unit
Estimated working hours 2,200 per annum (this includes setting up time of 200 hours). Supervisory salary per
month `3,000. The machine occupies 1/4th of the space in the workshop and the supervisor devotes 1/5 th of this
time for the machine.

PROBLEM: 23
A machine is purchased for cash at `9,200. Its working life is estimated to be 18,000 hours after which its scrap
value is estimated at `200. It is assumed from past experience that;
1. The machine will work for 1,800 hours annually.
2. The repair charges will be `1,080 during the whole period of life of the machine
3. The power consumption will be 5 units per hour at 60 paise per unit.
4. Other annual standing charges are estimated to be:
 Rent of the department (1/5th area is occupied by the machine) `780
 Lighting (out of 12 points, 2 points engaged in the machine) `288
 Foreman’s salary (1/4th of his time is occupied in the machine) `6,000
 Insurance premium (fire) for machinery `36
 Cotton waste etc., `60
Find out the machine hour rate on the basis of above data for allocation of the works expenses to all jobs for
which the machine is used.

PROBLEM: 24
The following annual charges are incurred in respect of a machine in a shop where manual labour is almost nil
and where work is done by means of five machines of exactly same type of specification.
 Rent and rates (proportional to the floor space) for the shop `4,800
 Depreciation on each machine `500
 Repairs and maintenance for the five machines `1,000
 Power consumed (as per meter) @5 paise per unit for the shop `3,000
 Electric charges for light in the shop `540
 Attendants: There are two attendants for the five machines and they are each paid `60 per month.
 Supervision: For the five machines in the shop there is one supervisor whose emoluments are `250
p.m.
 Sundry supplies for the shop `450
 Hire purchase installments payable for the machine (including `300 as interest) `1,200.
The machine uses 10 units of power per hour. Calculate the machine hour rate for the machine for the year.

PROBLEM: 25
A factory works on an average 168 hours in a month. There are four machines in a factory for which the
necessary particulars are provided.

Machine numbers
Particulars
1 2 3 4
Annual depreciation 3,300 12,000 1,80 33,000
Annual interest on 1,200 4,500 0 6,750
capital 600 5,550 1,05 900
Annual repairs 98 300 0 390
Monthly sundry expenses 12% 10% 450 8%
Portion of floor area 50
15%

The monthly charges for rent and taxes for the entire factory are `16,500. One foreman supervises all the four
machines and his salary is `2,520 p.m. An attendant is getting `250 p.m. to look after all these machines. In the
execution of a certain work machine 1 is used for 84 hours and machine 2 for 72 hours and machine 3 for 100

64
hours and machine 4 for 120 hours. The cost of materials is `1,79,650 and that of direct labour is `3,350.
Calculate the cost of the work order.
PROBLEM: 26
A machine shop has four new machines each occupying equal area of space.
Cost of the machines were: A – `20,000; B – `25,000; C – `30,000; D – `40,000.
The following are the expenses per annum of the machine shop.

Rent 10,000 Power

Rates and water 4,240 : 5,100
Light and heat 3,200 A 5,000
Administration 9,600 B 12,000
Running expenses 20,000 C 14,500
D

Compute machine hour rate for each machine assuming 45 hours per week, 50 weeks a year, 80% utilization
and life of machine 10 years, without scrap value.

PROBLEM: 27
With the following figures compute machine hour rate for machine A for a four week period. The machine is
expected to work for 108 hours.
Rent and rates 150 Power 60
Lighting 20 Sundries 150
Depreciation 100 Canteen expenses 10
Indirect wages 100 Repairs, etc 40

Particulars Machine A Machine B Machine C

Space occupied (Sq. ft.) 100 200 300
Number of light points 1 3 6
Cost of machines `2,500 `1,500 `1,000
Number of workers 1 2 2
Power (actual `25 `15 `20
Direct wages `200 `300 `500

UNIT V
PROCESS COSTING
MEANING
Q: WHAT IS PROCESS COSTING? WHAT ARE ITS FEATURES OR CHARACTERISTICS?
(2/5 MARKS)
Process costing is a method of costing. This method refers to costing of distinct process involved, while
converting raw material into finished product. It helps to ascertain the cost of the product at each distinct
process or operation or stages of production. Here the raw material has to pass through two or more processes
before completion. This method of costing is applied by industries manufacturing textiles, soaps, biscuits,
paints, cements, chemicals, medicines, paper and pulp oil refining, milk dairy, etc. Here the raw material
passes from one process to another process. Thus, the last process gives the finished product. The distinct
processes are in a sequential order and the output of one process becomes the raw material of the next process
and so on.

Definitions:
Charles, T. Horngren says “Process costing deals with the mass production of like units that usually pass
in continuous fashion through to series of production steps called operations or processes”.
According to ICMA London, “Process costing is that form of operation costing, where standardized
goods are produced”.

CHARACTERISTICS
65
 The factory is divided into a number of process cost centres or departments and in each cost centre an
account is maintained setting up process cost centres.
 All types of cost – direct and indirect – relating to process are recorded for each process.
 The finished product of one process is the raw material for the next process and this procedure continues
until the final product arrives. The product and processes and standardized.
 The cost of the previous process is transferred to the subsequent process alone with output.
 Total cost of finished final product comprises of all cost incurred in all processes.
 Finished products at the end are homogenous i.e., indistinguishable.
 The cost of normal wastage is added to goods units produced. Apart from this, these occurs abnormal
wastages and abnormal gains.
 In certain industries there arise by-products and joint products which require further processing.

Q: NAME THE INDUSTRIES WHERE PROCESS COSTING IS APPLIED. (5 MARKS)

 Producing industries such as cement, paper, paints, textiles, rubber, iron and steel, ceramics etc.,
 Chemical industries as oil, soap, chemicals, perfumes, medicines.
 Mining industries such as mineral, oil & refineries, coal, gold, sulphur, iron, gas etc.,
 Public utility works electricity generation, gas, water supply etc.,

ADVANTAGES OF PROCESS COSTING

Q: EXPLAIN THE ADVANTAGES AND DISADVANTAGES OF PROCESS COSTING. (5 MARKS)
 It helps in the computation of cost of the process as well as of the end product at short intervals.
 Average cost of homogeneous product can easily be computed.
 Cost control if made easier as the cost records are kept at the shop floor to assess the efficiency of
production.
 It facilities price quotations as the element of cost are more or less standardized.
 It involves can clerical work than job costing.
 Expenses can be allocated to process easily and costs become accurate.

DISADVANTAGES OF PROCESS COSTING

 Costs accumulated at the end of the period are only historical costs which are not of much use for
managerial control.
 It determining the cost of each process, work-in-progress is usually valued only on estimate basis which
leads to inaccurate results.
 When two or more dissimilar products are produced in the same process the related cost is divided among
products on the basis of some weight age assigned which often becomes unscientific.
 Average costs are not always accurate. It there is an error in cost determination, the cost per unit in process
affects the cost in the next process as well as the cost of work in progress and finished products.

COSTING PROCEDURE
Q: EXPLAIN STAGES IN PROCESS COSTING PROCEDURE. (2/5 MARKS)
Stages in process costing procedure:
The factory or concern is divided into distinct processes or operations and a separate account is opened
for each process (cost centre). All expenditure – of material, labour, direct expenses and overhead – are
charged to the process concerned. In brief:
 Materials:
It required for each process are drawn from store against material requisitions or bills of material
and debited to cost. When the materials are issued in bulk, the person-in-charge of the department has to
keep the account of material consumed. When the finished product of the one process becomes to raw
material of the next process, the account of the receiving process should be debited with the cost transfer, in
addition to the cost of additional material, if any.
 Labour:

66
 Wages paid to labourers and workmen who are engaged in particular processes are directly allocated
to the process. If workers are engaged in a number of processes, the wages paid may be apportioned on the
basis of time-keeping.
 Direct expenses:
Direct expenses such as depreciation, insurance, electricity, repair etc., are directly allocated to the
respective account.
 Overheads:
Rent, telephone, lighting, gas, water etc., which are some common expenses of one or more
processes may be apportioned to the various processes on suitable basis. Generally, these overheads are
recovered at predetermined rates or based on direct wages or prime cost.

DIFFERENCE BETWEEN PROCESS COSTING AND JOB COSTING

Q: EXPLAIN THE DIFFERENCE BETWEEN JOB COSTING AND PROCESS COSTING.
(5 MARKS)
Process costing Job costing
The production is a continuous flow of stock in Production is executed against specific order from
anticipation of demand customers
Since the production is a continuous flow, individual The different jobs may be independent of each other.
identity is lost
Since production is continuous there is always work in Jobs may or may not have opening or closing work in
progress at the beginning and closing progress.
Costs are accumulated for each process for a period Costs are accumulated for each job.
Costs are found out at the end of the cost period Costs are found on at the completion of the jobs.
Costs are transferred from one process to another Costs are not transferred unless there is surplus
production.
Production is a continuous process; through Since each unit is different, managerial attention is
standardized system; managerial control is easy needed.
Paper work is less. Since every job is costed separately, there is more
work
Since production is of standard products, they are Production is on the basis of individual specifications.
uniform; similarities are there Therefore each job is dissimilar to others.

NORMAL LOSS, ABNORMAL LOSS AND ABNORMAL GAIN

Q: WRITE SHORT NOTES ON: A) NORMAL LOSS OR NORMAL WASTAGE, B) ABNORMAL
LOSS, C) ABNORMAL GAIN, D) WASTAGE, E) SCRAP, F) SPOILAGE AND G) DEFECTIVES.
(2 MARKS)
 Normal loss or normal wastages:
This is called process losses. Because of the nature of raw material, some loss in inherent and is
unavoidable. This is known as normal wastage or normal loss. The percentage of such losses is anticipated
from past experience by the management losses of this type should be absorbed by good unit produced i.e.,
the cost units is charged to goods units-output. Any value realizable in the normal loss will be credited to
the process account.

 Abnormal loss:
In certain cases, it can be seen that the loss exceeds the predetermined loss. Any loss exceeding the
normal loss is called abnormal loss. Abnormal loss should not affect the normal cost of production. It is
caused by accidents, sub-standard material, carelessness, etc. Therefore, abnormal loss is valued just like
good units and transferred to separate account called abnormal loss account.
Formula:
Normal cost of normal production
Valus of abnormal loss = X Units of abnormal loss
Normal output

 Abnormal gain:
When the actual process loss or wastage is less than the determined percentage of normal loss or
wastage, the difference is known as abnormal gain or effective. Like abnormal loss, abnormal gain does not
67
 affect the cost of normal production. The abnormal gain is valued in the same manner as abnormal loss and
credited to abnormal gain account.
Formula:
Normal cost of normal output
Valus of abnormal gain = X Units of abnormal gain
Normal output
WASTAGES, SCRAP, SPOILAGE AND DEFECTIVE
 Wastage:
According to terminology of cost accounting, ICMA, London “Wastage is discarded substance
having no value”. Charles T Horngren says, “Wastage is material that is lost, evaporates or strings in a
manufacturing process or is a residue that has no measurable recovery value”. Thus, wastage has neither
recovery value nor has any use.

 Scrap:
Scrap is the incidental residue from certain types of manufacture usually of small amount and low
value recoverable without further processing. For instance, during production some raw materials are left
over in the form of dust, iron filing, odd pieces of timber, strips of cloth, cutting and pieces of leather etc. A
scrap is always visible.

 Spoilage:
Spoilage is defined as “that portion of raw material which has been spoiled or destroyed in the
manufacturing process but which can be used again in manufacture as raw material or sold as second”. It is
caused by defective production, parts cut to wrong size, chemical mix in wrong proportion etc. The spoiled
material cannot be repaired or re-conditional but has to be either re-used as raw material or disposed off by
sale.

 Defective:
Defectives are those units of finished products which are not up to the standard. These will be some
kind of imperfection in them. Defective arise due to inadequate equipment, inefficient supervision,
defective planning, poor workmanship etc.

JOINT PRODUCT COSTING- MEANING

Q: WHAT IS JOINT PRODUCT COSTING? (2 MARKS)
The term joint product is used when two or more products arise simultaneously in the course of
processing in such proportion and of such nature that no one can be regarded as the major product.

CHARACTERISTICS (OR) FEATURES OF JOINT PRODUCT

Q: EXPLAIN THE CHARACTERISTICS OF JOINT PRODUCT. (5 MARKS)
 They are produced from the same basic raw material.
 They are comparatively of equal importance.
 They are produced simultaneously from a common process.
 They require further processing after the point of separation.
 No product can be called as a major product.

METHODS OF APPORTIONMENT OF JOINT COSTS

Q: EXPLAIN THE METHODS OF APPORTIONMENT OF JOINT COSTS. (5/10 MARKS)
Accounting for joint products implies the assignment of a joint cost to each of the joint products. The
following methods are adopted as regards apportionment of total cost before separation point. They are:

 Average unit cost method:

In this method it is assumed that the total cost of the process is borne by all units equally. The total
process cost of pre-separation is divided by the total units produced when processes are common and
inseparable from products and expressed in common units i.e., weight or volume applicable to all product.
 Physical units method:

68
 In this method the joint costs are apportioned on the basis of some physical unit (raw material) i.e.,
in meters, tones, etc. Physical units are the units in which the basic raw material are measured and are
determinable at the point of separation of the joint products. This method cannot be applied when one
product is a gas and another is a liquid.
 Survey method:
This method is adopted after a technical survey of all factors involved in the production and
distribution of products. Percentages of point’s value are assigned to each product to denote its relative
importance and common costs are apportioned on the basis of total points.
 Market value method:
In this the joint costs are apportioned on the basis of the proportion of market price of the products.
Thus products having higher prices are charged with higher portion of the joint costs and products having
lesser price get lesser share of the joint costs. The different methods under market value are:
 At point of separation:
When the market value of each joint product is known at the point of separation the joint cost is
apportioned in the proportion of these values. The market value for the purpose may be either the market
value per unit or the amount of market value of the entire units of each joint product.
 After further processing:
Application of this method is easy as the selling price of each finished product will be readily
available, from the sale value of each joint product, the post split off cost of respective product is deducted
and on the basis of values obtained, the joint cost is apportioned.
 Net realizable value (or) reserve cost method:
Under this method, estimated net profit, direct selling & distribution expenses and post separation
process costs are deducted from the sales values of each finished joint product.

BY-PRODUCT COSTING – MEANING

Q: WHAT IS BY-PRODUCT COSTING? (2/5 MARKS)

A by-product is a secondary or subsidiary product which emerges as a result of manufacture of the main
products. It is the residual material which is incidentally obtained from the production of a major product and
has only relatively small value.

DEFINITION:
Koyhler defines a by-product as, “a secondary product obtained during the course of manufacture
having relatively small importance as compared with that of the chief product or products”.
The term is often used to denote any products of relatively small value that are produced simultaneously
with products of greater value. By-product may be those which can be sold in the same form as originally
produced or which should undergo further processing before sale.

FEATURES OF BY-PRODUCT

Q: WHAT ARE THE FEATURES OF BY-PRODUCT COSTING? (5 MARKS)

 They are produced incidental to the main product.
 Their value is very low compared to that of major product.
 They can be sold immediately after separation before undergoing further processing.
 They emerge from the same basic raw material.
 They are produced simultaneously from a common process.

METHODS OF ACCOUNTING FOR BY-PRODUCT

Q: EXPLAIN THE METHODS OF ACCOUNTING FOR BY PRODUCT?

By-product can be two types – certain products need further processing after separation. By-product are
produced along with main products and the same are comparatively of less value.
 Non cost method: (sale value method)
 Other income method:

69
 The value realized by the sale of by-product is treated as other or miscellaneous income because of
negligible value. The stock of by-product is valued at zero value of balance sheet purposes.
 Crediting sales value of the process account:
Under this method the value of by-products is credited to the process accounting, so that the cost of
the main product is reduced. For balance sheet purposes, the unsold stock of by-product carries zero value.
 Credit to sale value less selling and distribution expenses:
In certain cases, by-product need selling and distribution expenses and these expenses are deducted
from the sale value. The net amount is credited to process account.
 Crediting actual cost to the process:
In case the by-product need further processing before sale, the amount is ascertained and deducted
form sale value. The net amount is credited to process account.

 Cost method:
 Replacement cost:
Under this method, the by-product are utilized in the same industry as raw material and valued at the
market price, the process account is credited to the value.
 Standard price:
In this method, the by-products are valued at standard price (predetermined cost) and credit is given
to the process account.
 Apportionment on suitable basis:
Where by-products are prominent, they will be treated as joint products and as such joint cost is to
be apportioned.

Q: WHAT DO YOU UNDERSTAND BY OPERATING COSTS? (2/5 MARKS)

Operating costing is the cost of rendering services. It is the cost of producing and maintaining a service.
Industries using operating costing do not produce tangible product; useful service like hospitals, canteens etc.
There is internal as well as external service. Service rendered in the same organization is known as internal
service e.g., repairs and maintenance department or canteen in a factory. Services rendered to consumer are
known as external service e.g., hospital, transports, power generation, etc. The operating cost per unit is
calculated by dividing the total cost by the number of service units produced or rendered.

Q: DEFINE OPERATING COSTING. (2 MARKS)

According to Wheldon, “Operating costing actually is unit costing as applied to the cost of services”.
As per ICMA, “Operating costing is that form of operation costing which applies where standardized services
are provided either by an undertaking or by a service cost centre within an undertaking”.

Q: EXPLAIN THE CHARACTERISTICS FEATURES OF OPERATING COSTING. (5 MARKS)

Operating costing has special application to undertaking which provide services to the community as a
whole rather than manufacture of product. Such undertakings where operating is applied, generally posses the
following characteristics:
 There undertakings render unique service to their customer.
 They invest large proportion of their capital in fixed assets.
 The requirement of working capital comparatively less.
 The operating cost is divided into fixed and variable and they are of utmost importance.

Q: WHAT DO YOU MEAN BY COST UNIT? (2 MARKS)

Cost unit:
It is a unit of product, service or time in relation to which costs may be ascertained. Job is a cost unit
which consists of a single order. Batch is a cost unit which consists of a group of identical items. Cost unit is a
base for measurement of cost. Cost unit are of two types namely single and composite.

Q: WHAT ARE THE TYPES OF COST UNITS? (5 MARKS)

 Simple cost units:
In simple cost unit the unit is obvious, for example, per student, per mile, per bed etc.
70
 Composite cost unit:
In composite cost unit, more than one unit are combined, for example:

Name of the services / undertaking Cost unit

Passenger transport Per passenger km.
Goods transport Per tone, per km
Hospital Per patient bet, patient day or week
Electricity supply Per kwh
Canteen Per man show
Gas work 1000 cubic feed produced
Steam production 1000 lbs. raised
Lodge Per person per day

Q: WHAT IS THE MEANING OF TRANSPORT COSTING? (2 MARKS)

It is very essential to differentiate the costs of different expenses head. In a broad way there are two
types – fixed (standing costs and operating and running charges.

Q: STATE THE OBJECTIVES OF TRANSPORT COSTING. (2/5 MARKS)

 It helps in controlling, operating and maintenance cost.
 Cost of using own vehicle and hired vehicle can be compared.
 Operating costs of different vehicles can be compared and thus efficiency can be improved.
 Comparison of oil consumption and time taken for a trip with other trips is possible.
 Proper apportionment of costs to different department which are the service is possible.
 It provides information for giving quotation and fixing the rates.

SIMPLE PROCESS ACCOUNTS

PROBLEM: 1
Calculate the cost of each process and total cost of production from the data given below:
Particulars Process I Process Process III
II
Materials 2,250 750 300
Labour 1,200 3,000 900
Direct expenses 500 500 500
Work 1,890 2,580 1,870
overheads
Other indirect expenses of `1,275 should be apportioned on the basis of wages.

PROBLEM: 2
The manufacture of a product ‘X’ requires two distinct processes, process I and Process II. On completion, the
product is transferred from process II to finished stock. The following relate to the product for a particular
period.
Particulars Process Process II
I
Direct materials 8,000 2,000
Direct labour 6,000 7,000
Direct expenses 4,000 3,000
Production overheads 2,000 1,000
Production during the period was 1,000 units. There was no stock of raw materials of work-in-progress either
at the beginning or at the end of the period. Show the process accounts until the final process is completed.

PROBLEM: 3
71
Product A passes through three distinct processes. The product is transferred to finished stock after the third
process. Prepare the process accounts from the information given below:
Particulars Process I Process Process III
II
Direct 4,000 600 550
materials 1,500 1,600 900
Direct labour 650 400 --
Direct expenses
Total production overhead during the period were `6,000. It is apportioned to different processes on the basis of
150% of direct labour. There was no opening or closing stock. Production during the period was 200 units.

PROBLEM: 4
Calculate the cost of each process and total cost of production from the data given below:
Particulars Process I Process Process III
II
Materials 1,125 375 150
Labour 600 1,500 450
Direct expenses 250 250 250
Work 945 1,290 935
overheads
Other indirect expenses of `638 should be apportioned on the basis of wages.

PROBLEM: 5
The manufacture of a product ‘Y’ requires two distinct processes, process I and Process II. On completion, the
product is transferred from process II to finished stock. The following relate to the product for a particular
period.
Particulars Process I Process II
Direct materials 4,000 1,000
Direct labour 3,000 3,500
Direct expenses 2,000 1,500
Production overheads 1,000 500
Production during the period was 500 units. There was no stock of raw materials of work-in-progress either at
the beginning or at the end of the period. Show the process accounts until the final process is completed.

NORMAL LOSS WITH SCRAP VALUE

PROBLEM: 6
Samson & co., produces a product through two processes ‘R’ and ‘S’. The following details pertaining to
process ‘R’ for January 1996 are available.
Inputs Rs
Material (500units) 10,000
labour 8,000
Indirect expenses 7,000
Normal loss in the process is estimated at 5% of the input which possesses a scrap value of Rs. 31per unit.
Prepare the process account.

PROBLEM: 7
Sakthi industries processes a patent material used in construction of buildings. The material is produced in
three grades - soft, medium and hard.

Particulars Process I Process II Process III

Raw material used (tones) 1,000 -- --
Cost per tonne `200 -- --
Manufacturing wages and expenses `87,500 `39,500 `10,710
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 Weight lost (% of input of the 5% 10% 20%
process) 50 tonnes 30 tonnes 51 tonnes
Scrap (sold at `50 per tonne) `350 `500 `800
Sale price per tonne
Management expenses were `17,500 and selling expenses `10,000. Two-thirds of the output of process I and
one-half of the output of process II are passed on the next process and balance is sold. The entire output of
process III is sold. Prepare the process account and a statement of profit.

PROBLEM: 8
Aparna Chemicals Ltd., is engaged in the manufacture of product J which passes through three consecutive
processes X, Y and Z. From the following particulars, prepare process cost accounts showing the cost of the
output and the cost per unit at each stage of manufacture.
Particulars Process X Process Y Process Z
Direct wages `6,400 `12,000 `29,250
Factory overheads `5,600 `5,250 `6,000
Raw materials consumed `24,000 -- --
Production (gross) 37,000 units -- --
Wastage 1,000 units 1,500 500 units
Opening stock (units from previous -- units 16,500 units
process) -- 4,000 5,500 units
Closing stock (units from previous process) units
1,000
units
The value at which units are to be charged to process Y and Z is the cost per unit of Process X and Y
respectively.

ABNORMAL LOSS – ONE PROCESS

PROBLEM: 9
In process A, 100 units of raw material were introduced at a cost of `1,000. The other expenditure incurred by
the process was `600. Of the units introduced 10% are normally lost in the course of manufacture and they
possess a scrap value of `3 each. The output of process A was only 75 units. Calculate the value of abnormal
loss.
PROBLEM: 10
From the following information, prepare process II account
Transfer from process I 1,000 units at `4 per
Labour cost unit
Materials `1,000
Production overhead `3,500
`700
Normal process loss has been estimated at 10% of the input, which can be sold for `2 per unit. Actual
production realized was 850 units.
PROBLEM: 11
In process I, 600 units were introduced at `20 per unit. The normal process loss is 20% of the input. The scrap
is sold at `3 per unit. Labour and overhead expenses incurred in the process amounted to `1,320. 500 units
were completed and transferred to finished stock account. You are required to show the process account and
abnormal gain account.

ABNORMAL LOSS AND GAIN –TWO PROCESSES

PROBLEM: 12
Make out necessary account from the following details:
Particulars Process A Process B
Materials 30,000 3,000
Labour 10,000 12,000
Overheads 7,000 8,600
Input (units) 20,000 17,500
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 Normal loss 10% 4%
Sale of waste per `1 `2
unit
There was no opening or closing stock or work in progress. Final output from process B was 17,000 units.

PROBLEM: 13
Make out necessary account from the following details:
Particulars Process X Process Y
Materials 60,000 6,000
Labour 20,000 24,000
Overheads 14,000 17,200
Input (units) 40,000 35,000
Normal loss 10% 4%
Sale of waste per unit `1 `2
There was no opening or closing stock or work in progress. Final output from process B was 34,000 units.

PROBLEM: 14
The product of a manufacturing concern passes through two processes A and B and then to finished stock. In
each process, normally, 5% of the total weight is lost and scrap is 10% which from process A and B realizes `80
per ton and `200 per ton respectively. The following are the figures relating to both the processes.
Particulars Process A Process B
Materials in tons 1,000 70
Cost of material per ton `125 `200
Wages `28,000 `10,000
Manufacturing expenses `8,000 `5,250
Output in tons 830 780
Prepare process cost accounts showing cost per ton of each process. There was no stock or work-in-progress in
any process.

PROBLEM: 15
The product of Vijay Industries passes through three distinct processes – A, B and C. It is ascertained that the
normal loss in process will be: A – 2%; B – 4%; C – 10%. In each case, the percentage of loss is computed on
the number of units entering the process concerned. The loss of each process has a scrap value. The loss of
process A, B and C is sold at `1, `2 and `3 respectively.
Particulars Process A Process B Process C
Materials 6,000 4,000 9,000
Labour 8,000 6,000 3,000
Manufacturing expenses 1,520 2,246 1,870
2,000 units have been issued to process A at a cost of `10,000. The output of each process has been as under:
Process A – 1,950; Process B – 1,900; Process C – 1,600. There is no work in progress in any process. Prepare
1) Process account, 2) Normal loss account, 3) Abnormal loss account and 4) Abnormal gain account.

PROBLEM: 16
The product of a company passes through two processes to completion known as A and B. from past
experience it is ascertained that loss is incurred in each process as:
Process A-2% process B-5%
In each case the percentage of loss is computed on the number of units entering the process concerned.
The loss of each process possesses a scrap value. The loss of processes A and B is sold at Rs.5 per 100
units.
The output of each process passes immediately to the next process and the finished units are passed into
stock.

Particulars Process A Process B

Material consumed 6,000 4,000
Direct labour 8,000 6,000

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 Manufacturing expenses 1,000 1,000

20,000 units have been issued to process A at a cost of Rs. 10,000.thr output of each process has been as under:
Process A 19,500; Process B 18,800
Prepare process accounts.

PROBLEM: 17
A product passes through two processes and then to finished stock. The normal wastage of each process is as
follows: Process A 3% and process B5%.
The wastage of process A was sold @ rs.5 per unit and that of process B at 10per unit 20,000 units were
introduced into process A at the beginning of january 1998 at a cost at Rs.40 per unit.
Other expenses were as under:

Particulars Process A Process B

Sundry materials 40,000 60,000
Wages 2,00,000 3,20,000
Manufacturing expenses 30,000 28,500

The output of process A was 19,000 units and that of process B 18,200 units. Prepare the process accounts,
normal loss account, abnormal loss account and abnormal gain account.

BY-PRODUCT
PROBLEM: 18
In the manufacture of main product, 100units of a certain by-product were producted. The market value of the
by-product was rs.40 per unit. The by- product required further processing costs a mounting to rs. 1,500 and
selling and distribution overheads amounting to Rs. 250 are incurred. Calculate the amount to be credited to the
process account in respect of the by-product.

PROBLEM: 19
A factory is engaged in the production of a chemical X and in the course of its manufacture a sby- product Y is
produced, which after a separate process has a commercial value. For the month of January 2001, the following
are the summarized cost data:

Particular Separate expenses

Joint expenses
s X (`) Y (`)
Materials 19,200 7,360 780
Labour 11,700 7,680 2,642
Overheads 3,450 1,500 544

The output for the month was 142 tonnes of X and 49 tonnes of Y and the selling price of Y averaged Rs. 280
per tonne.
Assuming that the profit of Y is estimated at 50% of the selling price, prepare an account showing the cost of X
per tonne.
PROBLEM: 20
In the manufacture of main product, 200units of a certain by-product were producted. The market value of the
by-product was rs.40 per unit. The by- product required further processing costs a mounting to rs. 3,000 and
selling and distribution overheads amounting to Rs. 500 are incurred. Calculate the amount to be credited to the
process account in respect of the by-product.

OPERATING COSTING
PROBLEM: 21
From the following information, calculate total kms and total passenger kms. No. of busses – 5; Days operated
in a month – 30; Trip made by each bus – 4; Distance of route – 20 kms long (one side). Capacity of the bus is
50 passengers. Normal passengers can travel 75% of capacity.

PROBLEM: 22
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From the following information, calculate total kms and total passenger kms. No. of busses – 10; Days
operated in a month – 30; Trip made by each bus – 4; Distance of route – 20 kms long (one side). Capacity of
the bus is 50 passengers. Normal passengers can travel 75% of capacity.

PROBLEM: 23
Mr. subramayam furnishes you the following data and wants you to compute the cost per running km. of
vehicle A.
Particulars `
Cost of vehicle 2,50,000
Road license fee p.a. 800
Supervisor’s salary p.a. 2,700
Driver’s wages per hour 4
Cost of fuel per liter 12
Repairs and maintenance per km. 2
Tyre cost per km. 1
Insurance p.a. 700
Garage rent p.a. 1,300
Kilometer run per liter 20
Kilometer run during the year 15,000
Estimated life of vehicle kms. 1,00,000
Tonnes per km(average) 6

They Charge interest 5% P.A on the cost of vehicle. The vehicle runs 20 kms per hour on an average.
PROBLEM: 24
A transport service company is running five buses between two towns which are 50kms. Apart seating capacity
of each bus is 50 passengers. The following particulars were obtained from their books for April 1998

Particulars `
Wages of drives, conductors, etc. 24,000
Salaries of office and supervisory staff 10,000
Diesel, oil, etc. 35,000
Repairs and maintenance 8,000
Taxes and insurance 16,000
Depreciation 26,000
Interest and other charges 20,000

The actual passengers carried were 75% of the capacity. All the buses run all the day in the month. Each bus
made one round trip per day. Find out the cost per passenger Kilometer.
PROBLEM: 25
A transport service company is running five buses between two towns which are 50kms. Apart seating capacity
of each bus is 50 passengers. The following particulars were obtained from their books for April 1998

Particulars `
Wages of drives, conductors, etc. 48,000
Salaries of office and supervisory staff 20,000
Diesel, oil, etc. 70,000
Repairs and maintenance 16,000
Taxes and insurance 36,000
Depreciation 52,000
Interest and other charges 40,000
The actual passengers carried were 75% of the capacity. All the buses run all the day in the month. Each bus
made one round trip per day. Find out the cost per passenger Kilometer.

PROBLEM: 26

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Mr. Ram Ltd., has started transport business with a fleet of 10 taxies. The various expenses incurred by him are
given below:
Particulars `
Cost of each taxi 75,000
Salary of office staff 1,500 p.m.
Salary of garage staff 2,000 p.m.
Rent of garage 1,000 p.m.
Driver’s salary (per taxi) 400 p.m.
Road tax and repair per taxi 2,160 p.m.
Insurance premium at 4% of cost
p.a.

The life of taxi is 3,00,000 km and at the end of which it is estimated to be sold at `15,000. A taxi runs on an
average 4,000 km per month of which 20% it runs empty. Petrol consumption is 9 km. per litre of petrol costs
`6.30; per litre oil and other sundry expenses amount to `10 per 100 km. Calculate the effective cost of running
taxi per km. If the hire charge is `1.80 per Km, find out the profit he may expect to make in the first year of
operation.

PROBLEM: 27
Laxmi Travels, a transport company is running a fleet of six buses between two towns 75 kms. apart. The
seating capacity of each bus is 40 passengers. The following particulars are available for the month of April 1985.
Particulars `
Wages of drives, conductors, etc. 3,600
Salaries of office and supervisory staff 1,500
Diesel, oil, etc. 10,320
Repairs and maintenance 1,200
Taxes and insurance 2,400
Depreciation 3,900
Interest and other charges 3,000
The actual passengers carried were 80% of the capacity. All the buses run all the day in the month. Each bus
made one round trip per day. Find out the cost per passenger Kilometer.

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