Cost accounting book of 3 rd sem mba @ bec doms

1. Cost Accounting
BSPATIL 1

2. Syllabus
Paper 3.3 Cost Accounting
Cost Accounting – Elements of Cost + Cost Concepts
Accounting and Control of Material Cost.
Labour – Wage payment and incentive – Labour Cost Control – Labour Turnover.
Overhead – Classification – Allocation, Appointment and Absorption of overhead
Process Costing – Process losses – inter-process profits.
Standard costing – Variance analysis
Cost Ledgers- Reconciliation of cost and financial profits – Integral Accounting
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3. Contents
Lesson: 1 Introduction of Cost Accounting
Definition – Cost Concepts – Element of Cost – Installation of Costing System
Lesson: 2 Material Cost
Nature – Purchasing Functions – Stores Control – Stock Levels – EOQ – Pricing or
Material Issues – ABC-Analysis – Material houses.
Lesson: 3 Labour Cost
Nature – Wage Policy – Wage Payment methods – Incentive schemes, Leson turnmen.
Lesson: 4 Overhead Cost
Nature - Classification – Allocation – Apportionment of overhead cost – Absorption
of overhead: methods, Machine Hom Rate method.
Lesson: 5 Job Costing and Batch Costing
Nature – features – Cost Sheet preparation – Utilities – Limitations.
Lesson: 6 Contract Costing
Features – Types or Contract
Lesson: 7 Process Costing
Simple Process Costing – Process with Normal and abnormal causes – Inter process
profit
Lesson: 8 Standard Costing and Variance Analysis
Definition – Uses and Limitations – Material Cost Variance – Labour Cost Variance –
Overhead Cost Variance and Sales Variance
Lesson: 9 Cost Ledger Accounting
Nature – Control Accounts and its Uses – Preparation of Cost Ledger Account
Lesson: 10 Integral Accounting
Nature – Uses – Preparation of Integral Accounts
Lesson: 11 Reconciliation of Cost and Financial Accounts – Need for Reconciliation – Steps in
reconciliation – Preparation of Reconciliation Statement.
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4. Lesson: 1
INTRODUCTION OF COST ACCOUNTING
Cost Accountancy
“It is the application of costing and cost accounting principle, method 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 for the
purpose of managerial decision – making”.
The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its
purposes are Cost-control and Profitability – ascertainment. It serves as an essential
tool of the management for decision – making.
Cost Accounting
“The process of accounting for cost from the point at which expenditure is
incurred or committed to the establishment of its ultimate relationship with cost
centres and cost units. In its widest usage it embraces the preparation of statistical
data, the application of cost control methods and the ascertainment of the
profitability of activities carried out or planned” Cost accounting means such as
analysis of accounting and other information as to enable management to know the
cost involved in each activity together with its significant constituent elements in
order to arrive at proper decisions.Cost accounting provides management with cost
data relating to products, processes, jobs and different operations in order to control
the costs and maximize the earnings. It play a vital role in all the business activities.
Definition of Cost Accounting
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 these from for the
purpose of managerial decision making.
Objects of Cost Accounting
1. To serve as a guide to price fixing of products.
2. To disclose sources to wastage in various operations of manufacture.
3. To reveal sources of economy in production process.
4. To provide for an effective system of stores and material.
5. To measure the degree of efficiency of the various departments or units of
production.
6. To provide suitable means and information to the top management to
control and guide the operations of the business organisation.
7. To exercise effective control on the costs, time and efforts of labour,
machines and other factors of production.
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5. 8. To compare actual costs with the standard costs and analyse the causes of
variation.
9. To provide necessary information to develop cost standards and to
introduce the system of budgetary control.
10.It enables the management to know where to economize on costs, how to
fix prices, how to maximize profit and so on.
TECHNIQUES AND METHOD OF COSTING
The types and techniques of costing are as follows:
1. Historial Costing:
‘The ascertainment of costs after they have been incurred’ Historical costs are,
therefore, ‘postmortem’ costs as under this method all the expenses incurred on the
production are first incurred and them the costs are ascertained.
2. Standard Costing:
‘The preparation and use of standard costs, their comparison with actual costs and
the analysis of variance to their causes and points of incidence’.
Here the standards are first set and then they are compared with actual performances.
The difference between the standard and the actual is known as the variance. The variances
are analyzed to find out their causes and also the points or locations at which they occur.
3. Marginal Costing:
‘The ascertainment of marginal costs and of the effects on profit of changes in
volumes or type of output by differentiating between fixed costs and variable costs’.
The fixed costs are those which do not change but remain the same, with the
increase or decrease in the quantum of production. The variables costs are those which do
change proportionately with the change in quantum of production.
The marginal costing takes into account only the variable costs to find out ‘marginal
costs’. The difference between Sales and Marginal costs is known as ‘Contribution’ and
contribution is an aggregate of Fixed costs and Profit/Loss. So the fixed costs are deducted
from the contribution to find out the profits. Marginal costing is a technique to ascertain the
effect on profits. Marginal costing is a technique to ascertain the effect on profit by the
change in the volume of output or by the change in the type of output.
4. Direct Costing:
The practice of charging all direct cost to operations, process or products, leaving all the
indirect costs to be written off against profits in the period in which they arise
5. Absorption Costing
‘The practice of charging all costs, both variables and fixed, to operations, processes or
products.
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6. This is the traditional technique as opposed to Marginal or Direct costing techniques.
Here both the fixed and variables cost are charged in the same manner.
Methods of Costing
The methods of costing can be divided into three main groups:
1. Job Costing;
2. Process Costing; and
3. Farm Costing.
1. Job Costing: The job costing methods are applicable where the unit of manufacture
is one and complete in itself. They include printers, job foundries, tool manufactures,
contractors, etc. the following methods are included in Job Costing:
(i) Contract Costing: This method if applied in undertakings erecting buildings or
carrying out constructional works, e.g., House buildings, ship building, Civil
Engineering contracts. Here the cost unit is one and completed in itself. The cost unit
is a contract which may continue for over more than a year. It is also known as the
Terminal Costing, since the works are to be completed within a specified period as
per terms of contract or agreement executed by the contractor and contractee.
Contracts can be differentiated from fobs in as much as the contracts jobs are
carried out outside the factory and generally are of a long-term while jobs are
carried out inside the factory and are of a short duration. If an order complete
in itself and meant only for the person who has placed the order, this
job-order is executed inside the press and the completion of the order takes a
short time as against the contract which may take years.
(ii) Batch Costing: In this method, a batch of similar or identical products is
treated as a job. Here the unit of cost is a batch of group of products, costs are
collected and analyzed according to batch numbers and the costs are
ascertained batch wise. This method is applied in pharmaceutical industries
where medicines or injections are manufactures batch wise or in general
engineering factories producing components in convenient batches.
1. Process Costing: Process costing method is applicable to those industries
manufacturing an number of units of output requiring processing. Here an article has
to undergo two or more processes for reaching the stage of finished goods and
succeeding process till completion.
Classification of Cost
The cost-classification is the process of grouping costs according to their
characteristics. The cost can be classified into the following:
1. According to elements;
2. According to Functions or Operations;
3. According to Nature or Behaviour,
4. Accounting to Controllability,
5. According to Normality,
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7. 6. According to Relevance to decision-making and Control.
According to Elements: The cost is classified into i) Direct Cost, and ii) Indirect Cost
according to elements, viz., Materials, Labour and Expenses, the description of which
occurs in the earlier pages of this chapter.
According to Functions: the cost is classified into the following:
i) Production Cost or Manufacturing Cost,
ii) Administration Cost,
iii) Selling Cost, and
iv) Distribution Cost,
A brief description of each these items are given below:
i) Production Cost is ‘The cost of sequence of operation which begins with supplying
materials, labour and services and ends with primary packing of the product’.
It is also known as Manufacturing of Factory Cost.
ii) Administration Cost is “The Cost of formulating the policy, directing the organisation
and controlling the operations of an undertaking, which is not related directly to a
production, selling, distribution, research or development activity or function.”
Administration Cost comprise office and Administration expenses.
iii) Selling Cost is “The cost of seeking to create and stimulate demand (sometimes
termed ‘marketing’) and of securing order.”
It is also known as Selling expenses or Selling overheads which include all the
expenses of Selling Department.
iv) Distribution Cost is “The cost of sequence of operations which begins with making
the packed product available for dispatch and ends with making the
re-conditioned returned empty package, if any, available for re-use”.
It is known as Distribution expenses or overheads which include expenses like
packing, warehouse expenses, cost of freight, shipping charges and also the
expenses of re-conditioning the returning empty packages for using them again.
According to Nature or Behaviour: Cost can be classified into
i) Fixed Cost ii) Variable Cost, and iii) Semi-Fixed for Semi-variable Cost.
i) Fixed Cost is “A cost which tends to be unaffected by variations in volume of output.
Fixed costs depend mainly on the effluxion of time and do not vary directly with
volume of rate of output. Fixed Costs are sometimes referred to as period costs in
systems of direct costing.” Fixed costs or Fixed expenses are those expenses
which do not change with the increase or decrease in the quantum of production
but remain stable. They are period costs, e.g., Rent of Building, Salaries etc.
ii) Variable Cost is “A cost which tends to vary directly with volume of output, Variable
costs are sometimes referred to as direct costs in systems of direct costing.”
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8. Variable costs or expenses are those which increase in direct proportion with the
increase in production or which decrease in direct proportion with the decrease in
production, e.g., Direct Materials, Direct Labour, Power, Fuel etc.
iii) Semi-fixed or Semi-variable cost is “A cost which is partly variable.” This is a cost
with changes but not in direct proportion to the increase or decrease in the
production-output, e.g., Repairs and Maintenance, Salary of supervisors etc.
According to controllability: The cost can be divided into:
i) Controllable Cost, ii) Uncontrollable Cost.
i) Controllable Cost: This is a cost which can be influenced by the action of a specified
member of an undertaking. The organisation is divided into departments or
responsibility centres each managed by a Head. The costs of a particular
department or centre re guided by the person-in-charge of the department. The
costs which can be controlled by a ‘specified member’ who is generally an
important link in the management are the controllable costs. they Head of a
cost-centre or a department ahs control over variable costs only which include
Prime cost and other variable overheads. So the controllable costs are the variable
costs.
v) Uncontrollable Costs: it is a cost which cannot be influenced by the action of a
specified member of an undertaking. Uncontrollable costs are generally the
Fixed costs, the control of which does nto lie within the province of a member
of the undertaking. The change in Fixed costs is a mater to be decided at the
top level of the management depending upon the policy of the undertaking.
Another example of he uncomtrollable cost is where the cost of one
department is shared by the other department for reason that the other
department is taking the benefit of services of the department. Suppose, the
cost of Power departments is shared by the Machine Department, the cost of
this share is uncontrollable as it has no control over the cost of the other
department, viz., the Power Department.
According to Normality:
The cost is classified into i) Normal cost, and ii) Abnormal cost
i) Normal Cost: It is the cost at a given level of output in the condition at which that
level of output is normally attained.
ii) Abnormal cost: it is a cost which is beyond normal cost.
According to relevance to decision-making and Control:
The costs classified on this basis are the following
i) Shut-down Cost: A cost which will still be required to be incurred even though a plant
is closed or shut-down for a temporary period, e.g., the cost of rent, rates,
depreciation, maintenance etc., is known as shut-down cost.
ii) Shun Cost: A cost which has been incurred in the past or sunk in the past and is not
relevant to the particular decision-making is a sunk cost. If it is decided to replace
the existing plant; the written down book value of the plant less the sale value of
the existing plant, is a Sunk a Irrevocable cost.
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9. iii) Opportunity Cost: “The net selling price, rental value or transfer value which could be
obtained at a point in time if a particular asset or group of assets were to be sold,
hired, or put to some alternative use available to the owner at that time” is the
opportunity cost. The cost which are related to the sacrifice made or the benefits
foregone are opportunity costs. to take an example, if a part of the factory
building has been let out on rent and now we want to use that portion for
installing a plant, we would naturally lose the rent that we used to get. So the loss
of rent is the opportunity which would arise due to putting the part of that factory
building to an alternative use available to the owner, and this cost should be kept
in view while installing the plant.
iv) Imputed cost: it is hypothetical cost required to be considered to make costs
comparable. If the owner of the factory charges rent of the factory to the cost of
production to make cost comparable with that of those undertakings which run
production in rented factories, it is an Imputed cost as the rent has actually not
been paid. Some is the case with charging Interest on one’s own capital.
COST-CENTRE AND COST-UNIT
Cost are ascertained according to Cost Centres or Cost Units.
Cost-centre
A Cost-Centre is a very wide term and includes the Productions. Department Processes,
Work orders, Service Department, Operations, Machine Centers, Area or regions of sales,
Warehouses, Persons, etc., of which the cost is to be ascertained. A Cost-Centre can be
classified into the following four types:
1. Impersonal, 2. Personal, 3. Operation, 4. Process.
For manufacturing operations, the cost centres may be Production cost centers, i.e., the
Production Departments engaged in producing, or the Service cost-centres, i.e., the Service
Departments which help the production work e.g., Store, Power Dept. Internal Transport
Dept., Repairs and Maintenance Dept., etc.,
For sales operations, the cost-centres, all the machine or the persons operating those
machines are brought together under one cost-centre for determination and control of costs.
where the work is carried on through processes, each process is a cost centre. A machine or
a group of machines can also be cost-centre. The Cost Centres are very useful for analysis,
ascertainment and control of costs.
Cost Unit
A Cost Unit is a unit of quality of product, service, or time (or a combination of these) in
relation to which costs may be ascertained or expressed.
Job is a cost unit which consists of a single order (or contract).
Batch is a cost unit which consists of a group of identical items which maintains its identity
throughout one or more stages of production.
Product Group is a cost unit which consists of a group of similar products.
Thus, cost unit is a sub-division into proper nomenclatures attributable to a unit of
measurements of cost. Cost Units are of two types: 1) Single. 2) Composite. The examples of
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10. Single Cost unit are-per tone, per meter, per kilogram etc., and the examples of composite
units are-per passenger-kilometer, per tone-kilometer etc.
INSTALLATION OF COSTING SYSTEM
The need and importance of the installation and the organisation of a good system of cost
accounting are being increasingly realized presently all over the business versatility. The
common experience of enthusiastic youths climbing the business – tree and falling mid-way
without even collecting the leaves owes to the ignorance of he use installation and
organisatoin of accosting system, and to the infatuation that the profits could be earned
without it. A good system is the key-point governing, the mechanism of an enterprise in
the field of cost control, ascertainment of profitability, and managerial decision-making.
Installation of a cost system is not an expense but an investment as the rewards are much
greater than the expenses incurred. The cost system is for the business and not the
business for a system of cost. Therefore, the system has to be so designed as to meet the
specific needs of the enterprise.
A) General Consideration for installing Costing System
The general considerations to be observed in installing a costing system are as follows:
The Objective: Whether the objective of installing the costing system is limited to a
specific area, e.g. material management, or fixing selling price. Or to arrive at a
certain managerial decision; or the object is to install the system for covering all the
aspects of cost affecting the business. The approach to install the system will be
dependent on its objectives.
The Area of Operation: Having decided the objective, the areas of operation of the
system are to be studied, by which the management can be best benefited. If
production is slack, attention will have to be paid to increase it; if production is good
but the sales are receding, study will be made to increase the sales and action taken
according to the results of study and analysis. Such areas which require immediate
attention are to be carved out on priority basis to be handled by the cost system,
The Organisation of the Business: No system of cost installation would succeed until
the organisation structure of the business is taken into account. The organizational
part would help to determine the scope of working and improvement. If the interests
of management call for certain minor changes in the organizational structure, to its
advantage, the same may have to be done.
The Conception & Reception of the Idea: The idea of the installation of the cost
system is to be placed before the staff and the workers in a manner that it is well
received and not objected to on flimsy grounds. The success of the system would
depend on the cooperation of he persons engaged in the enterprise, and the
cooperation will be forth coming only if the idea and plans are well conceived and
received. The benefits of introducing the system to all the sections should be well
explained.
Collection of Data & Prompt Information: The cost data works as a base for
decision-making. There should be evolved a proper system for the collection of the
required cost data and information promptly. Secondly, there should be a system to
verify the correctness of the data supplied, otherwise the conclusions drawn would be
wrong and time spent in its working would go waste.
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11. Cost Records & Cost Books: The maintenance of cost records and cost books depends
on the size and nature of the business, but the basic requirements. The manner in
which the financial accounts could be interlocked into an integral accounting system
has to be studied and worked out. Decision has to be taken if two separate set of
books-one for financial accounts and other for cost accounts-have to be maintained
and thereafter the results are to be reconcile. Proper books and records are to be
kept and maintained to meet the requirements of either of the two situations
mentioned above.
Control system for the Elements of Cost: System would have to be devised for
recording and controlling costs of materials, labour and overheads, in accordance
with costing principles and procedures.
Type and Method of Costing: The choice of method of costing would depend on the
nature of production, e.g., Job Cost method or the Process Cost method. For cost
control, standard costing along with Budgetary control may have to be selected and
applied. Similarly, for decision making, Marginal and Differential costing techniques
may be found useful. Preparations for the application of the particular method and
technique/type should be made initially.
Responsibility Accounting: Responsibility accounting is a technique of cost control by
delegating, etc., known as responsibility centres. Its has to be judged whether a
particular official who had been assigned a particular function, has implemented the
same or not within the time’ allotted to him, or not, and thus the responsibility has
got to be fixed for failure-action on individual persons, for the sake of control of cost.
For this purpose, a system of responsibility accounting should be evolved.
B) Specific considerations for installing costing system
The specific considerations as distinct from general considerations to be kept in view while
installing a cost system are as follows:
Size and Nature of Business: In a business of big size, a detailed cost system is
necessary while in a small business, the system should be within the requirements so
that the expenses on the installation and its working may not out-weigh the utility.
The cost system is good for business engaged in manufacturing or in
service-rendering concerns but for others. Even in production enterprise like colliery
where the production costs are all direct costs, the financial where the production
costs are all direct costs, the financial accounts may be so designed as to obviate the
need of any cost system, unless otherwise called for.
Products: the nature of product determines the method of costing to be applied. If
the material content of the product is more valuable, the material cost records need
be kept in comparatively more elaborate manner so as to make material cost control
effective. Same is the position with regard to labour and overhead.
Organisatoin: The organizational set up for a costing system should be modeled that
the control part is exercised by the Cost Accountant, as such, the present
organizational set up of the costing department need close study to suggest
necessary changes.
Functional study: The functional divisions of an undertaking based on cost are a)
Manufacturing, b) Administration, and c) Selling & Distribution. A study of the present
working of the different departments in necessary to suggest improvements.
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12. C) Principles for Smooth Working
The following principles should be kept in mind while introducing the cost system:
The system should be simple and easy to operate.
The system should be flexible, so that it may be expanded or contracted per needs of
the business.
The existing pattern should be disturbed only as little as may be considered desirable.
The desired changes be introduced gradually and not in haste.
Confidence be created by the Cost accountant in the minds of management and
Executives regarding the utility of the system, so as to avoid unnecessary criticism
And to obviate obstacles.
D) Line of Action
The following line of action is recommended for the installation of cost system.
Determination of the type of costing and the method of costing, as may be suitable
for the undertaking.
To prepare forms, card, report-performs, books etc., for keeping records of all the
elements of cost, viz., material, labour and overheads.
To decide issues regarding material cost control, i.e., purchase, storing, issue and
valuation.
To decide matters regarding labor cost control, i.e., job evaluation, merit rating,
appointment, time recording, division of work, remuneration of labour and other
allied problems like idle time, overtime, labour turnover, casual workings, etc.
Where the work is carried on more by machines, proper records be kept for the
machines.
To suggest a suitable system for the collection, classification and analysis of all.
Types of everheads, i.e., manufacturing, administrative, and selling & distributive.
To decide the methods of allocation and apportionment of overheads among the
production departments and Service departments which should be earlier clearly
demarcated, and to decide the method of absorption of overheads.
To decide normal capacity of production and prepare budgets and standards.
To maintain books of cost control based on double-entry principle.
To devise information system by which the costing department may communicate to
other departments and receive reports and other necessary informations promptly .
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13. Merit of Cost Accounting
Helpful in Planning and Decision Making: Cost information brings to light the profitable
activities of the organisation. It provided the sound and rational basis for planning, the
changes in products, plants, processes and techniques of production. The information
provided by cost accounting is also useful in evaluating the various alternatives involved in a
situation before taking any final decision.
Inventory Control: As an efficient stores accounting system is essential to an adequate
system of cost accounts, in effective check is provided on all materials and stores.
Ascertainment of Costs: Cost accounting is very helpful in calculating the cost of an article
being produced by the enterprise. It helps in fixing the selling price of the product.
Standard Costs: It helps the production manger not only to find what various jobs and
processes have cost but also what they should have cost. The pre-planned standard costs
are used for comparison of the cost of the products.
Assistance in Manufacturing: Cost accounting pinpoints lapses in purchases of raw
materials and other articles, their utilization. It indicates where wastages are occurring long
before the production is finished. It helps to take immediate steps to avoid such losses and
wastes.
Promotion of Sales: Cost accounting is also very helpful in the promotion of sales by
adopting an appropriate price policy. The technique of break even analysis serves as
constant remember to increase the sales to the break even point. It also seeks to control the
selling and distribution coasts.
Evaluation of Profitability: It helps in elimination unprofitable activities and operations.
Profit can be Maximised: Cost accounting helps the management in maximizing profits by
eliminating all wastes and uneconomical processes. This cost accounts help in increasing
points and minimizing loses.
COST SHEET
Cost Sheets are statements setting out the costs of a product giving details of all the costs.
Presentation of costing information depends upon the method of costing. A cost sheet can
be prepared weekly, monthly, quarterly or annually.
In a cost sheet besides total expenditure incurred, cost per unit of output in case of each
element of cost can be shown in a separate column. The cost sheet should give cost per unit
in the previous period for the purposes of comparison.
Advantages of Cost Sheet
1. It is a simple and useful medium of communication which gives information about
costs to all levels of management in a simple and lucid form.
2. It helps in comparative study of the various elements of costs with the past results
and standard cost. Thus it helps the management in control process.
3. It helps the management in fixing up the selling price more accurately.
4. If acts as a guide to the manufacturer and helps him in formulating a definite and
profitable production policy.
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14. 5. It enables a producer keep a close watch and control over the cost of production.
6. It shows the total cost and the per unit of the units produced during the given period.
Problem 1
The following particulars have been extracted from the costing records of a manufacturing
co., for the year ended 30th June, 1991.
Rs.
Raw material purchase 1,00,000
Wages
Direct 60,000
Indirect 10,000
Office Salaries 22,000
Finished Goods stock 10,000
Advertising 6,000
Agent’s Commission 10,000
Rent, rates & taxes etc (9/10 for works , 2,000
1/10 for office)
Works 4,000
Building-repairs 2,000
Salaries-plant 4,000
Depreciation Rs.
Plant Machinery 4,000
Building 2,000
Carriage inward 2,000
Carriage Outward 6,000
Sales 4,00,000
Opening Stock-
Raw material 40,000
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15. Travelling expenses 2,000
Power 2,000
Plant Maintenance 8,000
Miscellaneous expenses
Plant 2,000
Office 2,000
Closing Stock
Raw Materials 40,000
Finished goods 6,000
Building is occupied 9/10 by factory and 1/10 by office. Production 20,000 (Units)
You are required to prepare a detailed cost statement showing
i) Materials consumed
ii) Prime cost
iii) Works on cost.
iv) Cost of production
v) Cost of sales and
vi) Profit earned
Solution
Cost statement of the year ended 30th June, 1991.
Particular Total Cost per
Cost unit
Opening Stock of raw 40,000
material
Add Purchases 1,00,000
Add Carriage inward 2,000
1,42,000
Less Closing stock or 40,000
raw materials
i) Materials consumed 1,02,000 5.10
Direct labour 60,000 3,00
ii) Prime Cost 1,62,000 8.10
Add: Factory overheads
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16. Indirect Wages 10,000 0.50
Power 2,000 0.10
Plant Maintenance 8,000 0.40
Rent, rates and taxes 1,800 0.09
(9/10)
Misc. Expenses 2,000 0.10
Repairs – Building 1,800 0.20
(9/10)0.20
Salaries – Plant 4000 0.20
Depreciation – Plant 4,000 0.09
-Building (9/10) 1,800 34,000 1.77
iii) Works cost 1,97,400 9.87
Add: Office Overheads
Office Salaries 22,000 1.10
Rents, Rates and Taxes 200 0.01
(1/10)
Misc. expenses 4,000 0.20
Repairs – Building (1/10) 200 0.01
Depreciation- Building 200 26,600 0.01 1.33
(1/10)
iv) Cost of Production 2,24,000 11.20
Add: Opening Stock of 10,000
finished product
2,34,000
Less: Closing stock of 6,000
finished goods
Cost of goods sold 2,28,000
Add: Selling and
distribution overheads
Carriage outwards 6,000
Travelling expenses 2,000
Advertising 6,000
Agent’s Commission 10,000 24,000
Cost of Sales 2,52,000
Add Profit margin 1,48,000
v) Sales value 4,00,000
Problem 2
The cost of Sale of Product A is made up as follows:
Materials used in 55000 Direct Expenses 5000
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17. Manufacturing
Materials used in 10000 Indirect Expenses 1000
Primary packing (factory)
Materials used in selling 1500 Administration expenses 1250
product
Materials used in Factory 750 Depreciation of office 750
building & equipments
Materials used in office 1250 Dep. On factory buildings 1750
Labour required in 10000 Selling expenses 3500
Producting
Labour required for 2000 Freight on material 5000
factory supervision purchased
Advertising 1250
Assuming that all products are manufactured are sold, what should be the selling price to be
obtained as a profit of 20% on selling price?
Solution
COST SHEET
STATEMENT OF COST AND PROFIT
Direct material Rs. Rs.
Materials used in manufacturing 55000 100000
Materials used in primary packing 10000
Freight on material purchased 5000 70000
Direct labour 10000
Direct expenses-factory 5000
Direct expenses-factory 85000
PRIME COST
Factory overheads 750
Labour required for factory supervision 2000
Indirect expenses – factory 1000
Dept. on factory building 1750 5500
WORKS COST 90500
Administration O-H
Materials used in OH10 1250
Administration expenses 1250
Dept. on office building equipment 750 3250
COST OF PRODUCTION 93750
Sellings Distribution O-H
Materials used in selling the product 1500
Selling expenses 3500
Advertising 1250 6250
COST OF SALES 100000
Profit (20% on selling price or 25% on cost) 25000
SELLING PRICE 125000
Problem 3
From the following data prepare a cost & profit statement of Vijay stoves manufacturing company
for the year 1990.
Stock of materials as on 35000 Establishment expense 10000
1.1.1990
BSPATIL 17

18. Stock of materials as on 49000 Completed stock in hand -
31.12.1990 1.1.90
Purchase of materials 52500 Completed stock in hand 35000
31.12.90
Direct wages 95000
Factory expenses 17500 Sales 189000
The number of stoves manufacturing during the year 1990 was 1000. The company wants to quote
for the contract for the stoves to be quoted are of uniform quality and make similar to those
manufacturing in the previous year. But cost of materials has increased 15% and cost of factory
labour by 10%. Prepare a statement of net profit to be quoted to give the same percentage of net
profit of turnover as was realized during the year 1990 assuming that the cost per unit of O.H.
charges will be the same as the previous year.
BSPATIL 18

19. Solution
COST AND PROFIT STATEMENT OF STOVES 1990
Amount Amount Rs.
Rs.
Opening Stock of Materials35000
Purchase of Materials
52500
87500
Closing stock of Materials 4900
VOLUME OF MATERIAL CONSUMED 82600 20.65
Direct wages 95000 23.75
PRIME COST 177600 44.40
Factory expenses 17500 4.37
WORK COST 195100 48.77
Establishment expenses 10000 2.50
COST OF PRODUCTION 205100 51.27
Opening completed stock -
Cost of production during the prd 205100
Closing completed stock 35000
COST OF SALES 170100
PROFIT 18900
SELLING PRICE 189000
STATEMENT SHOWING QUOTATION PRICE FOR 1000 STOVES
Materials consumed 20650
15% increase 3098
23748
Factory wages 23750
10%a increase 2375
PRIME COST 26125
Factory expenses 49873
4370
WORK COST 54243
Establishment expenses 2500
TOTAL COST 56743
(profit 10% of selling price of 1/9 of 6305
cost)
SELLING PRICE 63058
BSPATIL 19

20. Lesson 2
Material Cost
The term ‘materials’ refers to such commodities which are supplied to the manufacturing
industry in their crude or original forms. They are raw in nature of have to be processed further.
Broadly, these may be classified in the following groups: Raw materials, components, consumable
stores, Maintenance Materials, Tools etc.
Since the underlying purpose of cost accounting is to minimize the cost of production, it is
important that an effective control is exercised over them. The storage space and storage costs re
reduce thereby. Control over materials is also necessary to prevent extra-expenses on their
unnecessary purchase and improper use. A regular supply of materials greatly helps the production
schedule. It is necessary, therefore, that statements are prepared to accurately record the value of
materials consumed by each department of job.
Material Cost Control envisages a proper organisatoin for the efficient purchasing and
storing of the materials, and for making them issued to the departments or the cost-centres in
appropriate quantities. At the proper times and valued at the right prices.
The materials cost control aims at keeping the material cost within reasonable limits,
budgets or standards.
This control is exercised beginnings from the point the orders are prepared for being placed
with the suppliers, and ending at the point the materials are effectively utilized in production or are
disposed off otherwise.
The following factors contribute to purchase control:
i) Determination of Quantity to be purchased
Quantities purchased in excessive number or weight block the working capital and the
quantities purchased below the reasonable limit endanger the continuous working of the
factory.
ii) Determination of the Ordering Point
The ordering point of the ordering level is one at which the order for purchase of materials is to
be placed with the suppliers when the stock of that material is reduced to that point by
consumption or otherwise.
iii) Determination of Price at which to be purchased
The selection of right suppliers and the best terms available out of the quotations received
helps this factor.
The Purchase cycle constitutes the following:
1. Initiating the purchase;
2. Receiving of the Purchase Requisitions;
3. Deciding important factors relating to purchase;
4. Selecting the suppliers;
5. Placing purchase-orders and follow-up
6. Receiving the supply and returning unwarranted suppliers;
7. Inspecting the material received; and
8. Passing invoices for payment.
The important factors to be decided are:
a) What to purchase;
b) When to purchase; and
c) How much to purchase.
BSPATIL 20

21. After receiving the Purchase Requisitions, the next step is to select the suppliers to whom the
orders may be sent for the supply. This is done by inviting tenders or quotations from different
suppliers.
While inviting the tenders, the supplying firms should be requested to state their terms and
conditions of supply, delivery time, mode of payment, etc., clearly and to send the tenders in
sealed covers.
Having accepted the tenders, the orders are place by the Purchase Department with the
firms selected fro the purchase of requisitioned materials.
The purchaser order should be prepared on the printed form and should contain all the
necessary details, so as to leave no room for any ambiguity or doubt and so as to avoid legal
complications.
Follow-up of the Purchase order if essential to keep the schedule of supply by the specified
date so that production work may not suffer.
The Receiving Department checks the supply from the copy of the Purchaser order and
prepares his report of the goods received.
The Inspection Department makes an inspection of the goods received regarding the quality
and specifications.
Stores Records
1. Bin Card
A Bin card, also known as Bin Tag or Stock card, is a card showing quantitative record of the
receipts, issues and closing balances of the material kept in the corresponding bin. The Bin card
is placed in the bin or shelf or is hung over the almirah or the rack otherwise known as ‘Bin’.
Separate Bin cards are prepared for each item of stores and if two different materials are kept in
one almirah, two Bin cards, one for each, are prepared, treating the almirah as two bins.
2. Stores Ledger
Stores Ledger is a record of stores, both in quantity and value and is maintained by the
stores Accountant. It is similar to Bin card but with the main difference that value of material is
shown in the Stores ledger. Stores Ledger is an important book and the account of each item of
stores is maintained separately. While Bin cards are maintained by store-keeper in the store,
Store Ledger is maintained in the accounting department by the Stores Accountant.
Material Control and its Requirements
“ ‘Material Control’ may be defined as the regulation of the procedures for requisitioning,
buying, receiving, storing, handling and usage of materials”.
The main requirements of a system of material control are:
Planning and fixation of definite responsibility for each function of material.
Co-ordination between departments responsible for requisitioning, purchasing, receiving,
inspecting, storing and utilizing the materials,
Centralization on purchases.
Use of material purchase budget and material requirement budget.
Use of standard and uniform forms, and
BSPATIL 21

22. Proper system of stock control.
For proper application of the material control the following steps are necessary.
1. Purchasing of materials
2. Receiving and inspecting of materials
3. Storing of materials
4. Pricing material Issues
5. Accounting materials losses.
6. Keeping physical and perpetual inventory
Purchasing of Materials
In a large manufacturing concern, a separate purchase department is set up with the object of
effecting all purchases. The top management lays down the purchase department. It is the
function of the purchaser department to decide: i) What to purchaser; ii) When to purchase; iii)
form where to purchase; iv) how much to purchase, and v) finally at what price the material
should be purchased.
Maintenance of Stock Levels
The next important point after determination of EOQ is to decide as to when the order for
purchase should be placed. The answer is simple. The order for purchase should be placed when
the stock is reduced by usage to the Order Point. The Order Point is one where the order should be
placed for the economic order quantity. For deciding Order Point, two things, viz., (1) Lead time
and (2) Usage during Lead time, are the determining factors. Lead time is the supply time, or to be
more specific, Lead Time is “the time interval between placing an order and having materials on the
factory floor ready for production…”
Usage means the sue of materials by consumptions for productions, or the stock of finished
goods sold.
Sometimes purchase are made in large bulk in a season if the goods are seasonal, i.e.,
available in one season only, or at a time when it is feared that the goods may not be found
available in the near future due to some reason.
Special items for which no limit or order-points are fixed may be purchased as and when
needed.
To avoid over-stocking and under stocking each items of the inventory has the Maximum
Level. Minimum Level and an Order point.
Order Point
It is also known; ‘Ordering Level’; or ‘ Recorder Point’, or ‘Reordering Level or ‘Ordering
Limit’, it has been stated earlier that Order Point is at which order for supply of materials or
goods is placed. To decide the Order Point, three factors are considered, viz., (1) Lead time
(2) Usage during Lead time, and (3) Minimum Limit, or the Safety stock.
In order to ensure that the optimum quantity of material is purchased and stocked, neither
less nor more, the storekeeper applies scientific techniques of materials management.
Fixing of certain levels for each items of materials is one of such techniques.
The following levels are generally fixed.
1. Maximum level
2. Minimum level
3. Order level
4. Danger level
1. Maximum level
BSPATIL 22

23. The maximum stock level indicates the maximum quantity of an item of material which can be
held in stock at any time.
The maximum stock can be calculated by applying the following formula.
Maximum level – Re-order level + re-order quantity – (minimum consumption X minimum
re-order period)
2. Minimum level
Minimum level represents the quantity below which the inventory of any items should not
allowed to fall; in other words, an enterprise must maintain minimum quantity of stock so that
the production is not hampered due to non-availability of materials. If some buffer inventory is
acting as a cushion against reasonable expected maximum usage.
Formula:
Minimum level = Re-order level – (Normal consumption x normal re-order period)
3. Re-ordering Level Point
Re-ordering stock level in relation to an items of stock is the point at which it becomes
essential to initiate purchase orders for its fresh supplies. Normally, re-ordering level is a point
between the maximum and the minimum levels. Fresh orders must be placed before the actual
stocks touch the minimum level.
Reorder level = maximum re-order period x maximum usage.
4. Danger level
The danger level is below the minimum level and represents a stage where immediate steps are
taken for getting stock replenished. When the stock reaches danger level it is indicative that if
no emergency steps are taken to restock the material, the stores will be completely exhausted
and normal production stopped. Generally the danger level of stock is fixed above the minimum
level but below the re-ordering level.
Economic Order Quantity Analysis
Economic Order Quantity
This represents the normal quantity to be placed on order when the stock has reached its
re-order level. Re-ordering quantity is to be fixed taking into account the maximum and minimum
stock levels. The quantity ordered must be that which, when added to the minimum stock, will not
exceed the maximum stock to be carried at any point of time. The following factors govern the
re-ordering quantity.
1. Average consumption
2. Cost of pacing order
3. Cost of storage
4. Interest on capital etc.,
Carrying cost of inventory consists of
i) The costs of physical storage, such as cost of space, handling and upkeep expenses,
insurance, cost of obsolescence etc.
ii) Interest on capital invested (the opportunity cost of the capital blocked up) and
iii) Cost of placing the order each time.
Economic order quantity or economic lot size (if it relates to production) refers to the number
ordered in a single purchase or number of units should be manufactured in a single run so that the
total costs-ordering or set up costs and inventory carrying costs are at the minimum level. In other
BSPATIL 23

24. words, it is the quantity that should be ordered at one time so as to minimize the total of
i) Cost of placing orders and receiving the goods, and
ii) Cost of storing the goods as well as interest on the capital invested. The economic order
quantity can be determined by the following simple formula.
EOQ = Economic order quantity or number of units in one lot.
A = Annual usage in units
S = Ordering costs for one order (or set-up costs for one set-up)
I = Inventory carrying costs per unit per year.
This formula is based in three assumptions:
i) Price will remain constant throughout the year and quantity discount is not involved.
ii) Pattern of consumption, variable ordering costs per order and variable inventory carrying
charge per unit per annum will remain the same throughout, and
iii) EOQ will be delivered each time the stock balance, excluding safety stock, is just reduced to
nil.
Problem 1
Suppose the annual consumption is 675 units, 10% is the interest and cost of storing an
article costing Rs. 30 per unit, cost of placing and order is Rs. 18. Calculate the E.O.Q.
Solution:
Where A = Annual usage
S = Ordering cost for one order
I = Inventory carrying costs per unit per year.
Problem 2
Two components A and B are used as follows:
Normal usage 50 units per week each
Minimum usage 25 units per week each
Maximum usage 75 units per week each
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
BSPATIL 24

25. c) Maximum level d) Average stock level
Solution
Re-order level = Maximum consumption * maximum re-order period
Component A = 75*6 = 450 units
Component B = 75*4 = 300 units
Minimum level = Re-order level – (Normal consumption * Normal re-order period)
Component A = 450-(50*5) = 200 units
Component B = 300-(50*3) = 150 units
Maximum level = Re-order level + Reorder Quantity –
(Minimum consumption * Minimum re-order period)
Component A = 450 + 300 – (25*4) = 650 units
Component B = 300 + 500 – (26*2) = 750 units
Average Stock level = ½ (Minimum level + Maximum level)
Component A = ½(200+650) = 425 units
Component B = ½(150+750) = 450 units
Need for Inventory Control
The term ‘Inventory’ is used to denote (i) goods awaiting sale (the stock items of a trading
concern and the finished stocks of a manufacturer); (ii) the goods in course of manufacture, known
as work-in-progress, and (iii) goods to be used directly or indirectly in production, i.e., raw
materials and supplies.
In a manufacturing company, normally the cost of materials constitutes fifty percent of the
production cost and the cost of inventory (i.e., raw materials W.I.P., and finished good) represents
about one-third of the total assets. As the costs of materials and inventory are quite formidable
but at the same time controllable, there is a great need felt for proper planning, purchasing,
handling and accounting for the same, and also to organize the system of inventory control in a
manner that it may provide the maximum profitably to the management.
Objectives of Inventory Control
The objectives of inventory control as listed below:
1. To exercise proper control on the purchases and issues of inventories; proper storing;
elimination of wastage; and regulating the proper supplies to works and to customers;
2. Pricing of the inventories on suitable basis;
3. Proper recording, and scientific inventory management
4. To have proper assessment of income through the process of matching appropriate costs
against revenues.
5. To maintain inventory of sufficient size for the operations to go on uninterruptedly but the
size should match with the optimum financial involvement.
BSPATIL 25

26. Techniques of Inventory Control
The techniques or the tools generally used to effect control over the inventory are the following:
1. Budgetary techniques for inventory planning;
2. A-B-C. System of inventory control;
3. Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically;
4. Maintenance of Stock levels to decide when to purchase;
5. Perpetual inventory system and the system of store verification;
6. Reduction of surplus stocks and review of slow-moving or stagnant items.
7. Control Ratios.
Budgetary Techniques
For the purchase of raw materials and stocks, what we required is a purchase Budged to be
prepared in terms of quantities and values involved. The sales stipulated as per sales Budget of the
corresponding period generally works out to be the key factor to decide the production quantum
during the budget period, which ultimately decides the purchases to be made and the inventories
to be planned.
A-B-C Analysis
To exercise proper control on stores, it is essential that the store items should be classified
according to values so that the most valuable items may be paid greater and due a attention
regarding their safety and care, as compared to others. The stores are divided into three categories
generally, viz., A, B, and C.
In the ABC system, greatest care and control is to be exercised on the items of ‘A’ list as
any loss or breakage or wastage of any items of this list may prove to be very costly; proper care
need be exercised on ‘B’ list items and comparatively less control is needed for ‘C’ list items. The
rules relating to receipt maintenance issue and writing off stores items should be formed in
accordance with the utility and value of the items based on the above categorization.
Manufacturing organizations find it useful to divide materials into three categories for the
purpose of exercising selecting control on materials. An analysis of the material cost will show that
a smaller percentage of items may represent a smaller percentage of the value of items the
percentage number of which is more or less equal to their value of consumption. Items falling in
the first category are treated as ‘A’ items, of the second category and ‘B’ items and items of the
third category are taken as ‘C’ items. Such an analysis of materials is known as ABC analysis. This
technique of stock control is also known as stock control according to value method or always
Better Control method or Proportional parts value. Analysis method. Thus, under this technique of
material control, materials are listed in ‘A’, ‘B’ and ‘C’ categories in descending order based on
money value of consumption.
ABC analysis measures the cost significance of each item of materials. It concentrated on important
items, so it is also known as ‘Control by importance and Exception’.
Advantages:
1) A Strict Control is exercised on the items which represent a high percentage of the material
costs.
2) Investment in inventory is reduced to the minimum possible level.
3) Storage cost is reduced as a reasonable quantity of materials, which account for high
percentage of value of consumption will be maintained in the stores.
VED Analysis:
VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The
spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the
critically to production.
BSPATIL 26

27. Perpectual Inventory System
Perpectual Inventory is a system of records maintained by the controlling department, which
reflects the physical movement of stocks and their current balance. It aims at devising the system
of records by which the receipts and issues of stores may be recorded immediately at the time of
each transaction and the balance may be brought out so as to show the up-to-date position.
The records used for perpectual inventory are:
(1) Bin Cards;
(2) Store Ledger Accounts or Stores Record cards;
(3) The forms and documents used for receipt, issue and transfer of materials.
Advantages of Perpectual Inventory system
1. It keeps the record of stocks upto date.
2. The materials are kept within the Minimum and Maximum Limits. Non-observance of the
limits fixed is detected.
3. The materials going out of stock are easily detected and purchased at the appropriate time
to avoid the risk of closing down.
4. It acts as a moral check on the staff of the stores Department and so the possibilities of loss
or theft of materials are minimized.
5. The recording of stocks in Bin cards as well as Store Record cards minimizes the error in
entering the receipts and issues of stocks.
6. The discrepancies noted after physical counting are detected and corrective action is taken
promptly to avoid future occurrence.
7. The materials getting state or being wasted are detected and placed in right atmosphere.
8. The prompt balancing of closing stocks enables quick preparation of final accounts.
9. The slow moving inventories, obsolete or dormant stocks are brought to the notice of the
Purchase Department so that such stocks may purchased future in lesser quantities as
required.
10.The availability of correct figures of stocks helps in the insurance of the stocks.
Control Ratios
The control ratios are mainly two –
(1) Inventory Turnover Ratio which we have studied and
(2) Input-output Ratio.
(1) Inventory Turnover
Inventory Turnover is a ratio of the value of the materials consumed during a period to the
average value of inventory held during that period.
Certain materials are slow moving. It means their consumption rate quite show and so capital
remains locked up and storing costs continue to be incurred in such materials if these materials
are stored in excess of the requirement the rate of consumptions in terms of value or in terms
of days is indicated by Inventory Turnover ratio. The number of days in which the average
inventory is consumed can be ascertained by dividing the period by the Inventory turnover ratio.
If the inventory turnover rate in terms of value of materials is high, or if the length of the
inventory turnover period is short, the material is said to be fast moving. So if the rate of
consumption is fast, or if the inventory turnover rate is good, it is a healthy measure of
efficiency of materials control, as the capital employed is properly utilized.
2. Input-output Ratio
The Input-output Ratio is the ratio of the raw material put into manufacture and the standard
raw materials content of the actual output.
BSPATIL 27

28. This ratio enables one to find out whether the usage of the materials is favourable or not. A
standard ratio of input of materials and output of material should be determined and the actual
ratio should be compared with the standard ratio.
Pricing of Material Issues
The pricing of issue of materials is not as simple as the pricing of receipts. As the issue are
made out of the various lots purchased at different prices, the questions arises as how to price
the issues, there are several methods used for pricing the issues and the selection of a proper
method depends upon the following factors:
1. The type of work-job or process;
2. Range of price fluctuations and market trends;
3. The Inventory turnover period and the carrying or the non-carrying cost i.e., the frequency
of purchases and E.O.Q.
4. The need for maintenance of uniformity is costs of the products within the industry.
5. The nature and durability of the material – whether it evaporates or shrinks, or absorbs
moisture, etc.
Method of Pricing
The various methods used for pricing of the materials are:
Cost Price Methods:
1. First in First out (FIFO)
2. Last in First out (LIFO)
3. Highest in First out (HIFO)
4. Base stock price
Average price Methods:
1. Simple Average
2. Weighted Simple Average
3. Periodic Weighted Average
4. Moving Simple Average
5. Moving Simple Average
6. Moving Weighted Average
First in First out Method (FIFO):
Under this method materials received first are issued first. After the first lot of the material
purchased is over, the next lot is taken up for issue. As such, the materials are issued in the order
in which they are received in the stores. The pricing of the issue of the first lot is done at the rate
of purchase of the first lot. Similarly, the pricing pattern follows for the subsequent lots. The
closing stock in this method is valued at the latest purchase price and thus it represents the
current conditions as far as possible.
Merits
1. It is simple to operate
2. The materials are charged at costs only. So the purchase price is recovered in full without
showing any profit or loss on issue.
3. This method is good where
a. The prices are falling;
b. The consumption rates of the materials is slow
4. The Closing stock is shown at current rates.
Demerits
1. It is not suitable in the situation when the prices show a rising trend, as it will charge the
material at the lower rate than the replacement rate.
BSPATIL 28

29. 2. The same type of materials issued to two jobs at two different prices will show different
costs.
3. If the prices fluctuate to much, the clerical errors may be many.
Last in First Out (LIFO):
Under this method, the material received last is issued first LIFO method and as such,
pricing of issues is done in the reverse order of purchases. In times of rising prices, this method is
considered best for application, as the current cost of materials contributes to the cost of
production.
Merits
1. The material cost represents current prices except when the purchases were made long
ago,
2. It is simple to operate and the pricing is done on cost basis
3. It relates current cost to current sale price, and enables the management to make correct
decisions.
4. It is more useful when purchases are not too many and the prices are either steady or are
rising. It is more suitable for bulky materials with high unit prices.
Demerits
1. With high fluctuations in rates, the calculations become more complicated, and give way
to more clerical errors.
2. The work of pricing is held up if the latest receipt rate is not readily available.
3. As in FIFO, costs of different batches of production are distorted and more than one
price is adopted, in some cases, for pricing a single requisition.
4. Closing stock is valued at a cost which does not represent current conditions.
Highest in First Out (HIFO):
Under this method the material received at the highest price in the stock is issued first. This
method is good when it is desired to keep the inventory value of the materials at the lowest
possible price.
Base Stock Price Method
In this method a minimum quantity of stock is always held at a fixed price as reserve in the
stock. This minimum stock is known as base stock or the safety stock and is not used unless an
emergency arises. This stock is valued at long-run ‘normal’ price, while the stock in excess of this
stock is priced on some other basis, usually are FIFO or the LIFO basis. It is not an independent
method in itself a it is conjoined with either FIFO or the LIFO method.
Simple Average Method
The issue is prices at an average price and not at the exact cost price as in the earlier
methods. The simple average is calculated by dividing the total of the rates of the materials in the
stock from which the materials to be priced could have been drawn, by the number of the rates of
prices.
This method can be used with advantage if
(a) The purchase prices to not fluctuate considerably, and
(b) It is difficult to identify the different issues of the materials.
Weighted Average Method
Merits
1. This method irons out the wide fluctuations in the prices.
2. With every new issue, a new rate is not calculated.
BSPATIL 29

30. 3. The total value of the material issued does not behave up and down to the total value of the
material received, as is the case with Simple Average Method.
Demerits
1. Calculations are tedious. Prices are worked out in decimals to get correct results.
2. A lot of materials purchased at a very high price at one time continues to reflect its effect in
the average, for a considerable time after it is exhausted.
Periodic Simple Average Method
This method is similar to Simple Average Method except that the average rate is calculated
periodically, say monthly or quarterly or once in the accounting period. If calculated monthly, the
average of the unit prices of all the receipts during the month is adopted as the rate for pricing
issues during the subsequent month.
Periodic Weighted Average Method
This method is similar to Weighted Average Method except that the calculation is made
periodically, say at an interval or one month. The rate so arrived is used for the issues made in the
next month.
Moving Simple Average Method
This represents a price which is obtained by dividing the total of the periodic simple average
prices or a given number of periods, the last of the periods being that for which the materials are
to be issued, by the number of periods.
Moving Weighted Average Method
This is just similar to the Moving Simple Average Method except that the periodic
average price, in this system, is based on the weighted average.
Problem 3
1) Show the Store Ledger entries as they would appear when using
i) FIFO
ii) LIFO
iii) Weighted average method
iv) Simple average method
April 1. Balance 300 units Rs. 600/-
2. Purchase 200 units Rs. 440/-
4. Issued 150 units
6. Purchase 200 units Rs. 460/-
11. Issued 150 units
19. Issued 200 units
22. Purchase 200 units Rs. 480/-
27. Issued 250 units
Solution
1) Stores Ledger Account as per FIFO METHOD
Date Details Receipt Issued Balance
Qty Rate Amt Qty Rate Amt Qty Rate Amt
April Balance 300 2/- 600 - - - 300 2/- 600
1
2 Purchase 200 2.20 440 - - - 300 2.00 600
200 2.20 440
BSPATIL 30

31. 4 Issue 150 2.00 300 150 2.00 300
200 2.20 440
6 Purchase 200 2.30 460 150 2.00 300
200 2.20 440
200 2.30 460
11 Issue 150 2.00 300 200 2.20 440
200 2.30 460
19 Issue 200 2.20 440 200 2.30 460
22 Purchase 200 2.40 480 200 2.30 460
200 2.40 480
27 Issue 200 2.30 460 150 2.40 360
50 2.40 120
Value of Closing Stock : 150 units at the rate of Rs. 2.40 value Rs. 360/-
2) LIFO METHOD
Date Details Receipt Issued Balance
Unit Rate Amt Unit Rate Amt Unit Rate Amt
April Balance 300 2.00 600 - - - 300 2.00 600
1
2 Purchase 200 2.20 440 - - - 300 2.00 600
200 2.20 440
4 Issue 150 2.20 330 300 2.00 600
50 2.20 110
6 Purchase 200 2.30 460 300 2.00 600
50 2.20 110
200 2.30 460
11 Issue 150 2.30 345 300 2.00 600
50 2.20 600
50 2.30 115
19 Issue 50 2.30 115 200 2.00 400
50 2.20 110
100 2.00 200
22 Purchase 200 2.40 480 - - - 200 2.00 400
200 2.40 480
27 Issue 200 2.40 480 150 2.00 300
50 2.00 100
Value of Closing Stock : 150 units @ Rs. 2.00 value is Rs. 300/-
3) WEIGHTED AVERAGE METHOD
Date Details Receipt Issued Balance
Unit Rate Amt Unit Rate Amt Unit Rate Amt
April Balance 300 2.00 600 - - - 300 2.00 600
1
2 Purchase 200 2.20 440 - - - 500 2.08 1040
BSPATIL 31

32. 4 Issue - - - 150 2.08 312 350 2.08 728
6 Purchase 200 2.30 460 - - 550 2.16 1118
11 Issue - - - 150 2.16 324 400 2.16 864
19 Issue - - - 200 2.16 432 200 2.16 432
22 Purchase 200 2.40 480 - - - 400 2.28 912
27 Issue - - - 250 2.28 570 150 2.28 342
Value of Closing Stock : 150 units at the rate of Rs. 2.28 value Rs. 342.00/
4) SIMPLE AVERAGE METHOD
Date Details Receipt Issued Balance
Unit Rate Amt Unit Rate Amt Unit Rate Amt
April Balance 300 2.00 600 - - - 300 2.00 600
1
2 Purchase 200 2.20 440 - - - 500 2.10 1050
4 Issue - - - 150 2.10 315 350 2.10 35
6 Purchase 200 2.30 460 - - 550 2.17 1193..50
11 Issue - - - 150 2.17 325.50 400 2.17 868
19 Issue - - - 200 2.17 434 200 2.17 434
22 Purchase 200 2.40 480 - - - 400 2.23 892
27 Issue - - - 250 2.23 557.50 150 2.23 334.50
Value of Closing Stock : 150 units at the rate of Rs. 2.23 value Rs. 334.50
Problem 4
The following is the record of receipts and issues a certain material in the factory during a week.
April 1997
1. Opening Balance 50 tonnes @ Rs. 10 per tone.
Issued 30 tonnes @ Rs. 10 per tones
2. Received 60 tonnes @ Rs. 10.20 per tone.
3. Issued 25 tonnes @ Rs. 10.20 per tone (stock verification reveals loss of tone)
4. Received back from orders 10 tonnes @ Rs. 10.20 per tone
(previously issued at Rs. 9.15 per tone)
5. Issued 40 tonnes @ Rs. 10.20 per tone.
6. Received 22 tonnes @ Rs. 10.30 per tone.
7. Issued 38 tonnes @ Rs. 10.30 per tone.
Solution
Stores Ledger Account Under LIFO
Date Receipts Issues Balance
Qty Rate Amt Qty Rate Amt Qty Rate Amt
1 30 50 10 500
1 30 10 300 20 10 200
2 60 10.20 612 - - - 20 10 200
60 10.20 612
3 - - - 25 10.20 255 20 10 200
1 10.20 10.20 35 10.20 357
20 10 200
4 10 9.15 91.5 34 10.20 346.80
- - - 20 10 200
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33. 34 10.20 346.80
10 9.15 91.50
5 - - - 10 9.15 31.50 20 10 200
3 10.20 306.0 4 10.20 40.80
6 22 10.30 226.6 20 10 200
4 10.20 40.80
7 - - - 22 10.30 226.6
4 10.20 40.80 8 10.00 80.00
12 10.00 120.0
BSPATIL 33

34. Closing Stock 8 tonnes @ Rs. 10 = Rs. 80/-
Stores Ledger Under FIFO
Date Receipts Issues Balance
Qty Rate Amt Qty Rate Amt Qty Rate Amt
1 30 50 10 500
1 30 10 300 20 10 200
2 60 10.20 612 - - - 20 10 200
60 10.20 612
3 - - - 20 10 200
5 10.20 51 55 10.20 561
1(los 10.20 10.20 54 10.20 550.80
s)
4 10 9.15 91.5 - 54 10.20 550.80
- - 10 9.15 91.50
5 - - - 40 10.20 408 14 10.20 142.80
10 9.15 91.50
6 22 10.30 226.6 - 14 10.20 142.80
10 9.15 31.50
22 10.30 226.60
7 - - - 14 10.20 142.80
10 9.15 91.50 8 10.3 82.40
22 10.30 226.60
Closing stock 8 tonnes @ Rs. 10.30 = 82.40
BSPATIL 34

35. Chapter – 3
Labour Cost
“Labour Cost, representing the human contribution to production, is an important cost factor
which requires constant control, measurement and analysis.”
A rational approach to the problems of labour, fair maintenance of wage records for wage
ascertainment, fair wage policy, and the incentives for earning more wages go a long way in
providing a sense of security and stability to the workmen, in minimizing the labour turnover, and
in exercising effective labour cost control.
Labour cost control aims at the control of the labour cost per unit of production and not at
the reduction of the wage rates of the workmen.
Efficiency of labour (a concept meaningless to material) has an important impact on the successful
working of a business.
Labour cost is second major element of cost. Proper control and accounting for labour cost is one
of the most important problems of a business enterprise. But control of labour cost presents
certain practical difficulties unlike the control of material cost.
Labour costs represent the various items of expenditure Such as:
Monetary Benefits:
i) Basic Wages;
ii) Dearness Allowance;
iii) Employer’s Contribution to Provident Fund;
iv) Employer’s Contribution to Employee’s State Insurance (ESI) Scheme;
v) Production Bonus;
vi) Profit Bonus;
vii) Old age Pension;
viii) Retirement Gratuity;
Fringe Benefits:
i) Subsidised Food;
ii) Subsidised Housing;
iii) Subsidised Education to the children of the workers;
iv) Medical facilities;
v) Holidays pay;
vi) Recreational facilities.
Economic utilization of labour is a need of the present day industry to reduce the cost of
production of the products manufactured or service rendered.
Control of labour costs is an important objective of management and the realization of this
objectives depends upon the cooperation of every member of the supervisory force from the top
executive to foreman. From functional point of view, control of labour cost is effected in large
industrial concern by the coordinated efforts of the following six departments-
1) Personnel Department,
2) Engineering Department,
3) Rate or time and Motion Study department
4) Time-Keeper Department
5) Cost Accounting Department
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36. 6) Pay-roll Department
Factors Governing a Satisfactory system of Wage Payment
The following factors should be considered while evolving a suitable and a successful
system of wage payment.
a) The system should depend upon the nature of the worked and the efforts involved.
b) It should guarantee a minimum living wage to ensure a satisfactory standard of living.
c) It should be based upon a scientific time and motion study.
d) It should be capable of being understood by al the employees.
e) It should be flexible and capable of being adapted to changed circumstances.
f) Its incidence on the cost per unit should be such that it does not form a considerable
proportion of the total cost per unit to deprive the employer of a fair margin of profit, given
the market price of the commodity produced by concern.
g) It should reduce the labour turnover.
h) The cost of working the system should be the least.
i) It should boost employee morale.
j) It should be acceptable to trade unions.
k) It should be correlated to the capacity of the concern to pay.
For labour-cost-control, the following factors should also be kept in view while devising the
system:
1. Production Planning:
Production should be so planned as to have the maximum and rational utilization of labour.
The product and process engineering, programming, routing, and direction constitute the
production-planning.
2. Setting up of standards
With the help of work study, time study and motion study are set up for production
operations. The standard cost of labour so set is compared to the actual labour cost and
the reasons for variations, if any, are looked into.
3. Use of labour budgets:
Labour budget is prepared on the basis of production budget. The number and type of
workers needed for the production are provided for along with the cost of labour in the
Labour budget. This budget is a plan for labour cost and is based on the past data
considered in future perspective.
4. Study of the effectiveness of Wage-policy:
How far the remuneration paid on the basis of incentive plan fro the departments help the
managerial control on labour and exercise labour cost control.
Characteristics of Good Wage System
1. Fair to both the Parties:
The system should be such as may be acceptable gladly to the employer and the
employees. for this purpose, the employer should decide the system in consultation with
the workers.
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37. 2. Easy to Calculate
The workers should be in a position to calculate their wages correctly and feel sure that
they have been correctly paid. Easy calculation will help the employer also in maintaining
simple records.
3. Related to Efficiency
‘Fair remunerations for fair output’, should be the idea and remuneration should be
related to the individual efficiency of the workers.
4. Minimum wage guaranteed
There should be a guarantee of minimum wages to the workers to enable them to
maintain their basic standards of life, and to do away with uncertainty-concept.
5. Incentive-oriented
The wage system should be such that the workers may feel encouraged to product more
and earn more wages.
6. Quality Improvement-oriented
In the race to earn more wages with an increase in production, the chances are that the
quality of the output may deteriorate. The system should, therefore, ensure ‘better
wages for better quality’.
Definite wage-base
The basis or the method of wage payment should be clearly defined and announced in
advanced to the workers, and it should not be changed frequently to suit the interest of the
employer, otherwise a sense of distrust may develop in the workers towards the scheme. A change
in the system should be effected only after taking the workers into confidence.
Labour Turnover
Labour turnover is an index denoting change in the labour force for an organisatoin during a
specified period. In every industry, works leave their job a new workers have to be appointed to
replace them. The ratio of the replaced workers to the number of works is the Labour Turnover
Ratio. If more workers leave the factory, the turnover would be high, and vice versa. A high
turnover is a costly affair and must be avoided.
Causes of Labour Turnover
The workers leave the factory either by
i) Resignation, or by
ii) Discharge by the employer, or
iii) Due to a cause not within one’s control.
Cause for resignation
The causes may be:
1. Low wages paid as compared to the wages paid in other factory which he is induced to
join.
2. Ill health and bad working conditions;
3. Lack of safety measures;
4. Dissatisfactions due to various causes such as
a. Hours of work
b. Improper placement
c. Unfair method of promotion,
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38. d. Bad relationship with Supervisor, or with fellow-workers in some cases.
Causes for Discharge
1. Incompetence;
2. Insubordination, disobedience, and disregard of the rules asn regulations;
3. Unpunctuality or lack of attention to duty;
4. Accidents or suffering from infectious disease;
5. Immoral character.
Causes not within control
1. Seasonal character of the industry where work is carried on during some part of the year
only;
2. Death of the worker;
Measurement of Labour Turnover
Labour Turnover is measured by applying any one of the following three Methods:
1. Separation Method
Multiplication of the formula by 100 indicated Ratio of the turnover in percentage.
2. Replacement Method
In this method, only the actual replacement are counted irrespective of the number of workers left.
If new workers are appointed for expansion programme, they are excluded from the number or
replacements.
3. Flux Method
This method is the combination of Method 1 and Method 2.
Effect of Labour Turnover on Cost
The Labour Turnover in excess of normal rate is high turnover, and the turnover below the
normal rate is low turnover. It is always better to keep the turnover low, but it should nto be
construed that the factories with low turnover are always more productive. There may be low
turnover in a factory for the reason that the workers engaged therein are below standard and so
they cannot find better place in other factories. Secondly, low turnover in the senior scales may not
provide promotion factories. Secondly, low turnover in the senior scales may not provide
BSPATIL 38

39. promotion opportunities to the young and promising employees and so they may like to shift to
other factories for better prospects.
A high turnover has an adverse effect on the cost of production due to the following reasons:
1. Change in workers interrupts production and the production goes down.
2. New comers take time in learning the factory procedure and the work procedure.
3. The tools and machines cannot be handled as efficiently by the new workers as hither to
done by the old staff. There are chances of more break-downs and of greater cost of repairs
of machines.
4. What is true of machines is also true of material handling and usage by the new workers.
5. The rate of accidents may increase, the rate of defectives in the finished output may
increase, and there may be increased wastage of time.
6. The cost of making selections and cost of imparting training to the new entrants would
further increase the cost and reduce the profits.
Cost of Labour Turnover
There are two types of costs
i) Preventive cost and
ii) Replacement costs
And amenities to the workers that they may be tempted to continue at their job in the factory and
not to leave it for example:
i) Personnel Administration: Only that portion of the cost of this department which is related
to the maintenance of good relationship between labour and management.
ii) Medical Services-Preventive as well as curative.
iii) Welfare activities and services.
iv) Miscellaneous schemes and benefits, e.g., Provident fund scheme, Pension scheme, Bonus
incentives schemes, etc.
The replacement costs are those incurred to recruit new workers and also the costs consequent or
incidental to replacement, for example:
(i) Cost in selection and appointment
(ii) Training cost
(iii) Loss of output due to delay in recruitment workers
(iv) Cost of inefficiency of new workers
(v) Cost of breakage of tools and machinery
(vi) Cost of increased spoilage and defectives
(vii) Cost of frequent accidents
The treatment of Prevention and Replacement costs is to charge them as overhead and apportion
to the different departments in the ratio of other workers.
IDLE TIME
The time when the worker does no work and remains idle, is the idle time. So the idle time
cost represents the wages paid for the time lost. The following are its causes:
1. Lack of proper planning:
That the production work should go on smoothly, depends upon proper planning. If the workers
do not have material at the right time, or the machines are not kept fir for working, the time goes
waste. Sometimes, delay in the proceeding process delays the operations of the succeeding
progress. Here also the workers have to wait due to faulty planning or bad management.
2. Careless in Supervision:
BSPATIL 39