Cost Accounts

WHAT IS COST ACCOUNTING• Cost sheet is a statement prepared to show the

different elements of cost• CHARACTERISTICS OF COST ACCOUNTS• Cost accounts are important part of financial

accounts• Cost accounts tell about per unit cost of production

or service• Main areas are material, labour and expenses

OBJECTIVE OF COST ACCOUNTS

• To ascertain the cost• To control the cost against various variances• To provide reliable cost data for controlling

business activities

TECHNIQUES OF COSTING• 1. Historical cost – actual expenses incurred in the

production• 2.Standard cost – it is estimated before actual

production. Later it is compared with the actual costs for the variances and changes are made in standard costs for future purpose

• 3.Marginal costing – only those expenses which are directly related to production like variable costs and no part of fixed costs are taken.

METHODS OF COSTING• Single costing – also called output or unit costing. Used in those

industries where only one item is produced in large quantites during the whole year.E.g. cement, flour, sugar, coal.

• Operating costing – used in those industries where no commodity is produced but public utility services are provided. E.g. railways, bus transport, electricity supply

• Process costing – used in those industries where production is completed through many processes or production may be sold after the completion of one or more processes.E.g. chemical, textile, oil

• Departmental costing – used in those factories where more than one items are made and the cost of each item has to be ascertained. Cost is divided amongst various departments and per unit cost of every department is found. E.g. in a furniture factory it has boxes, beds, tables etc.

ELEMENTS OF COST• Elements of cost

Material Labour Expenses

Direct material

Indirect material

Direct labour

Indirect labour

Direct expenses

Indirect expenses

Direct costs Indirect costs

Basic Cost Terms: Direct and Indirect Costs

• Direct Costs- Costs that can be traced to a given cost object product, department, etc.in an economically feasible way.

• Indirect Costs- Costs that cannot be traced to a given cost object in an economically feasible way. These costs are also known as “overhead”.

• Cost Assignment -Direct costs are traced to a cost object. Indirect costs are allocated or assigned to a cost object.

Direct cost ADirect cost B

Indirect cost C

Object X Object Y

Basic Cost Terms: Product and Period Costs

• Product Costs -Costs that “attach” to the units that are produced i.e., manufacturing costs) and are not reported expenses until the goods are sold.

• Period costs- Costs that must be charged against income in the period incurred and cannot be inventoried e.g., selling and administrative expenses

• Unit Costs -Total cost of units divided by units produced.

Product Costs

Direct cost Indirect cost

Product X

Inventory

Income statement

Period cost

Sale

Basic Cost Terms: Direct and Indirect Costs

• Variable Costs • Costs that change directly in proportion to changes in the related cost driver

• Fixed Costs • Costs that remain unchanged for a given time period regardless of changes in

the related cost driver.

• Other Common Functions for Cost Behavior • Semi-variable costs (part variable and part fixed) Step costs (aka semi-fixed

costs) • Main Assumptions Needed to Define Fixed and Variable Costs • Cost object, Time span, Linear functional form • Relevant range-the band of cost driver activity in which a specific

relationship between a cost and a driver holds.

Basic Cost Terms:

• Product costs can be Direct or Indirect (Overhead)• Not all Direct costs are variable . The depreciation

of a special piece of equipment bought to manufacture a single product line.

• Not all Overheads are fixed .• Processing of raw material purchase orders . • Electricity used in operating production equipment.

• Direct material + Direct labour + Direct expenses = Prime Cost

• Indirect material + Indirect labour + Indirect expenses = Factory overheads

• Prime Cost + Factory Overheads = Factory Cost• Factory Cost + Selling & Distribution & Admin Overheads

= Total Cost• Indirect materials are – threads, lubricants, glue etc.• Indirect labour are – supervision, inspection, salary of

factory clerks, general helpers, cleaners, employees in maintenance work

• Indirect expenses are – rent, insurance, taxes, depreciation, maintenance & repair, power, light, heat, small tools

• Selling & Distribution Overhead are – advertising, samples, depreciation of sales equipment, rent of branches, telephone, stationery , printing, freight, carriage out, sales promotion, sales accounting

• Administrative overhead – office salaries, rent, depreciation equipment, telephone, travel, property taxes, auditing expenses, stationery, printing, postage,

Classification of Costs• Natural classification of costs :• Direct material – raw cotton, construction material,

crude oil to make diesel, steel for automobiles. Even primary packing material like wrappings, cardboard boxes passing from one stage to the other.

• Import duties, dock charges, transport costs & storage of materials for direct production, cost of purchasing & receiving materials are all direct material cost

• Direct labour – operators & assemblers. They may be direct labour for some hours of the day & indirect labour for the remaining hours.

• Direct Expenses – other than direct material & direct labour.

• Cost of hiring special machinery, cost of special designs & patterns, fees paid to architects, surveyors, cost of transport & conveyance to the site of job or operations, cost of patents & royalties, cost of defective trials, licence fees, Hire charges for plants, insurance on special material chargeable to a job.

• Factory Overhead is the result of all indirect material, labour & expenses. They are indirect because though they are needed for the completion of a project but are either too small or so complex that it may not be possible to treat them properly

Cost Associated with the product• Product cost –it is full factory cost prior to sale & are

identified with the products• Period cost – not identified with the product or job &

are deducted as expenses during the period in which they are incurred like selling & admin expenses

• RELATIONSHIP WITH ACCOUNTING PERIOD• Capital cost – provides benefit to the future periods

& is classified as an asset. They flow into the cost stream as an expense when the asset is used up or written off.

• Revenue expenditure – benefits the current period & is classified as an expense.

Cost for Decision making & Planning• Opportunity cost – it is the cost of opportunity lost.

Machine used to make product A has the opportunity cost if the machine can be sold or if it can make product B. This is important in decision making but not recorded in accounting.

• Sunk Cost – is that already incurred. They are unavoidable cost & are all pat costs since these amounts cannot be changed once the cost is incurred. These costs happen due to decision in the past e.g.B.V. of existing assets, plant & equipment, inventory, investment in securities.

Costs for control• Controllable cost – “ a cost which can be influenced

by the action of a specified member of an undertaking”.e.g. indirect labour, cutting tools, power, lubricants.

• Standard costs – are planned or predetermined cost estimates for a unit of output in order to provide a basis for comparison with actual costs. They are used to prepare budgets. It is a unit concept & is on per unit of output, per labour hour etc. Budgetd cost is a total cost of an item at some activity level or output level.

Features of Cost control• Creation of responsibility centres with defined

authority & responsibility for cost• Formulation of standards & budgets that

incorporate objectives & goals to be achieved• Timely cost control reports (responsibility reporting)

describing the variances• Formulation of corrective measures to eliminate the

unfavourable variances• A systematic & fair plan of motivation to encourage

the workers• Follow-up to ensure the corrective measures are

being applied

Cost reduction Areas• Product improvement :• Quality of the product• Unnecessary weight, machine or labour operations• Wastes & losses to be eliminated• Proper product design• Production methods & layout :• Material & labour control• Standardisation of methods• Designing of tools, machinery & equipment• Modernisation of plant & equipment• Marketing areas :• Channels of distribution• Sales promotion schemes• Marketing research plan• Packaging methods & materials handling

Cost reduction Areas• Administrative areas :• Effective purchasing procedure• Fair personnel policy & schemes• Investment planning• Cash discount policy• Mechanised system of accounting• Labour welfare measure• Availability of servicing departments

Cost sheet

• Prime cost – has direct material, labour & expenses• Factory cost (work cost)- are factory overheads &

includes indirect materials, labour & expenses• Cost of production – has office & admin Overheads• Cost of sales has – selling & Distribution Overheads• Finally, deduct Cost of Sales from Sales to get Net

profit

Cost sheet format• Direct materials:• Opening stock• + purchases• + carriage inwards- Closing stock- ScrapDirect wagesDirect expenses+ Factory overheads :

– Indirect materials– Loose tools– Indirect wages– Rent & rates (factory)– Lighting & heating (factory)– Power & fuel– Repairs & maintenance– Cleaning

Cost sheet format

• Research & experiment cost• Factory plant depreciation• Works stationery• Welfare service expenses• Insurance : Fixed assets• Stock & finished goods• Work manager’s salary• Factory or Works Cost• Add: Office & Admin Overheads:• Rent (office)• Salaries (office)• Lighting & heating• Insurance of office building• Telephone & postage• Printing & stationery• Depreciation of office furniture & office equipments• Legal expenses• Audit fees• Bank charges Cost of Production

Cost sheet format

• Add:• Selling & Distribution Overheads :• Showroom rent & rates• Lighting & heating• Salesman salaries• Commission• Travelling expenses of salesmen• Sales printing & stationery• Advertising• Bad debts• Postage• Depreciation & expense of delivery van• Debt collection expenses• Carriage freight outwards• Samples & other free gifts Cost of Sales• Net profit or Loss• Sales

Cost sheet format

• Items of expenses which are appropriated from profits do not form part of the cost of a product

• They are :• Income tax• Dividends to shareholders• Commission out of profit to MD or Partners• Capital loss( loss arising out of sales of assets)• Interest on loan• Donations• Capital expenditure• Discount on shares & debentures• Underwriting commission• Writing of goodwill

• Q1) From the following particulars prepare a cost sheet for the year ended 31/12/2010

• Stock of finished good (1.1.10) 6000• Stock of raw material (1.1.10) 40000• Work-in-progress (1.1.10) 15000• Purchase of raw materials 475000• Carriage inwards 12500• Factory rent, taxes 7250• Other production expenses 43000• Stock of goods(31.12.10) 15000• Wages 175000• Work manager’s salary 30000• Factory employees salary 60000• Power expenses 9500• General expenses 32500• Sales for the year 860000• Stock of raw material 50000• Work-in-progress (31.12.10) 10000

Materials Control• Materials refers to the raw material used in production.

Sometimes stores are also referred to as materials• At times finished & partly finished goods are also

referred to as materials• It is the prime cost of production s it aims at efficient

purchasing of materials, storage & usage.• Material control is at two levels : 1) quantity controls

(2) financial controls (lesser investment in material)• So a balance has to be maintained between two

opposing needs i.e. (1) maintenance of sufficient inventory for efficient production (2) maintenance of investment in inventory at the lowest level

Objectives of Material Control• Desired quantity of material will be available when

needed for uninterrupted production• Material will be purchased as per needs & in economic

quantities• The investment in materials will be maintained at the

lowest levels in tune with the operational needs• Material will be purchased at the most favourable prices• Protection under loss by fire theft, handling• Storage in such a way that minimum of handling time &

cost is there• Vouchers will be approved for payment only if the

materials have been received & is available for issue

Economic Order Quantity (EOQ) (Reorder Quantity)

• The EOQ is the optimum or the most favourable quantity which should be purchased each time the purchases are to be made

• EOQ is where the costs of carrying inventory is equal or almost equal to the cost of not carrying inventory (cost of placing orders). At EOQ level the total of these costs is minimum

• The cost of carrying the inventory is the out of pockets cost associated with having inventory on hand e.g. warehouse charges, insurance, heat, light, losses due to breakage, spoilage

• Another opportunity cost which is not the out-of-pocket cost is cost incurred in purchasing the inventory. If funds borrowed to purchase the inventory then interest payments will be the direct cost.

Economic Order Quantity (EOQ)

• The costs of not carrying the inventory arise because of frequent placing of order at short intervals. E.g. extra purchasing, handling, transportation, higher price due to smaller quantities etc.

• The cost of placing the order decrease as the size of order increases.

• However the costs of carrying the inventory goes up if purchases have been made in large quantities.

• The point where there is lowest total cost per unit is EOQ

EOQ or Re-Order Quantity• The point where there is lowest total costs and the

size of material is ideal is EOQ.• EOQ = 2 * U * O• I C• U = Annual usage in units• O= Cost of placing an order• I= Percent cost of carrying inventory• C= Cost per unit of material• E.g. If the annual usage in units is 4000, cost of

placing an order is Rs.20, carrying cost is 10% & cost per unit is Rs.10 then what is the EOQ?

Re-order Level• The EOQ tells how much to buy at a particular time, but when

to buy is told by Re-Order level.• There is lead time involved , i.e. the time interval between

placing an order & receiving delivery.• The re-order level is the point or quantity level at which if

materials in stores reach, the order for supply of materials must be placed. This point initiates a new order.

• It is calculated with three factors :• 1. The expected usage• 2. The time interval between initiating an order & its receipt,

called lead time.• 3. The minimum inventory or safety stock• Re-order level= Max. Usage per period * Max. Re-order period.

Minimum Stock Level (Safety Stock)• The safety stock is kept to prevent stock out. It is to

be used only in abnormal cases.• If the usage pattern is known with certainty, & the

lead time is also known accurately then no safety stock is needed.

• However, either usage or lead time is varying then it is necessary for a firm to maintain safety stock level equal to the difference between expected usage over lead time & the maximum usage over lead time that the firm feels it is required for cost minimisation.

• Min. Stock level= Re-order level-(Avg. rate of consumption* Avg. Re-order period)

Maximum Stock Level

• The max. stock level means that the stock will not exceed this limit although there may be low demand for materials or quick delivery from suppliers.

• Max. stock level = Re-order level + Re-order Qty – (Min. consumption * Min re-order period)

Danger Level

• Generally the danger level of stock is below the min. stock level.

• Sometimes the danger level of stock is between re-order level & max. level.

• Danger level= Avg. consumption* lead time for emergency

Practice questions• Q1) Max. usage (units) 500 per day• Min. usage (units) 200 per day• Normal usage (units) 300 per day• EOQ (units) 50000• Reorder period or lead time 20-30 days• Minimum level (units) 5000• (10 days at normal usage)• Find : Reorder level, Maximum level,

• Q2) If a company’s weekly minimum & maximum consumption of material A are 25 & 75 units respectively. The re-order quantity as fixed by the company is 300 units, The material is received within 4 to 6 weeks from issues of supply order. Calculate minimum & maximum level of material A.

• Q3) About 50 items are required every day for a machine. A fixed cost of Rs.50 per order is incurred for placing an order. The inventory carrying cost per item amount to Rs. 0.02 per day. The lead period is 32 days.

• Compute: EOQ and Reorder level

• Q4) The cost of placing an order is Rs.20. The number of units to be purchased during the year is 5000 units. Purchase price per unit inclusive of transportation cost is Rs. 50. Annual cost of storage per unit is Rs.5. Details of lead time are Average 10 days. Max. 15 days, Min. 6 days. For emergency purchases 4 days.

• Rate of consumption is Average 15 units per day & max. 20 units.

• Calculate :• Reordering level• Maximum level• Minimum level• Danger level

Material Costing• This is done when materials are purchased at

different times for different processes & jobs. So different pricing has to be done for the materials issued from the storeroom. This is based on the different methods used. Only few of them are taken here :

• FIFO (First in First out)• LIFO (Last in First out)• HIFO (Highest in First out)• Simple Averages• Weighted Averages

Selection of a Material Pricing Method• The various methods which are in use have advantages & disadvantages.

The factors which should be taken into consideration are as follows:• Customs & practices within the industry• Frequency of price fluctuations & frequency of material purchases.• Relative value of materials cost to total cost of products.• Relative rate of stock turnover.• Quantities of materials to be purchased at any one time.• The effect of different pricing methods on tax liability.• The accuracy with which material issues can be computed.• Cost of clerical work involved in making these records.• The relationship of selling prices to the costs that are matched with

those prices.• The probability of using different methods for various classes of

inventory.

FIFO• Here it is good for the stocks that deteriorate very fast. So the oldest units

should be sold or used first & the inventory will only consist of the latest purchases.

• Q1) Jan 1. Opening balance is 500 units @ Rs.25 per unit• Jan 3. Issued 70 units• Jan 4. Issued 100 units• Jan 8. Issued 80 units• Jan 13. Received from supplier 200 units @ Rs.24.5 per unit• Jan 14. Returned to store 15 units @ Rs.24 per unit • Jan 16. Issued 180 units• Jan 20. Received from supplier 240 units @ Rs.24.75 per unit• Jan 24. Issued 304 units• Jan 25. Received from supplier 320 units @ Rs.24.5 per unit• Jan 26. Issued 112 units• Jan 27. Returzned to store 12 units @ Rs.24.5 per unit • Jan 28. Received from supplier 100 units @ Rs.25 per unit• Calculate on the FIFO basis the valuation of Closing Stock.

LIFO• The cost of the last lot of materials received is used to price materials

issued until the cost is exhausted.• It is a better matching of current costs with current revenues. It is good

for tax saving.• Q2) Prepare a stores ledger account from the following transactions

under LIFO method.• Feb 1. Received 1000 units @ Re.1 per unit• Feb 10. Received 260 units @ Re.1.05 per unit• Feb 12. Issued 700 units• Feb 14. Received 400 units @ Rs.1.15 per unit• Feb 21. Received 300 units @ Rs.1.25 per unit• Mar 16. Issued 620 units• Apr 12. Issued 240 units• May 10. Received 500 units @ Rs.1.10 per unit• May 25. Issued 380 units

HIFO• Highest in First Out. Here the materials received at the

highest price in the stock are issued first. So here the highest cost enters into the cost of goods sold & the inventory valuation is done at the lowest possible price.

• Simple Averages• The materials issued should be priced on an average

price & not on the exact cost price.• Weighted Average• Here the issued materials are priced at the average cost

price of the materials in hand, a new average being computed whenever materials are received. It is calculated each time the purchases are made.

• Q3) Use Simple & Weighted Averages to calculate the closing stock.

• May 1. Received 500 units @ Rs. 20 per unit• May10. Received 300 units @ Rs.24 per unit• May 15. Issued 700 units• May 20. Received 400 units @ Rs.28 per unit• May 25. Issued 300 units• May 27. Received 500 units @ Rs.22 per unit• May 31. Issued 200 units

Labour Costs & Control• Cost accounting for labour has three primary objectives :• 1. Determining labour costs in the cost of product or service.• 2. Reporting labour costs for planning & control• 3. Reporting labour costs for decision making• Direct labour• It consists of wages paid to the labour which convert raw materials into

finished output. It comprises of the wages which can be identified & allocated to cost units. E.g. assembly line workers, moulders, operators, samplers etc.

• Indirect labour• Is which is not engaged in converting raw materials into finished output.

It is the cost which cannot be allocated but which can be apportioned to or absorbed by the cost centres or cost units. It includes foremen, inspectors, watchmen, supervisors, storekeepers, timekeepers. After all the direct labour is charged what is remaining is indirect labour.

Organisation for Labour Control• These departments contribute to the efficient utilisation of labour & adequate

control over labour costs.• 1. Personnel Dept.• 2. Engineering Dept.• 3. Time-keeping Dept.• 4. Payroll Dept.• 5. Cost Accounting Dept.• Personnel Dept.- various dept. heads along with directors of personnel dept. involve

in employment, discharge, classification of employees, wage & wage systems.• Engineering dept.- It is involved in the preparation of plans for every job. Inspection

of posts & jobs at stages of production. Initiation & supervision of research work. Safety & efficient working conditions.

• Time keeping dept.- The total no. of hours worked by each employee to match his earnings.

• Absence of time-keeping will frustrate the l loyal & punctual employees .• Pension, gratuity, leave with pay, P.F., salary, promotion are linked to attendance

records.• Overhead costs being indirect costs can be done on the basis of labour hours.

• Payroll Dept.- It is the intermediate function between the timekeeping & the cost accounting dept. The functions are to :

• To compute employee wages• To prepare departmental payroll summaries• To calculate payroll taxes, deductions etc.• Cost Accounting Dept.- On the basis of the labour summary or job

cards, the cost dept. records direct labour costs on the cost sheets & indirect labour costs on the departmental expense sheets.

• Wage System:• It is a part of labour cost control. The following objectives have to be

met with an efficient wage system:• 1. Provision for flexibility• 2. Acceptance by employees to avert slowdowns & work stoppages• 3. Stabilisation of labour turnover• 4. Minimising of absenteeism• 5. Provision for incentive plans

• There are two wage systems to pay for labour:• 1. Straight time which is by hour, day or week.• 2. Piece work, which is by unit of product. So, the job performed or

no. of operations completed & the workers wages depend upon his output & the not upon the time he spends in the factory.

• Straight time- is found in those industries where:• The speed of production cannot be influenced by the energy or the

dexterity of the worker.• The quality of work is of paramount importance• It is difficult to measure the work done by the employee.• Piece Work- are suitable in the following cases:• Managerial supervision is not needed much for production.• Higher production reduces overhead cost per unit of output.• Labour costs can be computed in advance of production.• Labour control is easier by isolating workers whose work is inefficient

& below the minimum standard requirements.

• Time & Motion Study:• Time study means the time spent on each element of a job. The

total time taken by all the elements (stages) of a job is called the standard time.

• This standard time is the time which should be taken by an average employee to complete a job under standard (normal) working conditions.

• Motion study means dividing the work into basic elements of a job or a process for the purpose of eliminating unnecessary (defective) elements in a job.

• After investigating all movements in a job, process or operation it finds out the most scientific & systematic method of performing the operation.

• The time study fixes the standard time for a job or process & motion study eliminates the wasteful movements of a worker on the job. Both are complementary to each other.

• Objectives of Time & Motion Study• 1. Eliminating unnecessary human efforts• 2. Improving methods, techniques, processes• 3. Utilising effectively the materials, machines, human resources &

other facilities.• 4. Improving the workout environment, layout & design of plant &

equipment.• Labour Turnover• It is the rate at which employees leave employment at a factory & is

normally measured as the ratio of the no. of persons leaving in a period to the average no. on the payroll.

• Here all the persons who leave must be included, irrespective of voluntarily leaving or getting replaced.

• Labour Turnover=• Employees leaving/ Avg. no. employed * 100• The effects of high or low turnover rate should then be analysed on

training costs, production efficiency & employee morale etc.

Some Labour Cost Related Items• Overtime- is the work done beyond the normal hours of work.

Factories Act of 1948 says more than 8 hours of work in a day is O.T. So they should be paid generally at double rate than of basic time.

• Idle Time- Many times workers spend more time on the job but are paid less than that. That difference is idle time, the employer must pay though he obtains no direct benefit from that. In this holidays & leave are not included.

• Fringe Benefits- They are given in the form other than (basic wages, DA, HRA, CCA) like vacation & holiday pay, pension costs, group insurance, hospitalisation benefits, sick pay, night shift premium etc.

• These indirect benefits are treated as factory overhead like Leave with Pay for leaves like CL, EL, Special Leave etc.

• Employers Contribution to Insurance is treated as production overhead.

• Q1) In a factory Ram & Sham produce the same product using the same input of same material & at the same normal wage rate.

• Bonus is paid to both of them in the form of normal time wage rate adjusted by the proportion which time saved bears to the standard time for the completion of the product. The time allotted to the product is 50 hours. Ram takes 30 hours & Sham takes 40 hours to produce the product. The factory Cost of the product for Ram is Rs.3100 and for Sham Rs.3280. The factory OH rate is Rs.12 per man hour.

• Calculate 1) Normal Wage Rate 2) Cost of material used for the product 3) the input of material if the unit material cost is Rs.16.

• Q2) An article passes through five hand operations as follows:

• Operation Time per Grade of Wage rate• No. article worker per hour• 1 15 min. A Re 0.65• 2 25 min. B Re 0.50• 3 10 min. C Re 0.40• 4 30 min. D Re.0.35• 5 20 min. E Re 0.30• The factory works 40 hours a week and the production

target is 600 dozens per week. Prepare a statement showing for each operation and in total the number of operations required, the labour cost per dozen and the total labour cost per week to produce the total targeted output.

Factory Overheads• FOHS cannot be directly traced to a particular unit of output i.e.

product or jobs. It is the aggregate of indirect materials, indirect wages & indirect expenses.

• FOHS are Fixed, Semi-Variable & Variable.• Fixed FOHS do not vary in total amount with increase or decrease

in production activity. They are like management salaries, depreciation, rent, property taxes & amortisation of leaseholds.

• Semi-variable or semi-fixed are that remain fixed in total amount over a relatively short range of variation in output & then are abruptly changed to a new level where they remain fixed for another range of output. So if a third shift is added without increasing the plant facilities, i.e. the Fixed Costs such as Supervisor salaries may be increased because of night supervision, insurance premium may be raised due to additional fires, theft risk.

• Variable Costs are like repairs, power, workmen’s compensation, indirect labour which varies with changes in production. Though the proportion of increase or decrease of variable costs may not correlate to the increase or decrease in production of items.

• Accounting of FOHS• 1) Collection & Codification• 2) Allocation & Apportionment• 3) Absorption• 1) Collection & Codification- The Factory OHS are

collected & coded under different Cost Accounting numbers like factory supplies-O1, Indirect labour-O2, Insurance-O3 etc.

• 2) Allocation & apportionment- Here the costs are allocated to various departments or cost centres like production & service departments. Some expenses do not originate in a specific department. They are incurred for all & must be apportioned or appropriated to any or all departments using such items, e.g. power, light, rent, dep. on factory building etc.

• Cost apportionment is the process of charging expenses in an equitable proportion to the various cost centres or department.

• They are like:• Floor area occupied- for OHS like lighting & heating, depreciation on

building, caretaking, rent & rates etc.• Capital values- Dep. On plant, insurance on building, maintenance of

plant etc.• Direct Labour hours or machine hours- repairs & maintenance costs,

insurance on tools & fixtures etc.• No. of workers employed- accident insurance, dental, medical first aid.• Technical estimate- usage of oil & grease etc.

• Absorption of Factory OHS• After all the service dept. OHS have been apportioned to

production dept. the next step is to spread factory OHS to different products or jobs produced. This is called OHS absorption.

• It is the allotment of OHS to cost units. So, the expenses of a particular cost centre is finally charged to or absorbed in the cost of products, jobs etc passing through it.

• Methods of Absorption• Percentage on Direct Materials- It is by dividing total estimated

factory OHS by total direct materials cost. If factory OHS is Rs.300000 & Mat.cost is Rs.250000 then the absorption rate is (300000/250000)* 100= 120%

• Each job or product would be charged on the basis of 120% absorption rate.

• So if the mat.cost is Rs.50000 then by % on direct materials the factory OHS would be (50000)*120/100= Rs.60000.

• Percentage on Direct Wages:• (Factory OHS/ Direct labour Cost)* 100• If FOHS is Rs.200000 & the direct labour cost is rs.200000 then

the absorption rate is (200000/200000)*100 = 100%• So, a product with direct labour cost of Rs.30000 would be

charged with Rs.30000 for factory OHS.• Unit of Production basis :• It is the simplest method of charging factory OHS.• FOHS per unit= (FOHS/Units of production)*100• Labour Hour rate- One of the most popular methods. The

absorption of FOHS on this basis= (FOHS/Direct labour hours)*100. this is generally where lots of direct labour is involved in the process.

• Machine Hours rate- here the work is primarily on machines = (FOHS/Machine hours)*100

• Admin., Selling & Distribution OHS:• In this the following items are there:• Indirect material- Printing & stationery used in the

office• Indirect labour- Salaries, allowances, fees of BOD,

legal advisor etc• Indirect expenses- office rent, rates, lighting, heating

& cleaning, legal charges, bank charges, repairs of office equipments.

• Selling & distribution OHS are apportioned in the same way as FOHS & is apportioned to the particular product or the cost centre.

• It can be as % OF Sales, % of Factory Cost, % of GP etc.

• Q1) A factory is having 3 production departments A, B & C and 2 service departments - Boiler House & Pump room. The boiler house has to depend upon the pump room for supply of water & pump room in its turn is dependent on the boiler house for supply of driving the pump.

• The expenses incurred by the production departments during a period are A Rs.800000, B Rs.700000 & C Rs.500000. The expenses for boiler house are Rs. 234000 & the pump room are Rs.300000.

• The expenses of the boiler house & pump room are apportioned to the production departments on the following basis:

• A B C BH PR• Expenses of BH 30% 30% 30% 10%• Expenses of PR 40% 20% 20% 20% • Show clearly as to how the expenses of boiler house & pump

room would be apportioned to A,B & C departments.

Job, Contract, batch, project Costing• It is applied to determine the cost of specific jobs or batches of

production generally made as per the customers specifications.• The main feature is that no two job orders are necessarily alike & all the

orders do not pass through the same manufacturing process.• Eg. Building, contracting, furniture, printing, machine tool manufacturing

etc.• A job may be a product, project, service, batch etc.• The main components of a job cost sheet are – material costs, labour

costs & manufacturing OHS.• When a job is finished, its cost is determined by totalling prime costs &

absorbed OHS.• Here the cost is determined after the job is finished by totalling the prime

costs & OHS absorbed.• A finished goods account is made. When no unit on a job order is

completed , the total cost incurred on the job order so far becomes W-I-P.• The Questions here require to calculate the Net Profit derived after the

direct costs& OHS have been charged in the particular job.

• The following information is obtained from the books of a factory:

• Cost of completed jobs• Raw material supplied from stores Rs.88000• Wages Rs.100000• Chargeable expenses Rs.10000• Material returned to stores Rs.1000• Factory OHS are 80% of wages. Office OHS are 25% of

factory cost & selling & distribution OHS are 10% of cost of production.

• The completed jobs realised Rs.410000.Prepare a completed Job Account to find the net profit on the completed jobs.

Process Costing• This is that form of costing applied to standardised goods

produced in large volume with continuous production flow.

• It is used in industries like chemicals, textiles, steel, petroleum, cement, plastic etc.

• Nature of Process Costing:• They are accumulated for each production dept. or

process.• Each process or dept. has its own account & records the

processing costs incurred by the dept.• The product costing under process costing is an averaging

process. The unit cost is obtained by accumulating all manufacturing costs & dividing it by units produced

Differences between Process & Job Costing• Job costing is applicable for specific products or jobs. Process costing is in

the case of mass production of similar units having different processes.• In job costing, manufacturing costs are calculated for particular jobs. In

process the manufacturing costs are for the entire processes & the cost of particular jobs or products cannot be determined.

• In job costing time is not a major issue & can take more than one accounting period. In process costing the production is measured for specific processes for given time period like a month.

• Job costing is dependent on customers orders for a product. While process costing has production of units done for future sale.

• In job costing unit cost is got by dividing the cost of jobs by units produced. In process costing unit cost are process costs divided by process production.

• In job only one W-I-P a/c is maintained. In process individual W-I-P a/c is maintained for each process.

• Method of Process Costing:• In this all the materials, labour & direct expenses &

factory OHS are taken for each process. A separate process a/c is made & the balance is carried forward to the next process.

• Process Cost a/c in different situations:• When there is no process loss & no opening & closing

W-I-P• When there are process losses or gains (normal loss or

gain, abnormal loss or gain)• When there are opening & closing W-I-P at various

stages of completion• Inter process profits

• Q) Prepare process cost accounts for the following data:

• Items Total Process• I II III• Dir.mat. 4,40,000 3,60,000 60,000 20,000• Dir.wages 80,000 20,000 40,000 20,000• Dir. Expen. 1,00,000 60,000 40,000• Production OHS incurred is Rs.1,60,000 & is

recovered on 200% of direct wages. Production during the period was 20,000 units. There was no opening or closing W-I-P.