ORIENTAL Cost & Management Accounting COST: MEANING AND ITS ELEMENTS The term „cost. means the amount of expenses [actual or notional] incurred on or attributable to specified thing or activity. As per Institute of cost and work accounts (ICWA) India, Cost is „measurement in monetary terms of the amount of resources used for the purpose ofproduc tion o f good s or rend ering se rvices. Elements of cost Cost of pro duct io n/m anufa ctu ri ng cons is ts of vari ous expenses in curre d on produc tion/ma nufactu ring of goods or services. These are the eleme nts of cost, which can be divided into three groups: Material, Labour and Expenses. COST SHEET: MEANING AND ITS IMPORTANCE Cost sheet is a statement, which shows various components of total cost of a product. It classifies and analyses the components of cost of a product. Previous periods data is given in the cost sheet for comparative study. It is a statement, which shows per unit cost in addition to Total Cost. Selling price is ascertained with the help of cost sheet. The details of total cost presented in the form of a statement are termed as Cost sheet. Cost sheet is prepared on the basis of: 1. Historical Cost 2. Estimated Cost Historical Cost Historical Cost sheet is prepared on the basis of actual cost incurred. A statement of cost prepared after inc urring t he actua l cost is ca lled Hist orical Co st Sheet . Estimated CostEstimated cost sheet is prepared on the basis of estimated cost. The statement prepared before the commencement of production is called estimated cost sheet. Such cost sheet is useful in quoting the tender price of a job or a contract. Importance of Cost Sheet The importance of cost sheet is as follows: Cost ascertainment The main objective of the cost sheet is to ascertain the cost of a product. Cost sheet helps in ascertainment of cost for the purpose of determining cost after they are incurred. It also helps to ascertain the actual cost or estimated cost of a Job. BY Dinesh Makani For Private Circulation Only Page 1
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If office and administrative overheads are added to factory or works cost, total cost of
production is arrived at. Hence the total cost of production is calculated as:Total Cost of production = Factory Cost + office and administration overheads
Cost of goods sold
It is not necessary, that all the goods produced in a period are sold in the same period. There
is stock of finished goods in the opening and at the end of the period. The cost of opening
stock of finished goods is added in the total cost of production in the current period and cost
of closing stock of finished goods is deducted. The cost of goods sold is calculated as:
Cost of goods sold = Total cost of production + Opening stock of Finished goods – Closing stock of finished goods
Total Cost i.e., Cost of Sales
If selling and distribution overheads are added to the total cost of production, total cost is
arrived at. This cost is also termed as cost of Sales. Hence the total cost is calculated as:
Total Cost = Cost of Goods sold + Selling and distribution overheads
Sales
If the profit margin is added to the total cost, sales are arrived at. Excess of sales over total
cost is termed as profit. When total cost exceeds sales, it is termed as Loss.
Sales = Total Cost + Profit
Sometimes profit is calculated on the basis of given information in percentage of cost or sales.
In such a situation, the amount is assumed 100 in which the percentage is calculated. Then the
Profit is calculated in the following ways:
Case 1
If Cost is Rs.10,000 and profit on cost 10%. Assume the cost is Rs.100 and
profit on cost is Rs.10. Hence Profit on cost of Rs.10,000 is
10,000 × 10/100 = Rs.1,000
Thus the sales value is Rs 11000 (10,000 + 1000)
Case 2
If Cost is Rs.10,800 and profit on sales price is 10%. Assume sales price is
Rs.100. cost price is Rs.90 [i.e. Rs.100 – Rs.10]. When profit on cost of Rs.90 is
Rs.10. Hence profit on cost of Rs.10,800 is
10,800 × 10/90 = Rs.1,200
10,800 + 1200 = 12,000 sales value
Case 3
If sales price is Rs.12,100 and profit on cost is 10%. Assume Cost price is
Rs.100. Sales price is Rs.110 [i.e.100 + 10]. If sales price is Rs.110, profit isRs.10. Profit on sales price of Rs.12,100 is 12,100 × 10/110 = Rs.1,100 profit
BY Dinesh Makani For Private Circulation Only Page 3
Prime Cost = Direct material + Direct Wages + Direct expenses works/ factory cost;
Factory Cost = Prime cost + Factory overheads
Cost of production/office cost = Factory Cost + office and administration overheads Cost of production of goods sold = Cost of Production + Opening stock of Finished. Goods –
closing stock of finished goods
Total Cost = Cost of Production of goods sold + Selling and distribution overheads
Sales = Total Cost + Profit
CONTRACT COSTING
Contract costing is A form of specific order costing; attribution of costs to individual
contracts. A contract cost is Aggregated costs of a single contract; usually applies to major
long term contracts rather than short term jobs.
Features of long term contracts
- By contract costing situations, we tend to mean long term and large contracts: such as civil
engineering contracts for building houses, roads, bridges and so on. We could also includecontracts for building ships, and for providing goods and services under a long term
contractual agreement.
- With contract costing, every contract and each development will be accounted for
separately; and does, in many respects, contain the features of a job costing situation.
- Work is frequently site based.
Features of a Contract
- The end product
- The period of the contract
- The specification
- The location of the work
- The price
- Completion by a stipulated date
- The performance of the product
Collection of Costs
Desirable to open up one or more internal job accounts for the collection of costs. If the
contract not obtained, preliminary costs be written off as abortive contract costs in P&L In
some cases a series of job accounts for the contract will be necessary:
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The accounting system in which variable costs are charged to cost units and the fixed costs of
the period are written-off in full against the aggregate contribution. Its special value is in
decision-making.. (Terminology.)
The term „contribution. mentioned in the formal definition is the term given to the difference
between Sales and Marginal cost. Thus
MARGINAL COST = VARIABLE COST DIRECT LABOUR
+ DIRECT MATERIAL +DIRECT EXPENSE+ VARIABLE OVERHEADS
Marginal cost means the cost of the marginal or last unit produced. It is also defined as the
cost of one more or one less unit produced besides existing level of production. In this
connection, a unit may mean a single commodity, a dozen, a gross or any other measure of goods.
The marginal cost varies directly with the volume of production and marginal cost per unit
remains the same. It consists of prime cost, i.e. cost of direct materials, direct labor and all
variable overheads. It does not contain any element of fixed cost, which is kept separate under
marginal cost technique.
Contribution may be defined as the profit before the recovery of fixed costs. Thus,
contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus
profit (C = F + P).
In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixedcost (C = F). This is known as break-even point.
The concept of contribution is very useful in marginal costing. It has a fixed relation with
sales. The proportion of contribution to sales is known as P/V ratio, which remains the same
under given conditions of production and sales.
The principles of marginal costing
The principles of marginal costing are as follows.
a. For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the „relevant range.). Therefore, by
selling an extra item of product or service the following will happen.
. Revenue will increase by the sales value of the item sold.
. Costs will increase by the variable cost per unit.
. Profit will increase by the amount of contribution earned from the extra item.
b. Similarly, if the volume of sales falls by one item, the profit will fall by the amount of
contribution earned from the item. c. Profit measurement should therefore be based on an
analysis of total contribution. Since fixed costs relate to a period of time, and do not change
with increases or decreases in sales volume, it is misleading to charge units of sale with a
share of fixed costs. d. When a unit of product is made, the extra costs incurred in its
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This fundamental marginal cost equation plays a vital role in profit projection and has a wider
application in managerial decision-making problems.
The sales and marginal costs vary directly with the number of units sold or produced. So, the
difference between sales and marginal cost, i.e. contribution, will bear a relation to sales andthe ratio of contribution to sales remains constant at all levels. This is profit volume or P/V
Now, breakeven point can be easily calculated with the help of fundamental marginal cost
equation, P/V ratio or contribution per unit.
a. Using Marginal Costing EquationS (sales) – V (variable cost) = F (fixed cost) + P (profit) At BEP P = 0, BEP S –
V = F
By multiplying both the sides by S and rearranging them, one gets the following equation:
S BEP = F.S/S-V
b. Using P/V Ratio
Sales S BEP =
Contribution at BEP = Fixed cost P/ V ratio
P/ V ratio
4. Margin of Safety (MOS)
Every enterprise tries to know how much above they are from the breakeven point. This is
technically called margin of safety. It is calculated as the difference between sales or
production units at the selected activity and the breakeven sales or production.
Margin of safety is the difference between the total sales (actual or projected) and the
breakeven sales. It may be expressed in monetary terms (value) or as a number of units
(volume). It can be expressed as profit / P/V ratio. A large margin of safety indicates the
soundness and financial strength of business.
Margin of safety can be improved by lowering fixed and variable costs, increasing volume of
sales or selling price and changing product mix, so as to improve contribution and overall P/V
ratio.
Margin of safety = Sales at selected activity – Sales at BEP = Profit at selected activity
P/V ratio Margin of safety is also presented in ratio or percentage as follows:
Margin of safety (sales) x 100 %
Sales at selected activity
The size of margin of safety is an extremely valuable guide to the strength of a business. If itis large, there can be substantial falling of sales and yet a profit can be made. On the other
hand, if margin is small, any loss of sales may be a serious matter. If margin of safety is
unsatisfactory, possible steps to rectify the causes of mismanagement of commercial activities
as listed below can be undertaken.
a. Increasing the selling price—It may be possible for a company to have higher margin of
safety in order to strengthen the financial health of the business. It should be able to influence
price, provided the demand is elastic. Otherwise, the same quantity will not be sold.
b. Reducing fixed costs
c. Reducing variable costs
d. Substitution of existing product(s) by more profitable lines e.
Increase in the volume of output
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e. Modernization of production facilities and the introduction of the
most cost effective technology
BUDGET & BUDGETORY CONTROL
A budget is a plan expressed in quantitative, usually monetary term, covering a specific
period of time, usually one year. In other words a budget is a systematic plan for the
utilization of manpower and material resources.
In a business organization, a budget represents an estimate of future costs and revenues.
Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets.
Capital budgets are directed towards proposed expenditures for new projects and often require
special financing. The operating budgets are directed towards achieving short-term
operational goals of the organization, for instance, production or profit goals in a businessfirm. Operating budgets may be sub-divided into various departmental of functional budgets.
The main characteristics of a budget are:
1. It is prepared in advance and is derived from the long-term strategy of the organization.
2. It relates to future period for which objectives or goals have already been laid down.
It is expressed in quantitative form, physical or monetary units, or both.
Different types of budgets are prepared for different purposed e.g. Sales Budget, Production
Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional
budgets are afterwards integrated into a master budget, which represents an overall plan of the
organization.
ADVANTAGES OF BUDGETS A budget helps us in the following ways:
1. It brings about efficiency and improvement in the working of the organization.
2. It is a way of communicating the plans to various units of the organization. By establishing
the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus
minimizes the possibilities of buck passing if the budget figures are not met.
3. It is a way or motivating managers to achieve the goals set for the units.4. It serves as a benchmark for controlling on-going operations.
5. It helps in developing a team spirit where participation in budgeting is encouraged.
6. It helps in reducing wastage and losses by revealing them in time for corrective action.
7. It serves as a basis for evaluating the performance of managers.
8. It serves as a means of educating the managers.
BUDGETARY CONTROL No system of planning can be successful without having an effective and efficient system of
control. Budgeting is closely connected with control. The exercise of control in the
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10. Reports, statements, forms and other records to be maintained.
11. The accounts classification to be employed. It is necessary that the framework within
which the costs, revenues and other financial amount are classified must be identical both inaccounts and the budget departments.
There are many advantages attached to the use of budget manual. It is a formal record
defining the functions and responsibilities of each executive.
The methods and procedures of budgetary control are standardized.
There is synchronization of the efforts of all which result in maximization of the profits of the
organization.
Making a forecast Consideration of alternative combination of forecasts: Alternative combinations of forecasts
are considered with a view to contain the most efficient overall plan so as to maximize profits.
When the optimum -profit combination of forecasts is selected, the forecasts should be
regarded as being finalized.
Sales budget Past sales figures and trend. The record of previous experience forms the most reliable guide
as to future sales as the past performance is related to actual business conditions. However the
other factors such as seasonal fluctuations, growth of market, trade cycles etc., should not be
lost sight of salesmen's estimates. Salesmen are in a position to estimate the potential demand
of the customers more accurately because they come in direct contact with the customers.
However, proper discount should be made for over-optimistic or too conservative estimates of
the salesmen depending upon their temperament.
Plant Capacity. It should be the endeavor of the business to ensure proper utilization of plant
facilities and that the sale budget provides an economic and balanced production on the
factory.
General trade prospects. The general trade prospects considerable affect the sales. Valuable
information can be gathered in this connection from trade papers and magazines.Orders on hand. In case of industries where production is quite a lengthy process, orders on
hand also have a considerable influence in the amount of sales.
Proposed expansion of discontinuance of products. It is affects sales and therefore, it should
also be considered.
Seasonal fluctuations. Past experience will be the best guide in this respect. However, efforts
should be made to minimize the effects of seasonal fluctuations by giving special concessions
or off-season discounts thus increasing the volume of sales.
Potential market. Market research should be carried out for ascertaining the potential market,
for the company's products. Such an estimate on the basis of expected population growth,
purchasing power of consumers and buying habits of the people.
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Availability of material and supply. Adequate supply of raw materials and other supplies must
be ensured before drafting the sales programme.
Financial aspect. Expansion of sales usually require increase in capital outlay also, therefore,
sales budget must be kept within the bounds of financial capacity.
Production budget
Inventory policies. Inventory standards should be predetermined as that neither there is a
shortage nor over-stocking of goods.
Sales requirements. The quantity of goods to be sold would decide to a great extent how much
is to be produced. Therefore, this budget depends upon the sales budget.
Production stability. For reduction of costs, stability in employment and better utilization of
plant facilities, the production should be evenly distributed throughout the year. In case of
seasonal industries, since it is not possible to have stable levels of production or inventory, an
effort should be made to have the optimum balance between the two.
Plant capacity. How much can be produced depends upon the available plant capacity. Theremust be sufficent capacity to procede the annual requirements and also to meet seasonal high
demands.
Availability of material and labour. Adequate and timely supply of raw material and labour
should have an important effect on the planning of production. 6. Time taken in production
process. The production should commence
well in time deeping in view how much time it would take in the factory to translate the raw
materials into finished goods.
Capital Expenditure Budget
The budget provides a guidance as to the amount of capital that may be
Needed for procurement of capital assets during the budget period. The budget is prepared
after taking into account the available productive capacitates, probable reallocation of existing
assets and possible improvement in production techniques. If necessary separte budgets may
be prepared for edach item o assets, such a building budget, a plnat and equipment budget etc.
Cash budget The cash budget can be prepared by any of the following methods; 1. Receipts and payments
method 2. The adjusted profit and loss method 3. The balance sheet method.
1. Receipts and payments method : In case of this method the cash receipts from various
sources and the cash payments to various agencies are estimated. In the opening balance of
cash , estimated cash receipts are added and From the total, the total of estimated cash
payments are deduted to find out the closing balance.
2. The adjusted profit and loss method : In case of this method the cash budget is prepared on
the basis of opening cash and bank balances, projected profit and loss account and the
balances of the various assests and liabilities.
3. The balance sheet methos : With the helop of budget balances at the
end except cash and bank balances, a budgeted balance sheet can be prepared and the
balancing figure would be the estimated closing cash/ bank balance.
Thus under this method, closing balances other than cash/bank will have to be found out first
to be put in the budgeted balance sheet. This can be done by adjusting the anticipated.Research and Development Budget
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Cost accounting has long been used to help managers understand the costs of running a
business. Modern cost accounting originated during the industrial revolution, when thecomplexities of running a large scale business led to the development of systems for
recording and tracking costs to help business owners and managers make decisions.
In the early industrial age, most of the costs incurred by a business were what modern
accountants call "variable costs" because they varied directly with the amount of production.
Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to
production. Managers could simply total the variable costs for a product and use this as a
rough guide for decision-making processes.
Some costs tend to remain the same even during busy periods, unlike variable costs, which
rise and fall with volume of work. Over time, the importance of these "fixed costs" has
become more important to managers. Examples of fixed costs include the depreciation of
plant and equipment, and the cost of departments such as maintenance, tooling, production
control, purchasing, quality control, storage and handling, plant supervision and engineering.
In the early twentieth century, these costs were of little importance to mostbusinesses. However, in the twenty-first century, these costs are often more important than
the variable cost of a product, and allocating them to a broad range of products can lead to
bad decision making. Managers must understand fixed costs in order to make decisions about
products and pricing.
Thank You
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