Mca i fma u 4.2 marginal costing

MCA Financial Management Accounting

UNIT 4

CONCEPT OF COST

• The term ‘cost’ does not have definite meaning and its scope is extremely broad and general. it is therefore not easy to define or explain this term without leaving any doubt concerning its meaning .cost accountants ,economist and others develop the concept of cost according to their needs because one complete description of ‘cost’ to all situations is not possible. how ever some of the cost definitions given below:

COST

• 1. ACCORDING TO THE OXFORD DICTIONERY

• ‘THE PRICE PAID FOR SOMETHING’ 2.COST IS ‘THE AMOUNT OF EXPENDITURE (ACUTAL OR NOTIONAL )INCURRED OR ATTRIBUTABLE TO A GIVEN THING’ (CIMA,LONDAN) 3- ‘A COST IS THE VALUE OF ECONOMIC RESOURCES USED AS A RESULT OF PRDUCING OR DOING THE THINGS COSTED’

• (W M HARPER)

Concept of cost

• In fact ,in order to assign a definite meaning to the term cost . It should be used with a modifier or an adjective according to the specific purpose for its use. For example-direct cost ,fixed cost ,variable cost ,selling cost, marginal cost etc. have specific meanings.

CLASSIFICATION OF COST

• CLASSIFICATION IN TO DIRECT AND INDIRECT COST-(A)DIRECTCOST-A price that can be completely attributed to the production of specific goods or services. Direct costs refer to materials, labor and expenses related to the production of a product. (B)INDIRECT COST-Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and therefore are considered indirect costs.

CLASSIFICATION IN TO FIXED AND VARIBLE COSTS

• FIXED COST- THESE COSTS REMAIN CONSTANT IN ‘TOTAL’ AMOUNT OVER A SPECIFIC RANGE OF ACIVITY FOR A SPECIFIC PERIOD OF TIME i.e THESE DO NOT DECREASE OR INCREASE WHEN VOLUME OF PRODUCTION CHANGES.

• e.g BUILDING RENT ,MANAGERIAL SALARY

VARIABLE COSTS -

• THESE COST VERY IN DIRECT PROPORTION TO THE VOLUME OF OUTPUT. eg- DIRECT MATERIAL S,DIRECT WAGES ,POWER.

SEMI-VARIABLE COST

• THESE COSTS INCLUDE BOTH A FIXED AND A VARIABLE COMPONENT i.e THESE ARE PARTLY FIXED AND PARTLY VARIABLE. eg LIGHT AND POWER,MAINTENANCE AND REPAIRS.

SUNK COST• A SUNK COST IS AN EXPENDITURE

MADE IN THE PAST THAT CAN NOT BE CHANGED AND OVER WHICH MANAGEMENT NO LONGER HAS CONTROL.

MARGINAL COST

• MARGINAL COST IS THE ADDITIONAL COST OF PRODUCING ONE ADDITIONL UNIT.MARGINAL COST IS THE SAME THING AS VARIABLE COST .

OPPORTUNITY COST

• OPPORTUNITY COST IS THE SACRIFICE INVOLVED IN ACCEPTING AN ALTERNATIVE UNDER CONSIDERATION.IN OTHER WORDS ,IT IS A COST THAT MEASURES THE BENEFIT THAT IS LOST OR SACRIFICEDWHEN THE CHOICEOF ONE COURSE OF ACTION REQUIRES THAT OTHER ALTERNATIVECOURSE OF ACTION BE GIVEN UP.

Cost accountingcosting

• The chartered institute of management accountants (CIMA) London has defined costing as “the techniques and process ascertaining costs”

• Wheldon has defined costing “the classifying recording and appropriate allocation of expenditure for determination of costs,therelation of these costs to sales value and ascertainment of of profitability.

costing

• Thus simply costing means cost finding by any process or technique.

• Cost accounting-CIMA london defined as follows “cost accounting is the process of accounting for costs from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage ,it embraces the preparation of statistical data ,the application of cost control methods and ascertainment of profitability of activities carried out or planned”

Scope of cost accounting

• The scope of cost accounting is very wide. There are lots of techniques, tools, procedures, processes, programs are used in cost accounting for calculating cost and its control. But basically, we divide its scope within three major parts.

Three parts

1-Cost Ascertainment

2. Cost Records

3. Cost Control

scope• 1. Cost Ascertainment

In this region of cost accounting, cost accounting collects product's material, labor and overhead cost and try to calculate total and per unit cost of product. This total cost calculation will be based on historical or standard or estimated basis. After this, cost accountant will use any method of costing like specific order costing, operation costing, and direct costing technique. These techniques and methods may be used for calculating different nature products in same organization.

Scope of cost accounting• 2. Cost Records

In this part of cost accounting, cost accountant maintains cost books, vouchers, ledgers, reports and other cost related documents for future comparison and reference. It will also be under the scope of cost accounting.

Scope of cost accounting• 3. Cost Control

This is the end boundary of cost accounting scope. In this division, cost accountant used different techniques and methods for controlling the cost. Save One Rupees in the cost of product means we have earned one rupees in the production of goods. So, Cost accountant uses budgetary control, standard costing, break even point analysis and many other techniques for controlling the cost.

ELEMENTS OF COST

• There are broadly three elements of cost - (1) material, (2) labour and (3) expenses.:

• The substance from which the product is made is known as material. It may be in a raw state-raw material, e.g., timber for furniture and leather for shoe, etc. It may also be in manufactured state-components, e.g., battery for car, speaker for radio, etc, Materials can be direct and indirect.

Direct Material

• Direct Material: All materials which become an integral part of the finished product, the cost of which are directly and completely assigned to the specific physical units and charged to the prime cost, are known as direct material. The following are some of the materials that fall under this category:

(a) Materials which are specifically purchased; acquired or produced for a particular job, order or process.(b) Primary packing material (e.g. carton, wrapping, cardboard, etc.)(c) Materials passing from one process to another as inputs.In order to calculate the cost of material, expenses such as import duties, dock charges, transport cost of materials are added to the invoice price.

Material considered direct at one time may be indirect on other occasion. Indirect Material: All materials, which cannot be conveniently assigned to specific physical units, are termed as 'indirect material'. Such commodities do not form part of the finished products. Consumable stores, lubrication oil, stationery and spare parts for the machinery,pins,screws, nuts and bolts, thread etc are termed as indirect materials

LABOUR

• Labour

• Human efforts used for conversion of materials into finished products or doing various jobs in the business are known as labour. Payment made towards the labour is called labour cost. It can also be direct and indirect.

DIRECT LABOUR

• Direct Labour: Direct labour is all labour expended and directly involved in altering the condition, composition or construction of the product. The wages paid to skilled and unskilled workers for manual work or mechanical work for operating machinery, which can be specifically allocated to a particular unit of production, is known as direct wages or direct labour cost. Hence, 'direct wage' may be defined as the measure of direct labour in terms of money. It is specifically and conveniently traceable to the specific products Wages paid to the goldsmith for making gold ornament is an example of direct labour.

Example of direct labour

• Machine operator

• Shoe-maker

• Carpenter

• Weaver

• tailor

INDIRECT LABOUR

• Indirect Labour: Labour employed to perform work incidental to production of goods or those engaged for office work, selling and distribution activities are known as 'indirect labour'. The wages paid to such workers are known as 'indirect wages' or indirect labour cost.

• Example: Salary paid to the driver of the delivery van used for distribution of the product.

Example of indirect labour

• Supervisor

• Inspector

• Cleaner

• Clerk

• Peon

• watchman

EXPENSES

• Expenses

• All expenditures other than material and labour incurred for manufacturing a product or rendering service are termed as 'expenses'. Expenses may be direct or indirect.

DIRECT EXPENSES

• Direct Expenses: Expenses which are specifically incurred and can be directly and wholly allocated to a particular product, job or service are termed as 'direct expenses'. Examples of such expense are: hire charges of special machinery hired for the fob, carriage inward, royalty, cost of special and specific drawings, cost of patent rights,etc. These are also known as 'chargeable expenses'.

Indirect Expenses

• Indirect Expenses: All expenses excluding indirect material and indirect labour, which cannot be directly and wholly attributed to a particular product, job or service, are termed as 'indirect expenses'. Some examples of such expenses are: repairs to machinery, insurance, lighting and rent of the buildings,advertising,depreciation.

PRIME COST & OVERHEAD

• This is the aggregate of direct material, direct labour,direct expenses. Thus,

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

• Overhead- This is the aggregate of indirect material cost,indirect labour,indirect expenses. Thus,

• Indirect material+ indirect labour+indirect expenses = overhead

Classification of overhead

• 1-production overhead.• 2-office and administration overhead.• 3-selling and distribution overhead• Production overhead- also known as factory

overhead, works overhead or manufacturing overhead, these are those overheads which are concerned with the production function .

It includes indirect materials ,indirect wages, and indirect expenses in producing goods or services.

EXAMPLES

• INDIRECT MATERIAL- coal, oil grease etc. stationery in factory office. Cotton waste,brush,etc.

• Indirect labour- works manager salary, salary of factory office staff ,wages to factory watch man,factory sweeper.

• Indirect expenses- Factory rent,depreciation of plant,insurance of factory building ,factory lighting and power,internal transport expense.

Office and administration overhead

• This is the indirect expenditure incurred in general administrative function, i.e., in formulating policies,planning and controlling the functions, directing and motivating the personnel of an organization in the attainment of its objectives. These overheads are of general character and have no direct connection with production of sales activities .this category of overhead is also classified in to indirect material ,indirect labour and indirect expenses.

EXAMPLES

• INDIRECT MATERIAL- stationery used in general administrative office, postage etc.

• Indirect labour – salary of office staff, salary of managing director, Remuneration of directors of the company.

• In direct expenses- Rent of office building, legal expenses, office lighting and power, telephone expenses,Dep. of office furniture and equipments, sundry office expenses.

SELLING AND DISTRIBUTION EXPENSES

• Selling overheads is the cost of promoting sales and retained customers.e.g., advertisement ,sample for free gifts, salaries of sales man. Distribution cost includes all expenditure incurred from the time the product is completed until it reaches its destination.e.g., carriage outwards ,insurance of goods in transit, up-keep of delivery vans , warehousing etc.

Selling & Distribution expenses are also grouped in to

• 1-indirect material-packing material, stationery used in sales, cost of samples, price list ,catalogues,oil,grease etc.

• 2-indirect labour-salary of sales manager, salary of sales staff, salary of warehouse staff, salary of drivers of delivery van,etc.

• 3-indirect expenses- Advertising, travelling exp.,showroom exp.,carriage outwords,rent of warehoue, bad debts,insurance of goods in transit etc.

COMPONENTS OF TOTAL COST

• Direct Material xxx

• Direct Labour xxx

• Direct expenses xxx

• Prime cost ……..

• Factory overhead xxx

• Factory overheads or works cost …..

• Admin overhead xxx

• Cost of production ……

• Selling & distribution overhead xxx

• Total cost or cost of sales …..

From the following information relating to pune industries ltd.for the year ending 31st march 2011 you are required to prepare a statement of cost showing (a) prime cost (b)Factory overhead (c)cost of production (d) Total cost (e)profit or loss for the year.Direct wages---------------------------------------------- 2,40,0000Direct material purchased---------------------------- 3, 22,000Purchase returns-------------------------------------- 13000Drawing office salaries-------------------------------- 3100

Carriage on direct material----------------------------- 4200Chargeable expenses--------------------------------------- 2800Provision for bad debts------------------------------------- 2400Office expenses-------------------------------------------- 6400 Factory rent and rates------------------------------------14600Depreciation on plant------------------------------------ 8600Showroom rent------------------------------------- --------3000

Misc.selling expenses------------------------------------- 3,200Lighting-------------------------------------------------------- 900

Coal and water---------------------------------------------- 3400 Power---------------------------------------------------------- 2800Haulage hire------------------------------------------------- 2000Travelling expenses---------------------------------------- 6000Showroom telephone expenses------------------------ 1500Labour welfare expenses-------------------------------- 4600

Sales of scrap----------------------------------------------- 450Factory supervision---------------------------------------3500

Sales----------------------------------------------------------6,40,000

The following information were received from the books of poonam & co. for the quarter ending On 31stmarch2006.Sock of material on 31.3.2006-----70000 Expanses of stationery---------------11350Stock material on 1.1.2006--------100000 Travellers salaries and commission—9000Purchase of materials--------------8,03,290 Depreciation on office furniture------700Travelling expenses----------------- 5100 Director’s fees----------------------------8000Carriage inwards---------------------- 4500 Fuel, gas and water---------------------17,900Carriage outwards-------------------- 9150 Manager’s salary------------------------18000Drawing office salaries-------------- 7000 Income tax paid------------------------12000Depreciation on plant----------------8000 Donations-------------------------------4600

Factory, rent rates & insurance-----11,200 Air conditioning charges------------4000 Show room exp. ------------------------9000 labour welfare expenses-------------7200Production wages paid--------------2, 27,000 outstanding productive wages-----33,000Repair of machine, plant& tool----10,000 sales---------------------------------------13, 70,000Office expenses----------------------- 5000 office rent, rates & insurance-------29100 Prepare cost sheet giving the following information, assuming managers devotes 2/3 of his time to factory. 1)material used (2)prime cost(3)works cost(4)cost of production(5)cost of sales or Total cost6) Net profit and its percentage on total cost.

References

• Accounting for Managers by Dr. Sakshi Vasudeva Galgotia Publishing Company Chapter 21 Marginal Costing and Decision Making page no. 697

• Thank you