OM SAI RAM COST & MANAGEMENT ACCOUNTING [EXECUTIVE PROGRAMME] CA. Jitender Singh Get ready to LEARN with FUN….. 1
OM SAI RAM
COST & MANAGEMENT ACCOUNTING
[EXECUTIVE PROGRAMME]
CA. Jitender Singh
Get ready to LEARN with FUN…..
1
INDEXS. NO. TOPIC PAGE NO.
1 MATERIAL 3
2 LABOUR 41
3 MACHINE HOUR RATE 87
4 OVERHEADS 91
5 MARGINAL COSTING 125
6 RATIO ANALYSIS 162
7 STANDARD COSTING 203
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CHAPTER 1
INTRODUCTION
Material is one of the important elements of cost and it has been observed that in the total cost structure of a product, material content is about 60 to 65%. The term 'material' generally used in manufacturing concerns, refers to raw materials used for production, sub-assemblies and fabricated parts.
Material can be divided into two categories Direct material. Indirect material.
DIRECT MATERIALS Materials which can be conveniently identified with and can be directly allocated to a particular product, job or process. It is a part of prime cost
Examples: Basic Raw-Materials Primary Packing MaterialsTimber in furniture Can for tinned food and drinkCloth in Garments Bottles for water, wine and whiskyMilk & cream in ice cream Plastic Packing for Milk, Ghee & OilPaper in Books Tin packing for Ghee & Oil
INDIRECT MATERIALS
Materials which cannot be conveniently identified with and cannot be directly allocated to a particular product, job or process. It may or may not vary with the volume of output. It is a part of overheads.
Examples : (1) Stores used for maintaining machines such as lubricant oil & grease, cotton waste,
consumable stores etc. (2) Stores used by service departments (like power house, boiler house). (3) Materials of small value like nails used in furniture, thread used in stitching garments.
Distinction between Direct Material and Indirect Material
Basis of Distinction
Direct Material Indirect Material
Identification It can be readily identified with a specific job, contract or work order.
It cannot readily be identified with a specific job, contract or work order.
Treatment of cost It is directly charged to the specific job, contract or order
It cannot be directly charged to the specific job, contract or work order and is
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and forms part of prime cost. treated as part of overheads.Variability It varies directly with the
volume of output.It may or may not vary directly with the volume of output.
Note: Material which is direct in one unit may be indirect in another unit due to difference in the nature of work, process or method.
Importance of Distinction 1. For Ascertainment of Cost-It helps in ascertaining the material cost of different cost centers. 2. For Exercising Control over Cost-It helps in exercising proper control over material cost. 3. For Accounting Treatment-Direct material cost is treated as part of prime cost and
indirect material cost is treated as part of production overheads.
CONCEPT AND OBJECTIVES OF MATERIALS (INVENTORY) CONTROL
Meaning of Material Control
It involves the planning, organizing and controlling the procurement, storage and usage of materials so as to achieve the objectives of efficiency and economy.
Meaning of InventoryInventory comprises - (a) Stock of Raw-materials; (b) Stock of Work-in-progress; (c) Stock of Finished Goods; and (d) Stock of Stores and Spares
Meaning of Inventory Control
It involves the planning, organizing and controlling the purchase and storage of inventory so as to ensure the availability of inventory - (a) Of the required quality (b) In the required quantity (c) At the required time (d) At the minimum cost
Objectives of Material Control
1. To avoid the situation of under stocking i.e. to provide continuous supply of required materials so that the activities of production and service departments may not be held up.
2. To avoid the situation of over-stocking i.e. to maintain optimum investment in inven-tory so as to reduce carrying costs.
3. To ensure the procurement of materials and stores of the required quality at minimum cost from a reliable source.
4. To minimise the total cost (i.e. ordering costs & carrying costs). 5. To avoid wastages and losses during storage and usage. 6. To maintain proper and upto date records of inventory
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7. To provide the required information to help the management in taking inventory decisions.
Steps Involved in Purchase Procedure :
Step -1 – Receipt of Purchase Requisition.Step -2 – Issue of Enquiry letters and tenders.Step -3 – Finalization of quotations and placing of purchase orders on suppliers.Step -4 – Preparation, placement and follow up of purchase order.Step -5 – Receipt of Material.Step -6 – Inspection of Materials.Step -7 – Return of rejected Materials.Step -8 – Checking and passing of purchase invoices for payments.Step -9 –Making Payment to Supplier.
CERTAIN IMPORTANT TERMS
1. PURCHASE REQUISITION NOTEMeaning
Purchase Requisition is a written document prepared by the department requiring material which is used to make a formal request to the purchase department to purchase the materials specified therein.
Purposes of Purchase Requisition A purchase requisition serves the following purposes: (1) It authorizes the purchasing department to purchase the materials specified therein (2) It provides written record of details of materials required.
Numbers of Copies of Purchase Requisition Generally 3 copies of purchase requisition are prepared which are used as under:
(i). The original copy is send to the purchase department (ii). The second is retained by the store keeper (iii). Third copy is send to the costing department
Format of Purchase RequisitionA general format of purchase requisition is given below: PQR Ltd.P.R. No……… Date…….Department…….. Date by which materials are required…..
Place where materials are required……..Serial No. Description Code No. Quantity Remarks
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Requested by……………. Checked by…………………. Approved by………………..Content of purchase requisition Requisition no. Date of requisition. Code no of item required. Description of item. Quantity of item. Signature of concerned person.
2. ABC ANALYSISMeaning of ABC Analysis ABC analysis is a system of inventory control which exercises discriminating control over different items of stores classified on the basis of the investment involved. It is based on the principle of management by exception i.e. concentrate more on critical areas than others.
Working of ABC Analysis Usually all items of stores are classified into 3 categories according to their importance (i.e. their value and frequency of replenishment during a period) as follows:
Category
Composition Control
A It consists of those items. Which require large investments (say about 70% of total value of stores) but constitute a small percentage (say about 10%) of total items of stores.
High degree of control is exercised by use of various techniques such as Fixing Stock Levels like Max level, Min. Level, Reorder lever, Determining EOQ.
B It consists of those items which require relatively moderate investment (say about 20% of total value of stores) but constitute relatively moderate percentage (say about 20%) of total items of stores.
Moderate degree of control is exercised. Orders are placed on a periodic review basis.
C It consists of those items which require small investment (say 10% of total value of stores) but constitute a large percentage (say about 70%) of total items of stores.
Lower degree of control is exercised. Orders of large size are placed either after 6 months or once in a year to minimise ordering costs and to take advantages of bulk purchase.
Illustration of ABC AnalysisFollowing illustration will make clear this concept:
No. of items % of total no. of Items Value % of total value Category100 10 70,000 70 A200 20 20,000 20 B700 70 10,00.0 10 C
1000 1001,00,00
0100
Advantages of ABC Analysis
The advantages of ABC analysis are the following: (i). It ensures effective control on costly items (i.e. A category items) which require large
investment.
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(ii). It saves time and cost by exercising economic systems of control over low value items (i.e. C category items).
(iii). It ensures optimum investment in inventory considering the operational requirements and financial resources with the use of economic order quantities.
(iv). It ensures minimum total cost (i.e. ordering costs and carrying costs) of inventory. (v). It helps in the maintenance of high inventory turnover rate.
3. VED ANALYSIS [VITAL – ESSENTIAL - DESIRABLE ]
VED analysis is generally used for spare parts. The requirements and urgency of spare parts is different from that of materials. The demand for spare depends upon the performance of the Plant and Machinery. Spare Parts are classified as VITAL (V), Essential (E) and Desirable (D).
VITAL Spares : Are must for running the concern smoothly. These must be stored adequately, otherwise it may cause havoc in the concern.
ESSENTIAL Spares : These are also necessary spares but their stock may be kept at low level.
DESIRABLE Spares : Stocking of these type of spares may be avoided, if lead time is less.
Classification in V, E and D categories should be left to Technical Staff because they know the need, urgency and use of these spares.
4. FSN ANALYSIS [FAST – SLOW – NON MOVING]
FAST Moving : Materials which are very rapidly consumed either in actual production or in maintenance so that the stocks are to be replenished very frequently.
SLOW Moving : Materials which are not frequently required for consumption and not to be replenished so frequently. These are requisitioned by foreman once in a quarter or so.
NON Moving : Materials which are not moving temporarily but movement is expected soon because of their requirement in production. It is also known as DORMANT stock. If dormant materials are not required for production, these are to be declared as SURPLUS and should be disposed and loss on disposal should is treated as Factory Overhead.
Also, Obsolescence of material may arise on account of change in design or a change in the process of production. Surplus stores having no utility should be disposed off and loss on disposal of obsolete stores, being abnormal in nature, should be debited to COSTING PROFIT AND LOSS ACCOUNT.
5. ECONOMIC ORDER QUANTITY
Introduction One important question that is to be answered by the Purchase Manager is how much quantity is to be ordered at anyone point of time? It will be noticed that there are costs
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attached to the ordering quantity. These costs are of two types, the first is the ordering cost and the other one is the carrying cost.
Ordering cost is the cost of placing an order. These costs include costs like handling and transportation costs, stationery costs, costs incurred for inviting quotations and tenders etc. The more is the frequency of order, the more are these costs.
Carrying cost is the real out of pocket cost associated with having inventory on hand, such as warehouse charges, insurance, lighting, losses due to handling, spoilage, breakage etc, and another important component of carrying cost is the amount of interest lost due to the investment in the inventory. Carrying costs will go on increasing if the quantity of material in inventory goes on increasing.
Both, the carrying costs and the ordering costs are variable costs, of opposite behavior. If orders are more frequent, ordering costs will go on increasing but as the material ordered will be in less quantity, the carrying costs will decrease. On the other hand, if numbers of orders are reduced, the quantity per order will increase and the carrying cost will increase. The ordering cost will come down due to reduction of number of orders.
The most desirable quantity to be ordered is that quantity at which both, the ordering costs and carrying costs will be minimum. This quantity is called as 'Economic Order Quantity'.
The Economic Order Quantity guides the Purchase Manager regarding the quantity to be purchased of a particular material. This concept is based on some assumptions which are as follows:
The concerned material will be available all the time. ( i.e. Continuous supply). The material price will remain constant. Ordering cost and carrying costs are variable. Impact of quantity discounts on the prices is negligible..
Meaning of Economic Order Quantity (EOQ)
Re-order quantity is the quantity for which order is placed when the stock reaches reorder level. It is known as economic order quantity when it is the quantity which is most economical to order.
The EOQ refers to the quantity of inventory, at which total of ordering costs and the carrying costs is minimum.
At EOQ the ordering costs are equal to carrying costs.
Factors to be consideredEOQ is determined after considering the following factors:
1. Ordering Costs The term 'Ordering Costs' refer to the costs incurred for acquiring inputs. These costs include -
(i). Cost of placing an order, (ii). Cost of transportation, (iii). Cost of receiving goods, (iv). Cost of inspecting goods.
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There is an inverse relationship between order size and ordering cost.
Larger the order size Lower the ordering costs because of fewer ordersSmaller the order size Higher the ordering costs because of more orders
2. Carrying Costs The term 'Carrying Costs refer to the costs incurred in maintaining a given level of inventory. These costs include -
(i). Cost of storage space, (ii). Cost of handling materials, (iii). Cost of Insurance, (iv). Cost of deterioration or obsolescence, (v). Cost of store staff.
There is positive relationship between order size and carrying cost Larger the order Size Higher the carrying costs because of high average inventory.Smaller the order size Lower the carrying costs because of low average inventory.
3. Annual consumption (usage) of inventory. Annual consumption in unit terms shall be taken into consideration not in monetary termsImportance of EOQ The EOQ technique solves one of the major problems of the inventory management i.e. the order quantity problem by answering to the question: 'How much inventory should be ordered at a particular point of time?'
Assumptions of EOQ Technique (Most – Imp)Following are the assumptions of EOQ:
Prior knowledge of Annual Usage (consumption) Of inventory Constant rate of usage Constant ordering costs Constant carrying costs, and Zero lead-time/delivery period
How to determine EOQ? EOQ may be determined by any of the following three methods: 1. Graphical Method 2. Tabular Method 3. Formula Method
1. Graphical Method The optimum quantity of inventory which should be ordered at a point of time is determined after achieving a trade off between ordering cost and carrying costs.
Tutorial Notes: Annual total cost of ordering and carrying is minimum at EOQ order size. Carrying cost and ordering cost are equal at EOQ order size.
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Y
XO
Minimum total cost
Total C
ost
Carryin
g Cos
t
Cos
ts (
Rs)
Order Size QEOQ
Ordering Cost
2. Tabular or Trial and Error Method The ordering and carrying costs for different order sizes are computed and the order size with lowest total cost (ordering and carrying) of inventory is the EOQ as follows:
Particulars Different Order SizesOrder size I Order size II Order size III
(A). Annual Consumption (Units) …… …… ……(B). Order Size (Units) …… …… ……(C). No. of Order (A/B) …… …… ……(D). Cost per order (Rs.) …… …… ……(E). Total Ordering Cost (C X D) …… …… ……(F). Average Inventory (Units) (Order Size / 2) …… …… ……(G). Carrying cost per unit …… …… ……(H). Total Carrying cost (F X G ) …… …… ……(I). Total Cost (E + H) …… …… ……
Alternatively, total annual ordering and carrying' cost at different order sizes may be computed as follows:
Total annual ordering and carrying cost at any order size = [(No. of orders × Ordering cost per order) + (Average Inventory × Carrying cost per unit p.a.)
Or= [(Annual consumption / Order Size × ordering cost per order) + (Order size / 2 × Carrying cost per unit p.a.)]
Tutorial Note: Where quantity discounts are offered by the supplier of inputs, the most economical purchase level is that order size at which the total cost (i.e. total annual ordering & carrying Costs + Total Purchase price of annual consumption of inputs) is minimum.
3. FORMULA METHODEOQ may be calculated with the help of following formula
EOQ = √ 2 × A × OC
Where
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A = Annual consumption of unit in inputO = Ordering cost per orderC = Carrying cost per unit per annum
Limitations of EOQ Technique (1) Expected annual usage may not be same as the actual due to unusual and unexpected
demand for inventory. (2) Rate of usage may not be constant due to unusual and unexpected demand for inventory. (3) Ordering and carrying costs may not be constant due to fluctuations in the costs of
various components comprising costs. (4) Lead-time may not be constant due to reason beyond Supplier’s control.
6. FIXATION OF LEVEL OR STOCK LEVELS (Most – Imp)Another important aspect of material procurement is not to purchase too much or too little. Fixation of levels of materials is done precisely with these objectives in mind. The following levels of materials are fixed for achieving objectives like avoiding overstocking, ensuring that the material is ordered at right time and also avoiding shortage of materials.
Re-order LevelMeaning Re-order level is that level of stock at which fresh order should be placed for
replenishment of stock. It is fixed somewhere between maximum and minimum levels in such a way that fresh supplies are received in such a way that fresh supplies are received just before the minimum level is reached. It is the level at which purchase requisition should be made out for fresh supplies.
Objective The objective of fixing Re-order Level is to determine when the fresh order should be placed for replenishment of stock.
Factors This level is fixed after considering the following factors:(a) Maximum Rate of Consumption (b) Maximum Re-order Period (c) Minimum Level
Formula Re-order level is computed with the help of the following formula:Re-order level = Maximum Consumption × Maximum Re-order Period Or, = Minimum Level + (Normal Consumption × Normal Re-order Period)
Maximum Stock Level
Meaning Maximum Stock Level is that level of stock above which the stock in hand should not normally be allowed to exceed. It is the largest quantity of a particular material which may be held in the store at any time.
Objective The objective of fixing the maximum stock level is to avoid the costs of over-stocking such as -Cost of storage, cost of investment in stock, Cost of insurance, risk of obsolescence etc.
Factors This level is fixed after considering the following factors: (a) Re-order Level (b) Re-order Quantity (c) Minimum Rate of Consumption (d) Minimum Re-order Period (e) Availability of Working Capital
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(f) Availability of Storage space (g) Extra Cost of Storage (h) Extra Cost of Insurance
Formula Maximum Stock level is computed with the help of following formula:Maximum Level = Re-order + Re-order Quantity – (Minimum Consumption x Minimum Re-order Period)
Minimum Stock LevelMeaning Minimum Stock Level is that level of stock below which the stock in hand should
not normally be allowed to fall. It is the lowest quantity of a particular material which must be held in the store at all times.
Objective The objective of fixing the minimum stock level is to avoid the costs of under-stocking such as costs of stoppage of production due to shortage of materials like cost of idle labour, cost of idle plant & machinery etc.
Factors This level is fixed after considering the following factors: (a) Re-order Level (b) Normal Rate of Consumption (c) Normal Re-order period
Formula Minimum Stock Level is computed with the help of following formula:Minimum Level = Re-order Level – (Normal Consumption x Normal Re-order Period)
Average Stock LevelMeaning Average Stock Level indicates the average stock held by the organisation.Formula This level of stock may be computed by using anyone of the following formula:
Average inventory level = minimum level + ½ Re-order quantity
OR =Maximumlevel+ Minimum level
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Danger LevelMeaning Danger level is the level at which normal issues of the raw material inventory are
stopped and emergency issues are only made on special requisition approved by the competent authority. When stock reaches this level an urgent action is required for the fresh supplies of materials. It is generally below the minimum level. However some enterprises treat minimum level as danger level whereas some others fix the danger level above the minimum level but below the re-order level. Fixing danger level below the minimum level is meant for taking urgent corrective action whereas fixing it above the minimum level is for preventive action.
Objective The objecting of fixing danger level (below minimum level) is to determine when an urgent action is required for fresh supplies of materials.
Factors This level is fixed after considering the following factors:(a) Normal Rate of Consumption (b) Maximum Re-order Period for emergency purchases
Formula Danger level is computed with the help of the following formula:Danger Level = Normal Rate of Consumption × maximum Re-order Period for emergency purchases
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7. INVENTORY TURNOVER RATIOThere are several items in the store which are slow moving which means that they are issued to the production after a long time gap. Some items are such that they are never issued to the production as they have become obsolete or outdated and need to be disposed off. For identifying these items, it is necessary to compute the inventory turnover ratio. Inventory turnover ratio enables the management to avoid the capital being locked in such items. This ratio indicates the efficiency or inefficiency with which inventories are maintained. Inventory turnover ratio is calculated in the following manner.
Inventory Turnover Ratio =
Cost of material consum edAverage stock held during the year = …… Times
Where,Cost Materials Consumed = Opening Stock + Purchases – Closing Stock
Average stock = (Opening stock+Closing)
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Average No. of days for which an average inventory is held =Days during the periodInventory turnover ratio
Objective of Inventory Turnover Ratio The objective of computing the Inventory Turnover Ratio is to determine the efficiency with which inventories are maintained. In other words, the objective is to find out - (a) Fast Moving Stock i.e. stock in great demand(b) Slow Moving Stock i.e. stock in low demand (c) Dormant Stock i.e. stock having no demand at present (d) Obsolete Stock i.e. stock no longer in demand
Interpretation of Inventory Turnover Ratio
It indicates the speed with which the inventory is consumed. In general, a high ratio indicates fast moving stock and a low ratio indicates slow moving stock. However, too high ratio and too low ratio call for further investigation.A too high ratio may be the result of a very low inventory levels which may result in frequent stock-outs and thus the firm may incur high stock-outs.On the other hand, a too low ratio may be the result of excessive inventory levels, slow-moving or dormant or obsolete inventory and thus, the firm may incur high carrying costs. Thus, a firm should have a satisfactory level. MATRIAL ISSUE PROCEDUREThe following two documents are used for issue of materials to production department: (a) Material Requisition (or Stores Requisition)(b) Bill of Materials
8. MATERIAL REQUISITION
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Meaning - Material Requisition is a document which is used to authorize and record the issue of materials from the store.
Who prepares It? - It is usually prepared by a foreman but in case of costly materials or large quantity of materials, an approval by some higher authority may be required.
No. of Copies - Usually three copies of material requisition are prepared. One Copy for the Storekeeper, One Copy for the Cost Accounting Department and One Copy for the department initiating it.
Procedure - Two Copies of material requisition are sent to storekeeper. Storekeeper makes the entries in the Bin Card and then issues materials to the requisitionist and then sends one copy of requisition after signature to the Cost Accounting department that fills up the rate and amount column of requisition and makes in the entries in the Stores Ledger .
9. BILL OF MATERIALS (MATERIAL SPECIFICATION LIST)
Meaning - Bill of Materials is a list of standard quantities of all materials required for a particular job or work order or a process.
Who prepares It? - Bill of Materials is prepared by engineering or planning department in a standard form on receipt of an order. No. of Copies - Usually four copies of the Bill of Materials are prepared - one copy for Production Department, one copy for Stores Department, one copy for Cost Accounting Department and one copy is retained by engineering or Planning Department.
Procedure (i). Engineering Department sends three copies of Bill of Materials to Production Department (ii). Production Department sends two copies to Stores Department (iii). Store Department makes entries in the Bin Cards and then issues materials to the
Production Department and then sends one copy of Bill of Materials after signature to Cost Accounting Department.
(iv). Cost Accounting department fills up rate and amount column of bill of materials and makes entries in the Stores Ledger.
Basic Difference between Material Requisition and Bill of Materials (1) Material Requisition is prepared when a single or a few items of materials are requisitioned
whereas a Bill of Materials is prepared when all the materials required for a particular job are requisitioned.
(2) Material requisition is prepared by foreman whereas Bill of Materials is prepared by Engineering Department.
10.TWO BIN SYSTEM OR DOUBLE BIN SYSTEM(a) Under Two Bin System each bin is divided into two parts-one smaller part, to store the
quantity equal to the minimum stock or even the re-ordering level, and the other to store the remaining quantity .
(b) Issues are made out of the larger part; but as soon as it becomes necessary to use quantity out of the smaller part of the bin, fresh order is placed.
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(c) On receipt of supply of fresh order, quantity already issued out of smaller part of the bin is replaced out of fresh supply.
Smaller Part Lager Part
Minimum S. LevelOrEven ordering level Remaining Quantity
__________________________________Two Bin system________________________________
INVENTORY SYSTEMSThere are two inventory systems1. Periodic Inventory System and2. Perpetual Inventory System.
11.PERIODIC INVENTORY SYSTEMPeriodic Inventory System is a system of ascertaining the quantity and value of inventory on the basis of an actual physical count or measure or weight of all the inventory items on hand at the end of accounting period. It usually requires closing down of normal functioning for stock-taking. The cost of materials issued is calculated as a residual figure (Which may include cost of materials lost also) as under:
Cost of Materials issued = Opening Inventory + Purchases – Closing Inventory
12.PERPETUAL INVENTORY SYSTEMPerpetual Inventory system is a system of recording stores balances after every receipt and issue, to facilitate regular checking and to obviate closing down for stocktaking.
Objective of Perpetual Inventory System The basic objective of perpetual inventory system is to provide a continuous quantitative - cum-value record of receipts, issues and balances of each item of stores followed by continuous stock taking.
13.INVENTORY RECORDS
BIN CARD OR STOCK CARD Meaning: Bin Card consists of two terms 'Bin and Card'. Bin refers to an almirah, a rack, box, container or space where materials are kept. A separate bin is maintained for each item of material and is assigned an identification number.
A card is tied to or placed outside each bin to record the quantity of materials received, issued, returned and in hand in the bin. This card is called bin card or stock card.
This card also contains particulars regarding maximum level, minimum level, reorder level, Bin no, name and code of material, location and stores ledger folio.
Objective - The basic objective of Bin Card is to provide a continuous record of the quantity of materials received, issued, returned and in hand.
Who maintains It? - Bin Card is maintained by storekeeper in the stores.
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STORES LEDGER
Meaning - Stores Ledger is a subsidiary ledger in which a separate account is opened for each item of materials in the store to record both the quantity and cost of the materials received, issued, returned and in hand.
Objective - The basic objective of stores ledger is to provide a continuous record of both the quantity and cost of the materials received, issued, retuned and in hand.
Who maintains It - Stores Ledger is maintained by Cost Accounting Department and not by Stores Department.
Distinction between Bin Card and Stores Ledger Bin Card differs from Stores Ledger in the following respects:
Basis of Distinction Bin Card Stores Ledger(1) What it records? It records only the quantity of
material received, issued and in hand.
It records both the quantity and value of materials received, issued and in hand.
(2) Who maintained? It is maintained by storekeeper. It is maintained by Cost department
(3) Periodicity of posting
Posting in bin card is done simultaneously with the receipts and issues of materials.
Position in the stores ledger is usually done after the transaction at periodic intervals.
(4) Where Kept? It is kept outside the bin in store. It is kept outside the store generally in costing department.
(5) Physical verification
It facilities physical verification as records are updated as per physical movement
It does not facilitate physical verification
(6) Chances of error Less chances of error More chances of error
14.JUST IN TIME INVENTORY:
This principle envisages that there should be no intermediate stage like storekeeping. Material purchased from supplier should directly go the assembly line, i.e. to the production department. There should be no need of storing the material. The storing cost can be saved to a great extent by using this technique. The benefits of Just in time system are as follows : Right quantities are purchased or produced at right time. Cost effective production or operation of correct services is possible. Inventory carrying costs are eliminated totally. The stores function is eliminated and hence there is a considerable saving in the stores cost. Losses due to breakage, wastage, pilferage etc are avoided.
15.PRICING OF ISSUESOne of the important aspects of issue control is of pricing of the issues. Material is issued to
production and it is necessary to find out the consumption value of the material. Hence it is necessary to price the issues by using certain methods. The various methods of pricing of issues are given below :
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1) First In First Out [FIFO]:-As per this method, material received first is issued first. Thus the material in stock at the beginning of a period is issued firstly and then the issues are made according to the dates of purchases made. The consumption value will be as per the purchases made earlier and hence the latest price may not be charged to the consumption.
In case of rising prices it will result in charging lower prices while in case of falling price it will result in charging higher prices to the material consumption. The closing stock will be shown at the latest prices as the material purchased towards the end of the period will remain the stock.
2) Last In First Out [LIFO]:-The assumption under this method is that the material which is purchased last is issued first to the production. The main advantage of this method is that the issues are priced at the latest prices and hence consumption value is also the latest. This will make the product cost more realistic. However, the inventory valuation will be at the older price as material in balance will be from the earlier batches of purchases. Valuation of inventory according to this method is not accepted for inventory valuation in the preparation of financial statements.
3) Highest In First Out [HIFO]:-Under this method, the materials with highest prices are issued first, irrespective of the date upon which they are purchased. The basic assumption is that in fluctuating and inflationary market, the cost of material are quickly absorbed into product cost to hedge against risk of inflation. As the issues are shown at highest prices, the product costs tend to be on the higher side and hence this method is not suitable in competitive environment.
4) Simple Average Cost Method:-Under this method, the issues are charged at the average price of the material purchased without taking into consideration the quantities involved in the same. For example, if materials are purchased in three batches at prices of `18, `19 and ` 23, the issue will be charged at the average price of the three prices, i.e. `18 + `19 + ` 23 = ` 60/3 = ` 20. This method does not consider the quantities purchased. In price fluctuations this method is useful but if fluctuations are too wide, the method may not be useful.
5) Weighted Average Method:-This method considers the prices as well as the quantities of materials purchased. Thus weighted average is computed after each receipt by dividing the total amount by the total quantity. The issue is charged at prices arrived at according to this calculation. For example, if three consignments of materials are purchased at prices of `10, ` 12 and ` 11 and the quantities involved are respectively 1,000, 1,200 and 1,400. The weighted average price will be calculated as shown below. `10 × 1,000 + `12 × 1,200 + ` 11 × 1,400 = ` 10,000 + `14, 400 + `15, 400 = ` 39, 800/3,600 = `11.05. The subsequent issue will be charged at this price. This method is that it evens out the price fluctuations and reduces the number of calculations to be made.
6) Periodic Average Cost Method:-Under this method, instead of recalculating the simple or weighted average cost every time there is a receipt, periodic average is computed. The average may be calculated for the entire period. The price may be calculated as given below.
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Cost of Opening Stock + Total Cost of all receipts/Units in Opening Stock + Total Units received during the period.
7) Standard Cost Method:-Under this method, material issues are priced at a predetermined standard issue price. Any difference between the actual purchase price and the standard price is written off to the Costing Profit and Loss Account. Standard Cost is a predetermined cost and if it is set accurately, it can be very effective.
8) Replacement Cost [Market Price]:-It means the cost at which material identical to that is to be replaced could be purchased at the date of pricing of the issues as distinct from the actual cost price at the date of purchase. The replacement price is the price of replacing the material at the time of the issue of materials or on the date of valuation of closing stock.
9) Next In First Method:-Under this method, the price quoted on the latest purchase order or contract is used for all issues until a new order is placed. Thus this method is a variation of the Replacement Cost Method.
16.MATERIAL LOSSES (Most – Imp)One of the main reasons of rising material costs is the loss of material in the production process. The material losses can be categorized as given below.
Waste:-Waste is a loss of material either in stores or in production due to reasons like evaporation, chemical reaction, shrinkage, unrecoverable residue etc. Wastages may be visible or invisible. It is necessary to take steps to control the material wastage. In cost accounting, the wastage is divided into the following categories.
Normal Wastage:- This wastage is such that it cannot be avoided. It is inherent in any production process. The normal wastage is normally estimated in advance and included in the material cost. In other words, the good units should bear the cost of normal wastage.
Abnormal Wastage:-Any wastage over and above the normal wastage is the abnormal wastage. In other words it is more than the standard wastage. The cost of the abnormal wastage is not charged to the production, but it is written off to the Costing Profit and Loss Account.
Scrap:-Scrap is a residual material resulting from a manufacturing process. It has a recovery value and is measurable. The treatment of scrap in cost accounts is normally as per the following details :
If the value of scrap is negligible, the good units should bear the cost of scrap and any income collected will be treated as other income.
If the value of scrap is considerable and identifiable with the process or job, the cost of job
will be transferred to scrap account and any realization from sale of such scrap will be credited to the job or process account and any unrecovered balance in the scrap account will be transferred to the Costing Profit and Loss Account.
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If scrap value is quite substantial and it is not identifiable with a particular job or process, the amount will be transferred to factory overhead account after deducting the selling cost. This will reduce the cost of production to the extent of the scrap value.
Spoilage:- Spoilage is the production that fails to meet quality or dimensional requirements and so much damaged in manufacturing operations that they are not capable of rectification and hence has to withdraw and sold off without further processing. Rectification can be done at a cost which may not be economic. If the spoilage is within limits, it is called as 'normal' spoilage and anything exceeding this limit is called as 'abnormal' spoilage. The accounting treatment of spoilage is as follows :
The cost of normal spoilage is spread over to the good production by charging either to the specific production order or to the product overheads.
The cost of abnormal spoilage is charged to the Costing Profit and Loss Account.
Defectives:- The defectives are part of production units which do not confirm to the standards of quality but can be rectified with additional application of materials, labor and / or processing and made it into saleable condition either as firsts or seconds depending upon the characteristics of the product.
The accounting treatment of defectives is the same like that of spoilage. The cost of normal defectives is spread over the good units and the cost of additional processing is charged to a particular department/process if it is identifiable with the same. If it cannot be identified, it is charged to factory overheads. Cost of abnormal defectives is charged to the Costing Profit and Loss Account.
17.MATERIAL RETURN NOTE I.E., RETURN OF MATERIALS TO STORE Whenever materials supplied to a job are in Excess of its requirement or Found defective
such materials are returned to the stores. 1. Such materials should be returned with 'Material Returned Note'. 2. Material Returned Note is a document which contains details regarding the materials returned
to store. 3. The form of Material Returned Note is similar to that of Materials Requisition Slip and hence to
distinguish between the two, different colours are used.4. Returning department-
(i). prepares three copies of Material Returned Note (ii). sends two copies to the Stores Department (iii). retains one copy for its own reference
5. Stores Department records in the Bin Card and sends one copy after signature to the Cost Accounting Department.
6. Cost Accounting Department gives the necessary credit to the concerned job / department for the cost of materials returned.
18.TECHNIQUES OF INVENTORY CONTROLThe various techniques of inventory control are as follows: (1) ABC Analysis (2) Economic Order Quantity (EOQ)
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(3) Stock Levels, Minimum Lever, Maximum Level, Recorder Level, Re-order Quantity. (4) Inventory Turnover Ratio and review of Slow and Non-moving items. (5) Proper Purchase Procedure (6) Proper Storage Procedure (7) Proper Issue Procedure (8) Two Bin system (9) Use of Perpetual Inventory Records and Continuous Stock Verification.
(10) Establishment of a system of Budgets.
19.ORDER CYCLING SYSTEMIn the order cycling system, quantities in hand of each item or class of stock is reviewed periodically say, 30, 60 or 90 days. If in the course of a scheduled periodic review it is observed that the stock level of a given item will not be sufficient till the next scheduled review keeping in view its probable rate of depletion, an order is placed to replenish its supply. Review period will vary from firm to firm and also among different materials in the same firm. Critical items of stock usually require a short review cycle.
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CLASSROOM PRACTICE – LETS PLAY TOGETHER
Qus 1.From the following figures relating to two components X and Y, compute Reorder Level, Minimum Level, Maximum Level and Average Stock Level.
Particulars Component X Component Y Maximum consumption per week 75 units 75 units Average consumption per week 50 units 50 units Minimum consumption per week 25 units 25 units Reorder period 4 to 6weeks 2 to 4 weeks Reorder quantity 400 units 600 units
AnsThe computation of various levels is shown below.
(A). Reorder Level = Maximum Consumption × Maximum Reorder Period Component X = 75 units × 6 weeks = 450 units Component Y = 75 units × 4 weeks = 300 units.
(B). Minimum Level = Reorder Level- Average Consumption × Average Reorder Period Component X = 450 units - [50 units × 5 weeks] = 200 units Component Y = 300 units - [50 units × 3 weeks] = 150 units
(C). Maximum Level = Reorder Level + Reorder Quantity - [Minimum Consumption × Minimum Reorder Period] Component X = 450 units + 400 units - [25 units × 4 weeks] = 750 units Component Y = 300 units + 600 units - [25 units × 2 weeks] = 850 units
(D). Average Level = ½ [Maximum Level+ Minimum Level] Component X = ½ [750 units + 200 units] = 475 units Component Y = ½ [150 units + 850 units] = 500 units
Qus 2.PQR Ltd., manufacturers a special product, which requires 'ZED'. The following particulars were collected for the year 2007-08:
(i). Monthly demand of Zed : 7,500 units (ii). Cost of placing an order : `500 (iii). Re-order period : 5 to 8 weeks (iv). Cost per unit : `60(v). Carrying cost % p.a. : 10% (vi). Normal usage : 500 units per week (vii). Minimum usage : 250 units per week (viii). Maximum usage : 750 units per week
Required: (i). Re-order quantity (ii). Re-order level (iii). Minimum stock level (iv). Maximum stock level(v). Average stock level
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Ans
(i) Re-order quantity = √ 2 AOC
= √ 2×500 ×52 ×50060× 10 %
= 2,082 unit
(ii) Re-order level = Maximum re- order period × Maximum usage per week= 8 × 750 units per week = 6,000 units
(iii) Maximum stock level = re-order level – normal usage × Average recorder period= 6,000 – (500 × 6.5)=2,750 units
(iv) Maximum stock level = re- order level + re-order quantity – (minimum usage × minimum period)= 6,000 + 2082 – (5×250)= 6,832 units
(v) Average stock level = ½ (minimum stock level + maximum stock level ) = ½ (2,750 + 6832)= 4,791 units.
Qus 3.Materials X and Y are used as follows:Minimum usage − 50 units each per weekMaximum usage − 150 units each per weekNormal usage − 100 units each per weekOrdering quantities X = 600 units
Y = 1,000 unitsDelivery period X = 4 − 6 weeks
Y = 2 − 4 weeksCalculate for each material (i) Maximum level (ii) Minimum level and (iii) Ordering level.
Ans:Material XOrdering level = Maximum usage × Maximum delivery period
= 150 × 6= 900 units.
Minimum level = Ordering level - (Normal usage × Normal delivery period)= 900 − (100 × 5)= 400 units
Maximum level = (Ordering level + Ordering quantity) − (Minimum usage × Minimumdelivery period)
= 900 + 600 − (50 × 4)= 1,500 − 200= 1,300 units
Material YOrdering Level = Maximum usage x Maximum delivery period
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= 150 × 4 = 600 unitsMinimum Level = Ordering level − (Normal usage × Normal delivery period)
= 600 − (100 × 3) = 300 units.Maximum Level = (Ordinary level + Ordering quantity) - (Minimum usage × Minimum
deliveryperiod)= 600 + 1,000 − (50 × 2)= 1,600 − 100 = 1,500 units.
Normal delivery period has been computed as follows:
Material X =4+6
2 = 5 weeks
Material Y = =2+4
2 = 3 weeks
Qus 4.In a company, the weekly minimum and maximum consumption of Material-A are 25 and 75 units respectively. The re-order quantity as fixed by the company is 300 units. Material-A is received within 4 and 6 weeks from the date of issue of supply order. Calculate minimum level and maximum level of Material-A.
Ans: Computation of Minimum Level:- = Re-order Level - (Average rate of consumption × Average re-order period) = 450 units - (50 units × 5 weeks) = 200 units
Computation of Maximum Level :- = Re-order level + Re-order quantity - (Minimum rate of consumption × Minimum re-order period) = 450 units + 300 units - (25 units × 4 weeks) = 650 units
Working Note: Computation of Re-order level = Maximum usage per period × Maximum re-order period = 75 units × 6 weeks = 450 units.
Qus 5.A company manufactures a product from a raw material, which is purchased at As60 per kg. The company incurs a handling cost of `360 plus freight of `390 per order. The incremental carrying cost of Inventory of raw material is ` 0.50 per kg per month. In addition, the cost of working capital finance on the investment in inventory of raw material is ` 9 per kg. per annum. The annual production of the product is 1, 00,000 units and 2.5 units are obtained from one kg of raw material. Required
i). Calculate the economic order quantity of raw materials. ii). Advise, how frequently should orders for procurement be placed.
Ans:A = Annual requirement of raw material in kgs. = 1 kg × 1, 00,000 units/2.5 units = 40,000 kgsO = (handing and freight cost per order) = ` 360 + ` 390 = ` 750C = Carrying cost per unit per annum + investment cost per Kg. per annum
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= (0.5 × 12 months) + ` 9 = ` 15 per unit
(I). EOQ =√ 2 AOC
= √ 2 × 40,000 ×75015
= 2,000 kgs
(II). Frequency of orders for procurement ; = 365 days/ no. of orders = 365/ (40,000/2,000) = 18
Qus 6.ZED Company supplies plastic crockery to fast food restaurants in metropolitan city. One of its products is a special bowl, disposable after initial use, for serving soups to its customers. Bowls are sold in pack 10 pieces at a price of ` 50 per pack. The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs every year. The company purchases the bowl direct from manufacturer at ` 40 per pack within a three days lead time. The ordering and related cost is ` 8 per order. The storage cost is 10% per cent per annum of average inventory investment. Required:
i). Calculate Economic order quantityii). Calculate number of orders needed every year.iii). Calculate the total ordering and carrying cost of bowls for the year.iv). Determine when the next order to be placed should. (Assuming that the company does
maintain a safety stock and that the present inventory level is 333 packs with a year of 360 working days.
Solution (i) Number of orders per year
EOQ = = √ 2 AOC
= √ 2 × 40,000 ×84
= √1,60,000 = 400 packs
(ii) Economic Order Quantity = Annual requirements
Economic order quantity = 40,000
400 = 100 order per year
(iii) Ordering and storage costs Ordering costs = 100 orders × ` 8.00 = ` 800Storage cost = (400/2) × (10% of 40) = ̀ 800 Total cost of ordering & storage ̀ 1,600
(iv) Timing of next order (a) Day's requirement served by each order.
Number of days requirements = No . of working daysNo .of order∈a year
= 360100 = 3.6 days supply
This implies that each order of 400 packs supplies for requirements of 3.6 days only.
(b) Days requirement covered by inventory
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= Units∈inventory
Economic order quantity × (Day requirement served by an order)
= 333400 × 3.6 days = 3 days requirement
(c) Time interval for placing next order Inventory left for day's requirement - Lead time of delivery 3 day's requirements - 3 days lead time = 0 This means that next order for the replenishment of supplies has to be placed immediately.
Qus 7.The following data are available in respect of material X for the year ended 31st March. 1997:
Opening stock ` 90,000 Purchases during the year ` 2,70,000Closing stock ` 1,10,000
Calculate: (i) Inventory turnover ratio; and (ii) the number of days for which the average inventory is held. Solution:
(i) Inventory Turnover Ratio = Cost of sock of raw material consumedAverage stock of raw material =
2,50,0001,00,000 = 2.5
(ii) Average number of days = 365Inventory turnover ratio =
365 days2 .5 = 146 days
Which the average inventory is held
Working Note:Cost of sock of raw material consumed = Op. Stock + Purchase – Cl. Stock
= ` 90,000 + ` 2, 70,000 - ` 1, 00,000 = 2, 50,000Average Stock of raw material = (Opening Stock + Closing Stock) ½
= ( ` 90,000 + ` 1,10,000) / 2 = ` 1,00,000
Qus 8.A company has the option to produce a particular material from two sources: Source I assures that defectives will not be more than 2% of supplied quantity. Source II does not give any assurance, but on the basis of past experience of supplies received from it, it is observed that defective percentage is 2.8%.
The material is supplied in lots of 1,000 units. Source II supplies the lot at a price, which is lower by `100 as compared to Source I. The defective units of material can be rectified for use at a cost of `5 per unit. You are required to find out which of the following sources is more economical.
Ans:Comparative Statement of Procuring Material from two sources
Material Source I Material Source IIDefective (in %) 2 2.8Total defective units in a lot 20 (i.e. 1,000 units × 2%) 28 (i.e. 1,000 units × 2.8%)
(A) Additional price paid per lot 100 -
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(`)(B) Rectification cost of defect (`) 100 (i.e. 20 units × `5) 140 (i.e. 28 units × `5)(C) Total additional cost per lot
(`):[A + B]
200 140
Decision: on comparing the total additional cost incurred per lot of 1,000 units, we observe that it is more economical, if the required material units are procured from material source II.
Qus 9.A consignment consisting of 4 grades of materials was purchased for ` 1,20,000. Storekeeper sorted them out and recorded the following:
Grade A - 4,000 units Grade B - 8,000 units Grade C-10,000 units Grade D-12,000 units
Total sales of grade A amounted to ` 16,000 (rate of profit being 33 1/3% of cost) and those of B at a price 1.5 times that of A, but the rate of profit was 33-1/3 % of sales. Similarly Grade C material was sold for ` 50,000, yielding a profit of 20% on sales. Calculate the purchase price of each grade on the basis of the above information. Ans: Grade A Total Cost of A = Sales - Profit = ` 16,000 - ` 4,000Cost Price per unit of A Selling Price per unit of A
= ` 12,000 12,000/4,000 = ` 3 per unit = 16,000/4,000 = ` 4 per unit
Grade B
Selling Price per unit = ` 4 × 112
Less: Profit (33 1/3% of Sales) Cost per unit of B Total Cost of B
= ` 6 = ` 2 = ` 4 = 8,000 × 4 = ` 32,000
Grade C Total Sales Less: Profit (20% of sales) Total Cost Cost per unit
= ` 50,000 = ` 10,000 = ` 40,000 = ` 40,000/10,000 = ` 4 per unit.
Grade D Total cost of D = Total Cost of A,B,C&D - Total Cost of A, B & C = ` 1,20,000 - (` 12,000 + ` 32,000 + ` 40,000) = ` 36,000 = 36,000/12,000 = ` 3 per unitCost per unit of Grade D Thus, cost details are:
Grade of Material Units Per Unit (`) Total (`)A B C D
4,000 8,000
10,000 12,000
3443
12,000 32,000 40,000 36,000
1,20,000
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JUDGE URSELF
Qus 10.The following information is available in respect of material of No. 30:
Re-ordering quantity = 1,500 unitsRe-order period = 4 to 6 weeks Maximum consumption = 400 units per week Normal consumption = 300 units per weekMinimum consumption = 250 units per week.
Calculate: a) Re-order level; b) Minimum level; c) Maximum level; and . d) Average Stock level.
Ans. (a) 2,400 units; (b) 900 units; (c) 2,900 units (d) 1,900 units
Qus 11.From the following information you are required to calculate maximum level, minimum, level and ordering level for materials X and Y:
X YNormal usage per weekRecording quantityMaximum usage per weekMinimum usage perRecording period (weeks)
150900225
7512 to 18
2001,500
250100
6 to 12
[Ans Max. Level Min. Level Ordering Level X 4,050 1,800 4,050 Y 3,900 1,200 3,000]
Qus 12.In manufacturing its product Z, a company uses two types of raw-materials A and B in respect of which the following information is supplied:
One unit of Z requires 10 kg. of A and 4 kg. of B materials. Price per kg of A material is ` 10 and that of B is ` 20. Reorder quantities of A and B materials are 10,000 kg and 5,000 kg. Reorder levels of A and B materials are 8,000 kg and 4,750 kg respectively. Weekly production varies from 175 units to 225 units averaging 200 units. Delivery period of A materials is 1 to 3 weeks and B materials is 3 to 5 weeks. Compute: (i) Minimum Stock Level of A. (ii) Maximum Stock Level of B. Ans. (i) 4,000 kg., (ii) 7,650 kg.
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Qus 13.From the following information, calculate (a) Economic order quantity and (b) Total Annual Carrying and Ordering cost at that quantity (c) Re-order level, (d) Minimum level, (e) Maximum level, (f) Average Stock Level, (g) Danger level Rate of Usage: 5 kg. per unit of finished product. Weekly production of finished product varies from 50 units to 150 units.Purchase price of input unit ` 20. Annual carrying cost 6.5% Ordering cost per order `100 Lead time: 3 weeks to 7 weeks, For emergency purchase 2 weeks.
[Ans: (a) 2,000 units (b) ` 2,600 (e) 5,250 units (d) 2,750 units (e) 6,500 units (f) 4,625 units or 3,750 units (g) 1,000 units]
Qus 14.From the following particulars, compute Economic Order Quantity Annual consumption = 8, 10, 000 units Order placing and receiving costs: ` 10 per order Annual stock holding stock: ` 20Ans: 900 units
Qus 15.From the following particulars find out the economic order Quantity:i). Annual demand 12,000 unitsii). Ordering cost ` 90 per orderiii). Inventory carrying cost per annum `15Ans: 379 units (approx.)
Qus 16.A manufacturer buys certain equipment from outside suppliers at ` 30 per unit. Total annual needs are 800 units.
The following further data are available :Annual return on investment 10%Rent, taxes, insurance per unit, per year ` 1Cost of placing an order ` 100Determine the economic order quantity. Ans: 200 units.
Qus 17.Calculate the Economic Order Quantity from the following information. Also state the number of orders to be placed in a year :Consumption of materials per annum 10,000 kg.Order placing costs per order ` 50Cost per kg.of raw-materials ` 2Storage cost 8% of average inventory Ans: (i) 2,500 Kg., (ii) 4.
Qus 18.
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What do you understand by Economic Order Quantity? Find out the EOQ from the following: Annual usage ` 1,60,000 @ ` 40 per unit: Cost of placing and receiving one order ` 200: Annual carrying cost : 25% of inventory value. Ans : 400 units.
Qus 19.Calculate the economic order quantity and the number of orders to be placed in a year in each of the following cases: (Most-imp)Particular Case (a) Case (b) Case (c) Case (d) Annual Consumption 1,00,000 units ` 1,60,000 3600 units ` 5,20,000Cost of placing an order ` 50 ` 200 ` 40 ` 100Annual Carrying Cost 8% 25% 5% 6.5%Price per unit of material ` 20 ` 40 ` 64 ` 200
[Ans: (a) 2500 units, 40, (b) 400 units, 10 (c) 300 units, 12 (d) 200 units 13]
Qus 20.Calculate Economic Order Quantity from the following information:
Annual Consumption 1,00,000 units Carrying Cost 8% of Average Stock Per unit Cost ` 20 Ordering Cost ` 50 per order
[Ans: 2500 units]
Qus 21.A company manufactures a product having monthly demand of 2,000 units. For one unit of finished product 2 kgs of a particular raw material item is needed. The purchase price of the material is ` 20 per kg. The ordering cost is ` 120 per order and the holding cost is 10% per annum. Calculate:
(i). Economic Order Quantity (EOQ), and (ii). Annual cost of purchasing and storage of the raw material at that quantity.
[Ans: (i) 2400 kg. (ii) ` 4,800]
Qus 22.An average annual consumption of a material is 18,250 units at a price of `36.50 per unit. The storage cost is 20% on an average inventory and the cost of placing an order is `50. How much quantity is to be purchased at a time?Ans: 500
Qus 23.After inviting tenders, two quotations are received as under :Supplier A-` 2.20 per unit.Supplier B-` 2.10 per unit + ` 2,000 fixed charges irrespective of units ordered. (i) Calculate the order quantity for which the purchase price per unit will be the same. (ii) Select the supplier if the purchase officer wants to place an order for 15,000 units. Ans. (i) 20,000; (ii)A.
Qus 24.(Dec-2013)A manufacturer uses 75,000 units of a particular material per year. The material cost is `1.50 per unit and the carrying cost is estimated at 25% per annum of average inventory cost. The cost of
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placing an order is `18. You are required to determine the economic order quantity (EOQ), frequency of orders per annum and time between two consecutive orders.
(4 marks)
PAST EXAMINATION QUESTIONS
MULTIPLE CHOICE QUESTIONS 1. The term 'economic batch quantity' is used in relation to -
(a) Operating costing (b) Batch costing(c) Process costing(d) Unit costing.
2. Re-ordering level is equal to - (a) Maximum consumption x Minimum Re-order period (b) Maximum consumption x Maximum Re-order period. (c) Minimum consumption x Minimum Re-order period. (d) Normal usage x Normal delivery period.
3. When prices fluctuate widely, the method that will avoid the effect of fluctuations is - (a) FIFO (b) LIFO (c) Simple average(d) Weighted average
4. Obsolete stocks are those having- (a) Low turnover rate (b) No demand for technological change (c) No present demand, but may be in future (d) None of the above.
5. Continuous stock taking is a part of- (a) Annual stock taking (b) Perpetual inventory (c) ABC Analysis(d) None of the above.
6. The type of spoilage that does not affect the cost of inventories is - (a) Normal spoilage(b) Standard spoilage (c) Abnormal spoilage(d) Seasonal spoilage.
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FILL IN THE BLANKS 1. Quantitative record of receipts, issue and balance items of material in stores are entered in…… 2. Economic lot size is the order size that ……… the total cost of ordering and storing. 3. Inflated price method of valuing material issue is suited ……4. Material losses due to abnormal reasons be transferred to …….5. The three categories of inventory for a manufacturer are raw material, work-in-process and ….. 6. The process of physical verification of stores throughout the year is known as …….
True and False/Correct and Incorrect
1. Loss of material due to fire is treated as overhead and included for calculating cost of production.
2. Bin card maintained by the costing department. 3. Bin card shows the value of a material at any moment of time. 4. Assuming inflation, if a company wants to maximize net income, it would select FIFO as
the method of pricing raw materials.
Answer : MCQs Answers 1 2 3 4 5 6Options (b) (b) (d) (a) (b) (a)
Answers : Fill in the Blanks1. Bin card2. Minimizes3. When there is unavoidable wastage of material4. Costing Profit and Loss Account5. Finished goods6. Perpetual inventory system Answers : True/False1. False, Loss of material due to fire is treated as abnormal loss and it is Charged to costing profit
& loss account.2. False, Bin Card is maintained by the stores department.3. False, A separate bin card is maintained for each item of inventory indicating the quantity of
stock at any point of time.4. Ans. True, In Inflation prices are rising production cost is understated, thereby the net income
is maximised under FIFO method.
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TRAIN UR BRAIN
1. Material are purchased by – a) Purchase departmentb) Sales Departmentc) Accounts Departmentd) Material Department
2. Direct Material is a - a) Variable costb) Fixed Costc) Semi variable costd) Manufacturing cost
3. Which of the following is an accounting record?a) Stores ledgerb) Bills of materialsc) Bin cardd) All of these
4. Bin Card is also known as – a) Stores ledgerb) Bills materialc) Stock cardd) None of the above
5. Stores ledger is maintained by – a) Marketing departmentb) Cost Departmentc) Purchase Departmentd) Sales Department
6. In manufacturing industries, the important element of cost is – a) Labour b) Overheadc) Material d) All of the
above7. The store keeper should intimate a
purchase requisition when stock reaches – a) Maximum Level b) Minimum
Levelc) Re-order Level d) Average Stock
8. In ……… method, the materials are priced in the order of their receipts i.e., price of the oldest available stock is taken the issue price.a) LIFO b) FIFOc) HIFO d) NIFO
9. In ……. method, price of the latest available stock in taken as the issue price.a) LIFO b) FIFOc) Simple Averaged) Weighted average
10. The quantity of materials which should be ordered every time when an order is placed is known as – a) EOQ b) ABC Analysisc) VED Analysis d) Level Setting
11. ……… are the costs of bringing a material into the stores and the incurred every time an order is placed.a) Carrying costs b) Ordering Costsc) Average Costsd) None of the above
12. ……… are the costs incurred on the maintenance of material in the stores and includes clerical handling, obsolescence, loss on holding stock, pilferage, etc.a) Average Costs b) Ordering Costsc) Carrying costs d) Marginal costs
13. A process whereby all stock items are physically counted and then value is known as – a) Periodic stock takingb) Continuous stock takingc) Two Bin systemd) None of these
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14. An important factor of determining economic order quantity is – a) Storage costs b) Financial Costc) Inventory Cost d) Material Cost
15. All manufacturing concerns appoints a person as a - a) Store Keeper b) Brokerc) Agent d) Salesman
16. When inter departmental transfer of material take place within the organization, it is supported with – a) Credit Note b) Debit Notec) Material transfer Noted) Stores requisition Note
17. ABC analysis is a technique of –a) Inventory controlb) Budgetary controlc) Cost controld) None of these
18. …….. is the optimum size of the order for a particular item of inventory, at that point that ordering and carrying costs of inventory are minimized.a) EOQ b) ABC Analysisc) JIT System d) Material
19. Re-ordering level is equal to – a) Maximum consumption × minimum
re-order period.b) Maximum consumption × maximum
re-order period.c) Normal usage × normal delivery
period.d) Minimum consumption × minimum
re-order period.20. Calculate EOQ. Given
Weekly average requirement of raw material EXE – 50 unitsCost of placing an order ` 100Annual carrying cost per unit of EXE ` 15Annual carrying cost per unit of EXEa) 195 units b) 200 unitsc) 186 units d) 159 units
21. A manufacturer uses 75,000 units of a particulars material per year. The
materials cost is ` 1.50 per unit and the carrying cost is estimated to be 25% p.a. of average inventory cost. The cost of placing order is ` 18.Calculate EOQ and frequency of order per annum.a) 2863 units, 29 timesb) 2385 units, 82 timesc) 2683 units, 28 timesd) 2349 units, 15 times
22. Annual consumption of a material of a company is 1,00,000 units at ` 2.40 er unit. Each order costs ` 90 and carrying cost is 15% of the annual inventory value. Company operates 250 days per year. The procurement time is 10 days and safety stock is 1,000 units. Calculate the maximum stock level.a) 8071 units b) 7071 unitsc) 2349 units d) 2683 units
23. The average annual consumption of material is 20,000 kgs at a price of ` 2 per kg. The storage cost is 16% on average inventory and the cost of placing one order is ` 50. How much is to be purchased at a time?a) 2400 kgs b) 2500 kgsb) 2000 kgs d) 1500 kgs
24. If the minimum stock level and average stock level of raw material X are 4,000 and 9,000 units respectively. Find out the re-order quantity.a) 15,000 units b) 10,000 unitsc) 25,000 units d) 20,000 units
25. Cost of goods sold = ` 1,20,000, Gross Loss ¼ of sales. What is the amount of sales?a) ` 1,92,000 b) ` 50,000c) ` 72,000 d) ` 96,000
26. If the ordering cost per order is ` 40, carrying cost is 10% of average inventory value. Purchase cost is ` 10 per unit and Economic Order Quantity (EOQ) for the product is 800 units; What is the expected annual demand for the product?
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a) 8,000 units b) 10,000 unitsc) 20,000 unitsd) None of the above
27. The annual demand of certain component bought from the market is 1,000 units. The cost of placing an order is ` 120 and the annual storing charges work out 10% of the Cost of component. To get maximum benefit the firm should place order for how many units at a time? a) 1,000 units b) 900 unitsc) 800 units d) 600 units
28. for a particular item of store, the following information are available:Re-order quality = 1200 unitsMaximum consumption per week = 300 unitsNormal consumption per week = 200 unitsRe-order period = 2 to 4 weeksThe Re-order level will be – a) 600 units b) 400 unitsc) 1200 unitsd) None of the above
If the minimum stock level and average stock level of raw materials Aare 4000 to 9000 units respectively29. Calculate Re-order Level
b) 9,000 units b) 10,000 unitsc) 4,000 units d) 5,000 units
Consumption of materials per annum : 10,000 kg
Order placing cost per order : ` 50Cost per kg of raw materials : ` 2Storage costs: 8% on averageInventory
30. Calculate the Economic Order Quantitya) 2,500 kg b) 2,000 kgc) 1,500 kg d) 3,000 kg
31. Calculate the number of orders to be placed in a year.a) 5 b) 4c) 3 d) 2
From the following information:Annual Consumption of input 48000
unitsAnnual carrying cost 12%Purchase price of input unit ` 25Ordering cost per order ` 180
32. Economic order quantitya) 2000 b) 2400c) 4000 d) 8000
33. For EOQ, the number of orders per yeara) 30 b) 25c) 20 d) 10
34. For EOQ, how frequently should orders be placeda) 20 days b) 19 daysc) 24 days d) 18.25 days
35. For EOQ, Total Ordering Costa) 3600 b) 4000c) 4400 d) 5000
36. For EOQ, Total Carrying Costa) 4500 b) 3600c) 6000 d) None
37. Total Annual Carrying and Ordering cost at that quantitya) 10000 b) 9000c) 8000 d) 7200
Tulip Ltd produces a product which has a monthly demand of 4,000 units. The product Requires Components-A which is purchased at ` 20 for every finished product one unit of Component-A is required. The ordering cost is ` 120 per order and the holding cost is 10% per annum.Calculate –
38. Economic Order quantitya) 2500 b) 2600c) 2400 d) 2700
39. If the minimum lot size is 4,000 units, what is the extra cost Tulip Ltd. has to incur?a) 640 b) 440c) 460 d) 840
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A factory requires 1,500 units of an item per month. The cost of each unit is ` 27. The cost per order is ` 150 and inventory carrying charges work out to 20% of the average inventory. Calculate –
40. Economic order Quantity (EOQ)a) 1000 b) 2000c) 3000 d) 4000
41. Number of orders to be placed per yeara) 20 b) 10c) 30 d) 18
42. Would you accept a 2% price discount on a minimum supply of 1,200 units?a) Yes b) No
X Limited manufacturers of a special product, follows the policy of EOQ (Economic Order Quantity) for one of its components. The components’ details are as follows:Purchase price per components ` 200Cost of an order ` 100Annual cost of carrying one unit in inventory 10% of purchase unitsTotal cost of carrying inventory and ordering per annum ` 4,000The company has been offered a discount of 2% on the price of the components provides the lot size is 2,000 components at a time.
43. Compute the EOQa) 300 b) 400c) 200 d) 4000
EXE Limited has received an offer of quantity discounts on its order of materials as under:Price per Tonne Tonnes1,200 Nos1,180 Less than 5001,160 500 and less than 1,0001,140 1,000 and less than
2,000 1,120 3,000 and aboveThe annual requirement for the materials is 5,000 tonnes. The ordering cost per order is ` 1,200 and the stock holding cost
is estimated at 20% of materials cost per annum.
44. Compute the most economical purchase level.a) 1000 b) 2000c) 3000d) None of the above
45. Find EOQ if there are no discounts offered and the price per tone is ` 1,500?a) 300 b) 800c) 600 d) 200
A firm requires 50 items every day for a machine. A fixed cost of ` 50 per order is incurred for placing an order. The inventory carrying cost per item amounts to ` 0.02 per day. The lead period is 32 days.Compute
46. Economic order quantitya) 500 b) 1000c) 1500 d) 2000
47. Re-order levela) 1800 b) 1600c) 1900 d) 1400
A factory buys and uses components for production at ` 10 per unit. Annual requirement is 20,000 units. The carrying cost of inventory is 10% per annum and ordering cost is ` 40 per order.
48. Calculate EOQa) 1400 b) 1265c) 1600 d) 1700
49. Calculate No. of order to be placeda) 17 b) 18c) 16 d) 19
50. Total cost at EOQa) 201280 b) 201272c) 202000 d) 203000
51. Total cost of acquiring 20,000 units in one order and get a 3% discount from the supplier
a) 203740 b) 203000c) 203470 d) 203400
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X Ltd. manufacturers a special product ‘ZED’ and provides the following information:Demand of ZED various from 500 units to 1500 units per month.Semi-Annual carrying cost 6%.Raw –materials required per unit of finished product 2 kgOrdering cost per order ` 90Purchase price of input unit ` 25 per kg.52. Calculate Economics order quantity
a) 1400 b) 1200c) 1500 d) 1800
Pumpkin Pump Co. uses about 75,000 valves per year and the usage is fairly constant at 6,250 valves per month. The valves cost ` 1.50 per unit when bought in quantities and the carrying cost is estimated to be 20% of average inventory investment on the annual basis. The cost to place an order and process the delivery is ` 18. It takes 45 days to receive from the date of an order and a safety stock of 3,200 valves is desired.
53. The most economical order quantitya) 4000 b) 5000c) 3000 d) 6000
54. Frequency of ordersa) 30 b) 35c) 40 d) 25
55. The order pointa) 12575 b) 12675c) 12775 d) 12875
Normal usage 50 per weekMaximum usage 75 per weekMinimum usage 25 per weekRe-order quantity 300Re-order period 4 to 6 weeksCalculate for each component
56. Re-ordering levela) 550 b) 450b) 650 d) 750
57. Minimum levela) 200 b) 250
b) 300 d) 40058. Maximum level
a) 400 b) 500b) 600 d) 650
59. Average stock levela) 525 b) 425b) 225 d) 325
Monthly demand of product X – 1500 unitsRequirement of component to produce 1 unit of product X : 5 unitsOrdering, receiving and handling cost: ` 10 per orderTrucking Costs: ` 5 per orderDeterioration and obsolescence Cost: ` 10 per unit p.a.Interest Rate: 15% p.a.Storage Cost: ` 4,50,000 for 90,000 unitsPurchase Price of a component: ` 100
60. Calculate Economic Order Quantitya) 400 b) 300c) 500 d) 600
Ram Enterprises manufacturers a special product “ZED”. The following particulars were collected for the year 1986:(a) Monthly demand of ZED – 1,000 units.(b) cost of placing an order ` 100(c) Annual carrying cost per unit ` 15(d) Normal usage 50 units per week(e) Minimum usage 25 units per week.(f) Maximum usage 75 units per week(g) Re-order period 4 to weeks.Compute from the above.
61. Re-order Quantitya) 186 b) 200c) 300 d) 500
62. Re-order levela) 550 b) 450c) 650 d) 750
63. Minimum levela) 400 b) 500c) 200 d) 100
64. Maximum levela) 400 b) 536
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c) 600 d) 700
The following details are available from the books of Ruby Engineering Works Ltd. for the year ended 31st March, 2009:Monthly Demand (units) 2000Cost of placing an order (`) 200Annual Carrying Cost (` per unit) 30Normal Usage (units per month) 100Maximum Usage (units per month) 150Minimum Usage (units per month) 50Re-order Period (weeks) 4-6Assume 52 weeks in a year.Calculate the following:
65. Re-order Quantitya) 130 b) 140c) 126 d) 160
66. Re-order Levela) 207 b) 350c) 250 d) 400
67. Minimum Levela) 200 b) 300c) 100 d) 92
68. Maximum Levela) 400 b) 287c) 150 d) 200
A company manufacturers a product from a raw material, which is purchased at ` 60 per kg. The company incurs a handling cost of ` 360 plus freight of ` 390 per order. The incremental carrying cost of inventory of raw material is ` 0.50 per kg per month. In addition, the cost of working capital finance on the investment in inventory of raw material is ` 9 per kg. per annum. The annual production of the product is 1,00,000 units and 2.5 units are obtained from one kg of raw material.69. Calculate the economic order quantity of
raw materialsa) 3000 b) 2000c) 1000 d) 5000
70. How frequently should orders for procurement be placeda) 20 days b) 19 daysc) 18 days d) 25 days
71. Calculate Re-order level from the following:Consumption per week: 100-200 unitsDelivery period: 14-28 daysa) 5600 units b) 800 unitsc) 1400 units d) 200 units
72. Calculate EOQ (approx.) from the following details:Annual Consumption: 24000 unitsOrdering cost: ` 10 per orderPurchase Price: ` 100 per unitCarrying cost: 5%a) 310 b) 400c) 290 d) 300
73. Calculate the value of closing stock from the following according to FIFO method: 1st January, 2014:Opening balance: 50 units @ ` 4Receipts”5th January, 2014: 100 units @ ` 512th January, 2014: 200 units @ ` 4.50Issues:2nd January, 2014: 30 units18th January, 2014: 150 unitsa) ` 765 b) ` 805c) ` 786 d) ` 700
74. Calculate the value of closing stock from the following according to LIFO method. January, 2014: Opening Balance : 50 units @ ` 45th January, 2014: 100 units @ ` 512th January, 2014: 200 units @ ` 4.50Issues:2nd January, 2014 : 30 units18th January, 2014: 150 unitsa) ` 765 b) ` 805c) ` 786 d) ` 700
75. Calculate the value of ordering stock from the following according to weighted average method:1st January, 2014: Opening Balance: 50 units @ ` Receipts:5th January, 2014: 100 units @ ` 512th January, 2014: 200 units @ ` 4.50Issues:2nd January, 2014: 30 units18th January, 2014: 150 unitsa) ` 765 b) ` 805
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c) ` 786 d) ` 70076. Which of these is not a Material control
technique:a) ABC Analysisb) Fixation of raw material levelsc) Maintaining stores ledgerd) Control over slow moving and non
moving items77. Out of the following, what is not the work
of purchase department:a) Receiving purchase requisitionb) Exploring the sources of material
supplyc) Preparation and execution of
purchase ordersd) Accounting for material received
78. Bin Card is a a) Quantitative as well as value wise
records of material received, issued and balance;
b) Quantitative record of material received, issued and balance
c) Value wise records of material received, issued and balance
d) A record of labour attendance.79. Sores Ledger is a:
a) Quantitative as well as value wise records of material received, issued and balance;
b) Quantitative record of material received, issued and balance
c) Value wise records of material received, issued and balance
d) A record of labour attendance80. Re-order level is calculated as:
a) Maximum consumption × Maximum re-order period
b) Minimum consumption × Minimum re-order period
c) ½ of (Minimum + Maximum consumption)
d) Maximum level – Minimum level81. Economic order quantity is that quantity
at which cost of holding and carrying inventory is:
a) Maximum and equalb) Minimum and equalc) It can be maximum and minimum
depending upon case to case.d) Minimum and unequal
82. ABC analysis is an inventory control technique in which:a) Inventory levels are maintainedb) Inventory is classified into A, B and C
category with A being the highest quantity lowest value.
c) Inventory is classified into A, B and C category with A being the lowest quantity highest value
d) Either b or c83. Which one out of the following is not an
inventory valuation method?a) FIFO b) LIFOc) Weighted Average d) EOQ
84. After inviting tenders for supply of raw materials, two quotations are received as follows – Supplier P ` 2.20 per unit, Supplier Q ` 2.10 per unit plus ` 2,000 fixed chargesIrrespective of the units ordered. The order quantity for which the purchase price per unit will be the same – a) 22,000 units b) 20,000 unitsb) 21,000 unitsc) None of the above
85. Material control does not cover the following stage:
a) Purchase of materialsb) Storing of materialsc) Issue of materialsd) Production
86. Material control aims at achieving effective _________.
a) Material managementb) Quality controlc) Accounting of material
d) Material supply87. Material cost control is best defined as:a) The recording of accounting transactions relating to material cost.
b) Ensuring that losses due to poor stores procedures are minimized.
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c) Minimizing material cost by implementing control from the point at which the material is chosen to its issue into the production process.
d) The process of having a management member responsible for each phase of the movement of materials from the choice of material to its issue into the production process.
88. A perpetual inventory system may be defined as:a) The checking of physical stock
against the bin card information on a continuous basis.
b) The documentation system which records all stores transactions on a continuous basis.
c) The checking of stock on the same date in each accounting period.
d) Ensuring that stocktaking procedures conform to a previously agreed procedure.
89. Inventory consists of ____________.a) Intangible propertyb) Tangible Propertyc) Either of (a) or (b)d) Both (a) and (b)
90. Which of the following statement is correct in relation to “Need for proper inventory control”?a) Inventory may lead to keep men and
machines waiting.b) Materials do not constitute a
significant part of the total production cost hence proper planning and controlling of inventories is not a big deal.
c) Funds are not tied up in surplus stores and stock.
d) All of the above 91. Inventory is valued at ___________.
a) Replacement priceb) Replacement price or purchase
value, whichever is lowerc) At cost or net realizable value
whichever is lowerd) Replacement price or net realizable
value whichever is lower.
92. _____________ indicates the level of each particular item of stock at any point of time.a) Bill of material b) Material requisition notec) Bin Cardd) All of the above
93. Which of the following details are recorded in bin card?a) Date of order and suppliers name
along with addressb) Record of quantitiesc) Record of both quantities and valuesd) All of the above
94. Inventory held for sale in the ordinary course of business is known as _____________.a) Finished goodsb) Raw Materialsc) Work-in-progressd) All of the above
95. Stores Ledger is maintained in the __________.a) Storeb) Finance departmentc) Cost Accounting departmentd) Both a and b
96. Stock verification sheet are maintained to record the results of ____________.a) Physical verificationb) Financial controlc) financial verificationd) Quality verification
97. Stock adjustment Account is debited with ___________ and credited with _____________.a) Surplus, Shortage of stockb) Shortage of stock, surplusc) Excess, lossd) None of these
98. Bin card is a record of _______________ only.a) Cost b) Valuec) Quantity d) Expense
99. Bind card is maintained by the ____________.a) Cost accountant b) Clerkc) Storekeeperd) Branch Accountant
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100. Material abstract is also known as __________.a) Material issue analysis sheetb) Bill of materialsc) Stores Ledgerd) None of the above
ANSWERS1. a 2. a 3. a4. c 5. b 6. c7. d 8. b 9. a10. a 11. b 12. c13. a 14. a 15. a16. c 17. a 18. a19. b 20. c 21. c22. a 23. b 24. b25. d 26. a 27. a28. c 29. b 30. a31. b 32. b 33. c34. d 35. a 36. b37. d 38. c 39. a40. a 41. d 42. a43. c 44. a 45. d46. a 47. b 48. b49. c 50. b 51. a52. b 53. c 54. d55. a 56. b 57. a58. d 59. b 60. b61. a 62. b 63. c64. b 65. c 66. a67. d 68. b 69. b70. c 71. b 72. a73. a 74. b 75. c76. c 77. d 78. b79. a 80. a 81. b82. c 83. d 84. b85. d 86. a 87. c88. b 89. b 90. a91. c 92. c 93. b94. a 95. c 96. a97. b 98. c 99. c100. a
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CHAPTER 2
MEANING OF LABOURLabour is an essential factor of production. It is a human resource and participates in the process of production. Labour cost is a significant element of cost of a product or service. For costing purposes, labour may be classified into two broad categories 1. Direct Labour and 2. Indirect Labour.
DIRECT LABOURMeaningDirect labour is that labour which can be readily identified with a specific job, contract or work order. It includes: a) All labour directly engaged in converting raw materials into finished goods or in altering the
construction, composition or condition of the product. b) Any other form of labour which is incurred wholly or specifically for any particular job,
contract or work order.
FeaturesThe main features of direct labour are: a) It can be easily identified with a specific job, contract or work order. b) It varies directly with the volume of output.
TreatmentWages paid to direct labour are termed as 'Direct labour cost' and form part of Prime cost.
ExamplesSome examples of direct labour are: (a) Weaver in weaving unit (b) Carpenter in furniture unit (c) Tailor in Readymade wears unit (d) Baker in Baking unit (e) Halwai in confectionery unit (f) Labour employed on construction contract
INDIRECT LABOURMeaningIndirect labour is that labour which cannot be readily identified with a specific job, contract or work order. It includes all labour not directly engaged in converting raw-materials into finished goods or in altering the construction, composition or condition of the product.
FeaturesThe main features of indirect labour are: a) It cannot be easily identified with a specific job, contract or work order. b) It may or may not vary directly with the volume of output.
Treatment
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Wages paid to indirect labour are termed as 'Indirect labour cost' and are treated as part of overheads.
ExamplesSome examples of indirect labour are: a) Labour employed in Personnel Department b) Labour employed in Time-keeping Department c) Labour employed in Pay-roll Department d) Labour employed in Cost Accounting Department e) Labour employed in Repairs & Maintenance Department
Distinction between Direct Labour and Indirect LabourDirect labour differs from Indirect labour in the following respects:
Basis of Distinction
Direct Labour Indirect Labour
1. Identification It can be readily identified with a specific job, contract or work order.
It cannot readily be identified with a specific job, contract or work order.
2. Treatment of cost
Direct labour cost is directly charged to the specific job, contract or work order and forms part of prime cost.
Indirect labour cost cannot directly be charged to the specific job, contract or work order and is treated as part of overheads which are absorbed on some suitable basis.
3. Variability It varies directly with the volume of output.
It may or may not vary directly with the volume of output.
Note: Distinction is relative to each particular firm or industry since labour which is direct in one unit may be indirect in another unit due to difference in the nature of work, process or method.
Importance of Distinction 1. For ascertainment of cost-It helps in ascertaining the labour cost of different cost units. 2. For exercising control over cost-It helps in exercising proper control over labour cost. 3. For accounting treatment- Direct labour cost is treated as part of prime cost and indirect
labour cost is treated as part of production overheads.
LABOUR TURNOVER
Meaning of Labour Turnover Labour Turnover is the rate of change in the composition of labour force of an organisation due to retirement, resignation or retrenchment etc. during a particular period. It may be defined as the number of workers left or replaced or both in relation to the average number of workers employed during the period.
Three Methods of Measurement of Labour Turnover
1. Separation Rate Method
Labour Turnover =No .of Separations
Average Number of workers∈the period ×100
Where,
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No. of separations = No. of workers left
Average no. of workers =No .of Workers∈the beg+No .of Workers at the end
2
2. Replacement Rate Method
Labour Turnover = No . of replacement
Average Number of workers∈the period ×100
Where,No. of Replacements = No of workers recruited in the vacancies of those leaving excluding those recruited on account of expansion scheme
3. Flux method
Labour Turnover = No. of Separations+No . of replacement
Average Number of workers∈the period ×100
ORNo . of Separations+No .of accessions
Average Number of workers∈the period ×100
No. of Accessions = no. of Workers recruited in the vacancies of those leaving and those recruited on account of its expansion
Equivalent Annual Labour Turnover Rate In case Labour Turnover Rate is based on a period other than a year, An Equivalent Annual Labour Turnover Rate may be calculated as follows:
Equivalent Annual Labour Turnover Rate =Turnover rate for the period ×365
Number of days∈the period
Causes of Labour TurnoverType of Causes Examples
a) Personal Causes These include those causes which induce or compel workers to leave their jobs.
a. Change of jobs for betterment. b. Premature retirement due to ill health or old age. c. Domestic problems and family responsibilities. d. Discontent over the jobs and working environment.
b) Unavoidable Causes These include those causes which are not within the control of the management.
a. Seasonal nature of the business;b. Shortage of raw material, power, slack market for
the product etc; c. Change in the plant location; d. Disability, making a worker unfit for work;e. Disciplinary measures; f. Marriage (generally in the case of women).
c) Avoidable causes There include those causes which are within the control of the management and which
a. Dissatisfaction with job, remuneration, hours of work, working conditions, etc.,
b. Strained relationship with management, supervisors or fellow workers;
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require the attention of management on a continuous basis so as to keep the labour turnover ratio as low as possible .
c. Lack of training facilities and promotional avenues; d. Lack of recreational and medical facilities; e. Low wages and allowances.
Effects of High Labour Turnover High Labour Turnover increases the cost of production and decreases the profitability because of- 1. Loss of output between the time when worker left and new workers recruited 2. Increased cost of Selection and recruitment 3. Increased cost of Training 4. Increased cost of Tools, Equipments and machine breakages5. Increased cost of scrap, wastage, spoilage and defective wor6. Loss of output due to lower productivity of new worker along with fall in quality.
Two Types of Cost of Labour Turnover 1. Preventive Costs There are the costs which are incurred to keep the labour force contended
so that high labour turnover may be prevented. These costs include the following; (i). Cost of Personnel Administration (ii). Cost of Medical Services (iii). Cost of Welfare Activities such as canteen services etc. (iv). Cost of Social Security Schemes such as Pension, Provident Fund Schemes, Gratuity etc. (v). Cost of perquisites in excess of the average prevailing in industry.
2. Replacement Costs There are the costs which are incurred to meet the consequences of high labour turnover, There include the following; (i). Loss of output between the time when worker left and new workers recruited (ii). Increased cost of Selection and recruitment (iii). Increased cost of Training (iv). Increased cost of Tools, Equipments and machine breakages(v). Increased cost of scrap, wastage, spoilage and defective work (vi). Loss of output due to lower productivity of new worker
Suggestion Each company must work out the optimum level of labour turnover keeping in view its personnel policies and the behaviour of replacement cost and preventive costs at various levels of labour turnover rates.
Treatment of Costs of Labour Turnover Labour Turnover Costs Accounting Treatment
a) Preventive Costs There costs should be charged a part of production overheads and should be apportioned to different departments on the basis of number of workers engaged in each department.
b) Replacement Costs(i). Arising on account of fault
of any particular department.
(ii). Arising due to general reasons
These costs should be charged directly to that department. These costs should be charged as part of a production overheads and should be apportioned to different departments on the basis of number of workers engaged in each department.
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Remedial Steps to Minimize Labour Turnover The following steps are suggested to minimize labour turnover.
1. Exit interviewAn interview should be arranged with each outgoing employee to ascertain the reasons of his leaving the organisation.
2. Job analysis and evaluationBefore recruiting workers, job analysis and evaluation may be carried out to ascertain the requirements of each job. a) A standardised policy for Recruitment, Replacement, Performance Appraisal,
Education, Training and Development of Employees, Selection, Transfers, Promotions.3. A satisfactory level of Salaries and Wages 4. A satisfactory level of Welfare Schemes like canteen, medical, housing, recreation etc. 5. A satisfactory Social Security Schemes like, gratuity, pension, provident fund, industrial
accident compensation, 6. A standardised Grievance Procedure to settle worker's grievances with management. 7. A satisfactory policy for Workers' participation in management and Joint Consultation
Scheme.
INCENTIVE SCHEMESMeaning of Incentive Incentive may be defined as "the stimulation of effort and effectiveness by offering monetary inducement or enhanced facilities'. It may be monetary or non-monetary. It may be provided individually to every worker or collectively to a group of workers. The basis objective of incentive is to improve productivity and increase production so as to bring down the unit cost of production.
Essential Characteristics of a Good Incentive System A good incentive system should have the following characteristics: 1. It should be simple to understand and easy to operate. 2. It should be economical to introduce and operate. 3. It should be fair to both employees and employer 4. It should guarantee hourly wages to every worker irrespective of level of his efficiency. 5. It should provide adequate incentive to efficient workers. 6. It should place no limit on the earnings of workers. 7. It should not penalise the workers for reason beyond their control such as machine break
down, power failure etc. 8. It should provide for prompt payment of incentives at short intervals of time. 9. It should have approval of workers and trade union. 10.It should be capable of improving the morale of workers. 11.It should have managerial support in so far as production material, quality control,
maintenance, and non-monetary incentives are concerned. 12.It should be relatively permanent and should not be allowed to change very frequently. 13.It should be flexible enough so as to introduce the necessary changes (if any required)
TYPES OF INCENTIVES SYSTEMSThe incentives systems can be classified under various heads.
1. HALSEY PREMIUM PLAN
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The system is also known as split bonus plan or fifty-fifty plan. The plan was introduced by F.A. Halsey, an American engineer. Under this plan, a minimum hourly wage is paid and in addition the worker is paid a premium or bonus, if his performance is better than the accepted standard. If the job in completed in less than the standard time, he is paid bonus in addition to a minimum hourly wage. In practice, the bonus is calculated to give the employee 50% of the time saved. The remaining 50% goes to the employer.
1. FeaturesThe main features of Halsey Premium plan are as follows: a) Standard time is fixed for each work. b) It guarantees the hourly wages to workers for the actual time taken. c) Bonus is paid if the time is saved (i.e., when actual time is less than the standard time). d) Bonus is equal to 50% of the time wages of time saved.
2. Computation of Total EarningTotal Earnings = Time Rate Wages + BonusOr = Actual Time Taken × Time Rate + 50% [Time saved × Time Rate]
3. ExampleTime taken 6 Hours, Time Rate `10 per hour, Time Allowed 8 hoursTotal Earnings = 6 hours × `10 + 50% [(8 hours – 6 hours)] × `10
= `60 + `10 = ` 704. Advantages
It guarantees the hourly wages to workers for the actual taken time. It provided an incentive for an efficient worker who completes his work in less than the
standard time. It provides an incentive to the employer to provide better production facilities as he
receives 50% share in savings achieved.
2. HALSEY-WEIR SYSTEM This plan was introduced by G & J Weir Ltd. in Glasgow. This is the modified version of Halsey plan. The Halsey Weir System is the same as the Halsey System except that the bonus paid to workers is 30% of the time saved.
This method enjoys all the advantages of the Halsey plan but earned the unpopularity as larger share of bonus goes to the employer
3. ROWAN PLAN This plan was introduced by the J. Rowan. Under the Rowan method, the worker’s day rate is guaranteed. A standard time is fixed and if a saving is effected by the worker, a percentage equal to the percentage of saving is added to the actual time taken.
1. Featuresa) Standard time is fixed for each work. b) It guarantees the hourly wage to workers for the actual time taken. c) Bonus is paid if the time is saved (i.e., actual time is less than the standard time) d) Bonus is that proportion of time wages as time saved bears to the standard time.
2. Computation of Total Earnings
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Total Earning = Time Rate Wages + Bonus OR
Actual Time Taken x Time Rate +TimeSaved
Timeallowed × (Actual Time x Time Rate)
3. ExampleTime taken 6 hours, time Rate ` 10 per hour, Time Allowed 8 hours
Total earnings = 6 hours ×`10+8−68 × (6 hours ×` 10)
= ` 60 + 2/8 ×` 60 = ` 75
4. Advantagesa) It provides more incentive to moderately efficient workers who save time up to 50% of
the standard time than Halsey Plan. b) It provides an incentive to the employer to provide better production facilities as he
receives a large share in savings achieved. c) It protects the employer against wrong rate setting as the bonus can never reach 100% of
time wages as in Halsey Plan.
Comparison between Halsey Plan and Rowan Plan (Imp.)Time Saved Bonus, Earning Per Hour and Labour cost per
unita) When time saved is less than 50% of
standard timeBonus, Rate of increase in per hour earning and Labour cost per unit is higher in Rowan plan than Halsey Plan.
b) When time saved is 50% of standard time
Bonus, Earning per hour and labour cost per unit are same under both the plans.
(c) When time saved is more than 50% of standard time
Bonus, Rate of increase in per hour earning, and labour cost per unit are higher in Halsey Plan than Rowan Plan.
4. TAYLOR’S DIFFERENTIAL PIECE RATE SYSTEM The scheme was first introduce in the U.S.A. by F.W.Taylor, the father of scientific management, and was subsequently modified by Merrick. This system is based upon two or more fixed piece rates. One piece rate is used for workers, whose production is lower than the minimum prescribed production and a higher rate is paid per piece to workers who produce above the level.The system was designed with the following objective : To discourage below average worker by providing no guaranteed wages and setting low
piece rate for low level of production To reward the efficient worker by setting higher piece rate for higher level of production.
1. Featuresa) Standard time is fixed for each work. b) Two piece rates are fixed- (i) a lower rate (i.e., 80% of normal piece rate) for the worker
who produces below the standard output (ii) a higher rate (i.e., 120% of normal piece rates) for the worker who produces standard output or more than the standard output.
Note: Some authors also use 83%, and., 125% of the normal piece rates as lower and higher rates respectively.
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2. Computation of Total Earningsa) For worker who produces less than the standard output
Total earning = Actual output × Normal piece Rate × 80%
b) For worker who produces standard output or more than the standard outputTotal earning = Actual output × Normal piece Rate × 120%
3. Example : Standard output 100 units, Normal piece Rate Re 1 per piece, X produced 60 units, Y produced 100 units, Z produced 110 units. Earnings using Taylor's differential piece rate will be as follows:
X’s earning = 60 units × Re 1 × 80% = ` 48 Y’s earning = 100 units × Re 1 × 120% = `120 Z’s earning = 110 units × Re 1 × 120% = ` 132
4. Advantagesa) It provides incentive to efficient workers. b) It helps the employer to increase the production by offering higher rates to more efficient
workers. c) It helps the employer to reduce the overhead cost per unit because of increased
production.
5. Disadvantagesa) It penalizes very severely the inefficient workers because a slight reduction in output
may result in a larger reduction in their earnings. b) It does not guarantee the hourly wages and this insecurity affects the morale of worker. c) Labour cost will differ between two levels of performance because of two different rates.d) Higher and lower rates may be the source of conflict among the workers. e) Employer- Employee relations may also be strained if the standard is put at a high level.
5. BAUM’S DIFFERENTIAL SCHEME (MILWAKEE SCHEME) It is the combination of Halsey and Taylor’s differential piece rate system. This system provides incentives at different level of efficiency.
6. MERRICK’S DIFFERENTIAL PIECE RATE Under Taylor differential rate system, a below average worker is dealt with very severely. Merrick modified the Taylor’s differential piece rate system. Under this system, the punitive lower rate is not imposed for performance below standard and performance above standard is rewarded by more than one higher differential rate.1. Features
The main features of Merrick's Differential Piece Rate are as follows: a) Standard time is fixed for each work. b) Three piece rates are fixed as follows:
2. Reward Efficiency attained Piece Rate
Upto 83(1/3)% 100% of Ordinary Piece Rate
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Above 83(1/3)% and upto 100% 110% of Ordinary Piece RateAbove 100% 120% of Ordinary Piece Rate
3. Computation of Total Earningsa) For worker who produces up to 83(1/3)% of standard output
Total earning = Actual output × Normal Piece Rate
b) For worker who produces above 83(1/3)% and up to 100% of standard outputTotal earning = Actual output × Normal Piece Rate × 110%
c) For worker who produces above 100 % of standard outputTotal earning = Actual output × Normal piece Rate × 120%
4. ExampleStandard output 100 units, Normal piece Rate Re 1 per piece, X produced 60 units, Y produced 100 units, Z produced 110 units. Earnings using Merrick's Differential Piece rate will be as follows:
X’s earnings = 60 units ×` 1 = ` 60 Y's earnings = 100 units ×` 1 × 110% = ` 110 Z’s earnings = 110 units ×` 1 × 120% = ` 132
5. AdvantagesIn additional to advantages of Taylor's Differential Piece Rate System, one more advantage of Merrick's Differential piece Rate System is that it does not penalize the workers producing below the standard output by the low piece rate.
6. DisadvantagesIt has same disadvantages as Taylor's Differential Piece Rate system has except that it does not penalise the workers producing below standard output by the low piece rate.
Distinction between Taylor's Differential Piece Rate and Merrick's Differential Piece Rate
Basis of Distinction Taylor's Differential Piece Rate System
Merrick's Differential Piece Rate System
1. No. of Piece Rate Two piece rates are fixed. Three piece rates are fixed.2. Penalty for workers
producing below standard output
It penalises workers producing below standard output by low piece rate .
It does not penallse worker producing below standard output by low piece rate.
7. EMERSON’S EFFICIENCY SYSTEM
1. Features(a) Standard time is fixed for each work. (b) It guarantees the day wages to the worker regardless of performance. (c) Up to 66-(2/3)% efficiency - Hourly (Time) rate
Above 66-(2/3)% but up to 90% - Time Rate + 10% as BonusAbove 90% but up to 100% - Time Rate + 20% as Bonus
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Above 100% - Time Rate + 20% as Bonus + Additional Bonus of 1% for every increase of 1% beyond 100% efficiency.
2. Example Standard output 100 units, Daily wage Rate ` 100, X produced 60 units, Y produced 100 units, Z produced 110 units
Earnings under Emerson’s Efficiency SystemA
WorkerB Actual output
C Level of Efficiency
D Guaranteed
Time Wages `
E Bonus F = D+E Earnings Per
Worker `
X 60 60% 100
Nil 100
Y 100
100%
100
20% of ` 100 = 20
120
Z 110
110%
100
(20% + 10%) of ` 100 = ` 30
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3. Advantagesa) It guarantees the day wages to the worker and then provides security. b) It provides incentives even for those workers whose level of efficiency exceeds 66(2/3) %
but does not exceed 100%. c) It provides additional incentive for those workers whose level of efficiency exceeds 100%.
4. Disadvantagesa) The incentive is quite small to attract very efficient and ambitious workers. b) It does not provide any incentive for those whose level of efficiency is upto 66(2/3)%.
8. GANTT TASK AND BONUS SYSTEM This system combines time rate, piece work system and bonus. This system attempt to gain immediately some of the many advantages, which the introduction of Taylor’s differential, piece rate system promises to assure gradually.
1. Featuresa) It is combination of time rate, piece rate and bonus plan. b) Standard time is fixed for each work. c) It guarantees the day wages to the worker.
Three rates of payments are fixed as follows:Worker Rate of payment
For worker who produces less than the standard output
Guaranteed Time Rate
For worker who produces standard output only 120% of time RateFor worker who produces more than the standard output
120% of Piece Rate
2. Computation of Total EarningsWorker Total Earning
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a) For worker who produces less than the standard output
= AH × Time Rate
b) For worker who produces Standard output only
= (AH × Time Rate) × 120%
c) For worker who produces more than the standard output
= (Actual Output × Piece Rate) × 120%
3. ExampleStandard Hours allowed to produce 40 units - 8 hours, Standard wage Rate ` 20 per hour, X, V and Z completed the task in 10 hours, 8 hours and 6 hours respectively.
Earning under Gantt Task and Bonus System X's earnings = 10 hours ×` 20 = ` 200 Y's earnings = 8 hours ×` 20 × 120% = ` 192 Z's earnings = 40 units ×` 4 × 120% = ` 192 Note: Piece Rate = 8/40 ×` 20 = ` 4 per piece
4. Advantages(a) It guarantees hourly rate wages to less efficient workers. (b) It provides incentive to efficient workers. (c) It encourages better supervision and planning. (d) It helps the employees to increase the production by offering higher rates to more
efficient workers. (e) It helps the employer to reduce overheads costs per unit because of increased
production.
5. DisadvantageGuaranteed time rate may act as a disincentive for less efficient worker to increase his output in case high rate is fixed.
9. BEDAUXE POINT SYSTEM Under this system, the value of time saved is shared 75% to worker and 25% to supervisor. Workers who are not able to complete tasks allotted to them within the standard time are paid at the normal daily rate. In this system B’s (BEDAUXE)Points saved are calculated and 75% of B’s saved is given as bonus to worker. B simply means standard minutes.Example : If standard time is 10 hours and time taken is 8 hours and rate per hour is ` 1, the worker will get : [(8 hours X 1) + 75% X 120 (Points saved)]/ 60 = ` 9.50.
10. HAYNE’S MANIT SYSTEM Under this system Time Wages are guaranteed. Standard time is set in terms of standard man minutes called ‘MANITS’. A manit means a standard work performed in a standard minute. Bonus is given for the time saved. Ratio of sharing of Bonus between Worker, Employer and Supervisor will be 5:4:1.
11. BARTH SHARING PLAN This scheme does not provide guaranteed wages. Total Wages = Hourly Rate X [ Square root of ( Standard Time X Time Taken)]
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Total Wages is higher for less efficient people. As the efficiency increases, the earning decrease, therefore this plan is suitable for beginners and trainees. It does not encourage efficient workers.
12. DIEMER SCHEME This is a combination of Halsey’s and Gantt’s Schemes. A straight line increasing incentive is given beyond 100% efficiency.
13. ACCELERATED PREMIUM SYSTEM Increments of bonus increases at a faster rate as production increases. As this scheme encourages to get higher production, it should not be used where quality of output is important. Formula for calculating wages differ from one concern to another.
MEANING OF CERTAIN IMPORTANT TERMS
A. TIME STUDY1. Meaning
Time study is a technique which is used to measure the time that may be taken by a workman of reasonable skills and ability to perform various elements of the tasks in a job.
2. PurposeThe purpose of time study is to determine-
i). Time normally required to perform a certain job, and ii). A fair day's work for the workman.
3. Advantage of time study Better control of production Better control of cost Improved quality Lower percentage of spoiled work
B. MOTION STUDY1. Meaning
Motion study is a technique which involves close observation of the movements of body and limbs required to perform a job.
2. PurposeThe purpose of motion study is- i). To eliminate waste motion, and ii). To determine the best way of doing a job.
3. ToolsTime study is conducted with the help of a movie camera connected with micro-chronometer (i.e., a kind of clock).
Distinction between Time Study and Motion StudyBasis of
Distinction
Time Study Motion Study
1. Meaning It is a technique which is used to measure the time that may be taken by a workman of reasonable skills
It is a technique which involves close observation of the movements of the body and
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and ability to perform various elements of the tasks in a job.
limbs required to perform a job.
2. Purpose Its purpose is to determine time normally required to perform a certain job and a fair day’s work for the workmen.
Its purpose is to detect and eliminate wasteful motions and determine the best way of doing a job.
3. Tools of study
It is conducted with the help of stopwatch
It is conducted with the help of a movie camera connected with micro-chronometer (i.e., a kind of clock)
C. MERIT RATING1. Meaning
Merit Rating rates the individual merits of a job holder on the job. It is the quantitative or qualitative assessment of an employee's personality or his performance on the job made by his supervisor or any other competent person. This assessment will be applied to all workers, who fall within the groups being rated.
2. ObjectivesThe objective of merit rating is to provide a scientific basis for determining fair wages for each worker based on his ability and performance.
3. FactorsUsually the following factors are considered for merit rating purposes: Quality of work done, Quantity of work done, Knowledge applied, Skills used, Sense of Responsibility, Sense of judgment, Integrity, Punctuality, Reliability, Discipline, Co-operation.
4. AdvantagesAdvantages of merit rating are as follows: a) Merit Rating helps in determining fair wages for each worker. b) It helps in taking decisions like who deserves promotion, who deserves increment? c) It reveals employee's strong and weak points. d) It helps in ascertaining the suitability of the worker for a particular job when it is linked
with job evaluation. Distinction between Job Evaluation and Merit Rating
Basis of Distinction
Job Evaluation Merit Rating
1. Meaning It is assessment of relative worth of jobs hierarchy.
It is the assessment of the relative worth of a jobholder.
2. Job vs. jobholder
It rates the jobs It rates the jobholders.
3. Objectives Its objectives is to set up a rational wage and salary structure
Its objectives is to provide a scientific basis for determining fair wages for each worker based on his ability and performance
4. Usefulness It helps in establishing a simplified and rational wages and salary structure.
It helps in determining fair wages for each worker.
D. TIME KEEPING
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Methods of Time Keeping
Manual Methods Mechanical Methods
Attendance Register/Muster Roll Time Recording Clocks
Time keeping is a system of recording the arrival and departure time of each worker.
Objectives of Time Keeping 1. To provide data for the preparation of payroll. 2. To meet statutory requirements (i.e., Attendance Record) 3. To ascertain the Overtime 4. To ascertain the Idle Time 5. To ascertain the Labour Cost 6. To provide a basis for apportionment of overheads if based on labour hours 7. To control labour cost 8. To maintain discipline and punctuality among the workers
Methods of Time Keeping The various methods of Time Keeping are as follows:
E. TIME BOOKINGMeaning of Time Booking Time Booking is a system of recording the time spent by each worker on various jobs, orders or processes.
Objectives of Time Booking 1. To ascertain the labour cost of a job, order or process. 2. To check wastage of time by the worker after he enters the factory. 3. To ascertain the cost of idle time. 4. To provide a basis for apportionment of overheads where overheads are to be apportioned on
the basis of time spent on various jobs, orders or processes. 5. To control labour cost by comparing actual time with the standard time allowed on various
jobs. 6. To provide information for the computation of wages and bonus for the time saved under
various schemes of wage payment. 7. To ensure that the time for which a worker is paid is properly utilized.
Methods of Time Booking Depending upon the size of organisation, time booking may be done manually or mechanically. Large sized organisations use time recording clocks for recording starting and closing timings of work by every worker in respect of every job.
Distinction between Time Keeping and Time BookingBasic Distinction
Time Keeping Time Booking
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1. Meaning Time keeping is a system of recording the arrival and departure time of each worker.
Time Booking is a System of recording the time spent by each worker on various jobs, orders or processes.
2. Basic Objective
Its basic objectives are to maintain attendance record as per statutory requirements and to provide data for the preparation of payroll.
Its basic objective is to ascertain the labour Cost of a job, order or process.
3. Methods Manual Methods Attendance Register / MusterRollMechanical Methods Time Recording Clocks
1) Daily Times Sheet2) Weekly Time sheet
F. CASUAL WORKERSMeaning of Casual Workers Casual Workers are those who are not on the pay-roll of the factory but are engaged casually whenever there is extra load in the factory or whenever a regular worker is absent because of any reason.
Payment to casual Workers Usually casual workers are paid on daily basis.
Treatment of Wages Paid to Casual Workers a) Wages paid to casual workers in the nature of direct labour are treated as direct labour cost
forming part of prime cost.b) Wages paid to casual workers in the nature of indirect labour are treated as production
overheads.
G. OUTWORKERSMeaning of Outworkers Outworkers are those who work outside the factory premises and may be put under the following two categories:
I. Workers who are on the Pay-roll of the factorya) They are on the pay roll of the factory.b) They are sent at customer's premises to perform some specific duties such as Repair
work, plumber's work, sanitary work, Electric work etc. c) Job cards are usually issued to such workers to record the time spent by them on various
jobs.
II. Workers who are not on the payroll of the factory a) They are not on the payroll of the factory. b) They are supplied materials and specific tools. c) They use their own premises, lighting, tools etc. d) They deliver manufactured products. e) Strict supervision and control is required to ensure-
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i). That all material & tools if any, issued are properly accounted for, ii). That tool issued if any, from the factory are returned without undue wear and tear. iii).That quantity and quality of output are as per specifications given.
H. PAY-ROLL ACCOUNTINGMeaning of Pay-Roll Accounting Pay- Roll accounting is that part of financial accounting which is concerned with-
1. the computation of gross wages and deductions from gross wages with a view to ascertain net wages payable to each employee during a particular period, and
2. the preparation of Pay Roll and Pay Slip at periodic intervals (say weekly or monthly)
Meaning of Pay Roll (or Wage Sheet) Pay Roll is a periodic statement which shows:
a) Gross wages earned by each worker b) Deductions from Gross wages, and c) Net wages payable to each worker
How to calculate Gross Wages?Method of Wages
PaymentHow to Calculate Gross Wages
1. Time Wage System Gross Wages = Ordinary wages + Overtime PremiumWhere,Ordinary wages = Total hours as per Time card × Hourly RateOvertime Premium = Overtime Hours × Over Time Premium Rate
2. Piece Wage System(a) At a fixed rate per unit
Gross Wages = No. of Good units × Rate per unit
Note: In case a worker is to be allowed a minimum guaranteed time wage, any deficit will be entered in the wage sheet as ‘Wages make up’ and charged to Production Overheads.
(b) At a standard rate per hour for allowed hours for a job
Gross wages =Allowed Hours × Standard rate per Hour
Example I: A Worker's time as per Time Card 50 hours (including 10 overtime hours). Normal wage rate is ` 10 per hour and Overtime Wage Rate is 150% of Normal Wages Rate.
Ordinary Wages = 50 ×` 10 = ` 500 Add: Overtime Premium = 10 ×` 5 = `50 Gross Wages = ` 550
Example II: A worker produced 100 units. Piece rate per unit is ` 5. Gross Wages = 100 ×` 5 = ` 500
Deductions from Gross WagesThe Payment of Wages Act, 1963 authorises the following deductions: i). Fines and deductions for absence from duty.
ii). Deductions for damage or loss of goods or money expressly entrusted to the employed person.
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iii). House rent and cost of other amenities and services. iv). Deduction for recovery of advance. v). Income-tax.
vi). Deductions in respect of an order of a court or other competent authority. vii). Provident fund.
viii). Deductions of co-operative society dues. ix). Deduction for life insurance premium. x). Employee's State insurance contribution.
I. IDLE TIMEIdle Time is that time for which payment made but no direct production/benefit is obtained. The question of Idle Time arises only when the payment is made on time basis. It is calculated as follows:
Idle time = Time Recorded as per Time card - Time Booked on Job as per Job card.
Causes of Idle Time Idle time may arise due to anyone or more of the following causes.
Production causes a) Machine Break Down b) Power failures c) Waiting for work d) Waiting for Tools e) Waiting for Materials f) Waiting for Instructions
Administration causes (which arise due to administrative decisions)
a) Decision not to retrench regular trained workers in the period of depression
b) Decision not to work up to full capacity of plant.Economic causes (Which arise due to economic conditions & decisions)
Closure of seasonal industry during off- season.
Treatment of Idle Time Cost in Cost AccountsIdle Time cost may be treated in Cost Accounts as follows:
Idle Time Cost Accounting Treatmenta) Cost of normal & controllable Idle Time
(e.g., Machine Breakdown, waiting for work, tools, materials or instructions)
a) It is treated as part of cost and hence treated as part of production overheads
b) Cost of normal but uncontrollable Idle Time (e.g., set up time machine, interval between one job and another, personal needs)
b) It is treated as part of cost and hence charged directly to job by inflating wage rates (for example if wage rate is ` 5 per hour and worker’s effective hours during 8 hour work is 7 hours only, the inflated wage rate will = ` 5.71
c) Cost of abnormal Idle Time (i.e., due to abnormal reasons such as power failure, strikes, lock out, fire, flood etc.)
c) It is not treated as part of cost and hence charged to Costing Profit & Loss Account.
Control of Idle Time
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To exercise an effective control over Idle Time, the following steps are suggested:
Practical Steps involved in exercising Control over Idle TimeStep 1- Fix the standards for normal idle time such as tea/lunch breaks.Step 2- Prepare Periodic Idle Time Report showing the Idle Time, reasons and cost and submit the same to the competent authority.Step 3- Compare the Actual Idle Time with the standard Idle Time to find out the difference. (If any)Step 4- Investigate the causes of the difference.Step 5- Take the necessary corrective action promptly.
J. OVERTIME PREMIUM OR OVERTIME WAGESMeaning of Overtime Overtime is an extra time over and above the normal working hours. According to the Factories Act, 1949, a worker is entitled to overtime wages when he works for more than 9 hours on any day or more than 48 hours in-a-week.
Meaning of Overtime Payment In India, Overtime is to be paid at double the normal rate of wages. Overtime payment consists of following two parts:
Circumstances under which Overtime may arise 1. When it is desired at customer's request to complete the work within specified time. 2. When it is required to increase the output as per general production programme. 3. When it is required to make up any short fall in production due to abnormal conditions such
as flood, earthquake, breakdown of machinery etc. 4. When it is required to meet seasonal demand. 5. When it is required to increase the output to meet the additional market demand .
Effects of Overtime Payment 1. The overhead payment increases the cost of production in the following ways: a) Extra Cost There is an extra payment over and above the normal rate of wages. b) Reduced output during overtime there may be reduced output during overtime because of fall
in workers' efficiency during late hours. c) Reduced output during Normal Time There may be reduced output during normal time
because of development of a tendency to work in overtime. 2. Overtime working as regular feature has an adverse effect on the health of workers. 3. Overtime may lead to discontent among workers if overtime is not properly distributed
Treatment of Overtime Premium in Cost AccountsOvertime Premium is treated as follows:
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Overtime Payment = Overtime Hours × Overtime Wage Rates
Overtime Normal Payment= Overtime Hours × Normal Rate of Wages
Overtime Premium Payment= Overtime Hours × Extra Rate of Wages
Circumstances Treatment of Overtime Premiuma) When it is desired at customer's request
to complete the work within specified time.
It should be charged directly to the job or work concerned.
b) When it is required to Increase the output as per general production programme/ When it is required to meet the seasonal demand/ When it is required to increase the output to meet the additional market demand
It should be treated as production overhead.
c) When It is required to make up any short fall In production due to abnormal conditions such as flood, earthquake, breakdown of machinery etc.
It should be charged to Costing Profit & Loss Account.
METHODS OF WAGE PAYMENTSThe two principal methods of wage payment are as follows: 1. Time Rate Wage System2. Piece Rate Wage System
Time Rate Wage System 1. Features a) A worker is paid a fixed rate per hour or per day or per month for
the time devoted him. b) The time rate may be fixed with reference to rate prevailing in the
industry for similar work. But it must be noted that this rate must not be less than the minimum wages fixed under the Minimum Wages Act or any other Act for the time being in force.
c) Output produced by the worker is not relevant for calculating wages.
2. Computation of Wages
Wages = Actual time devoted × Time rate
3. Example Mr X, a worker, gets ` 10 per hour. If he works for 8 hours, he will get ` 80 (i.e., 8 ×` 10).
4. Advantages a) It provides guaranteed time wages to workers. b) Workers concentrate on the quality rather than the quantity of job
because they are not in hurry to complete the job. c) There is reduced damage or rough handling of machines, tools and
equipments due to slow and steady pace of the workers.
5. Disadvantages a) It does not act as an incentive to workers. b) It tends to increase overhead cost and labour production cost per
unit because of low production. c) There develops a tendency to go slow during the normal working
hours in the hope of getting overtime wages. This tendency arises where the practice of overtime wages is prevailing. There is lack of incentive to reach and sustain a reasonable level of work.
d) High degree of supervision is required to secure a fair day’s work.
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Piece Rate Wage System1. Features a) A worker is paid at a fixed rate per unit produced or job
completed. b) Time spent on job is not considered for calculating wages.
2. Computation of wages
Wages = Number of units produced x piece rate per unit
3. Example Mr Y, a worker gets ` 5 per piece. If the produces 20 pieces, he will get ` 100 (i.e., 20 ×` 5).
4. Advantages a) It acts as an incentive to workers to produce more and earn more as the remuneration is directly linked with performance.
b) It tends to reduce overhead cost and labour cost per unit because of high production.
c) It eliminates the tendency of workers to go slow as remuneration is directly linked with performance.
d) Low degree of supervision is required because the worker themselves take care of the time and output.
e) It simplifies cost ascertainment because labour cost per unit is available in advance.
5. Disadvantages a) It does not guarantee time wage to workers and hence workers feel insecure.
b) Workers tend to increase the quantity ignoring the quality thereof.
c) There may be excessive damage to machines, tools and equipment and excessive wastage of materials due to speedy pace of workers.
d) The calculation of pieces rate is more difficult than time rate.e) It is usually opposed by trade unions and workers. f) It is detrimental to the long-term health and working efficiency of
the workers because in his anxiety to earn more he may overstrain and overwork resulting in fatigue and breakdown of the biological system.
g) It is not suitable for setting up group incentive plans unless all the workers' jobs happen to carry the same hourly wage rate or production standard.
Distinction between Time Rate Wage System and Piece Rate Wage SystemTime Rate Wage System and Piece Rate Wage System can be distinguished as follows:
Basis of Distinction
Time Rate Wage System Piece Rate Wage System
1. Basis of Payment
A worker is paid at a fixed rate per hour, per day or per month for the time devoted by him.
A worker is paid at a fixed rate per unit produced or job completed.
2. Linkage between
There is no linkage between performance and reward. Both efficient and inefficient workers get
The linkage between performance and reward motivates the people to
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Performance and Reward
the same amount of wages so long as they spend equal time on the job.
produce more and earn more.
3. Quality Quality of work tends to be high. Quality of work tends to be low.4. Wastage There is less chance of wastage of
materials and machinery.There are more chances of wastage of materials and machinery.
5. Supervision Close supervision is required. Close supervision is not required.
6. Maintenances Cost of maintenance is low. Cost of maintenance is high.7. Attitude of
Trade UnionsTrade Unions prefer it. Trade Union oppose it
8. Economic Security
It provides sense of economic security to employees.
It does not provide sense of economic security to employees.
9. Usefulness This method is useful where a worker has to do a variety of dissimilar jobs or where tasks cannot be readily measured, inspected and counted.
This method is useful where a worker has to do the jobs of a repetitive nature or where tasks can be readily measured, inspected and counted.
10.Adoption This method is adopted for compensating clerical staff, managers and operatives employed in jobs which do not require much skill.
This method is adopted for compensating skilled and official workers who can increase their earning by working to their full capacity.
11.Assurance A worker is assured of his wages for work period irrespective of his output.
No such assurance is given.
GROUP BONUS SYSTEM1. Meaning of Group Bonus System
Group Bonus Scheme is a scheme in which bonus is calculated on the basis of collective production of a group of workers and is distributed among the individual members of the group on some agreed basis.
2. When Introduced Group Bonus Scheme is generally introduced where performance of an individual worker cannot be measured and the ultimate production is dependent on the collective efforts of a group of workers. For example, in the construction work, it is the teamwork that produces results.
3. Types of Group Bonus Plans a) Priest man Production Bonus Plan – Bonus is payable to the Department if Actual Output is greater than Standard Output. Bonus is given on the basis of the percentage by which actual output exceeds standard output.b) Cost Premium System – Here Bonus is dependent on output and agreed % of any Cost Saved in use of Material and services. c) Rucker’s Plan (Share of Production Plan) – Ratio of Earning and Added value is calculated. Any reduction in this ratio increases the wages. Added value is the change in market value.d) Scanlon Plan – It is similar to Rucker’s Plan. But ration of Earnings and Production at Selling Price is used for Bonus.e) Towne Gain Sharing Plan - Bonus is half of any saving in Labour Cost as compared to Standard Cost of Labour.
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Elements of Wages
Basic Wages Benefits in Cash Benefits in kind (Fringe benefits)
Dearness Allowance House Rent Allowance City Compensatory Allowance Night Shift Allowance Uniform Allowance Conveyance Allowance Medical Allowance Bonus Employer's Contribution to Provident Fund Employer's Contribution to Employee's State Insurance Leave Pay Holiday Pay Sick Pay Gratuity Pension Overtime
Medical facilities Housing facilities Canteen facilities Conveyance facilitiesRecreational facilitiesEducational facilities Training facilities
PROFIT SHARING SCHEMES1. Meaning Profit sharing is one of the monetary incentive schemes under which in addition to
wages, worker are entitled to share the profit of the concern at an agreed rate. 2. How to distribute share in profit Worker's share in profit may be distributed in any of the
following ways: i). By paying in cash ii). By crediting to Provident Fund iii). By paying some part in cash and by crediting remaining part to Provident Fund.
3. How to treat Share of Profit in Cost AccountsIn India, profit sharing schemes take the form of an annual bonus that is governed by the Payment of Bonus Act, 1965. Payment of Bonus should be treated in Cost Accounts as follows:
Bonus Accounting Treatment(i). Minimum Statutory Bonus to Direct
workersIt may be taken as direct charge by inflating wage rate.
(ii). Minimum Statutory Bonus to Indirect Workers
It may be taken as an item of overheads.
(iii). Extra Bonus to Direct and Indirect Workers
It should be excluded from Cost Accounts.
CO-PARTNERSHIP1. Meaning of Co-Partnership
Co-partnership is one of the monetary incentive schemes under which workers are given opportunity to have a share in capital, profit and control of the business in which they are employed.
2. Example of Co-partnership When Shares are allotted to workers of a company in proportion to their share of bonus, workers are entitled to receive dividend on shares held by them and are entitled to participate in the management of the company because of voting power attached to shares held by them.
ELEMENTS OF WAGES
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Tutorial Notes: i). Provident Fund, Employees' State Insurance Corporation Premium and bonus are payable on
the basic wages, dearness allowance and value of food concession. ii). Following items are considered while computing labour cost and not Gross Wages earned by
worker. a) Employer's contribution to P.F., ESI, Family Pension Fund b) Expenditure on amenities c) Leave Salary
iii). Overtime wages are considered while computing Gross Wages and not labour cost. iv). Holiday Pay (Leave with Pay) : Employees are entitled to certain holidays. Amount paid for
these days are known as Holiday Pay. It is treated as part of Production Cost either by charging it as overheads or by inflating the labour cost.
v). Night Shift Allowance : Allowance given for working at night to clear the heavy work load. It is a part of work overheads. If night shift is worked at customer’s request, then it should be charged to that job.
vi). Learner’s Wages : It is treated as Direct Labour if it can be identified with Job/Product; otherwise it is considered as part of overheads.
vii). Training Cost : It is apportioned to various departments on the basis of number of trainees in each Department.
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CLASSROOM PRACTICE – LETS PLAY TOGETHER
Que 1.Problem based on labour turnoverThe extracts from the payroll of a factory is a follows: Number of Employees at the beginning of April 2013 150 Number of Employees at the end of April 2013 250 Number of Employees resigned during April 2013 25 Number of Employees discharged during April 2013 5 Number of Employees replaced due to resignations and discharges during April 2012
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Required: Calculate the labour turnover rate and equivalent annual rate for the factory by different methods.Ans:
1. Separation Rate Method = No .o f SeparationAverage No. o f Workers × 100
= 25 + 5(150 + 250)/2 ×100 = 15%
Equivalent Annual Labour Turnover Rate = TurnoverratefortheperiodNumberof days intheperiod
× 3 65
Equivalent Annual Labour Turnover Rate = 15%30
× 3 65= 182.5%
2. Replacement Method = No .o f ReplacementAverageNo. o f Workers × 100
= 20200 × 100 = 10%
Equivalent Annual Labour Turnover Rate = 10%30
× 3 65= 121.67%
3. Flux Rate = No .o f Separation + No. of ReplacementsAverageNo. o f Workers × 100
= 30 + 20200 × 100 = 25%
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Equivalent Annual Labour Turnover Rate = 25 %
30×3 65= 304.17%
Que 2.From the following data provided to you, find out the Labour Turnover Rate by applying: a) Flux Method b) Replacement Method c) Separation Method
No. of workers on the payroll: At the beginning of the month 500 At the end of the month 600 During the month, 5 workers left, 20 persons were discharged and 75 workers were recruited. Of these, 10 workers were recruited in the vacancies of those leaving, while the rest were engaged for an expansion scheme.
Computation of Labour Turnover Rate
Flux Method = No .o f Separation + No. of ReplacementsAverageNo. o f Workers in period × 100
= 5 + 20 + 10(500+600)/2 × 100 =
35550 × 100 = 6.36%
Replacement Method = No .o f Replaced during the periodAverageNo. o f Workers in period × 100
= 10(500 + 600)/2 × 100 = 1.82%
Separation Method = No .o f Separation during the periodAverageNo.o f Workers in the Period × 100
= 5+20
(500+600)/2× 100=4.545 %
Que 3.From the following Information, calculate Labour Turnover rate and Labour flux rateNo. of Workers as on 01.01.2013 = 7,600 No. of workers as on 31.12.2013 = 8,400 During the year, 80 workers left while 320 workers were discharged 1,500 workers were recruited during the year of these, 300 workers were recruited because of exits and the rest were recruited in accordance with expansion plans.
Ans:
Basic CalculationsMethod Formula &
Answer
1. Average Labour Force = L = 7600+8400
2=8,000
workers.
Separation = SL
= 4008000 = 5%
2. Number of Separations = S = Left + Discharged = 80 + 320 = 400 workers
Accession=
AL
= 12008000 = 15%
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3. Number of Accessions = A = 1,200 workers (given)
Notes: Replacements and New Recruitments are not relevant for calculation, in this question.
Flux ¿S+AL
= 400+12008000
= 20%
Que 4.The extracts from the payroll of a factory is a follows: Number of Employees at the beginning of April 2013 300 Number of Employees at the end of April 2013 500 Number of Employees resigned during April 2013 50 Number of Employees discharged during April 2013 10 Number of Employees replaced due to resignations and discharges during April 2013
40
Required: Calculate the labour turnover rate for the factory by different methods.
Ans:
1. Separation Rate Method = No .o f SeparationAverageNo. o f Workers × 100
= 50 +10(300+500)/2 ×100 = 15%
Equivalent Annual Labour Turnover Rate = Turnover rate for the periodNumber of days in the period
× 3 65
Equivalent Annual Labour Turnover Rate = 15%30
× 3 65 = 182.5%
2. Replacement Method = No .o f ReplacementAverage No . o f Workers × 100
= 40400 × 100 = 10%
Equivalent Annual Labour Turnover Rate = 10%30
× 3 65 = 121.67%
3. Flux Rate = No .o f Separation + No. of ReplacementsAverage No. o f Workers × 100
= 60 + 40400 × 100 = 25%
Equivalent Annual Labour Turnover Rate = 25 %
30×3 65 = 304.17%
Que 5.Calculate the number of separations during the year from the following information: Labour Turnover Rate (based on Separations) 10% Labour Turnover rate (based on Replacements) 8% No. of Replacements during the year 16 Ans:
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Step 1 Calculation of Average No. of Employees
Labour Turnover Rate (based on Replacements) = No. of Replacements
Average No . of Employees ×100
8 = 16
Average No .of Employees × 100
Average No. of Employees = 16.08 = 200
Step 2 Calculation of No. of Separations
Labour Turnover Rate (based on Separations) = No.of Separations
Average No .of Employess × 100
10 = No . of Separations
200 × 100
No. of Separations during the year = 10% of 200 = 20
Que 6.Calculate the number of workers replaced from the following information: Labour Turnover Rate (based on separations) 3% Labour Turnover Rate (based on flux) 8% No. of workers left & discharged 18
Ans:Step 1 Average No. of Workers
Labour Turnover Rate (based on Separations) = No .of Separations
Average No .of Workers × 100
3 = 18
Average No .of Workers × 100
Average No. of workers = 18× 100
3 = 600
Step 2 Calculation of No. of Replacements
Labour Turnover Rate (Flux Method) = No .of Separations+No .of Replacements
Average No . of Workers ×100
8 = 18+No. of Replacements
600 ×100
No. of Replacements = 48 – 18 = 30
Que 7.The cost accountant of Y Ltd. has computed labour turnover rates for the quarter ended 31 st
March, 2011 as 10% , 5% and 3% respectively under 'Flux Method', 'Replacement method' and 'Separation Method'. If the number of workers replaced during that quarter is 30. Find out the number of (a) workers left and discharged and (b) workers recruited and joined.
Ans:Flux rate = 10%Replacement Method = 5%Separation Method = 3%
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*If number of replacement and no. of separation would be taken then flux rate should be 8%. Therefore no. of separation and no. of accessions would have been taken.
Replacement Rate = No .o f ReplacementAverage no. of workers × 100
0.05 = 30Average no. of workers
Average no. of workers = 30
0.05 = 600
Separation Rate = No .o f SeparationAverage no. of workers
×100
3 = No . o f Separation600
×100
No. of separation = 18 workers
Flux Rate = No . o f Separation + No. of AccessionAverage no. of workers
×100
10 = 18 + No. of Accession600
×100
60 – 18 = No. of AccessionNo. of Accession = 42 workers
Que 8.Calculate the earnings of a worker under (i) Halsey Plan and (ii) Rowan Plan from the following particulars: a) Hourly rate of wages guaranteed 0.50 paise per hour. b) Standard time for producing one dozen articles - 3 hours. c) Actual time taken by the worker to produce 20 dozen articles - 48 hours.
Ans:Wage Rate per hour = ` 0.50Standard Time Allowed per Dozen = 3 HoursActual Production = 20 Dozens Standard Time Allowed for 20 Dozens = 3 Hours × 20 Dozens
= 60 HoursActual Time Taken to produce 20 Dozens = 48 Hours Time Saved = 60 - 48 = 12 Hours Earnings = Normal wages × Bonus
Under Halsey = (Actual Time Taken × Time Rate) + (50%× Time Saved × Time Rate) = (48 Hours × 0.50) + (50% × 12 × 0.50) = 24 + 3 = `27
Under Rowan = (Actual Time Taken × Time Rate) + (Time Saved × Time Taken
Time Allowed × Time Rate
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= (48 Hours × 0.50) + (12 × 4860 × 0.50)
= 24 + 4.80 = ` 28.80
Que 9.The firm employs five workers at an hourly rate of ` 2.00. During the week, they worked for four days for a total period for 40 hours each and completed a job for which the standard time was 48 hours for each worker. Calculate the labour cost under the Halsey method and Rowan method of incentive plan payments. Ans:
Statement showing the Calculation of Labour CostParticulars Halsey Method Rowan Method
(A) Actual Hours Worked (AH) [40 × 5]
(B) Standard Hours (SH) [48 × 5] (C) Hourly Rate Wages
(AH × Rate) = [200 × ` 2] (D) Bonus
(E) Total Labour Cost [C + D]
200 240
400
¿ 12 × (SH – AH) × R
¿ 12 × (240 - 200) × ` 2
= 40 440
200 240400 AH
AHSH (SH - AH) × R
200240
×(240 - 200) ×` 2
= 67 467
Que 10.A worker under the Halsey Method of remuneration has a day rate of ` 72 per week of 48 hours plus a cost of living bonus of ` 0.60 per hour worked. He is given an 8 hours task to perform which he accomplishes in 6 hours. He is allowed 30% of the time saved as premium bonus. What would be his total hourly rate of earnings, and what difference would it make if he was paid under the Rowan Method.
Ans: Standard Time allowed (SH) Actual Time taken (AH) Time Saved (SH - AH) Bonus allowed Wage rate: (R) (` 72/48) Living bonus rate: Premium bonus
8hours 6hours 2hours 30% ` 1.50 per hour ` 0.60 per hr. 30% of time saved (i.e. SH - AH)
Halsey method of remuneration= 6 X 2.10 + 2 X 1.5 X 30% = ` 13.5Rowan method of remuneration= 6 X 2.10 + 6 X 1.5 X 2/8 = ` 14.85
Que 11.A worker produced 200 units in a week's time. The guaranteed weekly wage payment for 45 hours is ` 81. The expected time to produce one unit is 15 minutes which is raised further by 20% under the incentive scheme. What will be the earnings per hour of that worker under Halsey (50% sharing) and Rowan bonus schemes?
Ans: Earning per hour under Halsey (50% sharing) Bonus Scheme:
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(A) Standard Hours for actual production (SH) = 200 units × 18 minutes60 Minutes = 60 hours
(B) Actual Hours (AH) = 45 Hours
(C) Earnings = (Hours Worked × Rate Per Hour) + 12 (SH - AH) ×Rate Per Hour
= (45 hours ×`1.80) + [12× (60 - 45) ×` 1.80]
= ` 81 + ` 13.50 = ` 94.50
(D) Earnings per hour = 94 .50
45 hours = ` 2.10 per hour
Earnings per hour under Rowan Bonus Scheme:
Earnings = AH × Rate Per Hour + AHSH
= (45 hours ×` 1.80) + [4560 × (60 - 45) ×`1.80]
= ` 81 + ` 20.25 = ` 101.25
Earnings per hour = 101.25
45 hours = ` 2.25 per our
Working Notes: (i). Expected time to produce one unit under incentive scheme = 15 × 1.20 minutes = 18 minutes (ii). Wage rate per hour (` 81/45 hours) = ` 1.80.
Que 12.( Most- Imp)A skilled worker in XYZ Ltd. is paid a guaranteed wage rate of `30 per hour. The standard time per unit for a particular product is 4 hours. P, a machine man, has been paid wages under the Rowan Incentive Plan and he had earned an effective hourly rate of ` 37.50 on the manufacture of that particular product.
Required: What could have been his total earnings and effective hourly rate, had he been put on Halsey Incentive Scheme (50%)?
Solution
Total earnings (under 50% Halsey Scheme) = Hours worked × Rate per hour + 12× Time saved
× Rate per hour
= (3 hours × ` 30) + (12 × 1 hour × ` 30)
Effective hourly rate = Total EarningsHour Taken =
Rs .1053 hours
= ` 35
Working Note: Let T hours be the total time worked in hours by the skilled workers (machine man P), ` 30 is the rate per hour; standard time is 4 hours per unit and effective hourly earnings rate is ` 37.S0 then
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Earning (under Rowan plan) = Hours worked × Rate per hr + Time Saved
Time Allowed × Time taken
× Rate per hr
`37.5 T = (T × ` 30) = (4- T ) 4 × T × `30
`37.5 = ` 30 + (4 - T) × ` 7.5 Or, `7.5 T = ` 22.5 Or, T = 3 hours
Que 13.(Most – Imp)Calculate the earnings of workers A, Band C under Straight Piece Rate System and Merrick's Piece Rate System from the following particulars:
Normal Rate per Hour `5.40 Standard Time per Unit 1 Minute Output per day is as follows: Worker A - 390 Units Worker B - 450 Units Worker C - 600 Units Working hours per day are 8.
Ans: Earnings of Workers under Straight Piece Rate System:
Worker A = 390 units × ` 0.09 = ` 35.10 Worker R = 450 units × ` 0.09 = ` 40.50 Worker C = 600 units × ` 0.09 = ` 54.00
Earnings of Workers under Merrick's Multiple Piece Rate SystemParticulars A B C
Efficiency level (Refer to Working note ii) Applicable wage rate per unit Earnings (`)
81.25%
0.0935.10
(390 units ×0.09)
93.75%
0.09944.55
(450 units × 0.099)
125%
0.108*64.80
(600 units × 0.108)
Note : *Some author suggests an increase of 30% over normal piece rate at an efficiency level of120% or more. In such a case the rate per unit would be ` 0.117 and total earnings would come to ` 72.20Working Notes: (i) Normal wage rate per unit = Normal Rate per Hour/Standard output per hour
= ` 5.40/60 = 9 Paise(ii) Efficiency level
Workers: A B CActual output per day (units) 390 450 600Standard output per day (units) 480 480 480
Efficiency level achieved
= Actual output units
Standard output units ×100 = 390480 × 100 =
450480 × 100 =
600480 × 100
= 81.25% = 93.75% = 125%
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Que 14.Using Taylor's differential piece rate system, find the earning of A from the following particulars:
Standard time per piece 12 minutes Normal rate per hour (in a 8 hours day) ` 20 A produced 37 units
Ans: 1. % of Efficiency
Standard output per day = 8 ×60
12 = 40 units Actual output = 37 units
% of Efficiency Actual OutputStandard Output × 100 =
3740 × 100 = 92.5%
2. Normal production per hour = 60 MinutesStandardTimeperpiece,i.e.12minutes = 5 Units
3. Normal piece rate per Unit = `205 Units
=¿`4
4. Total Earnings = 37 ×4 x 80% = 118.4
Que 15.Calculate the total wages earned by a workman for a working day of 8 hours under Halsey and Rowan plans: Standard production per hour 20units Actual production of the day 200units Wages rate per hour `30
Ans:
(i). Standard time = 20020 = 10 hours
(ii). Total wages of workman in Halsey scheme: Total wages = (Actual time × wages rate) + 50% (Standard Time - Actual time) × wage rate
= 8 × 30 + 50
100 (10 - 8) × 30
= ` 270
(iii). Total wages In Rowan plan:
Total wages = (Actual time × wages rate) +Standard time- A ctual TimeStandard Time × Actual time ×
wages rate
= 8 × 30 + 10−8
10 × 8 × 30
= ` 288
Que 16.( Group- Bonus)In a factory, Group Bonus System is in use which is calculated on the basis of earnings under time rate. The following particulars are available for a group of 4 workers P, Q, R and S.
72
i). Output of the group 16,000 unitsii). Piece rate per 100 units ` 2.50
iii). No. of hours worked by P 90Q 72R 80S 100
iv). Time rate per hour for P ` 0.90Q ` 1.00R ` 1.20S ` 0.90
Required: Calculate the total of Wages and Bonus earned by each worker.
Ans: Statement showing Computation of Total of Wages & Bonus earned by each worker
Worker
A
AH
B
Rate Per Hour(`)
C
Wages(`)
Hrs. × RateD=B×C
Bonus(WNs)
E
Total/Wages
& Bonus
F=D+EpQRS
907280
100
0.801.001.200.80
72729680
18182420
9090
120100
320 80 400
Working Notes:
(i). Total piece earnings of the group = 16000
100 × 2.50 = ` 400.00
(ii). Total Bonus = ` 400 - 320 = ` 80 divided in the ratio of time wages.
P 80320 × 72 = 18, Q
80320 × 72 = 18, R
80320 × 96 = 24, S
80320
× 80 = 20
Que 17.(Most – Imp)Two workmen, 'A' and 'B', produce the same product using the same material. Their normal wage rate is also the same. 'A' is paid bonus according to the Rowan system, while 'B' is paid bonus according to the Halsey system. The time allowed to make the product is 50 hours. 'A' takes 30 hours while 'B' takes 40 hours to complete the product. The factory overhead rate is ` 5 per man-hour actually worked. The factory cost for the product for 'A' is ` 3,490 and for 'B' it is ` 3,600. Required: a) Compute the normal rate of wages; b) Compute the cost of materials cost; c) Prepare a statement comparing the factory cost of the products as made by the two workmen.
Ans: Let x be the cost of material and y be the normal rate of wage per hour.
Worker A Worker B` `
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Material cost X XLabour wages 30Y 40YBonus Rowan system Halsey system
Time saved × Time taken
Time allowed × rate
Hours saved × 50% × rate
20 × 3050 x y = 12y = 10 ×
12 xy = 5y
Overheads 30 × 5 = 150 40 × 5 =200Factory cost X+ 42y + 150 = 3,490 X+ 45y + 200 = 36,00
Solving (1) and (2) we get X = 2,500 and y = 20 (i) Normal rate of wages is ` 20 per hour. (ii) Cost of materials = ` 2,500
Comparative Statement of factory cost
Worker A Worker BMaterial cost 2,500 2,500Wages 30 × 20 = 600 40 × 20= 800Bonus
( 2050 × 30 ×20 ) = 240 (10 ×
12 × 20 ) = 100
Overheads 30 × 5 =150 40 × 5 =200Factory cost 3,490 3,600
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JUDGE URSELF
Que 18.From the following data given by the personnel Department calculate the labour turnover rate by applying: a) Separation Method, b) Replacement Method, c) Flux Method.
No. of workers on the pay-roll: At the beginning of the month 900At the end of the month 1,100
During the month 10 workers left, 40 persons were discharged and 150 workers were recruited. Of these, 25 workers are recruited in the vacancies of those leaving, while the rest engaged for an expansion scheme.
Ans: A: 5%, B:2.5%, C: 7.5%
Que 19.Calculate the number of employees in the beginning and at the end of the year from the following information:
Labour Turnover Rate 3% Number of Separations during the year 12 No. of Employees at the end was 100 in excess of number of employees in the beginning.
Que 20.The standard time allowed to complete a job is 100 hours and the hourly rate of wage payment is ` 10. The actual time taken by the worker to complete the job is 80 hours. Calculate the total wages of the worker on the basis ofa) (i) Time Rate
(ii) Halsey Plan (iii) Rowan Plan
b) Also compute the effective earnings per hour under the above methods. Ans: A(i) ` 800, A(ii) ` 900, A(iii) ` 960
B(i) ` 10, B(ii) ` 11.25, B(iii) ` 12Que 21.
Standard Time allowed 10 units per hour Normal Piece Rate ` 5 for 10 units Differential Piece Rate: 80% of Piece Rate for output below standard 120% of Piece Rate for output at or above standard A produces 75 units in a day of 8 hours B produces 100 units in a day of 8 hours Required: Compute wages of A and B and Labour Cost per unit under Taylor Differential Piece Rate System.
Ans: Total Wages: A `30, B `60, Labour Cost per unit: A ` 0.40, B `0.60
Que 22.Standard Rate ` 5 per hour Standard Hours for the Job = 8 hours for 40 units Standard Piece Rate Re 1 per unit
Worker A completes the work in 10 hours Worker B completes the work in 8 hours Worker C completes the work in 6 hours
75
Required: Compute the Total earnings and earnings pet hour of A, B and C under Gantt Task Bonus Plan. Ans: Total earnings: A ` 50, B ` 48, C ` 48, Earning per Hour: A ` 5, B ` 6, C `8
Que 23.From the following calculate Total Earnings of A, B and C and labour cost per unit of A , Band C under merrick efficiency System.
Standard output: 2000 units per day Standard Rate: ` 200 per day Actual output: A - 1200 units, B 2000 units, C 2200 units
TRUE/FALSE QUESTIONSState with reason whether the following statements are True and False: 1. Abnormal idle time wages are included in the cost of production. 2. Job card is used to record the attendance of workers. 3. Time card is used to record time spent on job. 4. Wage sheet is prepared by Cost Accounting department. 5. Time & Motion study is conducted by Time keeping department 6. Where quality is important, piece rate system is the most suitable method of wage payment. 7. Where quantity is important, time rate system is the most suitable method of wage payment. 8. When time saved is more than 50% of standard time Rowan Plan allows more earnings to
workers than Halsey Plan. 9. Overtime wages due to seasonal pressure of work should be charged to Costing Profit & Loss
Account.10. Amount of bonus under Halsey Plan is always different from that under Rowan plan. 11. Cost of normal idle time should be charged to Costing Profit & Loss Account. 12. Fringe Benefits are charged to Costing Profit & Loss Account. 13. Minimum Statutory Bonus to Direct Workers should be treated as part of Overheads and to
indirect worker should be treated as part of direct labour cost. 14. Extra Bonus over minimum Statutory Bonus should be treated as overheads.
EXPLANATORY ANSWERSStatemen
t No.True/False
Reason
1. False Abnormal idle time wages are charged to Costing Profit & Loss Account.
2. False Job Card is used to record time spent by workers on a job.3. False Time card is used to record arrival and departure time of a
worker.4. False Wage sheet is prepared by Payroll Department5. False Time & Motion study is conducted by Engineering and Work
Study Department.6. False Where quality is important, time rate system is the most
suitable method of wage payment.7. False Where quantity is important, piece rate system is the most
suitable method of· wage payment.8. False When time saved is more than 50% of standard time Halsey
Plan allows more earnings to workers than Rowan Plan.9. False Overtime wages due to seasonal pressure of work should be
treated as overhead.
76
10. False Amount of bonus under Halsey Plan and Rowan Plan is same when time saved is exactly 50% of standard time.
11. False Cost of normal idle time should be treated as part of cost of production.
12. False Fringe Benefits are treated as part of cost of production.13. False Minimum statutory Bonus to Direct Workers should be
treated as part of direct labour cost and to indirect workers should be treated as part of overheads.
14. False Extra Bonus over Minimum Statutory Bonus should be excluded from Cost Accounts.
77
PAST EXAMINATION QUESTION
MULTIPLE CHOICE QUESTIONS
1. Under the high wage plan, a worker is paid - (a) At a higher time rate than the usual rate(b) According to his efficiency(c) At a double rate for overtime (d) Normal wages plus bonus.
2. Cost of labour turnover is – (a) Preventive cost (b) Direct cost (c) Fixed cost(d) Non-controllable cost.
3. The rate of change of labour force in an organization during a specified period is called- (a) Labour efficiency (b) Labour turnover (c) Labour productivity(d) None of the above
4. Holiday pay is treated as – (a) Fringe benefits cost (b) Direct labour cost (c) Overheads(d) Abnormal loss charged to profit and loss account.
5. Incentive schemes include- (a) Piece rate wage plan (b) Time rate wage plan (c) Differential piece rate wage plan(d) None of the above
FILL IN THE BLANKS (a) The time for which the employer pays remuneration to workers but obtains no direct benefit
is called …….(b) The time lost by workers who are paid on time basis, is known as …..
TRUE AND FALSE/CORRECT AND INCORRECT
1. If a labour saves half of time of the standard time, the incentive amount under Halsey Plan and Rowan Plan will be equal.
2. High labour turnover rate denotes good human relations. 3. Under differential piece rate of incentive scheme, there is no encouragement to
improve the performance of the workers.
78
4. By job rotation, labour turnover can be controlled/reduced upto some extent. 5. Under Flux Method, labour turnover is calculated by number of workers left divided by
average number of workers. 6. There is no need to record attendance of piece rate workers since attendance is not
relevant for ascertaining the amount of wages to be paid. 7. Idle facility and idle time are the same. 8. Overtime premium paid to all factory workers is usually considered direct labour. 9. High wages means high cost of production.
Answer : MCQs Answers 1 2 3 4 5Options (a) (a) (b) (a) (d)
Answers : Fill in the Blanks1. Idle time.2. Idle time.
Answers : True/False1. True,If the worker finishes the work in half of the time fixed for it, the wages earned under
Halsey and Rowan plans will be the same.2. False, High labour turnover indicates an unhealthy working atmosphere may be due to poor
management policies or poor supervision, etc.3. Incorrect, In differential piece rate system, higher wages, are given to more efficient workers.
Hence, it acts as an encouragement to improve the performance of workers.4. Correct, Job rotation leads to change in monotonous job of workers which controls labour
turnover to a certain extent since, worker's requirement of better job are fulfilled.5. Incorrect, Under Flux Method labour Turnover is calculated by Number of Workers Added and
separated divided by Average Number of Workers. i.e. Labour turnover according to Flux Method:
= × 100
Average of employees during a period
=
6. Correct, Under Piece Rate System the attendance is not relevant rather detailed records of individual workers output is necessary as wage are paid per piece.
7. False, Idle facility is the time allowed to the worker by the factory, where as idle time is the time that is lost due to unavoidable reasons, like break-down, etc.
8. False, Overtime hours at normal rate are treated as labour cost and charged to production accordingly but premium paid during the overtime is re- covered as production overhead through overhead recovery rate.
9. False, Highly skilled labors are very expensive but they are the most efficient as well as are the most expensive and can increase the production and thereby reduce the cost of production. Since, the costs would be stagnant whereas the production units would increase. Thus, high wages does not mean high cost of production.
79
TRAIN UR BRAIN
1. Direct Labour means – a) Permanent labour in the production
departmentb) Labour completing the work
manuallyc) Labour which is recruited directly
and not through contractors.d) Labour which can be conveniently
associated with a particular cost unit2. Labour turnover is measured by –
a) Replacement methodb) Separation methodc) Flux methodd) All of the above
3. The rate of change in labour force during a specified period measured against a suitable index is – a) Direct Labour turnoverb) Preventive costsc) Labour productivityd) Replacement cost
4. Labour cost which cannot be allocated but can be apportioned to or absorbed by units or cost centres is known as –a) Direct Labour b) Indirect
Labourc) Labour turnoverd) None of the above
5. Under Rown plan bonus percentage is – a) Fixed b) Not fixedc) Fluctuatingd) None of the above
6. Cost of abnormal idle time is transferred to costing – a) Manufacturing Accountb) Profit & Loss Accountc) Balance Sheetd) Trading Account
7. Overtime wage is paid at a higher rate than the normal wage rate – usually – a) Single b) Triplec) Double d) None
8. The causes which induce or compel workers to leave their jobs are –a) Unavoidable causesb) Avoidable causesc) Personal causesd) None of the above
9. Unavoidable causes includes – a) Seasonal nature of the businessb) Dissatifaction with working
conditionsc) Lack of proper training facilities and
promotional avenuesd) Unhealthy relationship with the
management10.Avoidable causes includes –
a) Seasonal nature the businessb) Change in the location of the plant or
factoryc) Lack of proper training facilities and
promotional avenuesd) Climatic condition
11.High Labour turnover increases the cost of production by – a) Even and continuous flow of
production is disturbedb) Increasing cost of training and
inductionc) New workers being in experienced
are more prone to accidents all of the above
d) All of the above12.Work done by a worker beyond his
normal working hours is known as –a) Over time b) Idle timec) Time rate d) Card time
13.A worker who does not work in the factory premises, but works at h is home or at site of the factory is called – a) In worker b) Out workerc) Sub worker d) Worker
14.The expenditure which can be allocated conveniently to a unit of cost is known as –
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a) Direct expensesb) Indirect expensesc) Advertising Expensesd) None of the above
15.Godwon keeper, office staff, salesman etc. are treated as – a) Direct Labour b) Indirect
Labourc) Additional Labourd) None of the above
16.The department responsible for recruiting and training workers and placing them to the jobs they are best- fitted in Labour Cost control is known as –a) Payroll Departmentb) Time keeping Departmentc) Personnel Departmentd) Cost Accounting Department
17.The department which prepares the plan and specification for each job in Labour Cost Control is known as – a) Payroll Departmentb) Time keeping Departmentc) Personnel Departmentd) Engineering and work study
Department18.The department which maintains a check
on the attendance of the workers and the time recorded by the worker on various jobs etc. in Labour Cost Control is known as – a) Time keeping Departmentb) Payroll Departmentc) Personnel Departmentd) Cost Accounting Department
19.Time and Motion study involves the Classification of labour movement into –a) Direct and Indirectb) Fixed and Variablec) Necessary and Wastefuld) None of the above
20.The technique for evaluating individual employee performance is known as – a) Job Evaluation b) Merit Ratingc) Time Booking d) Time Keeping
21.A worker is allowed 60 hours to complete the job on a guaranteed wage of ` 10 per hour. Under the Rowan plan his effective wage earnings are ` 12 per hour. What is the earnings under Halsey Plan? a) ` 12.25 b) ` 11.10c) ` 11.25 d) ` 10.25
The cost Accountant of A Ltd. has compound labour turnover rates for the quarter ended 31.3.1997 as 10%, 5% and 3% respectively under Flux method, Replacement method and separation method respectively. If the number of workers replaced during that quarter is 30.22.Find the number of workers left and
discharged?a) 18 b) 22c) 26 d) 20
23.Find the number of workers recruited and Joined.a) 40 b) 41c) 42 d) 44
From the following particulars:1. Hourly rate of wages guaranteed –
0.50 paise per hour2. Standard time for producing one
dozen articles – 3 hours3. Actual time taken by the worker to
produce 20 dozen articles – 48 hours
24.Calculate the earnings of a worker under Halsey plan.a) ` 25 b) ` 27c) ` 29 d) ` 31
25.Calculate the earnings of worker under Rowan Plan.a) ` 28.80 b) ` 28c) ` 29.01 d) ` 29
The following information relates to the personal department of a factory for the month of April, 1995:
Number of workers on April 1, 1995
950
Number of workers on Apri 30, 1,050
81
1995Number of workers who quit the fatory in April
10
Number of workers discharged in April
30
Number of workers engaged in April (including 120 on account of expansion scheme) 140
26.Calculate the labour turnover rate by separation methoda) 4% b) 5%c) 6 % d) 2%
27.Equivalent annual ratea) 73% b) 24.33%c) 48.67% d) None
The following information relates to the personnel department of a factory for the month of April, 1995:
Number of workers on April 1, 1995
950
Number of workers on Apri 30, 1995
1,050
Number of workers who quit the fatory in April
10
Number of workers discharged in April
30
Number of workers engaged in April (including 120 on account of expansion scheme) 140
28.Calculate the labour turnover rate by replacement method.a) 4% b) 5%c) 6% d) 2%
29.Equivalent annual ratea) 73% b) 24.33%c) 48.67% d) None
The following information relates to the personnel department of a factory for the month of April, 1995:
Number of workers on April 1, 1995
950
Number of workers on Apri 30, 1995
1,050
Number of workers who quit the fatory in April
10
Number of workers discharged 30
in AprilNumber of workers engaged in April (including 120 on account of expansion scheme) 140
30.Calculate the labour turnover rate by flux methoda) 4% b) 5%c) 6% d) 2%
31.Equivalent annual ratea) 73% b) 24.33%c) 48.67% d) None
The labour turnover rates of a manufacturing organization for the quarter ended 31st March, 2009 are 10%, 5%, and 3% under flux method, replacement method, and separation method respectively. The number of workers replaced during the quarter is 120.
32.Find the average number of workersa) 3000 b) 2400c) 4200 d) 6000
33.Find the number of workers left and dischargeda) 27 b) 72c) 168 d) 186
34.Find the number of workers recruited and joined including replacementsa) 27 b) 72c) 168 d) 18
Labour turnover Rate 3%Number of Separations during the yr 12No of Employees at the end were 100 in excess of number of employees in the beginning
35.Calculate the number of employees in the beginninga) 450 b) 350c) 550 d) 650
36.Calculate the number of employees at the end of the year a) 450 b) 350c) 550 d) 650
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Labour turnover rate (Based on Separations) 10%Labour turnover rate (Based on Replacements) 8%No. of Replacements during the year 16
37.Calculate the average number of employeesa) 300 b) 200c) 600 d) 500
38.Calculate the number of separations during the yeara) 30 b) 40c) 10 d) 20
Labour turnover rate (Based on Separations)
3%Labour turnover rate (Based on Flux)
8%No. of Workers left & discharge 18
39.Calculate the average number of employeesa) 300 b) 200c) 600 d) 500
40.Calculate the number of workers replaceda) 30 b) 40c) 10 d) 20
The cost of accountant of Y Ltd. has computed labour turnover rates for the quarter ended 31st March, 20XI as 10%, 5%, and 3% respectively under ‘Flux method’, ‘Replacement method’ and ‘Separation method’. If the number of workers replaced during that quarter is 30.
41.Find out the number of workers left and dischargea) 18 b) 22c) 26 d) 20
42.Find out the number of workers workers recruited and joined including replacements.a) 40 b) 41c) 42 d) 44
43.The relevant data is as below:Time Rate(p.h) `
0.6Time allowed 8 hoursTime taken 6 hoursTime saved 2 hoursa) 5 b) 6c) 4.50 d) 4.20
44.The relevant data is as below:Time rate (per hour) ` 0.6Time allowed 8 hoursTime taken 6 hoursTime saved 2 hoursa) 5 b) 6c) 4.50 d) 4.20
A worker produced 200 units in a week’s time. The guaranteed weekly wage payment for 45 hours is ` 1,350. The expected time to produce one unit is 15 minutes which is raised further by 20% under the incentive scheme.
45.Find earning per hour of the worker under Halsey (50% sharing)a) 35 b) 37.5c) 38 d) 40
46.Find earning per hour of the worker under Rowan bonus schemea) 35 b) 37.5b) 38 d) 40
Standard time allocated for a job is 20 hours and the rate per hour is ` 1 plus a dearness allowance @ 0.30 paise per hour worked. Actual time taken by a worker is 15 hours.
47.Calculate earnings under Halsey plana) ` 25 b) ` 45c) ` 30 d) ` 22
48.Calculate earnings under Rowan plana) ` 24.25 b) ` 23.25c) ` 25.25 d) ` 22.50
49.Normal rate per hour for worker A in a factory is ` 5.40. Standard time per unit for the worker is one minute. Normal piece rate per unit for the worker isa) ` 0.90 b) ` 0.09c) ` 0.11
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d) None of the above
Computation of Normal Wage rate per unitNormal Rate per hour ` 5.0Standard Output per hour 60 unitsNormal wages rate per hour (` 5.40/60 units) 0.09 p
50.Standard time is 60 hours and guaranteed time rate is ` 50 per hour. Under Rowan Plan, what is the amount of wages, If job is completed in 48 hours?a) ` 2.480 b) ` 2,680c) ` 2,880d) None of the above
51.Standard time is 60 hours and guaranteed time rate is ` 50 per hour. Under Halsey Plan, what is the amount of wages, If job is completed in 48 hours?a) ` 2,700 b) ` 2,680b) ` 2,880c) None of the above
52.Which of the following is an abnormal cause of the Idle time:a) Time taken by workers to travel the
distance between the main gate of factory and place of their work
b) Time lost between the finish of one job and starting of next job
c) Time spent to meet their personal needs like taking lunch, tea etc.
d) Machine break downs53.Labour turnover means
a) Turnover generated by labourb) Rate of change in composition of
labour force during a specified periodc) Either of the aboved) Both of the above
54.Which of the following is not an avoidable cause of labour turnover:a) Dissatisfaction with Jobb) Lack of training facilitiesc) Low wages and allowancesd) Disability, making a worker unit for
work
55.Calculate the labour turnover rate according to replacement method from the following No. of workers on the payroll: At the beginning of the month: 500 At the end of the month: 600
During the month, 5 workers left, 20 workers were discharged and 75 workers were recruited. Of these, 10 workers were recruited in the vacancies of those leaving and while the rest were engaged for an expansion scheme.a) 4.55% b) 1.82%c) 6% d) 3%
56.Calculate workers left and discharged from the following:
Labour turnover rates are 20%, 10% and 6% respectively under Flux method, Replacement method and Separation method. No. of workers replaced during the quarter is 80.a) 112 b) 80c) 48 d) 64
57.Calculate workers recruited and joined from the following:
Labour turnover rates are 20%, 10% and 96% respectively under Flux method, Replacement method and Separation method. No. of workers replaced during the quarter is 80.a) 112 b) 80c) 48 d) 64
58. At the time of coming in or leaving premises, the employee will use _____ at the factory gate for recording of the starting and finishing time.a) Job Card b) Clock cardc) Piece work card d) Time card
59.The difference between hours paid and hours worked is called:a) Normal time b) Time savedc) Standard Time d) Idle time
60.The flux rate method of labour turnover considers:a) Employees joinedb) Employee leftc) Employees joined and leftd) Employees replaced
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61.In Z Ltd. there were 80 employees on the rolls at the beginning of a year and 620 at the end. During the year 300 persons left service. The company has computed its labour turnover rates under flux method is 80%. The number of accessions during the period is:a) 220 b) 250c) 360 d) 150
62.Y Ltd. has 480 workers at the beginning and 520 workers at the end of the year. The company has computed its labour turnover rate for the year as 12%, 8% and 5% respectively under flux method, replacement method and separation method. The number of workers replaced during the year is 24. The number of workers left and discharged is:a) 30 b) 25c) 28 d) 32
63.X Ltd. has computed labour turnover rates for the year ended 31st March, 2009 as 9%, 6% and 3% respectively under flux method, replacement method and separation method. The number of workers replaced during the year is 42. On an average how many workers on the rolls.a) 700 b) 650c) 800 d) 820
64.Under Taylor’s differential piece rate system, a worker whose production is higher than the standard will get ______ of normal piece rate.a) 110% b) 115%c) 120% d) 130%
65.Under Hasley-Weir premium plan _____ of time saved is shared by employee.a) 30% b) 50%c) 75% d) 60%
66.The Standard time required per unit of a product is 20 minutes. In a day of 8 working hours a worker gives an output of 30 unit. If he gets a time rate of ` 20/hr.
his total earnings under Halsey bonus scheme was:a) ` 200 b) ` 192c) ` 180 d) ` 160
67.A firm employee 5 worker at an hourly rate of ` 2.00. During the work, they worked for four days for a total period of 40 hours each and completed the job for which the standard time was 48 hours for each worker. The labour cost under Halsey plan is:a) ` 440 b) ` 467c) ` 480 d) ` 420
A worker takes 6 hours to complete a job under a scheme of payment by results. Standard time allowed for the job is 9 hours. His wage rate is ` 1.50 per hour. Material Cost of the Job is ` 16 and overhead are recovered at 200% of total direct wages. 68.Calculate factory cost of the job under:
Rowan plana) 49.75 b) 50c) 60 d) 52
69.Calculate factory cost of the job under: Halsey Plana) 49.75 b) 50c) 60 d) 52
70.From the following particulars:Normal Rate per Hour ` 5.40Standard Time per unit 1 minute
Output per day of worker B 450 unitsWorking hours per day are 8 Calculate the earnings of worker B
under Merrick’s Multiple Piece Rate System.a) 44 b) 44.55c) 44.75 d) 45
71. ___________ is a method of evaluating the job in terms of its money value.a) Job Analysisb) Job Evaluationc) Work measurementd) Motion Study
72. The requirements of a particular job are known as _____________.a) Job Description b) Job Evaluationc) Job specification d) Motion study
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73. Qualities demanded from the job holder is technically known as _______________a) Job Description b) Job Evaluationc) Job specification d) Motion study
74. For conducting ________ workers are studied at their jobs and all their movements and motions are noted.a) Time study b) Merit Ratingc) Motion Study d) None of these
75. _______________ is connected with discovery of facts concerning a job and _________ is concerned with ascertaining the money value of a job.a) Job Analysis; Job evaluationb) Job Specification; Job Evaluationc) Job Description; Job Evaluationd) Motion study
76. _______________ is the assessment of the relative worth of jobs with a company whereas __________ is the assessment of the relative worth of man behind the job.a) Job Evaluation; Merit Ratingb) Job analysis; Job evaluationc) Job Analysis; Merit Ratingd) None of theses
77. _________________ are maintained to know how the worker’s time shown by the time card is spent on various job.a) Daily time sheetsb) Weekly time sheetsc) Job Cardd) None of theses
78. Overtime resorted at the desire of the consumer, should be charged to:a) Costing profit and loss accountb) to be charged directly to the jobc) not to be chargedd) charge to the highest profit making
department79. Labour cost covers _________________
a) Salaries or wages paid to the workersb) Various payments made to a worker
due to his employmentc) Overtime paymentsd) All of the above
80. The labour cost which is not traceable or identified to particular product or cost centre is known as ___________
a) Indirect labour costb) Direct labour costc) Variable labour costd) Either (b) or (c)
81. Which of the following reason shows that there is need for distinguishing between direct and indirect labour cost?a) Introduction of incentive schemesb) Minimizing the competition in
domestic marketc) Introduction of new product in the
market d) All of the above
82. Rent free accommodation or accommodation provided at concessional rate should be classified as _____________a) Fringe Benefitsb) Deferred Monetary Benefitsc) Fixed Standard labour costd) Pecuniary Benefits
83. __________________ is a process whereby assessment is done to know the worth of a particular job.a) Merit Ratingb) Performance appraisalc) Job Evaluationd) Induction
84. In case of time based payment method ______ is of utmost importance.a) Classification of workers as direct
labour and indirect labourb) Computation of factory overhead rate
on the basis of labour hoursc) Correct recording of employees
attendance timed) Classification of various payments
made to a worker.85. Direct labour cost should be ____________
a) Treated as production overhead.b) Charged using supplementary over-
head ratec) Considered as part of prime cost.d) Treated as abnormal cost and
charged to costing profit & loss account.
86. In time wage system, wage are paid according to the _______________.a) Production b) Timec) Both a and b d) None of these
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87. Under piece rate system of wage payment is made according to the ___________.a) Quantity of work doneb) Timec) Both a and bd) None of these
88. Taylors differential piece rate system provide for higher rate to ____________ workers.a) Inefficient b) Efficientc) Both a and b d) Lazy
89. ______________ is most suitable when quality of work is of prime importance.a) Piece rate systemb) Time wage systemc) Both a and bd) None of these
90. Formula of calculation of wages under Halsey Premium System is __________.a) R + [S × 50% ×R]b) [H × R] + [H × 50% × R]c) R + [H × 50% × R]d) [H × R] + [S × 50% × R]
ANSWERS
1. d 2. d 3. a4. b 5. a 6. b7. c 8. c 9. a10. c 11. d 12. a13. b 14. a 15. b16. c 17. D 18. a19. c 20. B 21. c22. a 23. C 24. b25. a 26. A 27. c28. d 29. B 30. c31. a 32. B 33. b34. c 35. B 36. a37. b 38. D 39. c40. a 41. A 42. c43. d 44. C 45. a46. b 47. D 48. b49. b 50. C 51. a52. d 53. B 54. d55. b 56. C 57. a58. b 59. D 60. c
61. a 62. B 63. a64. c 65. A 66. c67. a 68. D 69. a70. b 71. b 72. a73. c 74. c 75. a76. a 77. c 78. b79. d 80. a 81. a82. a 83. c 84. c85. c 86. b 87. a88. b 89. b 90. d
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CHAPTER 3
Qus 1.[Calculation of Effective Machine Hours]Calculate Effective Machine Hours for the purpose of computing Machine Hour Rate in each of the following alternative cases:
Case (a) budgeted working hours 2400, Maintenance hours 10%
Case (b) Budgeted working hours 8 hours per day for 300 days, Maintenance hours 10%
Case (c) There is 13 holidays on account for festivals and national holidays not falling onSundays. The factory works 8 hours a day. Maintenance hours 10%
Case (d) Total working hours available per week 44 hours Maintenance hours included in above 4 hours Setting up time (productive) 5 % Machine hour rate is worked out at the beginning of a year on the basis of 13 week period which is equal to 3 calendar months.
Case (e) Total working hours available per week 44 hours Maintenance hours included in above 4 hours Setting up time (unproductive) 5% Machine hour rate is worked out at the beginning of a year on the basis of 13 week period which is equal to 3 calendar months.
Ans: Case (a) Effective Machine hours = Budgeted working hours - Maintenance
hours = 2400 hours - 10% of 2400 hours = 2160 hrs.
Case (b) Effective Machine hours = Budgeted working hours - Maintenance hours = (300 days × 8 hours) - 10% of 2400 hours = 2,160 hours
Case (c) (A)No. of working days in a year [365 - Holidays = 365 - (13 + 52)] (B)No. of working hours per day (C) Total No. of working hours (A × B) [300 days × 8 hours] (D)Less: Maintenance hours @ 10%
300 days 8 hours
2400 240
(E) Effective Machine Hours 2160
Case (d) (A)No. of working weeks (B)No. of working hours per week (C) Total No. of working hours for 13 week period (13 × 44) (D)Less: Maintenance hours (13 × 4) (E) Effective Machine Hours
13 weeks 44 hours
572 52
520
Case (e) (A)No. of working weeks 13 weeks
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(B)No. of working hours per week (C) Total No. of working hours for 13 week period (13 × 44) (D)Less: Maintenance hours (13 × 4) (E) Total Machine hours (F) Less: Unproductive set up time (G)Effective Machine Hours
44 hours 572
52 520
26 494
Qus 2.[Calculation of the Cost of power per hour]Calculate the cost of power per hour for the purposes of computing Machine hour rate in each of the following alternative cases:
Case (a) Power consumption of machine during production 10 units per hour at a cost of `4 P.U.
Case (b) Power consumption of machine during operation 15 units. Rate of power per 100 units `500.
Case (c) Power consumption of machine during production 20 units per hourRate of power per 100 units ` 570Estimated working hours 2200 hoursMaintenance hours 200 hoursset up item (productive) 5 %Power is used during setting up
Case (d)Power consumption of machine during production 20 units per hourRate of power per 100 units ` 570Estimated working hours 2200 hoursMaintenance hours 200 hoursset up item (productive) 5%No power is used during setting up
Case (e) Power consumption of machine during production 20 units per hourRate of power per 100 units ` 570Estimated working hours 2200 hoursMaintenance hours 200 hoursset up item (unproductive) 5%Power is used during setting up
Case (f) Power consumption of machine during production 20 units per hourRate of power per 100 units ` 570Estimated working hours 2200 hoursMaintenance hours 200 hoursset up item (unproductive) 5%No power is used during setting up.
Ans: Case (a) Cost of Power per hour = 10 units × ` 4 = ` 40
Case (b) Cost of Power per hour = 15 Units × Rs .500
100 = ` 75
Case (c)
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Cost of Power per hour =20units× Rs.570 × 2000
100× 2000 = ` 114
Note: Effective Machine hours = 2200 - 200 = 2000 hours
Case (d)
Cost of Power per hour = 20units× Rs.570 × 1900
100× 2000 = ` 108.30
Note: Effective Machine hours = 2200 - 200 = 2000 hours Effective Machine hours which consumed power = (2200 - 200) - 5% of 2000
= 1900 hours
Case (e)Cost of Power per hour =
20units × Rs570× 2000100× 1900 = ` 120
Note: Effective Machine hours = 2200 - 200 - 5% of 2000 = 1900 hours Effective Machine hours which consumed power = 2200 - 200 = 2000 hours
Case (f)Cost of Power per hour =
20units× Rs.570 × 1900100× 1900 ` 114
Note: Effective Machine hours = 2200 - 200 - 5% of 2000 = 1900 hours
Qus 3.[Calculation of Depreciation per hour]Calculate depreciation per hour in each of the following alternative cases:
Case (a) Original cost `1, 00,000, Installation charges `10,000, estimated scrap value at the end
of useful life (10 years) 20% of original cost, Effective machine hours 2000.
Case (b) W.D.V. of machine (Deprecation @ 8% plus 2% on an average for extra shift allowance)
`5, 20,000. Machine hour rate is worked out at the beginning of each year on the basis of 13 week period which is equal to 3 calendar months
Total working hours available per week 44 hours Maintenance hours included in above 4 hoursSetting uptime (productive) 5%
Ans:
Case (a) Depreciation per hour= Original Cost + Installation charges - Scrap Value
Total useful life in hours
= Rs . 1 , 00 ,000 + R s. 10,000 - Rs.20,00010× 2000 = ` 4.50
Case (b) Depreciation per hour ¿ 10%ofRs .5,20,000 ×3 /12520 hours = ` 25
Note: Effective Machine hours for 13 week period = (13 × 44) – (13× 4) = 520 hours
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Qus 4.A Machine costing ` 5,74,000 excluding installation and erection costs of ` 6,000, has an anticipated life of 10 years, with a residual value of ` 10,000. It is depreciate on straight-line method. From the given information, compute a machine-Hour rate on the basis of anticipated working hours-Rent and Rates for the factory is `40,000 per annum. Area occupied by this machine-10% Insurance for this machine is ` 3,000 per annum.Repairs& Maintenance for the whole factory for the year is ` 10,000, 25% of this relates to this machine. Consumable stores attributable to this machine for the whole year is` 5,500. Total of production services is 40,000, 20% of this amount is applicable to this machine. Power cost is ` 15 per working hour.
The year contains 250 working days of 8 hours each, and it is anticipate that the machine will remain idle 20% of this time,
Ans: 1. Number of productive Hrs p.a. = Total Hours Less Idle time
= (250 days × 8 hours) - 20% thereon = 1,600 hours per annum
Statement of Overheads per annumPARTICULARS COMPUTATION `Depreciation Fixed [`5,74,000+`6,000-`10,000]÷10 year 57,000Rennet and Rates Fixed `40,000×10% 4,000Insurance Fixed Given 3,000Repairs & Maintenance Fixed `10,000 2,500Consumable Stores variable Given 5,500Production Services variable `40,000×20% 8,000Power variable 1,600 hours×`15 per hour 24,000Total Overheads 104000
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CHAPTER 4
Meaning of Overhead Overhead is the aggregate of indirect materials cost, indirect labour cost and indirect expenses which cannot be conveniently identified with and directly allocated to a particular cost centre or cost object in an economically feasible way. It is also known as indirect cost, burden or on cost.
Examples of Overhead(a) Indirect Materials Cost Stationery in Production Deptt., Administration Deptt., and
Selling and Distribution Deptt.(b) Indirect Labour Cost Salary of Works Manager/Office Manager/Sales Manager(c) Indirect Expenses Rent, Rates, Repairs, Insurance and Depreciation of Factory
Building, Adm office Building and Sales office Building
DIVISION- 1: CLASSIFICATION OF OVERHEADS
Meaning of Classification of Overheads Classification of overheads is the process of grouping the various items of overheads into distinct class/group on the basis of some common characteristics.
Bases of Classification of OverheadsGenerally, overheads are classified on the following basis:
Classification Overheads by Function
1. Production/Manufacturing/Factory Overheads
Meaning: Production overheads represent all the indirect costs incurred in connection with the production of product or service. These represent the aggregate of indirect materials cost, indirect labour cost and indirect expenses incurred by production department.
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Classification of Overheads
By BehaviourBy Function By Element
1. Indirect Materials 2. Indirect Labour 3. Indirect Expenses
1. Fixed Overheads 2. Variable Overheads 3. Semi-Variable Overheads
1. Production Overheads 2. Administrative
Overheads,: 3. Selling Overheads
Distribution Overheads
Examples: a) Indirect Materials Cost I. Cost of consumable stores and supplies like cotton waste,
lubricating oil etc. II. Cost of printing, postage & stationary used in Production
Deptt.b) Indirect Labour Cost I. Salary of supervisor, works manager and departmental
superintendants. II. Contribution to ESI, P.F., leave Pay, maternity Pay.
c) Indirect Expenses I. Rent, rates & taxes of factory building.II. Repairs, insurance & depreciation of factory building, plant &
machines and furniture. III. Factory telephone expenses. IV. Lighting, heating & cleaning of factory.
2. Administration Overheads Meaning Administration overheads represent the cost of formulating the policy, directing the organisation and controlling the operations of an undertaking which is not related directly to production, selling, distribution, research or development activity or function. These represent the aggregate of material cost, labour cost and expenses incurred by Administration Department for the general management of an organisation. These all costs are in the nature of indirect costs.
Examples: a. Materials
Costi). Cost of printing, postage & stationery used in Administration
department. ii). Cost of dusters, brushes etc. for cleaning.
b. Labour Cost i). Salary of managing director, whole time director, general manager, finance manager, accounts manager, secretary, legal manager and other staff working in Administration department.
ii). Remuneration of internal & statutory cost & financial auditors, Legal Advisors.
c. Expenses i). Rent, rates & taxes of office building. ii). Repairs, insurance & depreciation of office building, equipment, and
furniture.iii). Administration office telephone expenses. iv). Lighting, heating & cleaning of Administration office.
3. Selling Overheads Meaning Selling overheads represent the cost of seeking to create and stimulate demand and of, securing order. Thus, this is the cost of promoting sales and retaining customers. These represent the aggregate of materials cost, labour cost and expenses incurred by sales department for the sales management of an organisation. These all costs are in the nature of indirect costs.
Examples: a) Material
Costi). Cost of printing, postage & stationery used in sales department.
ii). Cost of catelogues, list prices etc.b) Labour Cost i). Salary of sales director, sales managers, sales officers, salesmen and
other staff working in sales department. ii). Commission to selling agents.
c) Expenses i). Rent, rates & taxes of sales office/showroom. ii). Repairs, insurance & depreciation of sales office building, equipment
and furniture. iii). Sales office telephone expenses.
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iv). Lighting, heating & cleaning of sales office. v). Advertising.
vi). Bad Debts. vii). Debt collection charges.
viii). Salesmen's travelling expenses. ix). Entertainment expenses on customer.
4. Distribution Overheads It represent the cost of the 'sequence' of operations which begins with making the packed product available for dispatch and ends with making the reconditioned returned empty package, if any, available for reuse. These also include expenditure incurred in moving articles to central or local storage, or in moving articles to and from prospective customers as in the case of goods on sale or return basis.In the gas, electricity and water industries 'Distribution' means pipes, mains and service which may be regarded as equivalent to packing and transportation. These represent the aggregate of materials cost, labour cost and expenses incurred by distribution department for the distribution management of the organisation. These all costs are in the nature of indirect costs.
Examples: a. Material Cost i). Cost of printing, postage & stationery used in distribution office
ii). Cost of secondary packaging iii). Cost of materials used in reconditioning of the empty containers
returned by customers for re-use.b. Labour Cost i). Salary of staff attached to distribution office like, packers,
dispatch staff ii). Salary of driver of distribution vehicle.
c. Expenses i). Rent, rates & taxes of distributing office/godown/ storage/warehouse
ii). Repairs, insurance & depreciation of distribution office Building, equipment & furniture, delivery van of distribution office
iii). Distribution office telephone expenses iv). Lighting, heating & cleaning of distribution office v). Depreciation, repairs & running expenses of delivery vans vi). Freight & carriage outward vii). Insurance of Finished Stock in godown.
Classification of Overheads by Behaviour/Variability
1. Fixed OverheadsMeaning Fixed overheads are those costs which do not vary with the change in the volume of production upto a given range. Examples Rent and Insurance of Building, Plant & Machinery & Furniture, Salary of manager etc.Characteristics Fixed overheads have two characteristics:
i). Total fixed overheads do no vary with the change in the volume of production upto a given range.
ii). Fixed overheads per unit varies with change in the volume of production i.e. fixed overheads per unit decreases as the production increases and vice versa.
Practical Example:output (unit) Total Fixed Overheads Fixed overheads per unit
A B C = B/A1 `1,000 ` 1,000
10 `1,000 ` 100
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100 ` 1,000 `10
Thus, Fixed overheads per unit goes on decreasing as the total number of output produced increases.
2. Variable Overheads
Meaning Variable overheads are those costs which vary in direct proportion to the volume of production.
Examples Consumable stores arid supplies, sales commission
Characteristics Variable overheads have two characteristics: i). Total variable overheads vary in direct proportion to the volume of production i.e. total
variable overheads decrease as the production decreases and vice versa.
ii). Variable overheads per unit remains fixed.
Practical Example:Output (unit) Total Variable Overheads Variable Overheads per unit
A B C = B/A 0 ` 0 ` 0 1 ` 10 `10
10 `100 ` 10 100 ` 1,000 ` 10
1,000 ` 10,000 `10
Thus, Variable Overheads per unit remains fixed end does not change with the changes in the volume of output.
Semi-Variable Overheads
Meaning Semi-Variable overheads are those costs of which one part remain fixed upto a given range and the other part varies with the change in the volume of production but not in the same proportion. For Example, an expense may not change if output is upto 50% Capacity but may increase by 2% for every 10% increase in output over 50% capacity but upto 70%.
Examples Telephone expenses of which hire part· is fixed and fee for calls is variable, Depreciation, Repairs & Maintenance, Delivery Van expense
Practical Example: Semi-Variable Overheads ` 3,00,000 are constant upto 75% capacity (7,500 units) but increase by 10% over 75% but upto 85% and then increase by 20% over 85% but upto 100% capacity.
Capacity Output (unit)Total semi-variable
Overheads (`)semi-variable Overheads per
unit (`)A B C = B/A
50% 5,000 `3,00,000 ` 60.00 60% 6,000 ` 3,00,000 ` 50.0070% 7,000 ` 3,00,000 ` 42.86 80% 8,000 ` 3,30,000 ` 41.25 90% 9,000 ` 3,00,000 ` 44.00 100% 10,000 ` 3.96,000 ` 39.60
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Classification of Overheads by Element
1. Indirect Materials Costs Indirect material costs are those materials costs which cannot Conveniently be identified with and directly allocated to a particular cost centre or cost Object in an economically feasible way. For Example, consumable stores and supplies, lubricants etc.
2. Indirect Labour Cost Indirect labour costs are those, labour costs Which cannot conveniently be identified with and directly allocated to a particular cost center of cost object in an economically feasible way. For example, salary of security staff salary of general manager.
3. Indirect Expenses Indirect Expenses are those expenses other than indirect material or indirect labour, which cannot conveniently be identified with and directly allocated to a particular cost center or cost object in an economically feasible way For example, rent, repairs, insurance and depreciation of building.
METHODS OF SEGREGATING SEMI-VARIABLE OVERHEADS INTO FIXED AND VARIABLE OVERHEADS
High and Low Method or Range Method Under this method the variable element of overhead per unit and total fixed element are ascertained as follows: Variable Element of Overhead per unit=Difference between the total semi variable overhead at highest and lowest volume / difference between the highest and lowest volume of outputExample:
Production Units Semi-Variable OverheadsHighest Volume 30,000 ` 80,000Lowest Volume 20,000 ` 60,000
Variable Element of Overheads per unit = Difference between total semi - variable overheads at highest and lowest volume/Difference between highest and lowest volume of output = ` 20,000 /10,000 ` 2per unit Total Variable Overheads at highest level = 30,000 × ` 2 = ` 60,000Total Fixed Overheads = ` 80,000 - ` 60,000 = ` 20,000 Total Variable Overheads at lowest level = 20,000 × ` 2 = ` 40,000 Total Fixed Overheads = ` 60,000 - ` 40,000 = ` 20,000
DIVISION – II COLLECTION OF OVERHEADSAfter classification, the next step is the collection of overheads
Meaning of Collection Overheads Collection of overheads means the collection of various items of overheads under suitable account heading and a unique Standing Order Number (S.O.N.) or Cost Account Number (C.A.N.).
Standing Order System Meaning The production overheads are usually collected through a system of standing order numbers. Standing order system is a system under which a distinct number is allotted to each item of cost for the purpose of identification.
Essential requisites for an effective system of Standing Order Number i). The S.O. numbers should be clearly defined so that all expenditure, may easily understand.
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ii). The classification into very large number of S.O. numbers should be avoided because this involves high cost of clerical labour. Besides this, this makes the control over costs very difficult.
iii). The classification into S.O. numbers should be flexible so that according to the needs of the factory, from time to time, suitable expansion or deletion of items can be easily done without seriously dislocating the existing system.
Methods of Allotting S.O.N. Following methods can be used to allot symbols or code numbers to identify each S.O.N:
a) Straight Numbering Method Under this method, each type of expenditure is allotted fixed number. For example
Standing order number: 20 for indirect material. Standing order number: 21 for indirect labour. Standing order number: 22 for indirect expenses.
b) Number Blocks Under this method, a block of numbers is generally earmarked to indicate the major heads of expenditure e.g. 1-20 for service labour, 21-50 for maintenance; 51-100 for fringe benefits etc.
c) Combination of Symbols and Numbers Under this method a combination of symbol alphabet and a number is used to represent a code. Here symbol alphabet stands for the main head of the expenditure and the number represents the concerned department.
For example R1 - Repair of factory building. [R stand for repair and 1 for Factory Building]R2 - Repair of machines. [R stand for repair and 2 for Factory Machine]
Cost Account Numbers (C.A.N.) Generally S.O. numbers are used to refer to various items of production overheads and Cost Account Numbers (C.A.N.) are used to refer to various items of administration and selling & distribution overheads. The method of allotment of numbers is the same in both the cases.
DIVISION – III : ALLOCATION OF OVERHEADS
Meaning Allocation of overheads is the process of charging the amount of an individual item of cost directly to a cost centre for which this item of cost was incurred.
Examples of Allocation of Overheads a) Where separate electric meters are installed in each of the department, the electricity charges
on the basis of electricity bills can be allocated to the respective departments. b) Salary & wages paid to indirect workers of each department can be allocated to the respective
departments.
Format of Statement showing the Allocation of Overheads Statement showing the Allocation of Overheads
Items of overheads Production Department Service DepartmentAllocated P 1 P2 P1 P2Direct Material - - ….. …..Direct Wages - - ….. …..Direct Expenses - - ….. …..
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Indirect Material ….. ….. ….. …..Indirect Wages ….. ….. ….. …..
Tutorial Note: All costs of service departments are considered as OVERHEADS.
CLASSROOM PRACTICE – LETS PLAY TOGETHER
Qus 1.B Ltd. has two production departments and two service departments and provides you the following data:
Production Departments Service DepartmentsP1 P2 S1 S2
Direct Materials 40,000 30,000 20,000 10,000 Direct Wages 20,000 15,000 10,000 5,000 Direct Expenses 10,000 7,500 5,000 2,500 Indirect Materials
5,000 5,000 5,000 5,000
Indirect Wages 2,500 2,500 5,000 2,500 Required: Prepare the Statement showing the Allocation of Overheads.
Ans: Statement showing the Allocation of OverheadsItems of Overheads Allocated Production Departments Service Departments
P1 P2 S1 S2Direct Materials - - 20,000 10,000 Direct Wages - - 10,000 5,000 Direct Expenses - - 5,000 2,500 Indirect Materials 5,000 5,000 5,000 5,000 Indirect Wages 2,500 2,500 5,000 2,500 Total Overheads Allocated 7,500 7,500 45,000 25,000
DIVISION IV: APPORTIONMENT OF OVERHEADS
Meaning Apportionment of overheads is the process of charging the proportion of common items of cost to two or more cost centers on some equitable basis (say Actual benefit/ Potential Benefit/Ability to pay)
Examples of Apportionment of Overheads a) Where only one electric meter is installed in a factory, the common electricity charges should
be apportioned to all the departments on the basis of no. of light points or floor area. b) Factory Rent is incurred for the factory as a whole and benefits all the departments in the
factory. Hence, it should be apportioned to all the departments on the basis of floor area occupied .
Basis of Apportionment of Overheads The following table suggests the basis of apportionment of some common items of production overheads:
Table Showing the Basis of Apportionment of some Common Items of Production Overheads
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Common Items of Production Overheads Basis of Apportionmenta) Factory Rent, Rates & taxes b) Repairs & maintenance of factory building c) Insurance of factory building d) Depreciation of factory building (If owned)
Floor area occupied Floor area occupied Floor area occupied Floor area occupied
a) Repairs & maintenance of plant & machinery b) Insurance of Plant & Machinery c) Depreciation of Plant & Machinery
Capital cost of plant & machinery Capital cost of plant & machinery Capital cost of plant & machinery
Insurance of stock Insured value of stocka) Supervision b) Canteen, staff welfare expenses c) Time keeping & personnel office expenses
No. of workersNo. of workers No. of workers
a) Compensation to workers b) Employees' State Insurance Contribution c) Provident Fund Contribution
Wages Wages Wages
Stores overhead/Stores keeping expenses Value of direct materialsMaterial Handling charges Weight of direct materialsLighting & Heating No. of light points or floor area occupied
Power/steam consumptionHorse power of machines or machine hours
Format of Statement Showing the Apportionment of Overheads Statement showing the Apportionment of Overheads
Statement showing the Apportionment of OverheadItems of Overheads
ApportionedBasic of
ApportionmentProduction
DepartmentsService Departments
P1 ` P2 ` S1 ` S2 `Fixed PowerGeneration Cost Normal Capacity ..... ….. ….. …..Variable PowerGeneration Cost
Actual Power Consumption (kwh)
….. ….. ….. …..
Lighting No. of Light Points ….. ….. ….. …..Depreciation Asset Value ….. ….. ….. …..Insurance Asset Value ….. …… ….. …..Rent, Rates & Taxes Floor Area ….. ….. ….. …..Repairs Floor Area ….. ….. ….. …..Stores Overheads Direct Material ….. ….. ….. …..Employee’s Insurance Charges
Direct Wages ….. ….. ….. …..
Staff Welfare Expenses
No. of Workers ….. ….. ….. …..
Supervision Expenses No. of Workers ….. ….. ….. …..Total Overheads Apportioned ….. ….. ….. …..
Qus 2.D Ltd. has two production departments and two service departments and provides you the following data:
Production Departments Service DepartmentsP1 P2 S1 S2
Direct Materials 40,000 30,000 20,000 10,000
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Direct Wages 15,000 20,000 5,000 10,000 Floor Area (sq. feet)
5,000 4,000 3,000 2,000
Value of Plant & Machinery
50,000 60,000 20,000 10,000
Value of Stock 35,000 25,000 5,000 5,000 No. of workers 100 50 25 25 No of light points 200 50 25 25 Horse power of machines
50 25 15 10
The indirect expenses for the period were: Factory Rent, Rates, Taxes & Repairs ` 14,000Depreciation, Insurances & Repairs machinery ` 28,000Insurance of stock ` 700Supervision & Staff welfare expenses `2,000Stores Overheads ` 1,000Lighting & Heating ` 3,000Power ` 1,000Required: Prepare the Statement showing the apportionment of overheads.
Ans: Statement showing the Apportionment of OverheadsItems of Overheads Basis of
ApportionmentTotal
`Production Deptt. Service Deptt.
P1`
P2`
S1`
S2`
1. Factory Rent, Rates, Taxes & Repairs
Floor Area 14,000 5,000 4,000 3,000 2,000
2. DepreciationInsurance & Repair ofMachinery
Value of Plant& Machinery
28,000 10,000 12,000 4,000 2,000
3. Insurance of stock Value of stock 700 350 250 50 504. Supervision & No. of workers 2,000 1,000 500 250 2505. Stores overhead Value of Materials 1,000 400 300 200 1006. Lighting & Heating No. of light points 3,000 2,000 500 250 2507. Power H.P. of Machinery 1,000 500 250 150 100
49,700 19,250 17,800 7,900 4,750
Basis of Apportionment of Overheads of service Departments The following table suggests the basis of apportionment of some common items of overheads of service departments:
Service Department Basis1. Purchase department Number of purchase orders or number of purchase
requisitions or value of materials purchased.2. Stores department Number of material requisitions or value materials
issued .3. Time-keeping department Pay-roll department
Number of employees or total labour hours or machine hours .
4. Personnel department, canteen, welfare, Medical, recreation dept.
Number of employees or total wages.
5. Repairs and maintenance Number of hours worked in each department.6. Power house Meter reading or H.P. Hour for powers.
Meter reading or floor space for lighting, heat
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consumed.7. Inspection Inspection hours or value of items inspected.8. Drawing office Number of drawings made or man-hours worked.9. Accounts department Number of workers in each department
SECONDARY DISTRIBUTION OF OVERHEADS
Meaning of secondary Distribution of Overheads Secondary distribution of overheads means the apportionment of overheads of service departments among the production departments on some suitable basis.
Methods of secondary Distribution
Apportionment to Production Departments only Under this method, the costs of service departments are directly apportioned to production departments only, ignoring the services rendered by one services department to another service department.
Qus 3.(Simple Method)CAS Ltd., has three production departments and four service departments. The expenses for department as per Primary Distribution Summary are as follows:
Production Departments: ` ` A 60,000 B 52,000 C 48,000 1,60,000
Service Departments ` ` Stores 8,000 Time-keeping and Accounts 6,000 Power 3,200 Canteen 2,000 19,200
The following information is also available in respect of the production departments Dept. A Dept. B Dept. C
Horse power of Machine 300 300 200
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Methods of Secondary Distribution
Apportionment to Production Departments only
Apportionment to both Production and Service Department
On Reciprocal basisOn Non-reciprocal basis
3.Trial and Error Method1.Simultaneous Equation Method
2.Repeated Distribution Method
Number of Workers 20 15 15Value of stores requisition in (Rs.) 2,500 1,500 1,000Required: Apportion the costs of service departments over the production departments
Ans: Statement showing the Secondary Distribution of Overheads
Item of Cost Basis of Apportionment
Total `
Production Departments
A`
B`
C`
Cost as per primary distribution summary Stores
Time-keeping and Accounts Power Canteen
Value of stores requisition (5:3:2) No. of workers (4:3:3)
H.P. of Machine (3:3:2) No. of workers (4:3:3)
1,60,000
8,000 6,000
3,200 2,000
60,000
4,000 2,400
1,200 800
52,000
2,400 1,800
1,200 600
48,000
1,600 1,800
800 600
1,79,200 68,400
58,000
52,800
Apportionment to both Production and Service Departments Under this method the costs of a service department are apportioned to both production departments and other service departments on some equitable basis. This may be done on reciprocal basis or non-reciprocal basis.
Apportionment on Non-reciprocal basis/Step Ladder Method This method involves the following three steps:
Practical Step involved in the Step Ladder methodStep 1 – Apportion the cost of first service department which serves the largest number of departments to production departments and other service departmentsStep 2 – Apportion the cost of second service department which serves the next largest number of departmentsStep 3- Continue this process till the cost of last service department is apportioned. Thus, the cost of Last service department is apportioned only to the production departments
Tutorial Note: Some authors are of the view that the cost of service department with largest amount of cost should be distributed first.
Qus 4.PH Ltd. is a manufacturing company having three production departments, 'A', 'B' and 'C' and two service departments 'X' and 'Y'. The following is the budget for April 2008:
Total ` A (`) B (`) C (`) X (`) Y (`)Direct Material 1,000 2,000 4,000 2,000 1,000Direct Wages 5,000 2,000 8,000 1,000 2,000Factory Rent 4,000Power 2,500Depreciation 1,000Other Overheads 9,000Additional Information:Area (sq. ft.) 500 250 500 250 500
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Capital Value of assets (` lacs) 20 40 20 10 10Machine-Hours 1,000 2,000 4,000 1,000 1,000Horse Power of machines 50 40 20 15 25
A technical assessment of the apportionment of expenses of service departments is as under: A % B % C % D % E %
Service Deptt. 'X' 45 15 30 - 10Service Deptt. 'Y' 60 35 - 5 -
Required: (i). A Statement showing distribution of overheads to various departments (ii). A statement showing re-distribution of service departments expenses to production
Departments. (iii). Machine hour Rates of the production departments 'A', 'B' and 'C'.
Ans(I) Statement showing Distribution of Overheads to Various Departments
Item BasisTotal
`A`
B`
C`
X`
Y`
Direct Materials Actual 3,000 - - - 2,000 1,000 Direct Wages Actual 3,000 - - - 1,000 2,000 Factory Rent Area 4,000 1,000 500 1,000 500 1,000 Power H.P. x M. Hrs. 2,500 500 800 800 150 250
Depreciation Cap., Value 1,000 200 400 200 100 100
Other Overheads Machine hrs. 9,000 1,000 2,000 4,000 1,000 1,000
Total Overheads Apportioned 22,500 2,700 3,700 6,000 4,750 5,350
(II) Redistribution of Service Department's Expenses
Particulars RatioA`
B`
C`
X`
Y`
Total Overheads 2,700 3,700 6,000 4,750 5,350Deptt. X overhead apportioned (45: 15 : 30 : 10) 2,138 712 1,425 -4750 475Deptt. Y overhead apportioned (60 : 35 : - : 5) 3,495 2,039 - 291 -5,825Deptt. X overhead apportioned (45: 15 : 30 : 10) 131 44 87 -291 29Deptt. Y overhead apportioned (60 : 35 : - : 5) 17 10 - 2 -29Deptt. X overhead apportioned 1 - 1 -2 -Total Overheads of Production Departments 8,482 6,505 7,513
(III) Machine Hour RateMachine Hours 1,000 2,000 4,000Machine Hour Rate (`) 8.48 3.25 1.88
1,000 2,000
Qus 5.A manufacturing company has three production departments and two service departments. The summary of departmental expenses are distributed as under:
` `Production Deptt.P1 32,000P2 26,000
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P3 28,000 86,000Service Deptt.S1 9,360S2 12,000 21,360
The service department expenses are charged on the following percentage basis: Production Deptt. Service Deptt.
Service Deptt.
P1 P2 P3 S1 S2
S1 20% 25% 35% - 20%S2 25% 25% 40% 10% -
Prepare a statement showing the apportionment of expenses of two service departments in production departments by simultaneous equation method.
AnsStatement showing Secondary Distribution by simultaneous Equation Method:
Production Departments P1(`)
P2 (`)
P3 (`)
Total (`)
As per Primary distribution 32,000 26,000 28,000 86,000 Service Department SI [80% of 10,776] 2,155 2,694 3,771 8,620Service Department S2 [90% of 14,155] 3,539 3,539 5,662 12,740
37,694
32,233
37,433
1,07,360
Working Note: Let X = Total overheads of Department of S1 Y = total overheads of Department of S2 X = 9,360 + 0.1Y Y = 12,000 + 0.2 X Solving (1) and (2) above X = 9,360 + 0.1 (12,000 + 0.2X] X = 9,360 + 1200 + 0.02 X 0.98 X = 10560 X = 10560/0.98 = 10,776Substituting the value of X in (2) above Y = 12000 + 0.2 x 10776 Y = 12000 + 2155 = 14,155
Qus 6.Dec 2013A manufacturing company has three production departments and two service departments. Given below are the production overheads incurred in respect of each department :
Production Department Service DepartmentP `1 ,80,000 X `2,34,000Q `1,70,000 Y `3,00,000R `1 ,50,000
Service department overheads are proposed to be charged to production departments on the following basis :
P Q R X Y
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Service Department X 20% 40% 30% --- 10%Service Department Y 40% 20% 20% 20% ---
You are required to prepare an overhead distribution summary. Apportion the overheads of the service departments using simultaneous equation method.
(4marks) DIVISION V: ABSORPTION OF PRODUCTION OVERHEADS
Meaning of Absorption of Overheads Absorption of overheads is charging overheads from cost centres to products or services by means of absorption rate which is calculated as follows:
Overheads Absorption Rate = Total overheads of the cost centre / Total quantum of the base
Methods of Absorption of Production Overheads The various methods of absorption of production overheads include the following:
1. Percentage of Direct Material cost2. Percentage of Direct Labour cost3. Percentage of Prime cost4. Direct Labour Hour rate5. Machine Hour Rate6. Rate per unit of Production
Let us discuss these methods one by one:
Percentage of Direct Material Cost Method Meaning Under this method direct material cost is used as basis for overhead
absorption rate. The rate is calculated as follows:Factory Overheads Rate = Amount of Production Overheads / Direct Material Cost × 100
Suitability This method is suitable in the following cases: a) Where the prices of materials do not fluctuate much. b) Where the output is uniform i.e. only one kind of product is produced. c) Where the proportion of overheads to total cost is insignificant.
Advantages a) It is suitable where the output is uniform.b) It is suitable where the prices of materials do not calculate widely
Disadvantages
a) It ignores the time factor while most fixed factory overheads vary with time.
b) Production Overheads like factory manager’s salary, rent & insurance of factory building do not change with every change in direct material cost.
c) It is not suitable where material prices fluctuate widelyd) It ignores the distinction between jobs done by skilled workers and those
done by unskilled workers.e) It ignores the distinction between jobs done by manual labour and those
done by machines.Practical Example
Factory overheads ` 12,000, Direct Material Cost ` 50,000 A Job No. 101 requires direct material cost of ` 5,000.
a) Overheads Rate = ` 12,000 / ` 50,000 × 100 = 24%b) Overheads Absorbed by Job No 101 = 24% of ` 5,000 = ` 1,200
Percentage of Direct Labour Cost MethodMeaning Under this method machines hours are used as basis for overhead absorption
rate. The rate is calculated as follows:
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Factory Overheads Rate = Amount of production Overheads / Direct Labour Cost × 100
Suitability This method is suitable in the following cases:a) Where labour is the major factor of productionb) Where labour rates do not fluctuate widelyc) Where both labour employed and work done are of uniform type.
Advantages a) It takes into account time factor.b) It is suitable where the labour rates do not fluctuate widely.
Disadvantages
a) It does not give satisfactory results where the workers are paid on piece rate basis.
b) It is not suitable where labour rates fluctuate widelyc) It ignores the distinction between the jobs done by skilled workers and
those done by unskilled workers.d) It ignores the distinction between the jobs done by manual labour and
those done by machines.Practical Example
Factory overheads ` 12,000, Direct Labour Cost ` 1,00,000 Job No. 101 requires direct labour cost of ` 10,000a) Overheads Rate = ` 12,000 / ` 1,00,000 × 100 = 12%b) Overheads absorbed by job No. 101 = 12% of ` 10,000 = ` 1,200
Percentage of Prime Cost MethodMeaning Under this method, prime cost is used as basis for overhead absorption rate.
The rate is calculated as follows:Factory Overheads Rate : Amount of Production Overheads × Prime Cost × 100
Suitability This method is suitable in the following cases:a) Where output is uniform.b) Where both the quantity of direct materials and direct labour hours are
constant.Advantages a) It takes into account both direct materials cost and direct labour cost
which give rise to overhead expenses.Disadvantage
sa) It has the same disadvantages as the first two methods have.b) In fact, the results are liable to be more misleading because of the
cumulative error of using both the labour and material cost as the basis of allocation of overhead expenses, on neither of which they are already dependent.
Practical Example
Factory overheads ` 12,000, prime cost ` 1,50,000, A job No. 1-1 requires prime cost of ` 15,000:a) Overheads Rate = ` 12,000 / ` 1,50,000 × 100 = 8%b) Overheads absorbed by job no. 101 = 8% of ` 15,000 = ` 1,200
Direct Labour Hour RateMeaning Under this method, direct labour hours are used for overhead absorption rate.
The rate is calculated as follows:Factory Overhead Rate = Amount of production Overheads / Direct Labour Hours
Suitability This method is suitability where manual is a dominant factor of production.Advantages a) It takes into account time factor.
b) It is suitable where manual labour is a dominant factor of production.Disadvantage
sa) It ignores the distinction between the jobs done by skilled workers and
done by unskilled workers.b) It ignores the distinction between the job done by manual labour and those
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done by machines.c) It requires the detailed records of labour.
Practical Example
Factory overheads ` 12,000, direct labour hours 10,000, A job No. 101 requires 1000 direct labour hours:a) Overheads Rate = ` 12,000 / 10,000 hours = ` 1.20 per direct labour hourb) Overheads absorbed by Job No. 101 = 1000 ×` 1.20 = ` 1,200
Machine Hour RateMeaning
Suitability This method is suitable where major portion of production is performed by machinery.
Advantages a) It takes into account time factor. b) It is suitable when major portion of production is performed by machines. c) It facilitates the ascertainment of accurate and reliable costs. d) The under-absorption of overheads would indicate the idle capacity of
machines.Disadvantage
sa) It is not suitable where major part of production is done by manual labour. b) It requires the detailed records of machines for each job or operation. c) It is difficult to understand and calculate. d) It is quite difficult to estimate machine hours in advance.
Practical Example
Factory overheads ` 12,000, Machine Hours 1,000, A Job No. 101 requires 100 Machine hours: a) Overhead Rate = ` 12,000 / 1,000 = ` 12 per machine hour b) Overhead absorbed by Job No. 101 = 100 ×` 12 = `1 ,200
Rate per unit of productionMeaning Under this method, number of units of production is used as basis for
overheads absorption rate. The rate is calculated as follows:Factory Overheads Rate = Amount of Production Overheads/No. of Units of Production
Suitability This method is suitable where output is uniform i.e. only single product or few grades of the same product are produced.
Advantages a) It is suitable where output is uniform.Disadvantage
sa) It ignores the time factor. b) It ignores the distinction between the jobs done by skilled workers and
those done by unskilled workers. c) It ignores the distinction between the jobs done by manual labour and
those done by machine.
REQUISITES OF A GOOD METHOD OF ABSORPTION OF PRODUCTION OVERHEADSA good method of absorption of production overheads should possess the following characteristics: 1. It should be simple to understand and easy to adopt. 2. It should take into consideration the time factor. 3. It should distinguish between the work done by skilled workers and work done by unskilled
workers. 4. It should distinguish between the work done by manual labour and the work done by machine. 5. It should not cause very much under/over absorption of overheads to any cost centre. 6. It should be economical to use. Format of Statement showing the computation of Machine Hour Rate Statement showing the computation of Machine Hour Rate.
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Qus 7.The following information relates to the production department for a certain period in a factory: Direct Materials consumed ` 75,000 Direct Wages ` 50,000 Production overheads ` 1,50,000 Labour Hours 30,000 hours Machine Hours 25,000 hours
For one Order No, 101 carried out in the department during the period, the relevant data were: Direct Material consumed ` 14,000 Direct Wages `11,000 Machine hours worked 5000 hours Labour hours worked 7000 hours
Required: Prepare a Comparative Statement of Cost of this order by using the following methods: (i) Direct Material Cost Percentage; (ii) Direct Labour Cost Percentage; (iii) Prime Cost Percentage; (iv) Labour Hour Rate; (v) Machine Hour Rate,
Solution: Step 1 : Computation of Production Overhead Rate
(i) Direct Material Cost Percentage = ProductionOverheadsDirect Material Cost × 100 =
1,50,00075,000 × 100 = 200%
(ii) Direct Labour Cost Percentage = ProductionOverheads
Direct Labour Cost × 100 = 1,50,00050,000 × 100 = 300%
(iii) Prime Cost Percentage = ProductionOverheads
Prime Cost × 100 = 1,50,0001,25,000 × 100 = 120%
(iv) Labour Hour Rate = ProductionOverheadsDirect Labour Hours × 100 =
1,50,00030 ,000 = ` 5 per labour hour
(v) Machine Hour Rate = ProductionOverheads
Machine Hours = 1,50,00025,000 × 100 = ` 6 per machine hour
Step 2 : Comparative Statement of Cost of Order No.101
Particulars DMC%
`
DLC%
`
PrimeCost %
`
DirectLabour
Hour Rate`
MachineHourRate
`Direct Material Cost 14,000 14,000 14,000 14,000 14,000Direct Labour Cost 11,000 11,000 11,000 11,000 11,000Prime Cost 25,000 25,000 25,000 25,000 25,000Production Overheads200% of DMC 28,000 - - - -
Qus 8.The budgeted expenses for the year are as follows:
Direct Material ` 9,000 Direct Wages @ ` 10 per hour ` 20,000 Direct expenses ` 1,000 Works Overheads ` 5,000
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Administration Overheads ` 3,500 Work overheads are charged at labour hour rate and administration overheads are charged as percentage on work cost.
The details of Job No. 101 are as follows: Direct Materials ` 2,250Direct Wages ` 5,000Direct Expenses ` 250
Required:a) Calculate rate of absorption of administration overheads. b) What price should be charged to Job No. 101 so as to earn 1/6th profit on sales.
Ans:-Calculation of Rate of Absorption of Administration Overheads
Direct Material 9,000Direct Wages 20,000Direct Expenses 1,000Work overheads 5,000Work Cost 35,000Administration overheads ` 3,500
Administration overheads as a percentage of Works Cost = Adm. overheads / Work Cost × 100 = 3,500 / 35,000 × 100 = 10%
Statement showing the Calculation of Selling price of job No. 101Direct Material 2,250Direct Wages 5,000Direct Expenses 250PRIME COST 7,500Works overheads [500 ×` 2.50] 1,250WORK COST 8,750Administration overheads [10% of ` 8,750] 875TOTAL COST 9,625Add: Profit @ 1/6th on sales means 1/5th on cost 1,925Selling Price 11,550
Working Notes: i). Direct Labour hours = Direct wages / Rate of hourly wages = ` 20,000 / ` 10 = 2,000 labour
hoursii). Rate of absorption of Works Overheads = Work overheads / Direct Labour hours
= ` 5,000 / 2,000 = ` 2.50 per labour hour
UNDER AND OVER ABSORPTION OF OVERHEADS
When may the situation of under/over absorption of overheads arise?The situation of under/over absorption of overheads (or overhead variance) may arise where a predetermined overhead rate is used to charge overheads.
Meaning of Under-absorption of Overheads Under-absorption of overheads means that the amount of overheads absorbed in the production is less than the amount of actual overheads incurred. For example, if overheads absorbed are `
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1,00,000 and the actual overheads incurred are ` 1,50,000 there is under-absorption to the extent of ` 50,000.
Meaning of Over-absorption of Overheads Over-absorption of overheads means that the amount of overheads absorbed in the production is more than the amount of actual overheads incurred. For example, if overheads absorbed are ` 1,50,000 and the actual overheads incurred are `1,00,000 bra is over-absorption to the extent of ` 50,000.
Causes of Under/over Absorption of Overheads Under/over absorption of overheads may arise due to anyone or more of the following reasons:
(a) Wrong estimation of overhead expenses. (b) Wrong estimation of output(c) Wrong estimation of machine/labour hours to be worked (d) Under/over utilization of production capacity(e) Seasonal fluctuations in the overhead expenses in some particular industries. (f) Unanticipated changes in Methods of production.
Treatment/Disposal of Under/Over Absorbed OverheadsThe under/over absorbed overheads may be disposed off by anyone of the following three methods:
1. Use of Supplementary Rate Method (a) When to use this method is usually used
(i). When the amount of under/over absorption of overheads is quite large &(ii). The under/over absorption of overheads is due to normal reasons like increase in
material prices/labour rates.
(b) How to calculate Supplementary of under/over absorbed overheads / Actual Base
Supplementary rate =Amount of under /¿absorbed overheads
Actual base
( c ) How to use
(i). In case of under-absorption The cost of Sales, Stocks of Finished Goods and Work-in-progress are increased by applying positive supplementary rate.
(ii). In case of over-absorption The Cost of Sales, Stock of Finished Goods and Work-in-progress are reduced by applying negative supplementary rate.
Write off to Costing profit & Loss Account Method(a) When to use: This method is usually used when:
(i). The amount of under/over absorbed overheads is not very large, or(ii). The under/over absorption of overheads is due to abnormal reasons like defective
planning, idle capacity etc. In this case, even large amounts are written off to Profit Loss Account.
(b) How to use the amount of under absorbed overheads is transferred to the debit of Costing profit & Loss Account and the amount of over absorbed overheads is transferred to the credit of Costing Profit & Loss Account.
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2. Carry over to Next Accounting Period MethodWhen to use: This method is usually used when:
(a) The period of normal business cycle is more then 1 year and overhead rates are determined on a long-term basis.
(b) In case of new projects more output in the next period(s) than that in initial stages is expected.
How to use : The amount of under absorbed overheads is transferred to the debit of Overhead Reserve/Suspense Account and the amount of over absorbed overheads is transferred to the credit of Overhead Reserve/Suspense Account.
Qus 9.Overheads actually incurred ` 1,50,000Overheads absorbed ` 1,00,000Goods sold 12,000 unitsStock of Finished Goods 11,000 unitsStock of Work-in-progress 1000 units (20% complete)Unabsorbed overheads were due to rising price levels.
Required:- How would under-absorbed overheads be treated in cost accounts?Ans:-
Step 1 - Under absorbed overheads = Actual overheads - Absorbed overheads = ` 1,50,000 - ` 1,00,000 = ` 50,000
Step 2 – Total equivalent units = 12,000 + 11,000 + 20% of 10,000 = 25,000 units
Step 3 – Supplementary Rate = Amount of under−absorbed overheads
Total equivalent units
= Rs .50,000
25,000 = `.2 per unit
Step 4 - Charging by Supplementary Rate: Cost of Sales (12,000 units ×` 2) ` 24,000Stock of Finished Goods (11,000 units ×` 2) ` 22,000Stock of Work-in-progress (2000 units ×` 2) ` 4,000
`50,000Step 5 – Journal EntryCost of Sales A/c Dr. ` 24,000 Finished Goods Ledger Control A/c Dr. `. 22,000Work-in-progress Ledger Control A/c Dr. ` 4,000
To Overheads Control A/c ` 50,000
Qus 10.X Ltd. which absorbs overheads at a pre-determined rate, provides you the following information :Overhead actually incurred ` 2,25,000Overhead absorbed ` 1,00,000It was round that 60% of the unabsorbed overheads were due to defective planning.
Required: How would unabsorb overheads due to defective planning be treated in cost accounts?
Ans:
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Step 1- Under-absorbed overheads = Actual overheads - Absorbed overheads = ` 2, 25,000 - ` 1, 00,000 = ` 1, 25,000
Step 2 - 60% of unabsorbed overheads due to defective planning = 60% of ` 1, 25,000 = ` 75,000 Step 3- ` 75,000 should be transferred to Costing Profit & Loss Account Step 4 - Journal entryCosting Profit & Loss A/c Dr. ` 75,000
To Overheads Control A/c ` 75,000
Qus 11.The total overhead expenses of a factory are ` 4,46,380. Taking into account the normal working of the factory, overheads were recovered from production at ` 1.25 per hour. The actual hours worked were 2,93,104. How would you proceed to close the books of account, assuming that besides 7,800 units produced of which 7,000 were sold? There were 200 equivalent units in work-in-progress. On investigation, it was found that 50% of the unabsorbed overheads were on account of increase in the cost of indirect material and indirect labour and the other 50% was due to factory's inefficiency.Ans:Unabsorbed overheads: `Overhead recovered from production = (2,93, 104hrs ×`1.25) = 3,66,380Actual Overheads = 4,46,380Unabsorbed Overheads = 80,000
Out of the total unabsorbed overheads of ` 80,000, 50% was due to increase in the cost of indirect material and labour. The amount of ` 40,000 (50% of ` 80,000) should therefore, be charged to units produced by means of supplementary rate.
Unabsorbed overhead = ` 40,000 Units produced = 8,000
Supplementary Rate = ` 40,000 / 8,000 = ` 5per unit'
Apportionment of Overheads: The amount of overheads of ` 40,000 will be apportioned between cost of sales, finished goods and work in progress as follows:
`Cost of Sales Account = 7,000 × ` 5 = 35,000Finished goods Account = 800 × ` 5 = 4,000Work in progress Account = 200 × ` 5 = 1,000
= ` 40,000The balance of ` 40,000(50% of 80,000) which represents unabsorbed overheads on account of factory's inefficiency (an abnormal factor) should be transferred to Costing Profit and Loss Account.
ACTUAL OVERHEAD RATES VS PRE -DETERMINED OVERHEAD RATES
Overhead absorption rate may be actual (i.e. based on actual figures) or pre-determined (i.e. based on estimated figures).
Actual Overhead Rate(a) Meaning Actual overhead Rate is that rate of overhead absorption which is
calculated after the actual overheads have been incurred.
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(b) Computation It is calculated by dividing the actual overheads by the actual base.(c) Formula Actual Overhead Rate = Actual Overheads for the period / Actual Base for
the period(d) Limitations (i). It does not facilitate the prompt preparation of cost sheet! quotations.
(ii). It does not provide any basis for cost control.(iii). It does not facilitate comparison of cost of one period with that of
another .period because it may fluctuate from period to period due to fluctuations in the amount of overheads.
Pre-determined Overhead Rate(a) Meaning Pre-determined overhead Rate is that rate of overhead absorption which is
calculated in advance before the incurrence of actual overheads, during the Period in which it is to be used.
(b) Computation It is computed by dividing the budgeted overheads by the budgeted base.(c) Formula Pre-determined Overhead Rate = Budgeted Overheads for the period /
Budgeted Base for the period(d) Advantages The advantages of using Pre-determined rates are as follows:
(i). Prompt Cost Ascertainment The pre-determined rates help in prompt cost ascertainment because these are computed in advance.
(ii). Cost Control The pre-determined rates help in cost control because actual overheads can be compared with predetermined overheads recovered.
(iii). Uniformity The pre-determined rates maintain uniformity by charging overheads at uniform overhead rate for the full budget period and thus, facilitates comparison of cost of one period with that of another period.
Distinction between Actual and Pre-determined Overhead RateBasis of Distinction Actual Overhead Rate Pre-determined Overhead Rate1. Meaning Actual overhead rate is
calculated by dividing the actual overheads by the actual base.
Pre-determined overhead rate is calculated by dividing the budgeted overheads by the budgeted base.
2. Formula = Actual Overheads for the period / Actual Base for the period
= Budgeted Overheads of the period / Budgeted base for the period.
3. Use of overheads Actual overheads are used. Budgeted overheads are used4. Use of base Actual base is used Budgeted base is used5. When computed? It is computed after the
expenses have been incurred.It is computed before the expenses are incurred.
6. Preparation of cost sheets/Quotations.
It does not facilities the prompt preparation of cost sheet/quotations.
It facilitates the prompt preparation of cost sheets/quotations.
7. Cost control It does not facilitate cost control.
It facilitates cost control by comparison of actual overheads with pre-determined overheads recovered.
BLANKET OVERHEAD RATE VS DEPARTMENTAL OVERHEADS RATES
Overhead absorption rate may be blanket (i.e. single rate for the entire factory) or departmental (i.e. separate rate for each department/cost centre).
Blanket Overhead Rate Meaning Blanket Overhead Rate is the single rate of overhead absorption which is
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computed for the entire factory.Computation
It is computed by dividing the total overheads or all departments/cost centres by the total base for all departments/cost centres.
Formula Blanket Overhead Rate= Total overheads for all departments/cost centres / Total base for all departments/cost centres
Suitability It is suitable only under the following cases:(i). Where only one product is produced (ii). Where two or more products are produced but
a. all products pass through all departments, and b. all products are processed for the same length of time in each
department.Limitations (i). It gives misleading and erroneous results where two or more products are
produced and all of these do not pass through all departments, for the uniform length of time.
(ii). It does not facilitate the proper assessment of the performance of individual departments or cost centres, and hence exercise of control becomes difficult.
(iii). It may over value work-in-progress if units included in work-in-progress do not ass through all the departments.
Departmental Overheads Rate(a) Meaning Departmental Overhead rate is a separate rate of overhead absorption which
is computed for each department/cost centre. Under this practice, there is use of multiple rates. For example, separate rates may be calculated for Production department, Service department, Cost centre, Product, Fixed overheads, Variable overheads.
(b) Computation It is computed by dividing the total overheads of a department/ cost centre by the base for that department/cost centre.
(c) Formula Departmental Overhead Rate = Total overheads of a department/cost centre / Base for that department/cost centre
(d) Suitability It is suitable where two or more products are produced and all of these do not pass through all departments for the uniform length of time.
Distinction between Blanket Overhead Rate and Departmental Overhead RatesBasis of Distinction
Blanket overhead Rate Departmental Overhead Rates
1. Meaning It is a single rate of overhead absorption computed for the entire factory.
There are the separate rates of overhead absorption computed for each individual department/cost centre.
2. Single vs. Multiple
Under this practice there is only a single rate.
Under this practice there are multiple rates.
3. Factory vs. Departmental
It is computed for the entire factory.
These are computed for each of the departments.
4. Suitability It is suitable where one product is manufactured or where work performed is more or less uniform.
These rates are suitable where two or more products are manufactured and where work per-formed in different departments is different.
5. Formula Total overheads for all departments/cost centres/Total base for all departments/cost centres
= Total overheads of a department/cost centre / base for that department/cost centre
Qus 12.From the following information calculate Actual and Pre-determined overhead absorption rates:
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Budgeted Overheads
Actual overheads
Budgeted Labour hours
Actual labour
Deptt. A ` 50,000 ` 48,000 ` 5,000 ` 6,000Deptt. B ` 25,000 ` 27,000 `10,000 `9,000Ans:-a) Actual overhead absorption rate = Actual overheads of a department / Actual labour hours of a
department Deptt. A = 48,000 / 6,000 = ` 8 per hourDeptt. B = 27,000 / 9,000 = ` 3 per hour
b) Budgeted overhead absorption rate = Budgeted overheads of a department / Budgeted labour hours of a department Deptt. A = ` 50,000 / 5,000 = ` 10 per hour Deptt. B = ` 25,000 / 10,000 = ` 2.50 per hour
Qus 13.From the following information calculate blanket and departmental overhead absorption rates:
Overheads Direct wages Deptt. A `50,000 `25,000 Deptt. B `25,000 ` 50,000
Ans: a) Blanket(or Single) overhead rate = Total Overheads for all departments / Total Direct wages of
all departments × 100= ` 75,000 / ` 75,000 × 100 = 100%
b) Departmental Overhead rate = Total Overheads for a department / Total Direct Wages of a department × 100
Deptt. A = ` 50,000 / ` 25,000 × 100 = 200% Deptt. B = `25,000 / ` 50,000 × 100 = 50%
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JUDGE URSELF
State with reason whether the following statements are True or False: 1. Allocation of overheads is the process of charging proportion of common items of overheads
to a particular cost centre. 2. Apportionment of overheads is the process of charging full amount of overheads to different
cost centres. 3. Absorption of overheads is the process of charging overheads to cost centres. 4. Charging a cost centre to those overheads which result only from the existence of that cost
centre is known as apportionment. 5. The code number given to factory overhead item is termed as Cost Account Number. 6. The code number given to Administration overhead item is termed as Standing Order
Number. 7. When actual overheads are less than the absorbed overheads, it is a case of under absorption. 8. In case the amount of under/over absorbed overheads is negligible, it is adjusted by
Supplementary Rate Method. 9. Under/over absorption of overheads arises only when actual overhead rates are used.
10. Under absorption of overheads decreases profit in Costing Books. 11. Under absorption of fixed overheads means the absence of capacity.
Explanatory AnswersStatemen
t No.True / False
Reason
1. False Allocation of overheads is the process of charging the full amount of overheads to a particular cost centre.
2. False Apportionment of overheads is the process of charging a proportion of common item of overheads to different cost centres.
3. False Absorption of overheads is the process of charging overheads to products or services.
4. False Charging a cost centre to those overheads which result only from the existence of that cost centre is known as allocation
5. False The code number given to factory overhead item is termed as Standing Order Number.
6. False The code number given to Administration overhead item is termed as Cost Account Number.
7. False When actual overheads are less than the absorbed overheads. it is a case of over-absorption.
8. False In case the amount of under/over absorbed overheads is negligible, it is transferred to Costing Profit & Loss Account.
9. False Under/over absorption of overheads arises only when pre-determined overhead rates are used.
10. False Under absorption of overheads decreases profit in financial books.11. False Under absorption of fixed overheads means the existence of Idle capacity.
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PAST EXAMINATION QUESTIONS
MULTIPLE CHOICE QUESTIONS
1. When the under or over absorbed overheads amount is significant, it should be disposed off by
(a) Transferring to costing profit and loss account (b) Using a supplementary rate (c) Carry over to next year(d) None of the above.
2. In element-wise classification of overheads, which one of the following is not included-(a) Fixed overheads (b) Indirect labour (c) Indirect materials(d) Indirect expenditure.
3. Absorption means- (a) Charging of overheads to cost centers (b) Charging of overheads to cost units (c) Charging of overheads to cost centres or cost units (d) None of the above.
Fill in the Blanks(1) …….. is the allotment of proportion of items of cost of cost centre/cost units. (2) The process of apportionment of factory overheads among production and service
department is called ……………… of factory overheads.
True and False / Correct and Incorrect
1. When the amount of under/over absorption is signification, it should be disposed off by carrying over as a deferred charge to the next accounting year.
Answer : MCQs Answers 1 2 3Options (b) (a) (b)
Answers : Fill in the Blanks1. Allocation2. Departmentalisation
Answers : True/False1. False, We should follow supplementary rate to show the effect in the over- heads itself.
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TRAIN UR BRAIN
1. The total cost of indirect materials, indirect labour and indirect expense is called – a) Material b) Labourc) Overhead d) Cost sheet
2. Overheads include – a) Rent b) Electricityc) Depreciation d) All of the above
3. ……………… includes all the indirect cost related to the manufacturing activities of any company.a) Production b) Sellingc) Distribution d) Fixed
4. All cost incurred for carrying out the administrative functions like formulation of policy decision making etc. of the organization under – a) Production Overheadb) Office and Administration Overheadc) Selling Overheadd) Distribution Overhead
5. ………. do not change with change in production or activity.a) Selling Overhead b) Fixed Overheadc) Variable Overheadd) Distribution Overhead
6. Overheads which vary in direct proportion with change in level of activity is –a) Variable overheadsb) Fixed Overheadsc) Selling Overheadsd) Distribution Overheads
7. Those which can be controlled by the management with proper care and efficient planning are known as –a) Variable Cost b) Fixed costc) Controllable Costd) Uncontrollable Cost
8. Those costs which cannot be controlled by the management are not predictable in nature are known as – a) Controllable costb) Uncontrollable Costc) Fixed Costsd) Variable Costs
9. The process of assigning manufacturing costs to various cost centres is referred to as – a) Cost apportionmentb) Cost Allocation
c) Cost Categoriesd) Cost Sheet
10. The process of distributing common costs on a proportionate basis is known as – a) Cost Allocationb) Cost Categories cost apportionmentc) Cost sheet
11. Both allocation and apportionment of costs over the various production and service departments is done in the table known as – a) Primary Distribution Tableb) Secondary Distribution Tablec) Preliminary Distribution Tabled) None of the above
12. ……….. method is used to apportion total costs of service departments to production departments.a) Direct b) Step Ladderc) Trial and Error d) All of the above
13. The recovery rate is calculated by dividing the overhead cost by the number of labour hours worked in the cost centre under – a) Prime Cost Method b) Labour Hour Rate Methodc) Machine Hour Rate methodd) Production Unit Method
14. The decrease in the value of the asset due to use, wear and tear and lapse of time is known as – a) Depreciation b) Assetsc) Timed) Diminishing Depreciation
15. Warehouse expenses is an example of –a) Selling Overhead b) Fixed Overheadb) Distribution Overheadc) Production Overhead
16. Direct expenses is also known as –a) Period Cost b) Prime Costc) Variable Cost d) Chargeable Cost
17. The process of redistribution of support departments cost to operating departments is called - a) Secondary distribution b) Primary Distributionc) Classificationd) All of the above
18. Where a cost is directly attributable to department, it is called - a) Departmentalization
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b) Allocationc) Service Departmentd) Classification
19. Overhead is classified on the basis of - a) Element b) Functionc) Behaviour or Natured) All of the above
20. Administration overheads include –a) Office rent, rates, taxesb) Salaries of administrative Staffc) Audit and legal feesd) All of the above
21. Packing and delivery charges is the item of – a) Distribution Overheadsb) Selling Overheadsc) Administration Overheadsd) Production Overheads
22. Which of the following is method of treatment of under/over absorption of overheads?a) Carry forward to subsequent yearb) Application of supplementary ratesc) Write Off to costing profit and loss
accountd) Both (a) and (b)
23. Administration overheads are generally absorbed as a percentage of – a) Works Cost b) Labour Costc) Prime Cost d) All of the above
24. A cost centre which consist of person or group of persons is known as – a) Operating Cost centreb) Process Cost Centrec) Personal Cost Centred) Impersonal Cost Centre
25. The apportionment of overheads of service department among the production department are known as – a) Secondary Distribution of overheadb) Primary distribution of overheadc) Territorial Distribution of overheadd) None of the above
26. Salary of a supervisor is an example of –a) Production Methodb) Selling overheadc) Administrative Overheadd) Manufacturing Overhead
27. Indirect cost can be classified as – a) Indirect materials b) Indirect labourc) Indirect expenses d) All of the above
28. When the under or over absorbed overheads amount is significant, it should be disposed off by ___________a) Supplementary rateb) Transfer to costing p/l accountc) Both d) None
29. State whether the following statement is “True” or “False”Administration overheads are recovered as a percentage of works cost.a) True b) False
30. The process by which cost items are charged direct to a cost unit or cost centre is called _________a) Absorption b) Apportionmentc) Allocation d) Allotment
31. Another name for direct expenses:a) Period Cost b) Variable Costc) Prime costd) Chargeable expenses
32. An organization is divided into number of departments and overheads are collected, allocated or apportioned to respective departments is called ___________a) Service Departmentsb) Divisionalisationc) Departmentalizationd) Classification
33. A common absorption rate used throughout a factory for all jobs and units of output irrespective of the departments in which they were produced is called _________a) Machine Hour Rateb) Department Absorption Ratec) Overall absorption rated) Blanket Absorption rate
34. Which of the following is not a method of cost absorption?a) Percentage of direct material costb) Machine hour ratec) Labour Hour rated) Repeated distribution method
35. Service departments costs should be allocated to:a) Only service departmentsb) Only Production departmentsc) Both Production and service
departmentsd) None of the production and service
departments
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36. Most suitable basis for apportioning insurance of machine would be:a) Floor Areab) Value of Machinesc) No. of Workersd) No. of Machines
37. Blanket overhead rate is:a) One single overhead absorption rate
for the whole factoryb) Rate which is blank or nil ratec) Rate in which multiple overhead rates
are calculated for each production department, service department etc.
d) Always a machine hour rate38. Factory overheads includes:
a) All manufacturing costsb) All manufacturing costs except direct
materials and direct labor.c) Indirect materials but not indirect
labor.d) Indirect labor but not indirect material
39. Prime cost means,a) Direct materials b) Direct laborc) Direct materials and direct labord) Direct materials, direct labor and
direct expenses40. Rent of the business premises is,
a) Fixed Cost b) Variable Costc) Semi-Variable Cost d) None of these
41. Apportionment of overheads of service departments to production departments is called as,a) Primary distribution of overheadsb) Secondary distribution of overheadsc) Allocation of overheadsd) Absorption of overheads
From the following informationOverheads Direct wages
Deptt ADeptt B
` 50,000` 25,000
` 25,000` 50,000
42. Calculate blanket absorption rate of the factorya) 100% b) 200%c) 50% d) 150%
43. Calculate departmental overhead absorption rate of deptt. Aa) 100% b) 200%c) 50% d) 150%
44. Calculate departmental overhead absorption rate of deptt. B
a) 100% b) 200%c) 50% d) 150%
From the following informationBudgeted
OverheadsBudgeted
Labour hours
Deptt ADeptt B
` 50,000` 25,000
` 5,000` 10,000
45. Calculate Pre-determined overhead absorption rate of deptt. a:a) 12/h b) 10/hc) 2.5/h d) 5/h
46. Calculate Pre-determined overhead absorption rate of deptt. Ba) 12/h b) 10/hc) 2.5/h d) 5/h
The budgeted expenses for the year are as follows: -Direct Material ` 9,000Direct Wages @ ` 10 per hour ` 20,000Direct expenses ` 1,000Works Overheads ` 5,000Administration Overheads ` 3,500Work overheads are charged at labour hour rate administration overheads are charged as a percentage on work cost.The details of Job No 101 are as follows:Direct materials ` 2,250Direct wages ` 5,000Direct Expenses ` 250
47. Calculate rate of absorption of administration overheadsa) 20% b) 30%c) 10% d) 40%
48. What price should be charged to Job No 101 so as to earn 1/6th profit on salesa) 12000 b) 11550c) 13000 d) 14000
Calculation Effective Machine Hours for the purpose of computing Machine Rate in each of the following alternative cases:
49. Budgeted working hours 2400, Maintenance hours 10%a) 2160 b) 1980c) 2400 d) 594
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50. Budgeted working hours 8 hours per day for 300 days, Maintenance hours 10%a) 2160 b) 1980c) 2400 d) 594
51. There are 13 holidays on account for festivals and holidays not falling on Sundays. The factory works 8 hours a day. Maintenance hour 10%.a) 2160 b) 1980c) 2400 d) 594
52. There are 12 holidays on account of festivals and national holidays not falling on Sundays and Saturdays. The factory works 8 hours a day and 4 hours on Saturdays Maintenance hour 10%.a) 210 b) 1980c) 494 d) 520
53. Total Working hours available per week44 hours
Maintenance hours included in above 4 hours
Setting up time (productive) 5%Machine hour rate is worked out at the beginning of a year on the basis of 13 week period which is equal to 3 calender months.a) 2160 b) 1980c) 94 d) 520
54. Total Working hours available per week44 hours
Maintenance hours included in above 4 hours
Setting up time (productive) 5%Machine hour rate is worked out at the beginning of a year on the basis of 13 week period which is equal to 3 calender months.a) 2160 b) 1980c) 494 d) 520
Calculate the cost of power per hour for the purposes of computing Machine hour rate in each of the following alternative cases:
55. Power consumption of machine during production 10 units per hour at a cost of ` 4 per unita) 50 b) 40c) 60 d) 70
56. Power consumption of machine during operation 15 units. Rate of power per 100 units
a) 50 b) 40c) 60 d) 75
57. Compute the machine hour rate from the following data:
`Cost of Machine 1,00,000Installation charges 10,000Estimated scrap value after the expiry of its life (15 years)
5,000
General lighting for the shop per month
200
Insurance premium for the machine per annum
300
Repairs and maintenance expenses per annum
960
Power consumption – 10 units per hour
1,000
Rate of power per 100 units 20Estimated working hours per annum – 2,200This includes Setting-up time of 200 hoursShop supervisor’s salary per month
600
The machine occupies 1/4th of the total area of the shop. The supervisor is expected to devote 1/5th of his time for supervising the machine. General lighting expenses are to be apportioned on the basis of floor area.a) 8.95 b) 7.95c) 8.88 d) 9
58. Calculate the machine hour rate from the following data:
`Cost of Machine 18,000Cost of installation 2,000Scrap value after 10 years 2,000Rates and rent for a quarter for the shop
600
General lighting 200 p.m.Shop supervisor’s salary 6,000
Per quarter
Insurance premium for a machine
120 p.a.
Estimated repair 200 p.a.Power 2 units per hour @ ` 150 per 100 unitsEstimated working hours p.a. 2,000The machine occupies 1/4th of the total area of the shop. The supervisor is
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expected to devote 1/6th of his time for supervising the machine. General lighting expenses are to be apportioned on the basis of floor area.a) 8.95 b) 7.95c) 6.66 d) 9
The following Information relates to the activities of production department for a certain period in a factory:
`Materials Used 72,000Direct Wages 60,000Hours of Machine operation 20,000Labour Hours worked 24,000Overheads chargeable to the department
48,000
One order carried out in the department during the period, the relevant data were:
`Materials used 4,000Labour Hours 1,650Direct Wages 3,300Machine Hours 1,200Compute factory overhead rates of overheads by
59. Direct Labour Hour Rate Methoda) 2.4 b) 2c) 3 d) 4
60. Direct Labour Cost Rate Methoda) 50% b) 60%c) 80% d) 100%
61. Machine Hour Rate Methoda) 2.4 b) 2c) 3 d) 4
State whether each of the statement is True or False, give reasons in brief.
62. Allocation and apportionment of overheads is one and the same.a) True b) False
63. When actual overheads are more than the absorbed overheads, it is called as over absorption of overheadsa) True b) False
64. Under/over absorption of overheads takes place only when a predetermined rate of overheads is used.a) True b) False
65. A blanket overhead rate means a single overhead rate for the entire factory.a) True b) False
66. Machine hour rate is not suitable for absorption of overheads if the work is done mainly by machinesa) True b) False
67. If the amount of under/absorption of overheads is significant, it is transferred to Costing Profit and Loss A/ca) True b) False
68. Cost of tube used for packing tooth paste is indirect material cost.a) True b) False
69. Cost of floppy disk used for office computer is administration overheada) True b) False
70. Fixed costs vary with volume rather than time.a) True b) False
71. Variable Cost varies with timea) True b) False
72. If the factory overheads for the month of April were ` 60000 and during the period 150 workers worked for 25 days at 8 hours per day then overhead absorption rate as per direct labour hour will bea) 16 b) 300c) 2 d) 400
73. The budgeted overheads amounted to ` 84,000. The budgeted and actual production amounted to 20,000 and 24,000 units respectively. This means that there will be,a) An under absorption of ` 16,800b) An under absorption of ` 14,000c) An under absorption of ` 16,800d) An under absorption of ` 14,000
X Ltd. which absorbs overheads at a pre-determined rate, provides you the following information:Overheads actually incurred ` 1,50,000Overheads absorbed ` 1,00,000Goods sold 12,000 unitsStock of finished goods 11,000 unitsStock of Work-in-progress 10,000 units
(20% complete)
Unabsorbed Overheads were due to rising price levels.
74. Calculate under absorption of overheadsa) 60000 b) 50000c) 10000 d) 100000
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75. Find equivalent unitsa) 30000 b) 40000c) 25000 d) 80000
76. Calculate supplementary ratea) 2/u b) 3/uc) 4/u d) 5/u
The total overheads expenses of a factory are ` 4,46,380. Taking into account the Normal working of the factory, overhead was recovered in production at ` 1.25 per hour. The actual hours worked were 2,93,104. How would you proceed to close the books of Accounts, assuming that besides 7,800 units produced of which 7,000 were sold, there 200 Equivalent units in works-in-progress. On investigation, it was found that 50% of the unabsorbed overhead was on account of increase materials and indirect labour and the remaining 50% was due to factory inefficiency.
77. Calculate under absorption of overheadsa) 60000 b) 50000c) 80000 d) 100000
78. Find equivalents unitsa) 8000 b) 40000c) 25000 d) 80000
79. Calculate supplementary ratea) 2/u b) 3/uc) 4/u d) 5/u
80. Calculate the amount charged to Costing Profit & Loss Accounta) 40000 b) 50000c) 80000 d) 100000
In a factory overheads of a particular department are recovered on the basis of ` 5 per machine hour. The total expenses incurred and the actual machine hours for the department for the month of August were ` 80,000 and 10,000 hours respectively. Of the amount of ` 80,000, ` 15,000 became payable due to an award of the labour court and ` 5,000 was in respect of expenses of the previous year booked in the current month (August). Actual production was 40,000 units, of which 30,000 units were sold. On analyzing the reasons, It was found that 60% of the under absorbed overhead was due to defective
planning and the rest was attributed to normal cost increase.
81. Calculate under absorption of overheadsa) 60000 b) 50000c) 80000 d) 10000
82. Find equivalent unitsa) 8000 b) 40000c) 25000 d) 80000
83. Calculate supplementary ratea) 0.2/u b) 0.1/uc) 0.4/u d) 0.5/u
84. Calculate the amount charged to Costing Profit & Loss Accounta) 4000 b) 5000c) 6000 d) 10000
85. Directors remuneration and expenses from a part of:a) Production overheadb) Administration overheadc) Selling Overheadd) Distribution Overhead
86. Salary of a foreman should be classified as a:a) Fixed Overheadb) Variable Overheadc) Semi-Fixed or Semi-Variable overheadd) None of the above
87. Which of the following is a service department?a) Refining departmentb) Machining Departmentc) Receiving Departmentd) Finishing Department
88. Which method of absorption of factory overheads do you suggest in a concern which produces only one uniform item of product?a) Percentage of direct wage basisb) Direct Labour hour ratec) Machine Hour Rated) A rate per unit of output
89. Factory overhead should be absorbed on the basis of:a) Relationship to cost incurredb) Direct Labour hoursc) Direct Labour costd) Machine hours
90. What is the basis for distribution of indirect material cost to various departments?a) Direct Allocation
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b) Cost of direct materials consumedc) Machine hours workedd) Either of the three
91. Basis of apportionment of stores service expenses is ________________.a) Value of Material consumed.b) Units of material consumed.c) Units producedd) None of the above
92. Basis of apportionment of welfare department expenses is ____________a) Wages of each departmentb) Number of employeesc) Material consumedd) Number of machineries
93. Under step method of re-apportionment of costs of service departments, the cost of last service department is apportioned only to the _____________a) Production Departmentb) Service Departmentc) Both a and bd) None of the above
94. Machine hour rate is obtained dividing the total running expense of a machine during a particular period by the __________a) Number of workersb) Number of products producedc) Number of machine hoursd) Wages
95. _____________ is the amount by which the absorbed overheads fall short of the actual amount of overheads incurred.a) Over absorption of overheadsb) Under absorption of overheadsc) Overhead absorptiond) None of these
96. Which of the following is not a method of cost absorption?a) Percentage of direct material costb) Machine hour rate methodc) Labour hour rate methodd) Repeated distribution method
97. In element-wise classification of overheads, which one of the following is not included?a) Indirect Materials b) Indirect labourc) Fixed overheadsd) Indirect expenditure
98. Which of the following statement is correct to relation to the term “Overheads”?
a) Overheads are attributable or traceable to particular job, process, service, cost unit or cost centre and hence treated as traceable costs.
b) Overheads cannot be allocated to any specific job, process because they are not capable of being identified with specific job or process.
c) Overheads forms part of prime cost.d) None of the above
99. Which of the following is not a production cause of idle capacity?a) Set-up and change-overtimeb) Lack of supervision and instruction.c) Lack of materials and toolsd) Strike
100. In which of the following “Line of best fix” is drawn to find out “variable overheads” and “fixed overheads” out of “Semi-variable” Overheads?a) Graphical Presentation Methodb) Analytical Methodc) High & Low Point Methodd) Least Square Method
101. Idle Capacity = ………………………a) Capacity Utilized (-) Practical Capacityb) Practical Capacity (×) Capacity Utilizedc) Capacity Utilized (+) Practical Capacityd) Practical Capacity (-) Capacity Utilized
102. Which of the following is correct treatment for “bad debts” in cost accounts?a) A part of default amount is treated as
bad debts and is recovered as selling overhead and absorbed in product cost.
b) Bad debt forms part of the prime cost of the product
c) If the bad debt is abnormal in nature, the abnormal portion in excess of the standard normal portion should be excluded from cost accounts and transferred to costing profit and loss Account.
d) Either (a) or (c)103. When _______________ is used on the basis of
budgeted overheads and the rate is applied to the actual basis, the actual overhead expenses may be different from the charged overheads.a) Predetermined rateb) Actual rate method of absorption
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c) Both a and bd) None of these
104. Expenses incurred during production other than direct materials and direct labour are called ___________ factory expenses; those charged to production on estimated basis are called ______________.a) Actual, Applied b) Applied, Actualc) Indirect, Direct d) None of these
105. The per unit expense of the _____________ portion factory overhead varies with the volume of production while _____________ portion remains the same with volume.a) Variable, Fixedb) Variable, Semi-Variablec) Fixed, Variabled) None of these
106. _______________ expenses are excluded from cost. a) Normal b) Abnormalc) Both a and b d) None of these
107. Such expenses which are included even though they are not incurred for taking managerial decisions are called ____________.a) Normal expenses b) Actual expensesc) Imputed expensesd) Notional Expenses
108. An overhead absorption (recovery) rate is used to : …………………..a) Share out common costs over
benefiting cost centres.b) Find the total overheads for a cost
centrec) Charge overheads to productsd) Control overheads
109. The arrangement of various items of overhead costs in logical groups having regard to their nature is known as ………….a) Absorption of overheadsb) Apportionment of overheadsc) Allocation of overheadsd) Classification of overheads
110. Maximum capacity of a plant refers to it: ………………..a) Theoretical Capacityb) Normal capacityc) Practical Capacityd) Capacity based on sales expectancy
ANSWERS
1. c 2. d 3. a4. b 5. b 6. a7. c 8. b 9. b10. c 11. a 12. d13. b 14. a 15. c16. d 17. a 18. c19. d 20. d 21. a22. d 23. a 24. c25. a 26. d 27. d28. a 29. a 30. c31. d 32. c 33. d34. d 35. c 36. b37. a 38. b 39. d40. a 41. b 42. a43. b 44. c 45. b46. c 47. c 48. b49. a 50. a 51. a52. b 53. d 54. c55. b 56. d 57. b58. c 59. b 60. c61. a 62. b 63. a64. a 65. a 66. b67. b 68. b 69. a70. b 71. b 72. c73. a 74. b 75. c76. a 77. c 78. a79. d 80. a 81. d82. b 83. b 84. c85. b 86. c 87. c88. d 89. a 90. a91. a 92. b 93. a94. c 95. b 96. d97. c 98. b 99. d100. d 101. d 102. d103. a 104. a 105. c106. b 107. d 108. c109. d 110. a
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CHAPTER 5
INTRODUCTION
The CIMA has defined marginal cost as ''the cost of one unit of product or service which would be avoided if that unit were not produced or provided."
Marginal costing is a technique of decision making, which involves:(a) Ascertainment of total costs(b) Classification of costs into (i) Fixed and (ii) Variable(c) Use of such information for analysis and decision making.
Thus, marginal costing is defined as the ascertainment of marginal cost and of the effect on profit of changes in volume of type of output by differentiating between fixed costs and variable costs.
Marginal costing is mainly concerned with providing of information to management to assist in decision-making and to exercise control.
Marginal costing is also known as variable costing or out of pocket costing.
The total cost is divided between variable and fixed cost. The variable cost per unit remains the same. It is the cost directly connected with each unit produced and sold. When a unit is realized and cost for that unit is incurred and paid, the excess of selling price per unit over variable cost per unit is called contribution per unit.
FEATURES OF MARGINAL COSTING1. Costs are separated into the fixed and variable elements and semi-varible costs are also
differentiated like-wise.
2. Only the variable costs are taken into account for computing the value of stocks of work-in-progress and finished products.
3. Fixed costs are charged off to revenue wholly during the period in which they are incurred and are not taken into account for valuing product cost/inventories.
4. Prices may be based on marginal costs and contribution, but in normal circumstances prices would cover costs in total.
5. It combines the techniques of cost recording and cost reporting.
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Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses + Variable Overheads
Margin: Net operating profit divided by sales.
Marginal Cost: The amount of any given volume of output, by which aggregate variable costs are changed if the volume of output is increased by one unit.
6. Profitability of departments or products is determined in terms of marginal contribution.
7. The unit cost of a product means the average variable cost of manufacturing the product.
8. Only the variable costs (marginal costs) are treated as the cost of the product.
9. The stock of finished goods and work-in-progress are valued at marginal cost only.
10. Prices are based on marginal cost plus contribution. Contribution is the difference between selling price and variable cost.
DIRECT COSTINGDirect costing is the practice of charging all direct cost to operations, processes or products, leaving all indirect costs to be written off against profits in the period in which they arise. Under direct costing the stocks are valued at direct costs, i.e., costs whether fixed or variable which can be directly attributable to the cost units.
DIFFERENTIAL COSTINGDifferential cost is the increase or decrease in total cost or the change in specified elements of costs that result from any variation in operation. It represents an increase or decrease in total cost resulting out of:(a) Producing or distributing a few more or few less of the products.(b) A change in the method of production or of distribution.(c) An addition or deletion of production or a territory; and(d) Selection of an addition sales channel.
Differential cost thus includes fixed and semi-variable expenses. It is difference between the total costs of two alternatives. It is an ad hoc cost determined for the purpose of choosing between competing alternatives, each with its own combination of income and costs. Differential cost many be incremental or decremental.
INCREMENTAL COSTINGIncremental costs and revenue are the difference between costs and revenue for the corresponding item under each alternative being considered.
For example: The incremental costs of increasing output from 1000 to 1100 units per week are the additional costs of producing an extra 100 unit per week.Incremental costs may or may not include fixed costs. If fixed costs change as a result of a decision, the increase in costs represents an incremental cost. If fixed costs do not change as a result of a decision, the incremental costs will be zero.Incremental costs and revenues can be compared with economist’s concept of marginal cost and marginal revenue. The main difference is that marginal cost/revenue represents the additional cost/ revenue of one extra unit of output whereas incremental cost/revenue represents the additional cost/revenue resulting from a group of additional unit of output.
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Differential Cost: A difference in cost between any two alternatives. Also seen as Incremental cost. Any cost that differs between alternatives in a decision making situation. In managerial accounting, this term is synonymous with avoidable cost and relevant cost.
ABSORPTION COSTING
Absorption costing technique is also known by other names as “Full costing” or “Traditional costing”. According to this technique, all costs are recognized or identified with the products manufactured. Both Fixed and variable costs of each product manufactured are taken into account to ascertain the total cost.
Income Determination under Marginal and Absorption Costing
Under Marginal Costing, only factory overheads costs that tend to vary with volume are charged to product cost in addition to prime cost. While evaluating inventory only direct materials, direct labour and variable factory overheads are included and are considered as product costs.Fixed factory overheads under direct or marginal costing are not included in inventory. It is treated as a period cost and charged against revenue when incurred.
Under Absorption Costing, sometimes called full or conventional costing, all manufacturing costs, both fixed and variable are charged to product costs.
Absorption Costing ` Marginal Costing `Sales RevenueLess: Manufacturing expenses (both fixed and variable)
------
Sales RevenueLess: All variable costs (both production and non-production)
------
Gross profitLess: Non-Production costs (both Fixed and variable)
------
ContributionLess: All fixed cost (both Production and non-production)
------
PBTLess: Tax Provision
------
PBTLess: Tax Provision
------
Net Income --- Net Income ---
ABSORPTION COSTING vs. MARGINAL COSTINGUnder marginal costing, it is presumed that variable costs are related to output and Fixed costs are related to the period. Hence, the Fixed costs are charged off to the Profit and Loss Account.
Marginal Costing FormatParticulars Amount Amount
Sales ValueLess: Variable CostDirect Materials CostDirect Labour CostVariable Factory OH and Selling & Distribution Overhead
Contribution = Sales – Variable CostsLess: Fixed costFixed Factory OverheadsAdministration OverheadsFixed Selling & Distribution Overheads
Profit or Loss = Contribution – Fixed Costs
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxx
xxxxxx
xxxxxx
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Absorption Costing: A costing method that includes all manufacturing costs - direct materials, direct labour and both variable and fixed manufacturing overhead – in the cost of a unit of product. Absorption costing is also referred to as the full cost method.
Absorption Costing FormatParticulars Product A Product B Product C Total
Sales RevenueLess: Variable Costs
xxxxxx
xxxxxx
xxxxxx
xxxxxx
Contribution Xxx xxx xxx xxxLess: Fixed Costs xxxProfit xxx
DISTINCTION BETWEEN MARGINAL AND ABSOPRTION COSTING
Marginal Costing
(a) The fixed production overhead is treated a period cost. It is charged at the period for which it is incurred.
(b) The opening and closing stocks are valued at variable production cost. The profit arrived under marginal costing is realistic profit.
Absorption Costing(a) The fixed production overhead recovery rate is calculated on the basis of normal production.
Overhead is charged on the quantity produced. Hence it is initially treated as product cost. If the actual production quantity is different from budgeted quantity, then there may arise under recovery or over recovery of fixed production overhead. It is finally adjusted with the cost of sales.
(b) The opening/ closing stock is valued at total cost per unit (variable + fixed). Hence the profit under absorption costing differs from profit under marginal costing.
The key differences can be summarised as under:
Basis of Difference Absorption Costing Marginal Costing1. Charge Full costs (fixed and variable)
are charged to production.Only variable costs are charged to production.
2. Classification Expenses are classified on functional basis.
The classification is as per nature of expenses fixed and variable.
3. Consideration of Cost
Fixed costs are considered inventariable costs.
Fixed costs are considered as period costs.
4. Focus The emphasis is on profit (sales minus total cost).
The thrust is on contribution (sales minus variable cost). Increase in contribution means increase in profit.
5. Inventory Valuation
Basis of inventory valuation takes into account fixed component of overheads.
Inventories are valued at marginal or variable cost.
6. Overheads Absorption
Since all overheads are absorbed to production, over-recovery of overheads can be there.
On account of only variable overheads being absorbed to production, there' can be under -recovery of overheads.
7. Treatment of Overheads
Over under-recovery of overheads can be transferred to Costing Profit & Loss Account.
Actual fixed overheads are wholly transferred to Costing Profit and Loss Account.
8. Decision Making Product Costing depends on Product costing considers only the
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total cost per unit. variable costs, hence decision making is affected.
CLASSROOM PRACTICE – LETS PLAY TOGETHER
Use of Absorption Costing Method for the Valuation of Finished Goods Inventory
When absorption costing method is used, production fixed overheads are charged to production and are included in product costs. Consequently, the closing stocks are valued on total cost (including fixed overheads) basis. The net effect is that the charge of fixed overheads to P/L account gets reduced, if closing stock is greater than the opening stock. This situation has the effect of inflating the profit for the period.
Where stock levels are likely to fluctuate significantly, profits may be distorted if calculated on absorption costing basis. If marginal costing is used, since the fixed costs are charged to P/L account as period cost, such a situation will not arise. The impact of using absorption costing on profits can be summarized as under:
When sales are equal to production, profits will be the same under absorption costing and marginal costing.
If production is higher than sales, the absorption costing will post higher profits than marginal costing.
If sales are in excess of production, absorption costing will show lower profits than marginal costing.
Since profit calculation in absorption costing can produce strange result, the managers may deliberately alter the stock levels to influence the profits if absorption costing is used. Hence, it is true to say that if absorption costing method is used, managers have the incentive to over produced to show better result.
LIMITATIONS OF MARGINAL COSTING
(i) Marginal cost assumes that all costs can be classified into fixed and variable but it is not so as there are costs which are either fixed or variable. For example, various amenities provided to workers may have no relation either to volume of production or time factor.
(ii) Contribution of a product itself is not a guide for optimum profitability unless it is linked with the key factor.
(iii) Marginal costing ignores time factor and investment. For example, the marginal cost of two jobs may be the same but the time taken for their completion and cost of machines used may differ. The true cost of a job which takes longer time and uses costlier would be higher. This fact is not disclosed by marginal costing.
(iv) The overheads of fixed nature cannot altogether be excluded particularly in large contracts while valuing work-in-progress. In order to show and correct position fixed overheads have to be included in work-in-progress.
(v) In the long run, the selling prices should be based on total cost, i.e., inclusive of fixed cost also. In the short run or in special situation when a production is sold below the total cost, customers may insist on the contribution of reduced prices forever which may not be possible in all cases.
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(vi) The main assumptions regarding behavior of costs are not true. The variable costs do not remain constant per unit of output. There may be changes in the prices of raw materials, wage rates etc., after a certain level of output has been reached due to shortage of material, shortage of skilled labour, concessions of bulk purchases etc. Similarly, the fixed costs do not remain static. They may change from one period to another. For example, salaries bill may go up because of annual increments or due change in pay rate etc.
CONTRIBUTION
Contribution margin of a product is the difference between the selling price and its variable cost. It is obtained by subtracting marginal cost from sales revenue of a given activity. The difference between sales revenue and variable cost is called contribution since it contributes towards fixed expenses and profit of the entire business.
It is also known as 'unit contribution margin' or 'marginal contribution per unit'.
In normal circumstances, selling prices contain an element of profit but there may be circumstances, when products may have to be sold at cost or even at loss. Therefore, the character of contributions will have the following composition under different circumstances:
(i) Selling price containing profit: Contribution = Fixed cost + Profit(ii) Selling price at Cost: Contribution = Fixed Cost(iii) Selling price at loss: Contribution = Fixed Cost – Loss
The contribution concept is based on the theory that the profit and fixed expenses of a business is a joint cost which cannot be equitably apportioned to different segments of the business. The concept of break-even analysis emerges out of this theory.
Example 1: Variable cost = ` 50,000; Fixed Cost = ` 20,000, Selling price = ` 80,000Contribution = Selling price – Variable Cost = ` 80,000 - ` 50,000 = ` 30,000Profit = Contribution – Fixed Cost = ` 30,000 - ` 20,000 = ` 10,000
Since, contribution exceeds fixed cost, the profit is of the magnitude of ` 10,000. Suppose the fixed cost is ` 40,000 then the position shall be:
Contribution – Fixed Cost = Profit = `30,000 - ` 40,000 = - ` 10,000The amount of ` 10,000 represents extent of loss since the fixed costs are more then the contribution. At the level of fixed cost of ` 30,000, there shall be no profit and no loss.
C0ST-VOLUME-PROFIT ANALYSIS
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Product A Product B Product CSales Revenue Sales Revenue Sales RevenueLess: Variable Cost Less: Variable Cost Less: Variable Cost= Contribution = Contribution = Contribution
Fund Towards Fixed Cost and Profits
The Cost-Volume-Profit (CVP) Analysis is the analysis of three variables cost, volume and profit. It helps management in finding out the relationship of costs and revenues to profit. It is a managerial tool showing the relationship between various ingredients of profit planning viz., cost, selling price and volume of activity.
The CVP analysis is very useful in profit planning. This analysis has facilitated the achieving of production and profit goals. As profit forecasting is possible in this accounting technique, CVP has gained popularity. Analysis of cost-volume-profit involves consideration of the interplay of the following factors:
(a) Changes in volume of sales;(b) Changes in selling price;(c) Changes in product costs per unit; and (d) Changes in variable costs per unit; and (e) Changes in total fixed costs.
The relationship between two or more of these factors may be(i) Present in the form of reports and statements.(ii) Shown in charts or graphs, or(iii) Established in the form of mathematical deductions.
Importance of CVP Analysis
It provides the information about the following matters:(i) The behavior of cost in relation to volume.(ii) Volume of production or sales, where the business will break-even.(iii) Sensitively of profits due to variation in output.(iv) Amount of profit for a projected sales volume.(v) Quantity of production and sales for a target profit level.
PROFIT-VOLUME RATIO
CVP analysis examines the behavior of total revenue, total costs and operating income as changes occur in the ouput level, the selling price, the variable cost per unit, or the fixed cost of a product.
Contribution per Unit = Selling Price Per Unit – Variable Cost Per Unit
The fixed production and selling overhead is fixed cost in terms of amount. This amount will continue to be the same at all levels of production and sales. The fixed overhead cost is net out of contribution and then the balance is profit.
Sales value (Selling price per unit × No. of units)Less: Variable Cost (Variable cost per unit × No. of units)
xxxxxxxx
Contribution Less: Fixed Costs
xxxxxxxx
Profit xxxx
P/V Ratio: It is called contribution to sales ratio (or profit volume ratio) = Contribution
Sales × 100
The P/V Ratio shows percentage of contribution to the sales value i.e. margin as percentage of sales out of it the fixed cost is met and there is a profit.
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Contribution = Sales Value × P/V Ratio
P/V ratio is a relative ratio. It cannot be adopted independently. If it is studied in an isolated way, it will not give much information. As fixed costs are not relevant in the calculation of P/V ratio, erroneous conclusions may be arrived.
How to improve P/V RatioP/V Ratio can be improved by:(i) Increasing the selling price.(ii) By reducing the variable costs.(iii) Reducing direct and variable costs by effectively utilizing men, machines and materials.(iv) Switching the production to more profitable products showing a higher P/V ratio.
P/V Ratio
= Contributation
SalesOr
= Sales –VariableCosts
SalesOr
= Change∈Contribution
Change∈SalesOr
= Change∈ProfitChange∈Sales
Que 1.[Computation of P/V Ratio]Calculate P/V Ratio in each of the following cases: Case (a) Contribution ` 3, Sales ` 15 Case (b) Sales ` 10 and Variable Cost ` 4 Case (c) Variable Cost ` 4, and Contribution ` 4 Case (d) Variable Cost to Sales Ratio 40% Case (e) Fixed Cost ` 2,000, Profit ` 400, Sales ` 6,000 Case (f) 2004 2005
Sales Profit
`4, 50,000 ` 60,000
` 5, 10,000 ` 75,000
Solution:
Case (a) P/V Ratio = ContributionSales × 100 =
Rs. 3Rs. 15 ×100
= 20%
Case (b) P/V Ratio = Sales – Variable CostSales × 100 =
Rs. 10 – Rs. 4Rs. 10 ×100
= 60%
Case (c) P/V Ratio = Contribution
VariableCost+C ontribution × 100 = Rs. 4Rs. 4 + Rs. 4 ×100
=50%
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Case (d) P/V Ratio = 100 – Variable Cost to sales Ratio =100 – 40 % = 60%
Case (e) P/V Ratio = Fixed Cost – ProfitSales × 100 =
Rs. 2000 + Rs. 400Rs. 6,000 ×100
= 40%
Case (f) P/V Ratio = Change in ProfitChange in Sales × 100 =
Rs. 75,000 – Rs. 60,000Rs. 5,10,000 ×100
= Rs. 15,000Rs. 60,000 × 100 =25%
Que 2.[Computation of New P/V Ratio]Selling Price per unit ` 10, Variable Cost per unit ` 4 Calculate P/V ratio in each of following cases:
(a). If selling price is reduced by 20%. (b). If selling price is increased by 20% (c). If variable cost is decreased by 25% (d). If variable cost is increased by 25% (e). If selling price and variable cost are reduced by 20% and 25% respectively. (f). If selling price and variable cost are increased by 20% and 25%respectively.
Solution:
New P/V Ratio = New selling Price - V ariable CostNew Selling Price ×100
(a) New P/V Ratio = (Rs. 10 – 20% of Rs. 10) – Rs. 4(Rs. 10 – 20% of Rs. 10) ×100 =50%
(b) New P/V Ratio = (Rs. 10 + 20% of Rs. 10) – Rs. 4(Rs. 10 + 20% of Rs. 10) ×100 =66
23%
New P/V Ratio = Selling Price -New V ariable CostSelling Price ×100
(c) New P/V Ratio = Rs. 10 -(Rs. 4 – 25% of Rs. 4Rs. 10 ×100 =70 %
(d) New P/V Ratio = Rs. 10 -(Rs. 4 + 25% of Rs. 4Rs. 10 ×100 =50%
New P/V Ratio = New Selling Price -New V ariable CostNew Selling Price ×100
(e) New P/V Ratio = (Rs. 10 – 20 % of Rs. 10) – (Rs. 4 – 25% of Rs. 4)(Rs 10 – 20 % of Rs. 10) ×100 =
62.5%
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New P/V Ratio = = (Rs. 10 + 20 % of Rs. 10) – (Rs. 4 + 25% of Rs. 4)(Rs 10 + 20 % of Rs. 10) ×100 = 58.33%
BREAK-EVEN ANALYSIS
Break-Even is the point where total revenue equals the total costs (variable and fixed). It is that level of activity at which n enterprise makes neither a loss nor any profit. At this point or level, the sales revenues are just equal to the costs incurred.
Methods for Determining Break-Even PointsBreak even analysis may be conducted by the following two methods:(i) Algebraic computations(ii) Graphic presentations
Algebraic Methods(i) Contribution Margin Approach
Break-Even Point (Units) = ¿Cost
Contribution per Unit
Break-Even point (`) = ¿Cost
P /V Ratio
Or = Break Even units × Selling price p.u.
P/V Ratio = Contribution
Sales × 100
Desired Sale = ¿Cost+Desired Profit
P/V Ratio
Desired sales or profit or fixed cost or to know variable cost we can use following equation i.e.,
Sales * P/V Ratio = Total Fixed Cost – Profit
At Break-Even Point: Contribution = Fixed Cost Contribution – Fixed Cost = 0
B.E.P (in %)=
¿CostsTotalContribution× 100
Or
= B . E . P .(¿ value)
TotalSales (¿value) × 100
Or
= B .E . P .(¿units)
TotalSales (¿units) × 100
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At BEP, Total Costs = Total Sales ….i
At BEP ∴Total CostTot al Sales = 1 ….ii
At BEP, Contribution = Fixed Cost ….iii
Or¿Cost
TotalContribution= 1 ….iv
(ii) Equation TechniqueIt is based on an income equation i.e.,
Sales – Total costs = Net ProfitBreaking up total costs into fixed and variable,Sales – Fixed costs – Variable cost = Net ProfitSales = Fixed costs + Variable cost + Net Profit i.e., SP(S) = FC + VC (S) + P.
Where, SP = Selling Price per unitS = Number of units required to be sold to break-evenFC = Total fixed costsVC = Variable cost per unitP = Net Profit (Zero)SP(S) = FC + VC (S) + 0SP (S) – VC (S) = FCOr, S(SP – VC) = FC FCS = FC (SP – VC)
To calculate the level of sales required to earn a particular level of profits, the formula is:Required Sales = (Fixed Cost + Desired Profit)/P/V ratio.
Assumptions of Break-Even Analysis
The Assumptions underlying break-even analysis are as below:(i) All costs can be easily classified into fixed and variable components.(ii) Both revenue of cost functions are linear over the range of activity under consideration.(iii) Prices of output and input remain unchanged.(iv) Productivity of the factors of production will remain the same.(v) The state of technology and process of production will not change.(vi) There will be no significant change in the levels of inventory.(vii) In the case of a multi-product company, the sales mix will remain unchanged.
Que 3.[Computation of New B.E.P]Selling Price per unit ` 10, Variable Cost per unit ` 4, Fixed Costs ` 35,000Calculate New B.E.P. in each of the following cases:
(a). If selling price is reduced by 20%.(b). If variable cost is decreased by 25%.(c). If fixed cost is increased by 20%.
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(d). If selling price and variable cost are decreased by 20% and 25% respectively and fixed cost is increased by 20%.
Solution:-
(a) New P/V Ratio = New Selling Price – Variable Cost
New Selling Price × 100
= (Rs10 – 20 % of Rs100)– Rs4
(Rs 10 – 20 %of Rs10) × 100 = 50%
New B.E.P. = ¿Cost
New P/V Ratio = Rs .35,00050 % = `
70,000
(b) New P/V Ratio = Selling Price – New Variable Cost
Selling Price × 100
=Rs 10 – (Rs 4 – 25 %of Rs 4 )
Rs .10 × 100 = 70%
New B.E.P. = ¿Cost
New P/V Ratio =Rs .35,000
70 % =
`50,000
(c) P/V Ratio = Rs 10 – Rs 4
Rs10 × 100 = 60%
New B.E.P. = New ¿Costs ¿P /V Ratio =
Rs 35,000+20 %of Rs35,00060 %
= ` 70,000
(d) New P/V Ratio = New Selling Price – NewVariable Cost
New Selling Price × 100
=(Rs 10 –20 % of Rs 10)– (Rs 4 – 25 % of Rs 4)
Rs10 – 20 %of Rs 10× 100
= 62.5%
New B.E.P. = New ¿Costs ¿New P/V Ratio
= Rs 35,000+20 %of Rs35,000
62.5% = ` 67,200
BREAK-EVEN CHART
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According to the Chartered Institute of Management Accountants, London, the Break-even chart means, “A Chart which shows profit or loss at various levels of activity, the level at which neither profit or nor loss is shown being termed as the break-even point”.
It is a graphic relationship between costs, volume and profits. It shows not only the BEP but also the effects of costs and revenue at varying levels of sales. The Break-even chart can, therefore, be more appropriately called the cost-volume-profit graph.
Computation of profit to earn a given level of profit
Output required to earn a given level of profit = O = F+ PS−V
Que 4.Selling Price per unit ` 10, Variable cost per unit ` 6, Fixed Cost ` 2,000. Calculate the number of units to be produced and sold to earn (a) zero profit (b) ` 400 (c) ` 500 Solution: S = ` 10, V = ` 6, F = ` 2,000
(a). O = F+ PS−V =
2,000+010−6 = 500 units
(b). O = F+ PS−V =
2,000+40010−6 = 600 Units
(c). O = F+ PS−V =
2,000+50010−6 = 625 units
MARGIN OF SAFETY
Margin of safety is the excess of sales over the break-even sales. It may also be considered as the excess of production over break-even point. It can be expressed in value as well as in percentage. The size of margin of safety shows the strength of the business. Small size of margin of safety indicates that the firm has large fixed expenses and is more vulnerable to changes in sales.In other words, if the margin of safety is large, a slight fall in sales may not affect the business very much but when it is small then a slight fall in sales may adversely affect the business. The margin of safety is calculated by using the following formula:
Margin of Safety = Proift
P /V Ratio or Profit
(Contribution+Sales)
Margin of safety is also immensely useful for making inter-firm comparison. This is being done by calculating their margin of safety ratio. This ratio can be calculated by using the following formula:
Margin of Safety Ratio = Marginof Safety
Sales × 100 = Actual Sales−Break Even Sales
Sales × 100
The soundness of a business is gauged by the size of the margin of safety. A low margin of safety usually indicates high fixed overheads so that profits are not made until there is a high level of activity to absorb fixed costs. A high margin of safety shows that break-even point is much· below the actual sales, so that even if there is a fall in sales, there will still be a point. A low margin of safety is accompanied by high fixed costs, so action is called for reducing the fixed costs or increasing sales volume.
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Measures for Improving Margin of SafetyMargin of Safety can be improved by taking the following measures:
(i) Increasing the selling price, provided the demand is inelastic so as to absorb the increased prices.
(ii) Reduction in fixed expenses.(iii) Reduction in variable expenses.(iv) Increasing the sales volume provided capacity is available.(v) Substitution or introduction of a product mixes such that more profitable lines are
introduced.
Que 5. [Computation of Margin of Safety]
Selling Price per unit ` 10, Variable Cost per unit ` 6 Fixed Cost ` 2,000, Actual Sales ` 20,000 Calculate Margin of Safety (in units).Margin of Safety (in value) and Margin of Safety (In %).
Solution: - Marginal Cost-SheetA. Actual Sales (in units) 2,000B. selling Price Per unit ` 10C. Total Sales (A × B) ` 20,000D. Less: Total Variable Cost (2000 × ` 6) ` 12,000E. Total Contribution (C - D) ` 8,000F. Less: Fixed Costs ` 2,000G. Profit ` 6,000
Margin of Safety(in units)
= Profit
Contribution per unit = Rs 6,000
Rs 10 – Rs 6 = 1500 units
Margin of Safety(in value) =
ProfitContribution per unit × Selling Price per unit
= Rs 6,000
Rs 10−Rs 6 × ` 10 = ` 15,000
Margin of Safety(In %) =
Marginof Safety (¿units)Actual Sales(¿units) × 100
= 15002000 × 100 = 75%
Or,
= Marginof Safety (¿Value )
Actual Sales(¿units) ×100
= Rs 15,000Rs .20,000
× 100 =75%
Or
=Profit
TotalContribution × 100 = Rs 6,000Rs 8,000 × 100 = 75%
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Que 6.The following information is given by Bharat Ltd. Selling Price per unit ` 10, Variable Cost per unit ` 6, Fixed Costs ` 24,000
You are required to calculate:
a) Profit-Volume Ratio b) Break-even Sales (in units) and (in rupees) c) Profit when sales are 10% above the Break-even Sales d) Sales to earn profit of ` 4,000 e) Sales to earn profit of ` 2 per unitf) New B.E.P. if selling price is reduced by 10% g) Margin of Safety sales if profit is ` 60,000.
Solution:-(a) Profit – Volume Ratio = Contribution / Sales × 100 = ` 10 – ` 6 / ` 10 × 100 = 40%(b) B.E.P. (in units) = Fixed Costs / Contribution per unit = ` 24,000 / ` 4 = 6,000 units
B.E.P. (in Rs) = Fixed Costs / P/V Ratio = ` 24,000 / 40% = ` 60,000(c) rofit When Sales are 6,600 units (i.e. 6,000 + 10% of 6,000)
A. No. of Sales units B. Selling Price per unit C. Total Sales D. Less: Variable Cost (6,600 × ` 6) E. Contribution F. Less: Fixed Costs G. Profit
6,600` 10
` 66,000` 39,600` 26,400` 24,000` 2,400
Alternatively Profit on 600 units = (600 × ` 10) × 40% = ` 2,400
(d) Sales to earn a profit of ` 4,000 Desired Sales (in Units) = Fixed Cost + Desired Profit / Contribution per unit
= Rs 24,000+Rs 4,000
Rs 4 = 7,000 units.
Desired Sales (in units) = ¿Cost+Desired Profit
P/V Ratio = ` 70,000
(e) Sales to earn a profit of ` 2 per unit Let Desired Sales be x and hence Desired Profit is ` 2x. Desired Sales (in units) x = Fixed Cost + Desired Profit / Contribution Per Unit = ` 24,000 + ` 2x / ` 4x = ` 24,000/2 = 12,000 units. Desired Sales (in `) = 12,000 × ` 10 = ` 1,20,000
(f) New Contribution = (` 10 - ` 1) – ` 6 = ` 3 B.E.P. (in units) = Fixed Costs / Contribution Per Unit = Rs 24,000 / Rs 3 = 8,000 units
B.EP. (in `) = ¿Costs
Contribution Perunit × Selling Price per unit
= 24,000
3 × ` 9 = ` 72,000
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(g) Margin of Safety = Profit
P /V Ratio
= 60,00040 % = ` 1,50,000
ANGLE OF INCIDENCEThe angle between the total cost line and total sales line shows the angle of incidence. It is an indicator of profitability above the break-even point. If the angle is large, the firm is said to make profits at a high rate and vice-versa. A high angle of incidence and a large margin of safety indicate sound business conditions.Example 3: DAKSH Ltd. provides the following data:Sales: ` 4,00,000, Variable costs: ` 2,40,000, Fixed costs: ` 1,00,000 and Net Profit : ` 60,000.Required: Draw a Profit-Volume graph and show the angle of incidence.
Solution:
From the above graph, the following data can be calculated:
P/V Ratio = Sales – Variable Expenses × 100/Sales= (` 4,00,000 - ` 2,00,000 × 100)/ ` 4,00,000= (` 1,60,000 × 100) / ` 4,00,000 = 40%
BEP = Fixed Cost/ P/V Ratio = (` 1,00,000 × 100)/40 = ` 2,50,000
Margin of Safety = Profit / P/V Ratio = ` 60,000/40% = ` 60,000 × 100/40 = ` 1,50,000
LIMITATIONS OF BREAK-EVEN POINT
The limitations of a break-even chart are as follows:
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Break-Even Point: It is the level of activity at which total only of the units equal total revenue, leaving no profit of loss.
(i) While preparing a break-even chart, it is assumed that revenue and costs can be represented with the help of straight lines. It may not always be true.
(ii) The preparation of a break-even chart requires the segregation of semi-variable costs into fixed and variable components. It may not always be possible to segregate semi-variable costs into fixed and variable elements accurately. There may be situation when semi-variable cost cannot be split.
(iii) A break-even chart assumes the selling price and variable cost per unit are constant at all levels of activity. It may not always be ture. Selling price as well as variable cost may either increase or decrease with the change in volume. Fixed costs also tend to vary beyond a certain output.
(iv) When a firm produces a number of products the apportionment of fixed expenses over various products may be difficult and often it may be done arbitrarily.
(v) A break-even chart assumes that business conditions will not change. This is hardly so.
(vi) A break-even chart does not consider the amount of capital employed in the business a very important factor for determining profitability of a concern.
Que 7.From the following information, you are required to find out (i) margin of safety; and (ii) volume of sales required earning profit of 10% on sales:
Total fixed cost (`) Total variable cost (`) Total sales (`) Sales (units)
4,500 7,500
15,000 5,000
Solution:
(i)Contribution per Unit = Sales−Variable Expenses
Units sold
= Rs .15,000−Rs .7,500
5000 = ` 1.5
Break-even Point = ¿ expense
Contribution per unit = Rs .4,500
Rs .1.5 = 3,000 units
Break-even Point Sales = 3,000 × ` 3 = ` 9,000
Margin of Safety = Actual Sales - Sales at Break-even Point = ` 15,000 - ` 9,000 = ` 6,000
(ii) Let units sold be x. Then the sales @ ` 3per unit will be = 3x Now 3x = 1.5x + 4,500 + .3x Or 1.2x = 4500 or x = 3750 units Or ` 3 × 3,750 units = ` 11,250. Volume of sales required to earn profit of 10% on sales = 3.750 units Or 3,750 × ` 3 = ` 11,250.
CASH BREAK-EVEN POINT
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When break-even point is calculated only with those fixed costs which are payable in cash, such a break-even point is known as cash break-even point. This means that depreciation and other non-cash fixed costs are excluded from the fixed costs in computing cash break-even point. Its formula is –
APPLICATIONS OF MARGINAL COSTING IN DECISION MAKING
PROFIT PLANNINGThere are four ways in which profit performance of a business can be improved:(a) By increasing volume;(b) By increasing selling price;(c) By decreasing variable costs; and (d) By decreasing fixed costs.Profit planning is the planning of future operations to attain maximum profit or to maintain a specified level of profit. The contribution ratio (which is the ratio of marginal contribution to sales) indicates the relative profitability of the different sectors of the business whenever there is a change in selling price, variable costs or product mix.
Pricing decision in special circumstances
The problem of pricing can be summarized under three heads –
(a) Pricing in period of recession: During recession times, a firm may sell its articles at a price less than the total cost but above the marginal cost for a limited period. This enables the firm to produce and use the services of skilled employees who are well-trained, to avoid deterioration of plant and machinery if kept idle, to keep the competitor away from securing the business of the firm and to take advantage of improved business conditions at a later date.
(b) Differential selling prices: There are two ways of doing this:
(i) The firm producing the branded article which covers the entire fixed overheads and uses the surplus capacity to produce another article which may be sold at a price above its marginal cost.
(ii) A firm may produced and sell a branded article which covers the entire fixed overheads and uses the surplus capacity to produced another article which may be sold at a price above its marginal cost.
(c) Acceptance of an offer: When a firm having surplus capacity receives an offer from a special or export market, a decision as to whether or not to accept the offer can be taken after analysis of the incremental cost and incremental revenue.
Submission of Tender: For submitting tender also the incremental cost and incremental revenue analysis is useful.
Make-or-buy Decisions: When the management is confronted with the problem whether it would be economical to purchase a component or a product from outside sources, or to manufacture it
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Cash break-even Point = Cash ¿Costs ¿
Contribution per unit
internally, marginal cost analysis renders useful assistance in the matter. Under such circumstances, a misleading decision would be taken on the basis of the total cost analysis. In case the proposal is to buy from outside, then what is already being made, and the price quoted by the outsider should be lower than the marginal cost. If the proposal is to make something that is being purchased outside, the cost of making should include all additional costs like depreciation on new plant, interest on capital involved and that cost should be compared with the purchase price.
Retain or Replace Decision: There are three major methods to arrive at a decision whether machine should be retained or replaced.(a) Marginal costing approach(b) Differential cost approach with interest on capital (c) Discounted cash flow method.
Shut down or continue: Very often, it becomes necessary for a firm to temporarily close down the factory due to trade recession with a view to reopen it in future. In such cases decisions should be based on the marginal cost analysis.Export vs. local sale: When the firm is catering to the needs of the local market and surplus capacity is still available, it may think of utilising the same to meet export orders at a price lower than that prevailing in the local market.
Change vs status quo: Any change regarding the firm or the decision to maintain status quo must be taken after proper marginal cost analysis.
Expand or contract: Considerations should be given to the following:(a) Additional fixed expenses to be incurred.(b) Possible decrease in selling price due to increase in production.(c) Whether the demand is sufficient to absorb the increased production.
Product Decisions: Many times the management has to take a decision whether to produce one product or another instead.
KEY FACTOR OR LIMITING FACTOR
Key Factor or Limiting factor represents a resource whose availability is less than its requirement. It is factor, which at a particular time or over a period limits the activities of a firm. It is also called Critical Factor (since it is vital or critical to the firm’s success) and Budget Factor (since budgets are formulated by reference to such limitations or restraints).
Examples of Key Factors: (a) Shortage of raw material; (b) Labour Shortage; (c) Plant capacity; (d) Sales Expectancy; (e) Cash availability etc.
In case of key factor situation the procedure for decision-making is as under:Steps Description
Step 1Step 2Step 3
Step 4Step 5
Identify the key factorCompute total contribution or contribution per unit of the product.Compute contribution per unit of the key factor, i.e. Contribution per hour, contribution per kg of raw material etc.Rank the products based on contribution per unit of the key factor.Allocate the key resources based on ranks given above.
To decide upon the priority of products, the following guidelines may be used:
Case Basis for deciding upon the priority of
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products(a) If maximum sales (in units) is s limiting
factor(a). Contribution per unit
(b) If maximum sales (in value) is a limiting factor
(b). Profit-volume ratio (or P/V Ratio)
(c) Of raw material is a limiting factor (c). Contribution per unit of raw material required to produce one unit of a product
(d) If labour hour is a limiting factor (d). Contribution per unit of labour hour required to produce one unit of a product
(e) If machine hour is a limiting factor (e). Contribution per unit of machine hour required to produce one unit of a product
(f) If there is heavy demand for the product (f). Profit/Volume Ratio (or P/V Ratio)(g) If there is low demand for the product (g). Low Break even point
Que 8. (Key Factor)X Ltd. which produces two products using the same raw-material and production facilities, provides you the following information:
Product A`
Product B`
Selling Price per unit 100 80Material @ ` 2 per kg 20 10Labour @ ` 3 per hour 15 30Variable Overheads @ ` 4 per machine hour 40 16Total fixed overheads: ` 6,00,000
Required: Comment on the profitability of each product when: (a) Sales Quantity is limited; (b) Sales Value is limited; (c) Raw-material is in short supply; (d) labour hours are limited; (e) Production Capacity (in terms of Machine Hours) is limited;
Solution:- Statement showing the Contribution per unit of key factorParticulars Product A
`Product B
`A. Selling Price per unit 100 80B. Less: Variable Cost
Material 20 10Labour 15 30Variable overheads 40 16
75 56C. Contribution per unit (A - B) 25 24
D. P/V Ratio Contribution
Sales × 100 25% 30%
E. Contribution per kg of Material ( Contribution per unit / Raw material required per unit)
`2510 = ` 2.5 `24
5 = ` 4.8
F. Contribution per labour hour ( Contribution per unit / Labour hours required per unit)
`255 = ` 5 `24
10 = Rs. 2.4
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G. Contribution per Machine hour ( Contribution per unit / Machine hrs required per unit)
`2510 = ` 2.5 `24
4 = ` 6
H. Break Even Point (Fixed Overheads / Contribution per
unit) `6,00,000
25 = 24,000 units `6,00,00024 = 25,000 units
A) When sales quantity is limited, Product A is more profitable because its contribution per unit is higher than that of Product B.
B) When sales value is limited, Product B is more profitable because its P/V Ratio is higher than that of Product A.
C) When Raw- Material is in short supply, Product B is more profitable because its contribution per kg. of raw material is higher than that of Product A.
D) When Labour hours are limited, Product A is more profitable because its contribution per labour hour is higher than that of Product B.
E) When Production capacity in terms of machine hours is limited , Product B is more profitable because its contribution per machine hour is higher than that of Product A.
Que 9.You are given the following information in respect of products X and Y of Bee Cee Co. Ltd.
Product X Product YSelling price ` 42 ` 33Direct material ` 15 ` 15Labour hours (50 paise per hour) 18 hours 9 hoursVariable overheads 50% of Direct wagesShow which product is more profitable during labour shortage.
Solution:Computation of Marginal Contribution
Product X Product YSelling price 42.00 33.00Less: Variable cost 28.50 21.75Marginal contribution 13.50 11.25
Profitability = Contribution
Key factor
For product X = 13.518 = 0.75
For product Y = 1125
9 = 1.25
Thus, product Y is more profitable than X during labour shortage. Que 10. (Accepting an Offer or Exporting Below Normal Price)The cost of a manufacturing company for the product is:
`Materials 12.00
9.006.00
Labour Variable expenses
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18.0045.00
Fixed expenses Total
The unit of product is sold for ` 51. The company's normal capacity is 1, 00,000 units. The figures given above are for 80,000 units. The company has received an offer for 20,000 units @ ` 36 per unit from a foreign customer.Advice the manufacturer on whether the order should be accepted. Also give your advice if the order is from a local merchant.
Solution:Marginal cost for additional 20,000 units
Per unit for 20,000 unitsMaterial 12.00 2, 40,000Labour 9.00 1, 80,000Variable expenses 6.00 1, 20,000Marginal cost 27.00 5, 40,000Additional revenue to be realised 7, 20,000Marginal cost 5, 40,000Net additional revenue (Marginal contribution) 1, 80,000
The offer should be accepted because it gives an additional contribution of ` 1, 80,000. The total profit will also increase by ` 1, 80,000 because fixed expenses have already been recovered from the local market. Further some, the order from the local customer should not be accepted at ` 36 per unit or at any rate below the normal price i.e., ` 45 because it will result in the general reduction of selling prices of the product.
Note: Acceptance of the additional order should not lead to production being in excess of the present capacity since, in that case, some fixed expenses may also go up substantially. If there is such an increase in fixed expenses, the increase should also be considered by inclusion in the total additional cost to be compared with the additional revenue. When alternative use of production facilities or alternative methods of manufacturing a product are available, contribution analysis should be used to arrive at the final choice. The alternative which will yield highest contribution shall generally and obviously be selected.
Que 11. (Make or Buy)Piquant Ltd. produces a variety of products, each having a number of component parts. Component-B has a selling price of ` 50 and a marginal cost of ` 30 per unit. It takes 5 hours to process on machine working to full capacity. Component A-10 used for Product-A could be made on the same machine in 2 hours for a marginal cost of ` 5 per unit. The supplier's price is ` 12.50. Should Piquant Ltd. make or buy Component A-10? Assume that machine hours are limited.
Solution:Contribution per unit of Component B = ` 50 - ` 30 = ` 20
Contribution per machine hour = Rs .20
5 = ` 4
If Component 'A-10' is produced, contribution lost = ` 4 × 2 = ` 8 So the full cost of producing one unit of component 'A-10' = ` 5 +8 = ` 13 Since it is available, in the market at ` 12.50, it is economical to buy Component A-10
COMPOSITE BREAK EVEN POINT
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A business undertaking may have different manufacturing establishments each having its own production capacity, and fixed costs but producing the same product. At the same time, the concern as a whole is a unit having different establishments under the same management. Hence the combined fixed costs have to be met by the combined BEP sales. In this analysis, there are two approaches namely:
(i). Constant product mix approach. (ii). Variable product mix approach. Under the first approach, the ratio in which the products of the various establishments are mixed is constant. This mix will be maintained at BEP sales also. Under the second approach the product of that establishment would be preferred where the contribution ratio is higher. The above two approaches are explained by the following illustration.
Que 12.There are two plants manufacturing the same products under one corporate management which decides to merge them.
Following particulars are available regarding the two plants:
Plant I Plant IICapacity operation 100% 60%Sales ` 6,00,00,000 ` 2,40,00,000Variable costs ` 4,40,00,000 ` 1,80,00,000Fixed costs ` 80,00,000 ` 40,00,000
You are required to calculate for the consideration of the Board of directors:(a) What would be the capacity of merged plant to be operated for purpose of break-even? (b) What would be the profitability on working at 75 per cent of the merged capacity?
Solution: Note: Sales and variable costs of Plant II must be brought from 60% to 100% before merger of two plants data at 100% capacity operation.
(a) Calculation of the Capacity of Merged Plant to Break-even at 100% Capacity.
P/V Ratio = Contribution
Sales × 100 = P/V Ratio
=2,60,00,00010,00,000 × 100 = 26 per cent.
Sales at Break-even Point = ¿Costs
P /V Ratio
= `1,20,00,000 / 26% = ` 4,61,53,846 (Approx.)
In terms of percentage capacity, sales at break-even point work out to 46.15 per cent approximately.
(` 4,61 ,53,84610,00,00,000 × 100)
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Workings Notes:
Sales at 100% capacity = ` 6, 00, 00,000 + (10060 × ` 2, 40, 00,000)
= ` 10, 00, 00,000
Contribution at 100% capacity = (` 6, 00, 00,000 - ` 4, 40, 00,000)
+ (10060 + ` 2, 40, 00,000)
- (10060 + ` 1, 80, 00,000)
= ( ` 1, 60, 00,000) + ( ` 1, 00, 00,000)
= ` 2, 60, 00,000.
(b) Calculation of profit on working at 75% of the merged capacity.
Marginal Cost Statement`
Sales (75% of `. 10, 00,000) 7,50,00,00075% of (` 4, 40, 00,000) + 100/60 × ` 1, 80,00,000 5,55,00,000Contribution 1, 95, 00,000Less: Fixed Costs 1, 20, 00,000Profit 75, 00,000
Que 13.Two manufacturing companies which 'have the following operating details decided to merge:
Company - I Company IICapacity utilisation (%) 90 60Sales (` in lakhs) 540 300Variable costs (` in lakhs) 396 225Fixed costs (` in lakhs) 80 50
Assuming that the proposal in implemented, calculate-1. Break-even sales of the merged plant and the capacity utilisation at that stage. 2. Profitability of the merged plant at 80% capacity utilisation.3. Sales turnover of the merged plant to earn a profit of ` 75 lakh.
Solution:1. Position of the Merged Plant at 100% capacity
Company I Company II TotalSales 600 500 1,100 Less: Variable Costs 440 375 815Contribution 160 125 285 Less: Fixed Costs. 80 50 130
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Profit 80 75 155
P/V Ratio of the merged plant = [(Contribution + Sales) × (100)]
=285
1,100 × 100 = 25.909%
Break even sales of the merged plant ¿Cost
P /V Ratio = 130× 1,100
285 = ` 501.75 lakhs
Percent of capacity utilization =501.751,100 × 100 = 45.61%
2. Profitability of the merged plant at 80% capacity ` (Lakhs)
Sales (at 80% capacity i.e., 80% of ` 1,100 lakh) 880Less: Variable Costs (80% of ` 815 lakh) 652Contribution 228Less: Fixed costs 130Profit 98
OR Total contribution at 80% capacity = 2851akh × 80% 228Less: Fixed Costs 130Profit
Profitability = 98 ×100
880 = 11.14% 98
3. Sales required to earn a profit of ` 75 lakh:
¿Cost+Desired ProfitP/V Ratio =
Rs .130 Lakh+Rs .75 lakh285 /1100
OR
= 205× 1,100
285 = ` 791.23 lakh
INDIFFERENCE POINTIt is level of sales at which total cost (and hence total profits) of two options are equal. The decision-maker is indifferent as to option chosen since both options will result in the same amount of profit.
Indifference Point (In `) = Difference∈¿Cost
Difference∈Variable cost ratio
= Differnece∈¿Cost
Difference∈PV Ratio
Indifference Point (Quantity) = Difference∈¿Cost
Difference∈Variable Cost per Unit
= Difference∈¿Cost
Difference∈Contribution per unit
Indifference point represents a cut-off indicator for deciding on the most profitable option. At the level of sales (i.e. indifference point)
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Level of Sales Most Profitable Option to be Reason(i) Below Indifference Point Option with lower fixed cost Lower the fixed cost, lower
will be the BEP, Hence more profits beyond the BEP.
(ii) At Indifference Point Both Options are equally profitable
Indifference point
(iii) Above indifference point Option with Higher PV ratio (lower variable cost)
The higher the PV ratio the better it is.
ASSUMPTIONS OF CVP ANALYSIS
(i) There is a linear function and a linear cost function.(ii) Price, total fixed costs and unit variable costs can be accurately identified and remain
constant over the relevant range.(iii) What is produced is sold.(iv) For multiple product analysis, the sales mix is known.(v) The selling price and costs are known with certainty.
CVP ANALYSIS UNDER RISK AND UNCERTAINTY
A variety of methods can be used by managers to cope with risk and uncertainty to apply CVP analysis. Some of them are following:
1. Management must realize the uncertain nature of future prices, cost and quantities.2. Managers should more away from consideration of break-even point to what might be
called a break-even band.3. Managers may engage in sensitivity or what-if analysis.4. Normal probability distribution can be used to estimate the risk.5. Two concepts useful to management are margin to safety and operating leverage. Both
the concepts are considered as measures of risk.
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JUDGE URSELF
Que 14.A product is sold at a price of ` 120 per unit and its variable cost are ` 80 per unit. The fixed expenses of the business are ` 8,000 per year. Find (i) BEP in ` and units, (ii) profits made when sales are 240 units, (iii) Sales to be made to earn a net profit of ` 5,000 for the year.
Que 15.From the following figures ascertain the break-even sales.
`Sales Fixed Costs Variable costs
20,00,0005,00,000
12,00,000Que 16.The sales of a company are @ ` 200 per unit Variable cost Fixed cost The capacity of the factory
` 20,00,00012,00,000
6,00,00015,000 units
Determine the BEP. How much profit is the company making?
Que 17.Sales are ` 1, 50,000, producing a profit of ` 4,000 in period I. Sales are ` 1, 90,000, producing a profit of ` 12,000 in period II. Determine the BEP.
Que 18.A factory produces 300 units of a product per month. The selling price is ` 120 and variable cost ` 80 per unit. The fixed expenses of the factory amount to ` 8,000 per month. Calculate: (i) the estimated profit in a month wherein 240 units are produced, (ii) the sales to be made to earn a profit of ` 7,000 per month.
Que 19.A company has annual fixed cost of ` 1, 40, 00,000. In the year 2007 - 08, sales amounted to ` 6, 00, 00,000 as compared with ` 4, 50, 00,000, in the preceding year 2006-07. Profit in 2007-08 is ` 42,00,000 more than that in 2006-07. On the basis of the above information, answer the following:
1. At what level of sales, the company would have break-even?2. Determine profit/loss on a forecasted sales volume of ` 8, 00, 00,000. 3. If there is a reduction in selling price by 10% in the financial year 2008 - 09 and company
desires to earn the same amount of profit as in 2007 - 08, what would be the required sales volume?
Que 20.The sales turnover and profit during two periods were as follows. Period-1 - Sales: ` 20 lakh; and Profit: ` 2 lakh Period-2 - Sales: ` 30 lakhs; and Profit: ` 4 lakh
Calculate: 1. P/V ratio; 2. Sales required to earn a profit of ` 5 lakh; and 3. Profit when sales are ` 10 lakh.
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Que 21.A company sells its products at ` 15 per unit. In a period if it produces and sells 8,000 units, it incurs a loss of ` 5 per unit if the volume is raised to 20,000 units; it earns a profit of ` 4 per unit. Calculate break-even point in terms of rupees as well as in units.
Que 22.Calculate the 'break-even-point' in units and in rupees and also arrive at 'margin of safety ratio' from the following information:
`Estimated sales (1,00,000 units)Less: Variable cost 12,00,000Fixed cost 4,00,000Net profit
20,00,000
16,00,0004,00,000
Que 23.Dinesh Ltd. has provided following information: Sale price Variable cost Fixed overheads
` 20 per unit ` 14 per unit ` 7, 92,000 per annum.
How many units must be sold to earn 10% of sales?
Que 24.A company produces a single product and sells it at ` 200 each. The variable cost of the product is ` 120 per. unit and the fixed cost for the year is ` 96,000. Calculate:
1. P/V ratio.2. Sales at break-even point.3. Sales units required to earn a target net profit of ` 1, 20,000.4. Sales units required to earn a target net profit of `1, 00,000 after income-tax, assuming
income-tax rate to be 50%.5. Profit at sales of ` 7, 00,000.
Que 25.Kaku Ltd. produces one standards type of article. The results of the last four months of the year 2013 are as follows:
Output unitsSeptember, 2013 200October, 2013 300November, 2013 400December, 2013 600
Prime cost is `10 per unit. Variable expenses are `2 per unit. Fixed expenses are `36,000 per annum. Find out the cost per unit in each month.
[Ans.: September: ` 27.00, October: `22.00,November: `19.50, December: `17.00].
Que 26.From the following data, which product would you recommend to be manufactured in a factory, time being the key factor?
Per unit of Product A
Per unit of Product B
Direct material 24 14Direct labour(`1 per hr.) 2 3
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Variable overhead(`2 per hr.) 4 6Selling price 100 110[Ans.: Contribution per hour: A: `35 per hr., B: `29 per hr. Therefore product ‘A’ is recommended].
Que 27.From the following information, find out the amount of profit earned during the year using the marginal costing technique:
Fixed cost ` 5,00,000Variable cost `10 per unitSelling price `15 per unitOutput level 1,50,000 units
[Ans.: Profit: `2,50,000]Que 28.From the following data, recommend the most profitable product mix, presuming that direct labour hours available are only 700:
Products A B
Contribution per unit `30.00 `20.00Direct labour per unit 10 hrs. 5 hrs.
The maximum production possible for each of the products A and B is 100 units. Fixed overheadsare`2,000.
[Ans.: Product A - 20 units, Product B - 100 units; Net Profit - `600]
Que 29.A factory produces 1, 00,000 units and sells the whole quantity @ `40. The variable cost is `18 and the fixed cost is `5 per unit. An order is received for 20,000 units @ `26 per unit. State the circumstance(s) in which the order should be accepted.
[Ans: If there is idle capacity and if the order is from govt. or from abroad]
Que 30.A company produces a component for its main product at a cost of `15 per unit the operations are heavily mechanised. An outsider offers to supply the component at 14, should the offer be accepted?
Que 31.You are given the following data for the coming year of a factory:
Budgeted output 80,000 unitsFixed expenses `4,00,000Variable expenses per unit `10Selling price per unit `20
Draw a break even chart showing the break-even point. If the selling price is reduced to `16 per unit what will be the new break-even point?
Que 32.(a) Explain P/V ratio.
(b) The sales turnover and profit during two periods were as follows:Period No. 1 Sales `20 lakhs Profit `2 lakhsPeriod No. 2 Sales `30 lakhs Profit ` 4 lakhs
(i) Calculate P/V Ratio, (ii) The sales required to earn a profit of `5 lakhs.
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Que 33.From the following results of a company, determine by how much the value of sales must be increased for the company to break-even?
Net sales `4,00,000Fixed costs `2,00,000Variable costs `2,40,000
Que 34.Golden Ltd. has annual fixed cost of `1,20,000. In the year 2010 sales amounted to `6,00,000 as compared with `4,50,000 in 2009 and the profit for 2010 was `50,000 higher than in 2009. You are required to:
(i) Estimates profits for 2011 on forecast sales volume of `8,40,000 on the assumption that this would not involve any addition to the company’s capacity; and
(ii) Calculate the break-even sales volume (in rupees) [Ans.: (i) `1,50,000 (ii) `3,60,000]
Que 35.Following information are available from the cost records of a manufacturing company:
Fixed expenses `4,000Break-even point `10,000
You are required to calculate:(i) P/V ratio(ii) Profit where sales are `20,000(iii) New break even point if selling price is reduced by 20%.
[Ans.: (i) 40%; (ii) `4,000; (iii) `16,000].Que 36.From the following information, calculate the break-even point and the turnover required to earn a profit of `36,000.
`Fixed overheads Variable cost per unit Selling price
1,80,0002.0020.00
If the company is earning a profit of `36,000 express the margin of safety available to it.[Ans.: 10,000 units; `2,40,000; `40,000]
Que 37.Merry Manufacturers Ltd., has supplied you the following information in respect of one of its products:
Total fixed costs 18,000Total variable costs 30,000Total sales 60,000Unit sold 20,000
Find out:(a) Contribution per unit,(b)Break-even point,(c) Margin of safety(d)Profit and(e) Volume of sales to earn a profit of `24,000.
[Ans.: (a) `1.50; (b) 12,000 units; (c) 8,000 units; (d) `12,000; (e) 28,000 units].
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Que 38.State, with reasons in brief, whether the following statements are true or false:1. When a factory operates at full capacity, fixed cost also becomes relevant for make or buy
decision2. Semi-variable costs are ignored in marginal costing.3. ‘Cost volume profit relationship’ is a more comprehensive term than ‘break-even analysis.4. Margin of safety is the difference of actual sale and standard sale.5. Contribution is not only the criterion for deciding profitability.Solution:(i) True, (ii) False, (iii) True, (iv) False, (v) True]
Que 39.Write the most appropriate answer from the given options in respect of the following:(i). Product cost under marginal costing include —
(a) Prime cost only(b)Prime cost and fixed overheads(c) Prime cost and variable overheads(d)Material cost and variable overheads.
(ii). Fixed cost per unit increases when ––(a) Production volume decreases(b)Production volume increases(c) Variable cost per unit decreases(d)Variable cost per unit increases.
(iii). The costing method in which fixed factory overheads are added to inventory is —(a) Direct costing(b)Marginal costing(c) Absorption costing(d)Activity based costing.
(iv). When the sales increase from `40,000 to `60,000 and profit increases by `5,000, the P/V ratio is(a) 20%(b)30%(c) 25%(d)40%.
(v). A company which has a margin of safety of `4,00,000 makes a profit of `80,000. Its fixed cost is ` 5,00,000, its break-even sales will be —(a) `20 lakh(b)`30 lakh(c) `25 lakh(d)`40 lakh.
(vi). Absorption means —(a) Charging of overheads to cost centres(b)Charging of overheads to cost units(c) Charging of overheads to cost centres or cost units(d)None of the above
(vii). Fixed costs remain fixed —(a) Over a short period
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(b)Over a long period and within relevant range(c) Over a short period and within a relevant range(d)Over a long period.
Solution:(i) (c), (ii) (a), (iii) (c), (iv) (c), (v) (c), (vi) (a) or (c), (vii) (c)
Que 40.Re-write the following sentences after filling-in the blank spaces with appropriate word(s)/ figure(s) :(a) At break-even point, the contribution will be equal to __________. (fixed costs)(b)Excess of budgeted revenues over the break-even revenue is called__________, (Margin of
Safety)(c) When there is no _______, profit figures revealed under marginal and absorption costing areidentical. (Inventories)
Que 41.Explain Cost-Volume-Profit (CVP) analysis.
Answer:Cost-Volume Profit Analysis: A producer always wishes to produce and sells a product till sales revenue at least equal to marginal costs plus fixed costs. Marginal costs are closely connected with volume and vary directly and proportionately with variations in volume.
On the other hand, fixed Costs remain constant and are not affected by the change in the volume of production. Thus, the amount of profit on the sale of a product depends upon the volume of production and its cost. Thus, we see that there is a close relationship between volume cost and profit. When an effort is made to establish this relationship; that process is known as 'cost volume profit analysis'. The cost volume profit analysis is an attempt to measure the effect of changes in :
(a) Volume of production(b) Cost (c) Price (selling) and (d) Product mix on profit
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TRAIN UR BRAIN
1. Marginal Costing is important to understand the relationship between cost, value, and profiting in -a) Financial Accountingb) Management Accountingc) Cost Accountingd) Computerized Accounting
2. In cost accounting marginal cost does not include – a) Fixed Cost b) Variable Costc) Inventory Costd) None of the above
3. The profit volume ratio indicates – a) The value of profitb) The value of salec) The rate of profitd) The rate of turnover
4. Sales minus variable cost = Fixed cost plus – a) Purchase b) Profitc) Variable Cost d) Loss
5. Total cost is equal to _________ at break-even point.a) Purchase Value b) Inventory Valuec) Sales value d) Profit
6. Profit is equal to – a) P/V Ratio ÷ Margin of Safety Salesb) P/V Ratio + Margin of Safety Salesc) P/V Ratio - Margin of Safety Salesd) P/V Ratio × Margin of Safety Sales
7. Contribution minus ___________ Cost is profit.a) Fixed b) Primec) Variable d) Direct
8. Margin of safety sales indicates –a) Total Sales ÷ Breaks even sales b) Total Sales × Breaks even salesc) Total Sales + Breaks even salesd) Total Sales - Breaks even sales
9. Break Even sales =
a)¿Cost
P /V Ratio
b)¿Cost
TotalCost × Sales
c)¿Cost
Contribution per unit
d)P /V Ratio
¿Cost10. When value of production in nil, the loss
will be equal to –
a) Prime cost b) Period costc) Fixed Cost d) Variable Cost
11. A large margin of safety means – a) Over productionb) Under Productionc) Under capitalizationd) The favourable condition of business
12. When contribution sales ratio is 30% and margin of safety in 10%, then profit will be –a) 10% b) 30%c) 12%d) Cannot be computed
13. Margin of safety can be improved by reducing the – a) Variable Cost b) Prime Costc) Period Cost d) Fixed Cost
14. When the firm neither earn profit nor incur loss, then it is known as - a) Margin of safety b) P/V Ratioc) Break-even pointd) None of the above
15. P/V ratios shows the relation between – a) Fixed cost and salesb) Variable cost and salesc) Profit and salesd) Contribution and sales
16. Marginal costing is also known as -a) Direct Costingb) Absorption Costingc) Variable Costd) Variable Costing
17. If the fixed cost exceeds the amount of contribution, it represents – a) Profit b) Loss c) Surplus d) Deficit
18. In ‘make or buy’ decisions, it is profitable to buy from outside only when the suppliers price is below the firm’s own –a) Fixed Cost b) Variable Costc) Contribution d) Profit
19. Marginal costing technique help in –a) Decision Makingb) Controlling costsc) Both (a) and (b)d) None of the above
20. An increase in variable cost – a) Reduces contributionb) Increases profit-volume ratioc) Increase margin of safety
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d) None of the above21. For make or buy decision variable cost
should be compared with ________ price.a) Cost b) Invoicec) Marketd) None of the above
22. Contribution =a) Sales + P/V Ratiob) Sales - P/V Ratioc) Sales × P/V Ratiod) Sales ÷ P/V Ratio
23. Break even is the point at which –a) TR > TC b) TR < TCb) TR = TCc) None of the above
24. A low margin of safety usually indicate high – a) Fixed costb) Fixed overheadsc) Fixed Incomed) All of the above
25. If total sales of a company is ` 9,60,000 and profit is ` 1,20,000 and contribution to sales ratio is 25%. Then fixed cost will be – a) ` 1,50,000 b) ` 1,00,000c) ` 1,20,000 d) ` 1,60,000
26. If the profit volume ratio of a company is 40%, sales value is ` 2,00,000 and margin of safety is 30%, then the net profit will be – a) ` 20,000 b) ` 22,000c) ` 26,000 d) ` 24,000
27. The sales price per unit is ` 50 and the variable cost to sales percentage is 5%. If the fixed cost for a period is ` 5,00,000, then the required sales to earn profit of 10% on sales is – a) ` 10,00,000 b) ` 20,00,000c) ` 30,00,000 d) ` 40,00,000
28. The fixed cost is ` 10,000, sales ` 80,000 and P/V ratio 30%. The amount of profit is – a) ` 7,000 b) ` 15,000c) ` 14,000 d) ` 9,000
29. The selling price per unit ` 10, variable cost ` 6 per unit and fixed cost ` 8,000, the break even production in units will be –a) ` 800 b) ` 2,000c) ` 3,000 d) ` 1,000
30. Sales ` 10,000, variable cost ` 6,000, fixed cost is ` 2,000. Break even sales will be –
a) ` 5,000 b) ` 10,000c) ` 15,000 d) ` 20,000
31. Sales ` 10,000, variable cost ` 6,000, fixed cost ` 2,000, P/V Ratio will be – a) 10% b) 30%c) 20% d) 40%
32. When break-even point is ` 10,000, profit is ` 500 and fixed cost is ` 2,000, then the variable cost will be – a) ` 5,000 b) ` 7,500c) ` 10,000 d) ` 12,500
33. __________when sales is ` 1,00,000, fixed cost is ` 15 and P/V Ratio is 40%, then profit will be – a) ` 12,000 b) ` 25,000c) ` 50,000 d) ` 80,000
34. A company maintains a margin of safety of 25% on its current sales and earns profit of ` 60 lakhs per annum. If the company has a profit volume (PV) ratio of 40%, its current sales amount to – a) ` 400 lakhs b ) ` 600 lakhsc) ` 625 lakhsd) None of the above
35. If sales are ` 2 lakhs, fixed cost is ` 30,000 and P.V. ratio is 40%, the amount of profit will be – a) ` 50,000 b) ` 80,000c) ` 20,000d) None of the above
36. X Ltd. has earned contribution of ` 2,00,000 and profit of ` 1,50,000 on sales of ` 8,00,000. What is the margin of safety?a) ` 5,75,000 b) ` 4,00,000b) ` 7,00,000 d) ` 6,00,000
37. A company maintains a margin of safety of 25% on its current sales and earns a profit ` 15 lakhs annum. If the company has a PV ratio of 40%, its current sales amount to –a) ` 100 lakhs b) ` 150 lakhsc) ` 165 lakhsd) None of the above
38. Selling price of a product is ` 5 per unit, variable cost is ` 3 per unit and fixed cost is ` 5,000. Then Break-even point in units will be – a) 5,000 b) 2,500c) 3,750d) None of the above
39. The P/V ratio of a product is 0.4 and the selling price is ` 0 per unit. The marginal cost of the product would be,
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a) ` 8 b) ` 24c) ` 20 d) ` 25
40. The selling price is ` 20 per unit, variable cost ` 12 per unit, and fixed cost ` 16,000, the breakeven point in units will bea) 800 units b) 2000 unitsc) 3000 units d) None of these
Calculate P/V Ratio in each of the following cases:
41. Contribution ` 3, Sales ` 15a) 60% b) 50%c) 20% d) 40%
42. Sales ` 10 and Variable Cost `4a) 60% b) 50%c) 20% d) 40%
43. Variable Cost ` 4, and Contribution ` 4a) 60% b) 50%c) 20% d) 40%
44. Variable Cost to Sales Ratio 40%a) 60% b) 50%c) 20% d) 40%
45. Fixed Cost ` 2,000, Profit ` 400, Sales ` 6,000a) 60% b) 50%c) 20% d) 40%
Selling price per unit ` 10, Variable Cost per unit ` 4 Calculate P/V ratio in each of following cases:
46. If selling price is reduced by 20%a) 60% b) 50%c) 20% d) 40%
47. If variable cost is increased by 25%a) 70% b) 50%c) 20% d) 40%
48. If selling price and variable cost are reduced by 20% and 25% respectivelya) 60% b) 50%c) 62.5% d) 40%
Selling price per unit ` 10, Variable Cost per unit ` 6Fixed Cost ` 2,000, Actual Sales ` 20,000
49. Calculate Break-Even Point (in units)a) 1000 units b) 2000 unitsc) 500 units d) 3000 units
50. Calculate Break-even point (in value)
a) 5000 b) 8000c) 6000 d) Nil
51. Calculate Break-Even point (in %)a) 70% b) 50%c) 20% d) 25%
Selling price per unit ` 10, Variable Cost per unit ` 4, Fixed Costs ` 35,000
52. Calculate New B.E.P if selling price is reduced by 20%a) 80000 b) 70000c) 50000 d) 35000
53. Calculate New B.E.P if variable cost is decreased by 25%a) 80000 b) 70000c) 50000 d) 35000
X Ltd. provides you the following informationFixed Expenses ` 4,000Break Even Point ` 10,000
54. Calculate P/V Ratioa) 50% b) 60%c) 40% d) 80%
55. Profit when Sales are ` 20,000a) 4000 b) 5000c) 6000 d) Nil
56. Sales to earn profit of ` 6,000a) 40000 b) 50000c) 20000 d) 25000
57. New Break Even Point if variable cost is increased by 25%a) 16000 b) 50000c) 20000 d) 25000
Selling price per unit ` 10, Variable Cost per unit ` 6, Fixed Cost ` 2,000, Actual Sales ` 20,000
58. Calculate Margin of safety (in units)a) 1000 units b) 2000 unitsc) 1500 units d) 3000 units
59. Dinesh Ltd. has provided following information:Sale price ` 20 per unitVariable Cost ` 14 per unitFixed Overheads ` 7,92,000
per annumHow many units must be sold to earn 10% of sales?
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a) 200000 units b) 198000 units
c) 300000 units d) 400000 units
P/V Ratio 40% Margin of Safety 60%, Sales ` 1,50,000
60. Calculate Break-Even Salesa) 24000 b) 60000c) 36000 d) 40000
61. Calculate Fixed Costa) 24000 b) 60000c) 36000 d) 40000
62. Calculate Net Profita) 24000 b) 60000c) 36000 d) 40000
Selling Price per unit ` 12, Variable Cost per unit ` 6Fixed Cost ` 2,400
63. Calculate Break Even Point (in units)a) 200 units b) 900 unitsc) 300 units d) 400 units
64. Calculate Break Even Point (in value)a) 5000 b) 4800c) 4000 d) 8000
65. A Company budgets a production of 10,000 units. The variable cost is estimated at ` 2 per unit. The fixed costs are estimated ` 60,000. The selling price is fixed it earn a profit of 25% on cost. Compute how many units must be produced and sold to earn a profit of ` 60,000.a) 20000 units b) 9000 unitsc) 30000 units d) 15000 units
A product is sold at a price of ` 120 per unit and its variable cost is ` 80 per unit. The fixed expenses of the business are ` 8,000 per year.
66. Find BEP in `a) 25000 b) 39000c) 24000 d) Nil
67. Find BEP in unitsa) 200 units b) 900 unitsc) 300 units d) 400 units
68. Profits made when sales are 240 unitsa) 1000 b) 1700
c) 1060 d) 160069. Sales to be made to earn profit of ` 5,000
for the year.a) 25000 b) 39000c) 24000 d) Nil
70. A company makes a single product and incurs fixed costs of ` 30,000 per annum. Variable cost per unit is ` 5 and each unit sells for ` 15. Annual sales demand is 7,000 units. The breakeven point is:a) 2,000 units b) 3,000 unitsc) 4,000 units d) 6,000 units
71. A company makes a single product and incurs fixed costs of ` 30,000 per annum. Variable cost per unit is ` 5 and each unit sells for ` 15. Annual sales demand is 7,000 units. The Margin of safety sales (units) is:a) 2,000 units b) 3,000 unitsc) 4,000 units d) 6,000 units
A company produces a single product and sells it at ` 200 each . The variable cost of the product is ` 120 per unit and the fixed cost for the year is ` 96,000.
72. P/V ratio.a) 50% b) 60%c) 40% d) 80%
73. Sales at break-even point.a) 250000 b) 390000c) 240000 d) Nil
74. Sales units required to earn a target net profit of ` 1,00,000 after Income-tax, assuming income-tax rate to be 50%.a) 2,000 units b) 3,700 unitsc) 2,700 units d) 6,000 units
75. `The Sales of a company are @ ` 200 per unit
20,00,000
Variable cost 12,00,000Fixed cost 6,00,000The capacity of the factory 15,000
unitsDetermine the BEP (units)a) 2,000 units b) 3,000 unitsc) 4,000 units d) 7,500 units
If the total fixed costs are ` 20,000 and there are four products having a total sales value of ` 1,00,000 and total variable costs of ` 60,000.
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76. Calculate Composite P/V ratioa) 50% b) 60%c) 40% d) 80%
77. Calculate Composite Break-Even Pointa) 24000 b) 60000c) 36000 d) 50000
Two manufacturing companies have decided to merge into one company. The operating details of two companies are as follows:
Company I Company IIPercentage of capacity utilization
90% 60%
Sales (`) 5,40,00,000 3,00,00,000Variable costs (`) 3,96,00,000 50,00,000Assuming that these two companies merge into one, determine:
78. The break-even sales of the merged company utilization at the breakeven levela) ` 5,01,73,678b) ` 5,01,73,600c) ` 5,01,73,700d) ` 5,01,73,800
79. The profitability of the merged company at the 80% level of capacity utilizationa) ` 198,00,000 b) ` 298,00,000c) ` 98,00,000 d) ` 398,00,000
80. The turnover of the merged company required to earn a profit of ` 75,00,000a) ` 398,00,000 b) ` 608,00,000c) ` 7,91,20,000 d) Nil
81. There are two factories under the same management. It is desired to merge these two factories.The following information is available:
Factory A Factory BCapacity Operation 100% 60%Sales (`) 300 lakhs 120 lakhsVariable costs (`) 220 lakhs 150 lakhsFixed Cost 40 lakhs 20 lakhs
Calculate the profit on working at 75% of the merged capacity.a) 5000000 b) 3000000c) 3750000 d) 9000000
82. ABC Ltd. manufactures a single product which it sells for ` 20 per unit. Fixed costs are ` 60,000 per annum. The contribution to sales ratio is 40 percent. ABC Ltd. breakdowna) 7,500 b) 8,000
c) 7,000 d) 7,40083. A company’s fixed cost amounts to ` 120
lakhs p.a. and its overall P/V ratio is 0.4. The annual saels of the company should be ` ________ lakhs to have a Margin of Safety of 25%.a) 400 b) 500c) 600 d) 700
84. The variable cost of product increases by 10% and the management raise the unit selling price by 10%. The fixed cost remain unchanged. Then BEP of the firm _________a) Increases b) Decreasesc) Remain the same d) Either a or b
85. A company maintains a margin of safety of 25% on its current sales and earns a profit of ` 30 lakhs per annum. If the company has a profit volume (P/V) ratio of 40%, its current sales amount toa) ` 200 lakhs b) ` 300 lakhsc) ` 325 lakhsd) None of the above
86. When the sales increase from ` 40,000 to `6 0,000 and profit increases by ` 5,000, thea) 20% b) 30%c) 25% d) 40%
87. Which of the below is the technique of costing?a) Process Costing b) Contract costingc) Marginal costing d) Activity based costing
88. Marginal costing provides required information to _________ for enabling them to take decisions.a) Creditors b) Managementc) Bankersd) None of the above
89. Marginal cost ______________ with _____________ in output.a) Increases, Increaseb) Increases, Decreasec) Decreases, Decreased) Both (a) and (c)
90. Under Marginal costing fixed cost are assumed to __________________ with the change in the level of production.a) Remain constant b) Increasec) Changed) None of the above
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91. Under Marginal costing variable cost are assumed to _____________ with the increase in the level of production.a) Remain constant b) Increasec) Changed) None of the above
92. According to marginal costing assumptions costs are influenced by ___________ mainly.a) Output b) Selling pricec) Variable Cost d) Fixed Cost
93. Advantages of marginal costing are _______a) Helps in managerial decisionsb) Simple techniquec) Cost Controld) All of the above
94. Under Marginal costing variable cost are assumed to ____________ with the decrease in the level of production.a) Decrease b) Increasec) Changed) None of the above
95. In _____________ costing both variable and fixed cost are charged to products.a) Absorption b) Marginalc) Both (a) and (b)d) None of the above
ANSWERS
1. B 2. b 3. c4. B 5. c 6. d7. D 8. d 9. a10. C 11. d 12. d13. D 14. c 15. d16. D 17. b 18. b19. C 20. a 21. c22. C 23. c 24. b25. C 26. d 27. b28. C 29. b 30. a31. D 32. c 33. b34. B 35. a 36. d37. B 38. b 39. b40. B 41. c 42. a43. B 44. a 45. d46. B 47. a 48. c49. C 50. a 51. d52. B 53. c 54. c55. A 56. d 57. a58. C 59. b 60. b61. A 62. c 63. d
64. B 65. d 66. c67. A 68. d 69. b70. B 71. c 72. c73. C 74. b 75. d76. C 77. d 78. a79. A 80. c 81. c82. A 83. a 84. c85. B 86. c 87. c88. B 89. d 90. a91. B 92. a 93. d94. A 95. a
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CHAPTER 6
RATIO AND ACCOUNTING RATIO
A Ratio is the numerical or an arithmetical relationship between two figures. It is expressed when one figure is divided by another. Ratio when calculated on the basis of accounting information, are called ‘Accounting Ratios’.
An Accounting Ratio may be defined as the mathematical expression of the relationship between two accounting figures having a mutual cause and effect relationship. For example, the figure of TURNOVER and GROSS PROFIT.
Ratio can be expressed as:1. Percentage say, gross profit ratio is 20% of sales2. Proportion say, current ratio is 2:1;3. Fraction say, net profit is one-tenth of sales;4. Times say, capital turnover ratio is 5 times.
MEANING OF RATIO ANALYSIS
Ratio analysis is the process of identifying the financial strengths and weakness of the enterprise by logically establishing relationship between the items of Balance Sheet or Income Statement or both to derive meaningful conclusions. The universally used technique for analysis of financial statements in modern times is the 'Ratio Analysis'.
INTER- FIRM COMPARISONMeaning –Inter – firm comparison involves the comparison of actual ratios of one firm with those of other similar firms belonging to the same industry or industry averages at the same point of time.Examples – Let us compare the Net Profit Ratio of X Ltd with that of Y Ltd & Z Ltd and industry for the year 2011.
X Ltd Y Ltd Z Ltd Industry16% 18% 21% 19%
The above table clearly indicates that – Net Profit Ratio of X Ltd is less than that of Y Ltd., Z Ltd and industry.Purpose – The purpose of Cross-Sectional Analysis is to ascertain the relative position of the enterprise in the industry and to identify the problem areas (if any).
TIME SERIES ANALYSISMeaning – Time Series Analysis involves the comparison of actual ratios of one period with those of earlier periods for the same enterprise.
Examples – Let us analyse the Net profit Ratios of X Ltd over a period of 4 years:2009 2010 2011 201220% 19% 18% 16%
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The above table clearly indicates that the Net Profit Ratio is declining over a period of 4 years.Purposes – The purpose of Time Series Analysis is to observe the behaviour of the same ratio over a given period of time.
BENCHMARKS
Benchmarks is a yardstick against which actual ratio is to be compared in order to make a qualitative judgement about the various aspects of the financial position and performance of an enterprise. Benchmark may be:
A past ratio of the same enterprise – a ratio could be compared with the past ratio of the same enterprise. This type of comparisons is known as Intra-firm comparison as is done under Time Series Analysis.
Ratio of Similar Firms – A ratio could be compared with the ratio of similar firms belonging to the same industry at the same point of time. This type of comparison is known as inter-firm comparison as is done under Cross Sectional Analysis.
Industry Average – A ratio could be compared with the industry average at the same point of time. This type of comparison is known as pattern comparison as in done under Cross Sectional Analysis.
Rule of Thumb – Rule of Thumb have evolved over a period of time. A ratio could be compared with rule of thumb. However these rules of thumb should be used cautiously.
Ratio Rule Of Thumb
Meaning
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Current ratio Quick ratioDebt-Equity ratio
2:11:12:1
Current Assets should be twice the Current Liabilities.Quick Assets should be equal to Current Liabilities.Long-term Debts could be twice the Shareholders’ Funds.
IMPORTANCE OF RATIO ANALYSIS TO VARIOUS PARTIES INTERESTED IN FINANCIAL STATEMENTS
The importance of Financial Statement analysis is different for the various users of information as management, investors, creditors, laborers, government and others.
Importance to Management – To get an overall view of the financial operations and condition of the company which enables them to plan and control the company's activities more effectively, to spot weaknesses in operations and take corrective action.
Importance to Investors - To form their own opinion as to the soundness of investing in a company by computing earnings per share, risk involved in the investment, the future earning potential and the investment opportunities, elsewhere.
Importance to Creditors - Creditors are interested in the company's ability to meet its financial obligations. Those who have lent money for short period, are more interested in the company's ability to repay the debts as and when it will become due.
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Importance of Debenture holders - Short term creditors are interested in the liquidity of the concern and from the Funds Flow Statement they are able to determine whether the amounts owing to them will be paid when due, while the long term creditors determine whether their principals (capital amount) and the interest thereon will be paid when due. Hence they analyze the profit-earning capacity, capital structure and future funds flow of the concern.
Importance to Government - Government regulates economic activities in various spheres and for this purpose analysis of financial statements of companies in one industry or of all companies is very helpful. Earning ratios and turnover ratios are used as barometers to indicate the health of an industry as a whole.
Importance to Labour - Labour has an interest in the operating results and the financial strength of a company. The remuneration of the worker must be generated from the company revenues thus, the worker's wages, to a great extent, depend upon the success of the firm. Frequently, labour unions use the information presented in the financial statements as a basis for their demand for increase in wages. Importance to Others - Besides, the news agencies, trade associations, labour bureaus, economic and commercial research institutes, stock exchanges, economists and research workers also are interested in the results arrived at by analysis of financial statements to know the progress being made and the present position of an industry.
CLASSIFICATION OF RATIOS
In view of the requirements of various users (e.g., Short-term Creditors, Long-term Creditors, Management, Investors) of the ratios, one may classify the ratios into the following four groups: 1. Liquidity Ratios2. Solvency Ratios3. Activity Ratios4. Profitability Ratios
LIQUIDITY RATIOS
Short-term Creditors are primarily interested in liquidity or short-term Solvency of the enterprise since their claims are to be met in the short-run. Liquidity or Short-term Solvency means the ability of the enterprise to meet short-term obligations as and when they become due. Usually the following ratios are calculated for this purpose:
1. Current Ratio2. Quick Ratios3. Absolute Cash Ratio
1. CURRENT RATIO
(a) Meaning – This ratio establishes a relationship between Current Assets and Current liabilities.
(b) Objective – The objective of computing this ratio is to measure the ability of the firm to meet its short-term obligations and to reflect the short-term financial strength/Solvency of a firm, i.e., to measure the safety margin available for short-term creditors.
(c) Components – There are two components of this ratio as follows:
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1. Current Assets: Current Assets refer to those assets which are held for their conversion into cash normally within a year. An asset is classified either as a Current Asset or Non-current Asset on the basis of the purpose for which an asset is held in the hands of user. Examples of Current AssetsCash Balance, Bank Balance, Debtors (after deducting Provision), Bills Receivable (after deducting provision), Marketable Securities (Realisable value), Stock, Prepaid Expenses, Short-term Loans & Advances (Debit Balance).
Important Notes The 'Provision for doubtful debts/bills' is deducted from the total amount of Debtors/Bills
Receivable in order to ascertain the realisable value of Trade debt Receivable. Unless otherwise stated, it is assumed that Debtors, B/R and Marketable Securities realizable
at their given book values.
2. Current Liabilities: Current Liabilities refer to those liabilities which are expected to be matured normally within a year.
Examples of Current LiabilitiesCreditors for Goods, Creditors for Expenses (or O/S Exp)Provision for Tax Unclaimed dividendBills Payable Bank OverdraftShort-term Loans and Advances (Credit Balance) Incomes received-in-advance
Computation – This ratio is computed by dividing the current assets by the current liabilities. This ratio is usually expressed as a pure ratio e.g. 2:1. In the form of a formula, this ratio may be expressed as follows:
Current Ratio¿ CurrentAssetsCurrent Liabilities
Imp Notes1. Current Ratio is calculated at a particular date and not for a particular period. 2. The excess of Current Assets over Current Liabilities is known as Working Capital.
Interpretation – It indicates rupees of current assets available for each rupee of current liability. Higher the ratio, greater the margin of safety for short-term creditors and vice-versa. However, too high/too low ratio calls for further investigation since the too high ratio may indicate the presence of idle funds with the, firm or the absence of investment opportunities with the firm and too low ratio may indicate the over trading/under capitalisation if the capital turnover ratio is high.
Traditionally, a current ratio of 2:1 is considered to be a satisfactory ratio. On the basis of this traditional rule, if the current ratio is 2 or more, it means the firm is adequately liquid and has the ability to meet its current obligations but if the current ratio is less than 2, it means the firm has difficulty in meeting its current obligations. The logic behind this rule is that even if the value of current assets becomes half, the firm can still meet its short-term obligations.
2. QUICK RATIO [OR LIQUID RATIO](a) Meaning – This ratio establishes a relationship between quick assets and current liabilities.
(b) Objective – The objective of computing this ratio is to measure the ability of the firm to meet its short-term obligations as and when due without relying upon the realization of stock.
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(c) Components – There are two components of this ratio as follows:
(i) Quick Assets: Quick Assets refer to those current assets which can be converted into cash immediately or at a short notice without a loss of value.
Examples of Quick AssetsCash Balances Bills Receivable (after deducting provision) Bank Balances Marketable Securities (Realizable Value) Debtors Short-term Loans and Advances (after deducting provision) (Debit Balance)
Imp Notes1. Inventories are not considered as quick assets because there is uncertainty as to whether or
not and the inventories can be Sold2. Prepaid Expenses are not considered as quick assets because they usually cannot be converted
into cash. 3. The 'Provision for doubtful debts/Bills' is deducted from the total amount of Trade
Debtors/Bills Receivable in order to ascertain the realizable value of Trade Debtors/Bills Receivable.
4. Unless otherwise stated, it is assumed that Debtors, B/R and Marketable Securities are realizable at their given book values.
(ii)Current Liabilities: Current Liabilities refer to those liabilities which are expected to be matured normally within a year. (Same as above)
Computation –This ratio is computed by dividing the quick assets by the current liabilities. This ratio is usually expressed as a pure ratio e.g., 1:1. In the form of a formula, this ratio may be expressed as under:
Quick Ratio = Quick Assets
Current Liabilities
Alternatively – Quick Ratio may be computed by dividing the Quick Assets by the Quick Liabilities as follows:
Quick Ratio = Quick Assets
Quick Liabilities
Where, Quick Liabilities = Current Liabilities – Bank Overdraft – Cash Credit
Tutorial NoteQuick Ratio is calculated at particular date and not for a particular period.
Interpretation – It indicates rupees of quick assets available for each rupee of current liability. Traditionally, a quick ratio of 1:1 is considered to be a satisfactory ratio. However, this traditional rule should not be used blindly since a firm having a quick ratio of more than 1 may not be meeting its short-term obligations in time if its current assets consist of doubtful and slow paying debtors while a firm having a quick ratio of less than 1, may be meeting its short-term obligations in time because of its very efficient inventory management. Thus, an enterprise should have neither a very high nor a very low ratio, it should have a satisfactory ratio. To judge whether the ratio is satisfactory or not, it should be compared with its own past ratios or with the ratio of similar enterprises in the same industry or with the industry average.
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Distinction between Current Ratio and Quick Ratio
Basis of Distinction
Current Ratio Quick Ratio
Relationship Current Ratios shows relationship between, Current Assets and Current Liabilities
Quick Ratio shows relationship between Quick Assets and Current Liabilities
Objectives Current ratio measures ability to meet current obligations as and when they fall due for payment over a period normally not exceeding one year
Quick Ratio measures enterprise's ability to meet current obligations without relying on the sale and collection of inventories.
Components of Ratio
The components of Current Ratio are Current Assets and Current Liabilities
The components of Quick Ratio are Quick Assets and Current Liabilities.
Formula for Computation Quick Ratio =
Quick AssetsCurrent Liabilities Quick Ratio =
Quick AssetsQuick Liabilities
Traditional Satisfactory Standard
It is 2:1 It is 1:1
Precaution While computing and using Current Ratio, quality of both inventory and receivables is required to be carefully assessed.
While computing and using Quick Ratio, quality of receivables is required to be carefully assessed (since the inventory has already been excluded)
3. ABSOLUTE CASH RATIO
(a) Meaning – This ratio measures a relationship between cash & marketable securities and current liabilities.
(b) Objectives – The objectives of computing this ratio is to measure the ability of the enterprise to meet its short-term obligations as and when due without relying upon the realization of stock and debtors.
(c) Components – There are two components of this ratio as follows:1. Cash and Marketable Securities and 2. Current Liabilities
(d) Computation – This ratio is computed by dividing the Cash and Marketable Securities by Current Liabilities. This ratio is usually expressed as a pure ratio e.g. 1:1. In the form of a formula, this ratio may be expressed as under:
Absolute Cash Ratio = Cash∧Marketable Securities
Current Liabilities
Interpretation – It indicates Cash and Marketable Securities available for each rupee of Current Liability. A very high absolute ratio indicates high liquidity at the cost of profitability since idle cash does not generate any return and marketable securities generate return at a rate lower than the rate of operating margin.
SOLVENCY RATIOS
Long-term Creditors are primarily interested in long-term Solvency of the enterprises since their claims are to be met in the long-run. Long-term creditors are the creditor having maturity after one year.
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Long-term Solvency means the ability of the enterprise to meet long-term liability on the due date. Long-term lender of funds is basically interested in two things:(a) Safety of Principal which is given by way of a loan.(b) Regular servicing of the loan in the form of –
1. Payment of Interest on loan, and 2. Repayment of Instalment of loan.
For example - A loan of ` 1 crore at 12% rate of interest is granted by X ltd. term of 5 years. X ltd. would like to be sure that –
(i) The principal amount of ` 1 crore is safe for 5 years (ii) It will get an interest of ` 12 lacs every year.
Solvency ratios show the long-term financial Solvency and measure the en ability to pay the interest regularly and to repay the principal (i.e., capital a maturity or in pre-determined installments at due dates. Usually the following calculated to judge the long-term financial Solvency of the concern:
SOLVENCY RATIOS1. Debt-Equity Ratio2. Total Assets to Debt Ratio3. Proprietary Ratio4. Capital Gearing Ratio5. Interest Coverage Ratio6. Preference Dividend Coverage Ratio7. Debt-Service Coverage Ratio8. Fixed Assets Ratio9. Ratio of Current Assets to Fixed Assets
1. DEBT-EQUITY RATIO
(a) Meaning – This ratio establishes a relationship between long-term debts and shareholders’ funds.
(b) Objectives – The oobjective of computing this ratio is to measure the relative proportion of debt and equity in financing the assets of a firm.
(c) Components – There are two components of this ratio as follows:(i). Long-term Debts which mean long-term loans (whether secured or unsecured) (e.g.,
debentures, bonds, loans from financial institutions).
(ii). Shareholders’ Funds which means equity share capital plus preference share capital plus reserves and surplus minus fictious assets (e.g., preliminary expenses).
(d) This ratio is computed by dividing the long-term debts by the shareholders' funds. This ratio is usually expressed as a pure ratio e.g., 2:1. In the form of a formula, this ratio may be expressed as follows:
Debt−Equity Ratio= Long−term DebtsShareholders’ Funds
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(e) Interpretation – It indicates the margin of safety to long-term creditors. A low debt-equity ratio implies the use of more equity than debt which means a larger safety margin for creditors since owner's equity is treated as a margin of safety by creditors and vice versa.
Case Creditors Implications from the point of view of FirmIn case of low Debts-Equity Ratio
Larger margin of safety since owner’s equity is treated as margin of safety by creditors.
1. Debt servicing is less burdensome.2. Less pressure and interference of creditors in
management.3. Capacity to raise additional debt.4. Not much benefit of trading on equity when the firm
earns a rate higher than the interest rate on borrowed funds.
In case of High Debt-Equity Ratio
Greater the risk to creditors
1. Debt servicing is burdensome under adverse business conditions.
2. Pressure & interference of creditors in management.3. Difficulties in raising additional debt.4. Benefits of trading on equity when the firm earns a
rate higher than the interest rate on borrowed funds.
2. TOTAL ASSETS TO DEBT RATIO
(a) Meaning – This ratio establishes a relationship between total assets and: long-term debts.
(b) Objectives –The objective of computing this ratio is to measure the safety margin available to the suppliers of long-term debts. It measures the extent which debt is being covered by assets.
(c) Components – There are two components of this ratio as follows:(i). Total Assets (Excluding fictitious assets like preliminary expenses)(ii). Long-term Debts which mean long-term loans (whether secure unsecured) (e.g.,
debentures, bonds, loans from financial institutions).
(d) Computations – This ratio is computed by dividing the total assets by the 1 term debts. This ratio is usually expressed as a pure ratio e.g., 2:1.
Total Assets ¿ Debt Ratio= Total AssetsLong−term Debts
Tutorial NoteTotal Assets to Debt Ratio is calculated at a particular date and not for a particular period.
(e) Interpretations – In indicates the margin of safety to long-term creditors. A high Total Assets to Debt ratio implies the use of more equity than debt which means a larger safety margin for creditors since owner's equity is treated as a m of safety by creditors and vice versa.
3. PROPRIETORY RATIO
(a) Meaning – This ratio measures a relationship between Equity and the Total Assets.
(b) Objectives – The objective of computing this ratio is to measure the proportion of total assets financed by the Equity (or Proprietors' Funds).
(c) Components – There are two components of this ratio as follows:
(i). Proprietors' Funds (same a Equity Shareholders' Funds)
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Note: Proprietors' Funds/Shareholders' Funds/Equity mean equity share capital plus preference share capital plus reserves and surplus minus fictitious assets (e.g., preliminary expenses).
(ii). Total Assets (excluding fictitious assets like preliminary expenses.
(d) Computation – This ratio is computed by dividing the Proprietors' Funds by Total Assets. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Proprietary Ratio¿ Proprietors ’ FundsTotal Assets ×100
(e) Interpretation – This ratio indicates the extent to which the assets of the enterprise have been financed out of Proprietors' Funds. A high proprietary ratio indicates the larger safety margin for creditors and the enterprise is not taking the benefit of trading on equity. A low proprietary ratio indicates the greater risk to creditors and the enterprise is taking the benefit of trading on equity.
Traditionally, a Proprietary Ratio of 1:4 is considered to be satisfactory which means 25% of the total assets should be financed out of equity.
4. CAPITAL GEARING
(a) Meaning – This ratio establishes a relationship between funds bearing Fixed Financial Payments and Equity Shareholders' Funds.
(b) Objective – The objective of computing this ratio is to measure the relative proportion of funds bearing Fixed Financial Payments to Equity Shareholders' Funds.
(c) Components – There are two components of this ratio as follows:
(i).Funds bearing Fixed Financial Payments e.g., debentures, bonds, loans from financialinstitutions, preference share capital.
(ii). Equity Shareholders' Funds which means Equity Share Capital + Reserves & Surplus minusfictitious assets.
(d) Computation – This ratio is computed by dividing the funds bearing fixed financial payments by equity shareholders' funds. This ratio is usually expressed as a pure ratio e.g., 3:1. In the form of formula, this ratio may be expressed as follows:
Capital Gearing Ratio = Funds bearing ¿Financial Payments ¿Equity Shareholders ’ Funds
Tutorial NoteCapital Gearing Ratio is calculated at a particular date and note for a particular period.
(e) Interpretation – If the Capital Gearing Ratio is less than 1, the company is said to be lowly geared and if it is more than 1, it is said to be highly geared. Capital gearing shows the extent of the risk (in relation to payment of fixed financial payments) to which the company is subject and also the opportunity for trading on equity. It indicates the margin of safety available to suppliers of funds bearing fixed financial payments. A high total Capital Gearing Ratio implies the use of less equity than funds bearing fixed financial payments which means a lower safety margin for funds bearings funds financial payments since owner's equity is treated as a margin
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of safety by the suppliers of funds bearing fixed financial payments and vice versa. Thus, the position highly geared and lowly geared company is as follows:
5. INTEREST COVERAGE RATIO (OR TIMES – INTEREST EARNED RATIO)
(a) Meaning – This ratio establishes a relationship between net profits before interest and taxes and interest on long-term debt.
(b) Objectives – The objective of computing this ratio is to measure the debt servicing capacity of a firm so far as fixed interest on long-term debt is concerned.
(c) Components – There are two components of this ratio as follows:(i). Net profits before interest and taxes
(ii). Interest on long-term debts.
(d) Computation – This ratio is computed by dividing the net profits before interest and taxes by interest on long-term debt. This ratio is usually expressed as 'X' number of times. In the form of a formula, this ratio may be expressed as follows:
Interest Coverage Ratio¿ Net profit before interest∧taxesInterest on Long−termdebt
(e) Interpretation – Interest coverage ratio shows the number of times the amount of interest on long-term debt is covered by the profits out of which that will be paid. It indicates the limit beyond which the ability of the firm to service its debt would be adversely affected. For instance, interest coverage of five times would imply that even if the firm's net profits before interest and tax decrease by 80% of the present level. the firm will still be able to pay interest out of profits. Higher the ratio, greater the firm's ability to pay interest but very high ratio may imply lesser use of debt and very efficient operations.
6. PREFERENCE DIVIDEND COVERAGE RATIO
(a) Meaning – This ratio establishes a relationship between net profits after interest and taxes and Preference Dividend on Preference Shares.
(b) Objectives – The objective of computing this ratio is to measure the Preference Shares servicing capacity of a firm so far as Fixed Dividend on Preference Shares is concerned.
(c) Components – There are two components of this ratio as follows:(i). Net profits after interest and taxes;(ii). Preference Dividend on Preference Shares
(d) Computation – This ratio is computed by dividing the net profits after interest and taxes by preference dividend on Preference Shares. This ratio is usually expressed as 'X' number of times. In the form of a formula, this ratio may be expressed as follows:
Preference Dividend Coverage Ratio¿ Net Profit after interest∧taxesPreference Dividend on Pref . Share
(e) Interpretation – Preference Dividend Coverage Ratio shows the number of times the amount of Preference Dividend is covered by the profits out of which that will be paid. It indicates the limit beyond which the ability of the firm to service its preference share capital would be adversely affected. For instance, preference dividend coverage of five times would
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imply that even if the firm's net profits after interest and tax 'decrease by 80% of the present level. The firm will still be able to pay preference dividend out of profits. Higher the ratio, greater the firm's ability to pay preference dividend but very high ratio may imply lesser use of preference share capital and very efficient operations.
7. DEBT-SERVICE COVERAGE RATIO
(a) Meaning – This ratio measures the relationship between Net Profits before Interest and Tax and Interest + Principal Portion of instalment.
(b) Objective – The objective of computing this ratio is to determine the firm's ability to payoff both the current interest and principal portion of the instalment.
(c) Components – There are two components of this ratio as follows:(i). Net Profit before Interest and Tax(ii). Interest and Principal portion of Instalment
(d) Computation – This ratio is calculated by dividing the Net Profit before Interest and Tax by the aggregate of Interest and Principal portion of Instalment. It is usually expressed in number of times.
In the form of a formula, this ratio may be expressed as follows:
Debt –Service Ratio =Net profit before Interest∧Tax
Interest +Principal portionof Instalment = times
Note: The principal portion of instalment is adjusted for tax effects since such payment is not deductible from net profit for tax purposes.
(e) Interpretation – Debt-Service Coverage Ratio shows the number of times the amount of interest on long-term debts and the principal portion of instalment is covered by the profits out of which that will be paid. It indicates the limit beyond which the ability of the firm to service its debt would be adversely affected. For instance, an debt service of five times would imply that even if the firm's net profits before interest and tax decrease by 80% of the present level, the firm will still be able to pay interest and instalment out of profits. Higher the ratio, greater the firm's ability to pay current interest and instalment but very high ratio may imply lesser use of debt and very efficient operations.
8. Fixed Assets Ratio
This ratio establishes a relationship between fixed assets and capital employed in the enterprise. The objective of computing this ratio is to measure the relative portion of capital employed being invested in fixed assets of the enterprise. This ratio is computed by dividing the fixed assets with capital employed. This ratio may be expressed as follows:
9. Ratio of Current Assets to Fixed Assets
This ratio establishes a relationship between current assets and fixed assets. This ratio is computed by dividing current assets with fixed assets. This ratio may be expressed as follows:
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Fixed Assets Ratio = ¿ Assets
Capital Employed
ACTIVITY RATIOSActivity ratios measure the effectiveness with which a firm uses its available resources. These ratios help in commenting on the efficiency of the enterprise in managing its assets. These ratios are also called 'Turnover Ratios' since they indicate the speed with which the resources are being turned (or converted) into Sales or Cost of Sales.Usually the following turnover ratios are calculated: ACTIVITY RATIOS1. Capital Turnover Ratio2. Fixed Assets Turnover Ratio 3. Current Assets Turnover Ratio 4. Net Working Capital Turnover Ratio 5. Stock Turnover Ratio 6. Debtors Turnover Ratio 7. Creditors Turnover Ratio
Tutorial NoteThese ratios may be calculated with reference to Sales or Cost of Sales but the same basis (i.e., Sales or Cost of Sales) once selected, should be used on consistent basis
1. CAPITAL TURNOVER RATIO(a) Meaning – This ratio establishes a relationship between net sales and capital employed.
(b) Objectives – The objective of computing this ratio is to determine the efficiency with which the capital employed is utilised.
(c) Components – There are two components of this ratio as follows:(i). Net Sales which mean gross sales minus sales returns; and(ii). Capital Employed which may be calculated as follows:(iii).
Liabilities Side Approach ` Assets Side Approach `Equity Share Capital + Reserves & Surplus (-)Miscellaneous ExpenditureEquity Shareholders’ Funds+ Preference Share CapitalShareholders’ Funds
+ Long term Debts
Capital Employed
XXXXXXXXXXXXXXXXXX
XXX
Net Fixed Assets+Investment+ Current AssetsTotal Assets(-)Current Liabilities
XXXXXXXXXXXXXXX
XXX XXX
Tutorial NotesSome accountants feel that the figure of' Capital Employed’ should be fairly representative of the capital investment throughout the accounting period and therefore, they prefer to make use of the
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Current Assets to Fixed Assets Ratio = Current Assets
¿ Assets
concept of ‘Average Capital Employed’ which can be obtained by dividing the aggregate of capital employed at the beginning and at the end of the accounting period, by 2.
(d) Computation – This ratio is computed by dividing the net sales by the capital employed. This ratio is usually expressed as 'x' number of times. In the form of a formula, this ratio may be expressed as follows:
Capital Turnover ratio¿ NetSalesCapitalEmployed = …… Times
Interpretation – It indicates the firm's ability to generate sales per rupee of capital employed. In general, higher the ratio, the more efficient the management and utilisation of capital employed. A too high ratio may indicate the situation of over-trading (or under-capitalisation) if current ratio is lower than that required reasonably and vice versa.
2. FIXED ASSETS TURNOVER RATIO(a) Meaning – This ratio establishes a relationship between net sales and fixed assets.
(b) Objective – The objective of computing this ratio is to determine the efficiency with which the fixed assets are utilised.
(c) Components – There are two components of this ratio as follows:(i). Net Sales which means gross sales minus sales returns;(ii). Net Fixed (operating) Assets which mean gross fixed (operating) assets minus
depreciation thereon.
(d) Computation – This ratio is computed by dividing the net sales by the net fixed (operating) assets. This ratio is usually expressed as 'x' number of times. In the form of a formula, this ratio may be expressed as follows:
Fixed Assets Turnover Ratio =Net SalesNet Fixed (Operating) Assets = Times …..
(e) Interpretation – It indicates the firm's ability to generate sales per rupee of investment in fixed assets. In general, higher the ratio, the more efficient the management and utilisation of fixed assets, and vice versa. It may be noted that there is no direct relationship between sales and fixed assets since the sales are influenced by other factors as well (e.g., quality of product, delivery terms, credit terms, after sales service, advertisement and publicity etc.).
3. CURRENT ASSETS TURNOVER RATIO
(a) Meaning – This ratio establishes a relationship between net sales and current assets.
(b) Objectives – The objective of computing this ratio is to determine the efficiency with which the current assets are utilised.
(c) Components – There are two components of this ratio as follows'(i). Net Sales which means gross sales minus sales returns;
(ii). Current Assets: Current Assets refer to those assets which are held for their conversion into cash normally within a year. An asset is classified either as a Current Asset or Non-current Asset on the basis of the purpose for which an asset is held in the hands of user.
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(d) Computation – This ratio is computed by dividing the net sales by the current assets. This ratio is usually expressed as 'x number of times. In the form of a formula, this ratio may be expressed as follows:
Current Assets Turnover Ratio =Net Sales
CurrentAssets = ……. times
(e) Interpretation – It indicates the firm's ability to generate sales per rupee of investment in current assets. In general, higher the ratio, the more efficient the management and utilisation of current assets, and vice versa. It may be noted that there is no direct relationship between sales and current assets since the sales are influenced by other factors as well (e.g., quality of product, delivery terms, credit terms, after sales service, advertisement and publicity etc.).
4. WORKING CAPITAL TURNOVER RATIO
(a) Meaning – This ratio establishes a relationship between net sales and working capital.
(b) Objectives – The objective of computing this ratio is to determine the efficiency with which the working capital is utilised.
(c) Components – There are two components of this ratio as follows:(i). Net Sales which mean gross sales minus sales returns; and
(ii). Working Capital which means current assets minus current liabilities.
Tutorial NoteSome accountants feel that the figure of ‘Working Capital’ should be fairly representative of the working capital throughout the accounting period and therefore, they prefer to make use of the concept of 'Average Working Capital' which can be obtained by dividing the aggregate of the working capital at the beginning and at the end of the accounting period, by 2.
(d) Computation – This ratio is computed by dividing the net sales by the working capital. This ratio is usually expressed as 'x' number of times. In the form of a formula, this ratio may be expressed as follows:
Working Capital Turnover Ratio = Net Sales
WorkingCapital = …… Times
(e) Interpretation – It indicates the firm's ability to generate sales per rupee of working capital. In general, higher the ratio, the more efficient the management and utilisation of working capital and vice versa.
5. STOCK TURNOVER RATIO
(a) Meaning – This ratio establishes a relationship between cost of goods Sold and average inventory of finished goods.
(b) Objectives – The objective of computing this ratio is to determine the efficiency with which the inventory is converted into sales.
(c) Components – There are two components of this ratio as follows:
(i). Cost of Goods Sold which is calculated as follows:Cost at Goods Sold = Opening Inventory + Net Expenses - Closing Inventory
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Or, = Net Sales - Gross Profit
(ii). Average Inventory which is calculated as follows:Average Inventory = (Opening Inventory plus Closing Inventory)/2
Tutorial Note1. If their figure of 'Average Inventory' cannot be ascertained due to the absence of the figure
of ‘Opening inventory’, the figure of 'Closing Inventory' may be applied by giving a suitable note to that effect.
2. If the figure of Cost of Goods Sold cannot be ascertained, the figure of sales may be used by giving a suitable note to that effect.
(d) Computation – This ratio is computed by dividing the cost of goods Sold by the average inventory. This ratio is usually expressed as 'x number of times. In the form of a formula, this ratio may be expressed as follows:
Stock Turnover Ratio =Cost of Goods SoldAverage Inventory ……. Times
(e) Interpretation – It indicates the speed with which the inventory is converted into sales. In general, a high ratio indicates efficient performance since an improvement in the ratio shows that either the same volume of sales has been maintained with a lower investment in stocks, or the volume of sales has increased without any increase in the amount of stocks. However, too high ratio and too low ratio call for further investigation. A too high ratio may be the result of a very low inventory levels which may result in frequent stock-outs and thus the firm may incur high stock-out costs. On the other hand, a too low ratio may be the result of excessive inventory levels, slow-moving or absolute inventory and thus, the firm may incur high carrying costs.
(f) Stock Velocity – This velocity indicates the period for which sales can be generated with the help of an average stock maintained and is expressed in terms of period. This velocity may be calculated as follows:
Stock Velocity= Average StockAverageCost of Goods Solutiond per day …..Days
Or
12months /52 weeks/365 daysStock Turnover Ratio = ….. Months/Weeks/Days
Note: Average Cost of Goods Sold per day = Cost of Goods Sold
No .of working days∈the year
6. DEBTORS TURNOVER RATIO (OR RECEIVABLES TURNOVER RATIO)
(a) Meaning – This ratio establishes a relationship between net credit sales and average trade debtors (or receivables)
(b) Objectives – The objective of computing this ratio is to determine the efficiency with which the trade debtors are converted into cash.
(c) Components – There are two components of this ratio as follows:(i). Net Credit Sales which mean gross credit sales minus sales returns; and
(ii). Average Debtors (or Receivables) which are calculated as follows:
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OpeningTrade Debtors+Opening Bills Receivable+Closing Trade Debtors+Closing Bills receivable2
Tutorial Notes1. If the figure of Average Debtors cannot be ascertained due to the absence of the figure of
opening Debtors, the figure of closing Debtors may be applied by giving a suitable note to that effect.
2. If the figure of Net Credit Sales is not ascertainable, the figure of total sales given may be used assuming that all sales are credit sales.
(d) Computation – This ratio is computed by dividing the net credit sales by average trade debtors. This ratio is usually expressed as 'x' number of times. In the form of a formula, this ratio may be expressed as follows:
Debtors Turnover Ratio = Net Credit SalesAverage Debtors= …… Times
(e) Interpretation – It indicates both the quality of debtors and the credit collection efforts of the enterprise. It indicates the speed with which the debtors are converted into cash each year. In general, a high ratio indicates the shorter collection period which implies prompt payments by debtors, and a low ratio indicates a longer collection period which implies delayed payments by debtors. However, too high ratio and too low ratio calls for further investigation. A too high ratio may be the result of a restrictive credit and collection policy which may curtail the sales and consequently profits. On the other hand, a too low ratio may be the result of liberal and inefficient credit and collection policy which may involve the risk of bad debts and burden of high interest cost involved in maintaining a higher level of debtors.
(f) Average Debt Collection Period (or Debtors’ Velocity) – This period shows an average period for which the credit sales remain outstanding or the average credit period actually enjoyed by the debtors. It measures the quality of debtors. It indicates the rapidity or slowness with which the money is collected from debtors. This period may be calculated as follows:
Debt Collection Period = Average Debtors
Average net Credit Sales per day …… Times
¿ , 12 months /52 weeks /365 daysDebtorsTurnover Ratio = ……. Months/Weeks/Days
Note: Average Credit Sales per day =Net Credit Sales for the year
No .of working days∈the year = …. Per day
7. CREDITORS TURNOVER RATIO (OR PAYABLES TURNOVER RATIO)
(a) Meaning – This ratio establishes a relationship between net credit purchases and average creditors (or payables)
(b)Objectives – The objective of computing this ratio is to determine the efficiency with which the creditors are managed and paid.
(c) Components – There are two components of this ratio as follows: (i). Net Credit Purchases which mean gross credit purchases minus purchases returns; and(ii). Average Creditors (or Payables) which are calculated as follows:
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OpeningTrade Creditors+Opening Bills Payables+Closing TradeCreditors+Closing Bills Payables2
Tutorial Notes1. If the figure of Average Creditors cannot be ascertained due to the absence of the figure of
Opening Creditors, the figure of Closing Creditors may be applied by giving a suitable note I to that effect.
2. If the figure of Net Credit Purchases is not ascertainable the figure of Total Purchases given may be applied assuming that all purchases are credit purchases.
(d)Computation – This ratio is computed by dividing the net credit purchases by average trade creditors. This ratio is usually expressed as 'x' number of times. In the form of formula, this ratio may be expressed as follows:
Creditors Turnover Ratio = Net Credit Purchase
AverageCreditors = ……. Times
Interpretation – It indicates the speed with which the creditors turn over on an average each year. In general, a high ratio indicates the shorter payment period which implies either the availability of less credit or earlier payments or a low ratio indicates a larger payment period which implies either the availability of more credit or delayed payments.Prudence demands that one should not make payment to creditors at a pace which is faster them the pace of receiving payments from debtors. That's why one should compare Creditors Turnover Ratio with Debtors Turnover Ratio to observe pace of discharging creditors.
(e) Debts Payment Period (or Creditors’ Velocity) – This period shows an average period for which the credit purchases remain outstanding or the average credit period actually availed of This period may be calculated as follows:
Average Debt Payment period =AverageCreditors
Average net Credit Purchases per day = …… Days
Or, 12months /52 weeks/365 days
CreditorsTurnover Ratio = ……… Months/Weeks/Days
Note: Average Net Credit Purchases per day =Net Credit Purchase for the yearNo .of working days∈the year = ….. per day
PROFITABILITY RATIOS IN RELATION TO SALES
1. GROSS PROFIT RATIO(a) Meaning – This ratio measures the relationship between gross profit and net sales.
(b) Objectives – The main objective of computing this ratio is to determine the efficiency with which production and/or purchase operations and selling operations are carried on.
(c) Components – There are two components of this ratio as follows:(i) Gross Profit – This is the excess of Net Sales over Cost of Goods Sold.(ii)Cost of Goods Sold is calculated as follows:
Cost of Goods Sold in case of a Trading ConcernParticulars `
A. Opening StockB. Add: Net Purchases
xxxxxx
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C. Add: Direct Expenses (e.g. carriage inward)D. Less: Closing StockE. Cost of Goods Sold (A + B + C - D)
xxxxxxxxx
Net Sales –which is Gross Sales (both cash and credit) minus Sales Returns.
(d) Computation - This ratio is computed by dividing the gross profit by the net sales. It is expressed as percentage. In the form of a formula, this ratio may be expressed as follows:
Gross Profit RatioGross Profit
Net Sales × 100 = ……. %
2. OPERATING PROFIT RATIO
(a) Meaning – This ratio measures the relationship between operating profit and net sales.
(b) Objective – The main objective of computing this ratio is to determine the operational efficiency of the management.
(c) Components – there are two components of this ratio as follows:(i). Operating Profit which is the excess of Gross Profit over other Operating Expenses (e.g.,
Office and Administrative Expenses, Selling and Distribution Expenses, Discount, Bad debts, Interest on short-term debts) and
(ii). Net Sales which means Gross Sales (both Cash = Credit) minus Sales Returns.
(d) Computation – This ratio is computed by dividing the operating profit by the net sales. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Operating Profit Ratio = Operating profit
Net Sales × 100 = ……. %
3. NET PROFIT RATIO
(a) Meaning - This ratio measures the relationship between net profit and net sales.
(b) Objective - The main objective of computing this ratio is to determine the overall profitability due to various factors such as operational efficiency, trading on equity etc.
(c) Components - There are two components of this ratio as follows: 1. Net Profit2. Net Sales
(d) Computation - This ratio is computed by dividing the net profit by the net sales. The figure of Net Profit may be taken either before tax or after tax. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
NetProfitRatio=Net Profit Before TaxNet Sales × 100= ……%
NetProfitRatio=Net Profit After TaxNet Sales × 100= ……%
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Interpretation - This ratio indicates (a) an average net margin earned on a sale of ` 100 (b) what portion of sales is left to pay dividend and to create reserves, and (c) firm's capacity to withstand adverse economic conditions when selling price is declining, cost of production is rising and the demand for the product is falling. Higher the ratio, greater is the capacity of the firm to withstand adverse economic conditions and vice versa.
4. OPERATING RATIO
Meaning - This ratio measures the relationship between operating cost and net sales.
Objective - The main objective of computing this ratio is to determine the operational efficiency with which production and/or purchases and selling operations are carried on.
Components - There are two components of this ratio as follows:
1. Operating Cost in the cost relating to the Operations of a business enterprise. Operating Cost which comprises (a) Cost of Goods Sold and (b) other Operating Expenses (e.g., Administrative Expenses, Selling and Distribution Expenses, Interest on short-term loans, Discount allowed and Bad Debts).
2. Net Sales which means gross sales minus sales returns.
Computation - This ratio is computed by dividing the operating cost by the net sales. This ratio is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Operating Ratio = OperatingCost
Net Sales × 100 = ……… %
Interpretation - This ratio indicates an average operating cost incurred on a sales of goods worth ` 100. Lower the ratio, greater is the operating profit to cover the non-operating expenses, to pay dividend and to create reserves and vice versa.
Tutorial Note:Both Operating Profit Ratio and Operating Ratio are complementary to each other and thus, if one of such ration is deducted from 100, another ratio may be obtained.
Distinction between Operating Ratio and Operating Profit Ratio
Operating Ratio differs from Operating Profit Ratio in the following respects:
Basis of Distinction
Operating Ratio Operating Profit Ratio
Relationship It shows the relationship between Operating Cost and Net Sales
It shows the relationship between Operating Profit and Net Sales.
Objective The objective of computing this ratio is to determine the efficiency with which production/purchase and selling operations are carried on.
The objective of computing this ratio is to determine the operational efficiency of the management.
Interpretation
This ratio indicates an average operating cost incurred on a sales of Rs 100
This ratio indicates (a) an average operating margin as a sales of Rs. 100. (b) What portion of sales is left to over non-operating expenses to pay dividend and to create reserves.
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Formula OperatingCostNet Sales × 100 = ……… %
Operating ProfitNet Sales × 100 = ……… %
EXPENSES RATIOS
To identify the causes of variations in the operating ratio, the following expenses ratios may be calculated:
1. MATERIAL CONSUMED RATIOThis ratio indicates the efficiency or otherwise in purchasing/utilising the raw materials. It is expressed as a percentage. in the form of a formula, this ratio may be expressed as follows:
Material Consumed Ratio = Matgerial Consumed pertaining ¿unitsSolution d ¿Net Sales × 100 = ……
%
2. CONVERSION COST RATIOThis ratio indicates the efficiency or otherwise of the manufacturing process. This ratio is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Conversion Cost Ratio= All manufacturing Expenses (excludingcost of material ) pertaining¿units Solutiond ¿
Net Sales × 100…%
3. ADMINISTRATIVE EXPENSES RATIOThis ratio indicates the efficiency or otherwise in the incurrence of administrative expenses. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Administrative Expenses Ratio = Administrative Expenses pertaining¿unit Solutiond ¿Net Sales ×
100 = … %
4. SELLING AND DISTRIBUTION EXPENSES RATIO
This ratio indicates the efficiency or otherwise in the incurrence of selling and distribution expenses. It is expressed as a Percentage . In the form of a formula, this ratio may be expressed as follows:
Selling and Distribution Expenses Ratio = Selling∧distributionexpense
Net sales × 100 = …….%
PROFITABILITY RATIOS IN RELATION TO INVESTMENT
Since the term 'Investment' may refer to 'Total Assets', 'Capital Employed' or 'Shareholders' Funds', the Return on Investment (ROI) can be calculated in anyone of the following ways:
1. Return on Total Assets2. Return on Capital Employed 3. Return on Shareholders' Funds.
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Tutorial Notes:Denominator to be used in calculating these ratios should be calculated preferably on average basis. If such average cannot be calculated then the amount of denominator in the beginning of accounting period should be used.
1. RETURN ON TOTAL ASSETS
(a) Meaning - This ratio measures a relationship between net profit before interest and tax, and total assets.
(b) Objective - The objective of computing this ratio is to find out how efficiently the total assets have been used by the management.
(c) Components - There are two components of this ratio as follows: (i) Net Profit before Interest and Tax. (ii) Total Assets (excluding fictitious assets, e.g., preliminary expenses)
Tutorial Note:Some accountants feel that the figure of 'Total Assets' should be fairly representative of the Investment in total assets throughout the accounting period and therefore, they prefer to make use of the concept of 'Average Assets' which can be obtained by dividing the aggregate of the total assets at the beginning and at the end of the accounting period, by 2.
Computation - This ratio is computed by dividing the net profit before interest and tax by total assets. This ratio is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Return on Total Assets =Net Profit before Interest∧Tax
Net Sales ×100 = …….. %
Interpretation - This ratio indicates the firm's ability of generating profit per rupee of total assets. Higher the ratio, the more efficient the management and utilization of total assets.
2. RETURN ON CAPITAL EMPLOYED/RETURN ON INVESTMENT (ROI)
(a) Meaning - This ratio measures a relationship between net profit before interest and tax and capital employed.
(b) Objective - The objective of computing this ratio is to find out how efficiently the long-term funds supplied by the creditors and shareholders have been used.
(c) Components - There are two components of this ratio as follows: 1. Net profit before Interest and Tax; 2. Capital Employed which refers to long-term funds supplied by the long-term creditors and
shareholders. It comprises the long-term debt and shareholders' funds.
Tutorial Notes:Some accountants feel that the figure of 'Capital Employed' should be fairly representative of the capital investment throughout the accounting period and therefore they prefer to make use of the concept of 'Average Capital employed' which can be obtained by dividing the aggregate of capital employed at the beginning and at the end of the accounting period, by 2.
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Computation - This ratio is computed by dividing the net profit before interest and tax by capital employed. It is expressed as a percentage. In the form of formula, this ratio may be expressed as follows:
Return on Capital Employed = Net Profit before Interest∧tax
Capital Employed × 100 = …… %
Interpretation - This ratio indicates the firm's ability of generating profit per rupee of capital employed. Higher the ratio, the more efficient the management and utilisation of Capital employed.
ROI = Operating Profit Ratio × capital Turnover Ratio
Net Profit before Interest∧TaxNet Sales × 100 ×
Net SalesCapital Employed
= Net Profit before Interest∧Tax
Capital Employed × 100
3. RETURN ON SHAREHOLDERS' FUNDS (OR RETURN ON EQUITY)
(a) Meaning - This ratio measures a relationship between net profit after interest and tax, and shareholders' funds.
(b) Objective - The objective of computing this ratio is to find out how efficiently the funds supplied by all the shareholders (Equity and Preference) have been used.
(c) Components - There are two components of this ratio as follows: 1. Net profit after Interest and Tax: 2. Shareholders' Funds which mean Equity Share Capital plus Preference Share Capital plus
Reserves and Surpluses minus Fictitious Assets (if any).
(d) Computation - This ratio is computed by dividing the net profit after interest and tax by shareholders' funds. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Return on Shareholders’ Funds =Net Profit after Interest∧tax
Shareholders ’ Funds × 100 = ……. %
Interpretation - This ratio indicates the firm's ability of generating profit per rupee of shareholders' funds. Higher the ratio, the more efficient the management and utilization of shareholders' funds.
4. RETURN ON EQUITY SHAREHOLDERS FUNDS
(a) Meaning - This ratio measures a relationship between net profit after interest, tax. and preference dividend, and equity shareholders' funds.
(b) Objective - The objective of computing this ratio is to find out how efficiently the funds supplied by the equity shareholders have been used.
(c) Components - There are two components of this ratio as follows:
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1. Net profit after interest, tax and preference dividend (including participating dividend if any, due to Participating Preference Shareholders).
2. Equity Shareholders' Funds which mean Equity Share Capital Plus Reserves and Surplus minus Fictitious Assets (if any).
5. EARNING PER SHARE (EPS)
(a) Meaning - This ratio measures the earnings available to an equity shareholder on a per share basis.
(b) Objective - The objective of computing this ratio is to measure the profitability of the firm on per equity share basis.
(c) Components - There are two components of this ratio as follows: 1. Net Profit after Interest, Tax and Preference Dividend; 2. Number of Equity Shares
(d) Computation - This ratio is computed by dividing the net profit after interest, tax and preference dividend by the number of equity shares. It is expressed as anSolutionute figure. In the form of a formula, this ratio may be expressed as follows:
Earningsper Share (EPS) = Net Profit after Interest, Tax∧Preference DividendNumber of Equity Shares = ` … per share
Interpretation - In general, higher the EPS, better it is and vice versa. While interpreting this ratio, it must be seen whether there is any increase in Equity Shareholders' Funds as a result of retained earnings without any change in numbers of outstanding shares. For instance, in the case of a company which is following a practice of ploughing back of profits and which is not capitalising its profits by way of issue of bonus shares, the interpretation of EPS without considering the effect of profits ploughed back in the business on earnings, will not be appropriate. EPS helps in determining the market price of the equity shares of the company. It also helps in estimating the company's capacity to pay dividend.
6. DIVIDEND PER SHARE
(a) Meaning - This ratio measures the dividend distributed per equity share.
(b) Objective - The objective of computing this ratio is to measure the dividend distributed per equity share.
(c) Components - There are two components of this ratio as follows: 1. Profits Distributed as dividend 2. Number of Equity Shares
(d) Computation - This ratio is computed by dividing the profit distributed as equity dividend by the number of equity shares. It is expressed as an absolute figure. In the form of a formula, this ratio may be expressed as follows:
(e)
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Dividend per Share (EPS) =Profit distributed an Equity dividend
Number of Equity Shares = ` …….. as share
Interpretation - In general, higher the DPS, better it is and vice versa.
7. PRICE EARNING RATIO
(a) Meaning - This ratio measures the relationship between the market price per share and earning per share.
(b) Objective - The objective of computing this ratio is to find out expectations of the shareholders about the earnings of the firm.
(c) Components - There are two components of this ratio as follows: 1. Market Price Per Share2. Earnings per Share (EPS).
(d) Computation - This ratio is computed by dividing market price per share by the earning per share. It is usually expressed as a pure number. In the form of a formula, this ratio may be expressed as follows:
Note: Market Price per share may be Average Share Price or Closing Share Price
Price-Earnings Ratio = Market Price Per Share
Earning Per Share(EPS)
Interpretation - It indicates the number of times of EPS, the share is being quoted in the market. In other words, it indicates the payback period within which the prospective investor can recover his investment in a single share by way of Earning Per Share (EPS). Unless affected by speculation usually higher P/E Ratio indicates that the company is growing and has good earning prospects but a lower P/E ratio need not always necessarily mean that the company is not growing and has no good prospects as it happens in case of a closely held public company where only a few shares are available in the market for general investors who generally do not trade much in those limited shares.
8. DIVIDEND PAYOUT RATIO
(a) Meaning - This ratio measures the portion of earning per share distributed as dividend.
(b) Objective - The objective of computing this ratio is to measure the portion of EPS distributed as dividend.
(c) Components - There are two components of this ratio as follows: 1. Earnings Per Share (EPS) 2. Dividend Per Share (DPS)
(d) Computation - This ratio is computed by dividing the DPS by EPS. It is usually expressed as a percentage. In the form of formula, this ratio may be expressed as follows:
(e)
Dividend Payout ratio = Dividend Per Share (DPS)Earning Per Share(EPS) × 100
Interpretation - In general higher the DP Ratio, better it is. An enterprise should have a satisfactory ratio. To judge whether the ratio is satisfactory or not, it should be compared with its
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own past ratios or with the ratio of similar enterprises in the same industry or with the industry average. Dividend Payout Ratio = Dividend Per share/Earning Per Share × 100
9. EARNING YIELD (EY)
(a) Meaning - This ratio measures the relationship between Earning Per Share (EPS) and Maker price per share.
(b) Objective - The objective of computing this ratio is to measure the performance of earnings in relation to market price per share.
(c) Components - There are two components of this ratio as follows: 1. Earnings Per Share2. Market Price Per Share
(d) Computation - This ratio is computed by dividing the EPS by the market price per share. It is usually expressed as a percentage. In the form of a formula, this ratio may be expressed as follows:
Earning Yield = Earning Per Share(EPS )Market Price Per Share
× 100
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CLASSROOM PRACTICE – LETS PLAY TOGETHER
Que 1The Balance Sheet of Jain Ltd. as at 31st March 2013 is as under: Liabilities ` Assets `Equity Share Capital (` 10 each) 1,00,000 Land & Building 6,00,00018% Pref. Share capital 1,00,000 Plant & Machinery 5,00,000General Reserve 60,000 Furniture & Fixture 1,00,000Profit & Loss A/c 2,40,000 12,00,00015% Debentures 8,00,000 Less: Depreciation (2,00,000
)Trade Creditors 40,000 10,00,000Bills Payable 30,000 Trade Investments (long-term) 1,00,000Outstanding Expenses 20,000 Stock 95,000Bank overdraft 10,000 Debtors 3,40,000Provision for Tax 2,40,000 Less: Provision 30,000 3,10,000
Marketable Securities 10,000Cash 10,000Bills receivables 10,000Prepaid Expenses 5,000Preliminary Expenses 60,000Underwriting Commission 40,000
16,40,000
16,40,000
Net Sales for the year 2012-2013 amounted to `20, 00,000. Net profit after tax ` 2, 40,000, Tax @ 50%. Calculate Current Ratio as at 31.3.2013.
SolutionCurrent Assets = Stock + Debtors - Provision on Debtors + Marketable Securities + Cash + B/R
+ Prepaid Expenses
= ` 95,000 + ` 3, 40,000 - ` 30,000 + ` 10,000 + ` 10,000 + ` 10,000 + ` 5,000 = ` 4, 40,000
Current Liabilities = Trade Creditors + B/P + O/s Exp + Bank O/D + Provision for Tax = ` 40,000 + ` 30,000 + ` 20,000 + ` 10,000 + ` 2, 40,000= ` 3, 40,000
Current Ratio = Current Assets
Current Liabilities
= Rs . 4 , 40,000Rs .3 , 40,000
= 22:17
Que 2Creditors `20,000, Working Capital ` 3,60,000, Other Current Liabilities ` 1,00,000. Calculate Current Ratio.
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Solution Current Liabilities = Creditors + Other Current Liabilities
= ` 20,000 + ` 1, 00,000 = ` 1, 20,000Current Assets = Current Liabilities + Working Capital
= `1, 20,000 + ` 3, 60,000 = ` 4, 80,000Current Ratio = Current Assets / Current Liabilities
= ` 4, 80,000 / ` 1, 20,000 = 4:1
Que 3Calculate the Quick Ratio from the following information: Current Assets ` 4,40,000, Stock ` 95,000, Prepaid Expenses ` 5,000, Current Liabilities `3,40,000. Creditors `20,000.SolutionQuick Assets = Current Assets - Stock - Prepaid Expenses
= ` 4, 40,000 - ` 95,000 - ` 5,000 = ` 3, 40,000
Quick Ratio = Quick Assets / Current Liabilities = ` 3, 40,000 / ` 3, 40,000 = 1:1
Note: Creditors are already included in current liabilities.
Que 4X has a current ratio of 2.5:1. Its stock is ` 80,000 and its current liabilities are ` 80,000. Calculate the liquid ratio. SolutionCurrent Ratio = Current assets/Current liabilities = 2.5Or = Current assets/` 80,000 = 2.5 Or, Current assets = ` 80,000 × 2.5 = ` 2, 00,000Liquid Assets = Current assets - Stock = ` 2, 00,000 - ` 80,000 = ` 1, 20,000Liquid Ratio = Liquid assets/Current liabilities = ` 1, 20,000/` 80,000 = 1.5: 1
Que 5X Ltd. has a current ratio of 2:1 and quick ratio of 1.5:1. Its current liabilities are ` 80,000. Calculate the value of stock. SolutionCurrent Ratio = Current Assets/Current Liabilities = 2
Or, = Current Assets/` 80,000 = 2 Current Assets = ` 80,000 × 2 = ` 1, 60,000Quick Ratio = Quick Assets/Current liabilities = 1 .5
Or, = Quick Assets/` 80,000 = 1.5 Quick Assets = `80,000× 1.5 = ` 1, 20,000Stock = Current Assets - Quick Assets
= ` 1, 60,000 - ` 1, 20,000 = ` 40,000
Que 6X Ltd. has a current ratio of 2.5:1 and quick ratio of 1.5:1. Its current assets are Rs. 2, 00,000. Calculate the value of stock. SolutionCurrent Ratio = Current Assets/Current Liabilities = 2.5
Or, = ` 2, 00,000/Current Liabilities = 2.5
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Current Liabilities = ` 2, 00,000/2.5 = Rs. 80,000 Quick Ratio = Quick Assets/Current Liabilities = 1.5
Or, = Quick Assets/` 80,000 = 1.5 Quick Assets = ` 80,000 × 1.5 = ` 1, 20,000Value of Stock = Current Assets - Quick Assets
= ` 2, 00,000 - ` 1, 20,000 = `80,000
Que 7Capital Employed ` 24, 00,000. Long-term Debt ` 16, 00,000. Calculate the Debt-Equity Ratio. SolutionShareholders' Funds = Capital Employed - Long-term Debt
= ` 24, 00,000 - `16, 00,000= ` 8, 00,000
Long-term Debts = ` 16, 00,000Debt-Equity Ratio = Long Term Debts / Shareholders' Funds
= ` 16, 00, 00 / ` 8, 00,000 = 2: 1
Que 8Total Debt ` 9, 00,000, Capital Employed ` 12, 00,000, Current Liabilities ` 1, 00,000, Calculate the Debt-Equity Ratio. SolutionLong-term Debt = Total Debt - Current Liabilities
= ` 9, 00,000 - ` 1, 00,000= ` 8, 00,000
Shareholder’s fund = Capital Employed - Long-term Debt = ` 12, 00,000 - ` 8, 00,000= ` 4, 00,000
Debt Equity Ratio = Long-term Debts / Shareholder’s Funds = ` 8, 00,000 / ` 4, 00,000= 2:1
Que 9Total Assets ` 2, 60,000, Total Debt ` 1, 80,000, Current Liabilities ` 20,000. Calculate the Debt-Equity Ratio. SolutionLong-term Debt = Total Debt – Current Liabilities
= ` 1, 80,000 – ` 20,000 = ` 1, 60, 000Shareholder’s Funds = Total Assets / Total Debt
= ` 2, 60,000 - 1, 80,000 = ` 80,000Debt-Equity Ratio = Long-term Debt / Shareholder’s
= ` 1, 60,000 / ` 80,000 = 2:1Que 10
Net profit before Interest and Tax `3, 20,000.Interest on Long term debt ` 40,000. Calculate Interest Coverage Ratio.
Solution
Interest Coverage Ratio = Net Profit before Interest∧Taxes
Interest on Long−term Debt
=Rs . 3 ,20,000
Rs . 40,000 = 8 times
Que 11
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Calculate Interest Coverage Ratio from the following information: 15% Debentures ` 8,00,000, Net Profit after Interest & Tax ` 2,40,000, Tax ` 2,40,000.
SolutionInterest on Long-term Debt = ` 8, 00,000× 15/100 = ` 1, 20,000Net Profit before Interest & Tax = Net Profit after interest & tax + Tax + Interest
= ` 2, 40,000 + ` 2, 40,000 + ` 1, 20,000= ` 6, 00,000
Interest Coverage Ratio = Net Profit before Interest∧Taxes
Interest on Long−term Debt
=Rs .6 , 00,000Rs .1 , 20,000 = 5 times
Que 12Fixed Assets (at cost) ` 12,00,000, Accumulated Depreciation till date `2,00,000, Trade Investments ` 1,00,000, Current Assets ` 4,40,000, Current Liabilities ` 3,40,000, Cash Sales ` 4,00,000, Gross Credit Sales `17,00,000, Sales Returns ` 1,00,000, calculate Capital Turnover Ratio. SolutionCapital Employed = Net Fixed Assets + Trade Investments + Current Assets - Current Liabilities
= ` 12,00,000 - ` 2,00,000 + `1,00,000 + ` 4,40,000 - ` 3,40,000 = ` 12, 00,000
Net Sales = Cash Sales + Net Credit Sales = ` 4, 00,000 + (` 17,00,000 - ` 1,00,000) = ` 20, 00,000
Capital Turnover Ratio = Net Sales
Capital Employed = Rs . 12,00,000Rs . 12,00,000 = 1.67 times
Que 13Shareholders Funds ` 4, 00,000, Long-term Debt ` 8, 00,000, Gross Profit at 20% on cost was ` 8, 00,000. Calculate Capital Turnover Ratio. SolutionCapital Employed = Shareholders' Funds + Long-term Debt
= ` 4, 00,000 + ` 8, 00,000= ` 12, 00,000
If Cost is ` 100, Gross Profit = `20 then Sales = ` 100 + ` 20 = ` 120 If Gross Profit is ` 20, then sales = 120
If Gross Profit is ` 8,00,000, then Sales = Rs .120Rs .20 × 8,00,000 = ` 48,00,000
Capital Turnover Ratio = Rs . Net Sales
Capital Employed =Rs . 48,00,000
12,00,000 = 4 times
Que 14You are given the following figures: `Current ratio 2.5Liquidity ratio 1.5Net working capital `3,00,000Fixed assets turnover ratio (on cost of sales) 2 times
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Average debt collection period 2 monthsStock turnover ratio (cost of sales/closing stock) 6 timesGross profit ratio 20%Fixed assets/shareholders net worth 0.80Reserve and surplus/capital 0.50Draw up the balance sheet of the company.Solution: Balance Sheet as on…………..
` `Share capital 5,00,00
0Fixed assets 6,00,000
Reserves and surplus 2,50,000
Stock 2,00,000
Long-term borrowings (balancing figure)
1,50,000
Debtors 2,50,000
Current liabilities 2,00,000
Bank 50,000
Workings If current liabilities = 1Current assets = 2.5It means the difference or working capital = 1.5Working capital or 1.5 = `3, 00,000∴Current assets = ` 5,00,000Current liabilities = ` 2, 00,000Liquidity ratio = 1.5And current liabilities = `2, 00,000Liquid assets (bank and debtors) (2,00,000 × 1.5) = `3,00,000Stock (5,00,000 - 3,00,000, i.e. current assets - liquid assets) =`2,00,000Cost of sales (as stock turnover ratio is 6) = `12, 00,000
Sales as G.P. ratio is 20%(12,00,000+ 20/80 × 12,00,000) = = ` 15, 00,000Fixed assets, `12,00,000/2 as fixed assets turnover is 6 = ` 6,00,000Debtors, `15,00,000 / 6 Debt collection period being 2 months = ` 2,50,000Shareholders' net worth, ` 6,00,000 × 1/ 0.80 = ` 7,50,000Out of shareholders' net worth, reserves and surplus = ` 2, 50,000Share capital = ` 5, 00,000
Que 15From the following information relating to Wise Ltd, prepare its summarised Balance Sheet.Current RatioAcid Test RatioGross Profit to Sales RatioNet Working Capital to Net Worth RatioSales to Net Fixed Assets RatioSales to Net Worth Ratio
2.51.50.2
0.32.01.5
Sales to Debtors RatioReserves to Capital RatioNet Worth to Long Term Loan RatioStock VelocityPaid up Share Capital
- 6.0- 1.0-- 20.0- 2 months- `10 lakhs
Solution: Balance Sheet of Wise LimitedLiabilities ` Assets `
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Share Capital (given) Reserves(WN 1) Long-Term Loans (WN 3) Current Liabilities(WN 10)
10,00,000 10,00,000
1,00,000 4,00,000
Fixed Assets (WN 12) Current Assets Stock (WN8) 4,00,000 Debtors (WN 5) 5,00,000 Bank (WN 10) 1,00,000
15,00,000
10,00,000Total 25,00,00 Total 25,00,000
Working Notes and calculations
1.ReservesCapital = 1 Since capital = ` 10, 00,000, Reserves also = ` 10, 00,000
2. Net Worth = capital + Reserves = ` 20,00,000
3.NetWorth
Long Term Loan = 20. So, Rs .20,00,000
Long Term Loan = 20
Hence, Long Term Loan = Rs .20,00,00020 =` 1, 00,000
4.Sales
Net Worth = 6 So, Sales
20,00,000 = 1.5
Hence, Sales = ` 20, 00,000 × 1.5 = ` 30, 00,000
5.Sales
Debtors = 6 So, 30,00,000Debtors = 6
Hence, Debtors = 30,00,000
6 = ` 5, 00,000
6. Gross Profit Ratio = 20% of Sales.
So Gross Profit = 20% ×` 30,00,000 = ` 6,00,000
7. Cost of Goods Sold = Sales - Gross Profit
= ` 30, 00,000 – ` 6, 00,000 = ` 24, 00,000
8. Stock Velocity =COGS
Inventory = Rs .24,00,000
Inventory
= 6 times. So, Inventory = 24,00,000
6 = ` 4,00,000
Note: In the absence of information, it is assumed that Opening Stock = Closing Stock = Average Stock.
9.Net Working Capital
Net Worth = Net Working Capital
Rs .20,00,000 =0.3.
So, Net Working capital = ` 20, 00,000 × 0.3 =` 6, 00,000
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10.Current Ratio = Current AssetsCurrent Liabilities = 2.5 times.
So, Current Assets = 2.5 × Current Liabilities
Net Working Capital = Current Assets - Current Liabilities = ` 6, 00,000. 2.5 × Current Liabilities - Current Liabilities =` 6, 00,000 1.5 × Current Liabilities = `. 6, 00,000
So, Current Liabilities =6,00,000
1.5 = ` 4, 00,000
Hence, Current Assets = 2.5 × 4, 00,000 = ` 10, 00,000
Inventory Debtors cash and Bank (WN 8) = ` 4, 00,000 (WN 5) = ` 5, 00,000 (bal. fig) ` 1, 00,000
11. Quick Ratio = Quick AssetsQuick Liabilities = 1.5 times
So, Current Assets- StockCurrent Liabilities – Bank OD = 1.5.
On substitution =Rs. 10, 00,000- Rs. 4, 00,000Rs. 4, 00,000 – Bank OD = 1.5 times
OnSolving, we get, Bank O/D = Rs. NIL
12.SalesNet Fixed Assets = 2. So,
Rs. 30,00,000Net Fixed Assets = 2
Hence, Net Fixed Assets = Rs. 30, 00,0002 = ` 15, 00,000
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TRAIN UR BRAIN
1. _________ is used to evaluate relationships among financial items.a) Ratio Analysis b) Trends Ratiosc) Accounting Ratios d) None of the above
2. The ratios are used to identify trends over time for one organization or to compare two or more organizations at one point in time.a) True b) Falsec) Partly True d) Partly False
3. Ratio Analysis focuses on – a) Liability b) Profitabilityc) Solvency d) All of the above
4. Ratios can be used in a form of _______ to identify areas when performance has improved or deteriorated over time.a) Short term Analysisb) Trend Analysisc) Vertical Analysisd) Horizontal Analysis
5. _______ are relationships, expressed in arithmetical terms, between figures which have a cause and effect relationship or which are connected with each other in some other manner.a) Ratio Analysis b) Trends Ratioc) Accounting Ratiod) None of the above
6. Ratio Analysis are useful tool for grasping the true message of the financial statements and understanding them.a) True b) Falsec) Partly True d) Partly False
7. Ratios act as indicators of - a) Financial Soundnessb) Strengthc) Positiond) All of the above
8. Ratio useful for all the constituents of the company i.e.i) Managementii) Shareholdersiii) Investorsiv) Creditorsv) Government
a) (i), (ii), (iii), (iv)b) (ii), (iii), (iv), (v)c) (i), (ii), (iv), (v)d) All of the above
9. ______ is interested in ratios because they help in the formulation of policies, decision making and evaluating the performance and trends of the business and its various segments.a) Management b) Shareholdersc) Investors d) Creditors
10. _______ deal with relationship between two individual or group of items appearing in the income or profit and loss statement.a) Balance Sheet Ratiob) Operating ratio or Profit and Loss
Ratioc) Combined Ratiosd) None of the above
11. ________ gives some yardstick to measure the profit in relative terms with reference to sales assets or capital employed.a) Profitability Ratiob) Turnover Ratioc) Financial Ratiod) Market Test Ratios
12. ________ are calculated to judge the financial position of the organization from short-term as well as long-term solvency point of view.a) Profitability Ratio b) Turnover Ratioc) Financial Ratiod) Market Test Ratio
13. Profitability Ratio =
a)Operating Profit (Net Margin)OperatingCapital Employment
+ 100
b)Operating Profit (Net Margin)OperatingCapital Employment
- 100
c)Operating Profit (Net Margin)OperatingCapital Employment
×100
d)Operating Profit (Net Margin)OperatingCapital Employment
÷ 100
14. Capital employed comprise – a) Share Capital + Reserve and Surplus +
Long-term loans + Non Operating Assets + Fictitious Assets
b) Share Capital + Reserve and Surplus + Long-term loans - Non Operating Assets - Fictitious Assets
c) Share Capital + Reserve and Surplus - Long-term loans + Non Operating Assets + Fictitious Assets
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d) Share Capital - Reserve and Surplus - Long-term loans + Non Operating Assets + Fictitious Assets
15. _________ is also referred to as return on net worth.a) Profitabilityb) Return on Investmentc) Return on Shareholder’s Fundsd) Return on Assets
16. Return on shareholder’s Funds =
a)Net Profit after Interest∧Tax
Shareholders' Fund+ 100
b)Net Profit after Interest∧Tax
Shareholders' Fund - 100
c)Net Profit after Interest∧Tax
Shareholders' Fund × 100
d)Net Profit after Interest∧Tax
Shareholders' Fund÷ 100
17. _________ Ratio express the relationship of gross profit to net sales or turnover.a) Gross Profit b) Net Profitc) Operating d) Activity
18. Gross Profit Ratio =
a)Gross Profit
Net Sales + 100
b)Gross Profit
Net Sales - 100
c)Gross Profit
Net Sales ×100
d)Gross Profit
Net Sales ÷ 100
19. The major component of cost is -a) Material b) Labourc) Overheads d) All of the above
20. Fixed Assets Turnover Ratio =a) Net Sales + Fixed Assetsb) Net Sales - Fixed Assetsc) Net Sales × Fixed Assetsd) Net Sales ÷ Fixed Assets
21. _________ Ratio is an indicator of the efficiency of the use of investment in stock.a) Fixed Assets Turnoverb) Working Capital Turnoverc) Stock Turnoverd) Debtors Turnover
22. Average inventory is calculated on the basis of the average inventory at the beginning and at the end of the accounting period.a) True b) Falsec) Partly True d) Partly False
23. _________ ratio measures the net credit sales of a firm to the recorded trade debtors thereby indicating the rate at which cash is generated by turnover of receivable or debtors.a) Fixed Assets turnoverb) Working Capital Turnoverc) Stock Turnoverd) Debtors Turnover
24. Debtors collection period depend upon the – a) Nature of the industryb) Seasonal character of the businessc) Credit policy of the firmd) All of the above
25. The term ‘creditors’ include –a) Trade Creditors b) Bills Payablec) Both (a) and (b)d) None of the above
26. Current Assets normally include –i) Inventoriesii) Sundry Debtorsiii) Loans and Advancesiv) Marketable Securitiesv) Bills Payablevi) Provision for Taxationvii)Bank Overdraft
a) (i), (ii), (iii), (iv)b) (iii), (iv), (v), (vi)c) (v), (vi), (iv), (viii)d) All of the above
27. Current Liabilities consists of –i) Inventoriesii) Sundry Debtorsiii) Loans and Advancesiv) Marketable Securitiesv) Sundry Creditorsvi) Bills Payablevii) Provision for Taxationviii) Bank Overdraft
a) (i), (ii), (iii), (iv)b) (iii), (iv), (v), (iv)c) (v), (vi), (iv), (viii)d) All of the above
28. Proprietary ratio = Shareholders' Funds?
a) Long term fundsb) Fixed Assetsc) Total Assetsd) Interest Charges
29. Fixed Assets Ratio = ?
LongTerm Funds
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a) Long Term Fundsb) Fixed Assetsc) Total Assetsd) Interest Charges
30. ______ Ratio is also known fixed charges over or interest cover.a) Debt Service b) Capital gearingc) Market Testd) Earning per share
31. Debt Service Ratio = Net Profit Before Interest∧Tax
?a) Long Term Funds b) Fixed Fundsc) Total Assetsd) Interest Charges
32. EPS = ?
No .of Equity Sharesa) Net Profit b) Gross Profitc) Debtorsd) None of the above
33. _________ ratio establishes relationship between the market price of shares of a company and its earnings per share (EPS).a) Price Earning b)Pay Outc) Dividend Yield d) Debt equity
34. ________ ratio expresses the relationship between what is available as earning per share and what is actually paid in the form of dividends out of available earnings.a) Price Earning b) Pay-outc) Dividend Yield d) Debt Equity
35. Dividend Pay-out Ratio =
a)Dividend per share
Market Price per share + 100
b)Dividend per share
Market Price per share - 100
c)Dividend per share
Market Price per share ×100
d)Dividend per share
Market Price per share ÷ 100
36. Which of the following actions will cause an increase in its current ratio?a) $ 1,000 worth of inventory is sold, and
an account receivable is created. The receivable exceeds the inventory by the amount of profit on the sale, which is added to retained earnings.
b) A small subsidiary which was acquired for $ 100,000 two years ago which was generating profits at the rate of 10% is sold for $ 100,000 cash (Average company profits are 15% of assets).
c) Marketable securities are sold at cost.
d) Both (a) and (b)37. Which of the following statement is
correct?a) If firms A and B have the same level of
earnings per share. And the same market to book ratio, they must have the same price earnings ratio.
b) Firms A and B have the same level of net income, taxes paid, earning power ratio (BEP) must be greater than that of firm B.
c) Firms A and B have the same level of net income. If firm A has a higher interest expense, its return on equity (ROE) must be greater than that of firm B.
38. If a company revalues its assets, its net worth –a) Will improveb) Will remain samec) Will be positively affectedd) None of the above
39. Proprietary ratio is calculated by – a) Total Assets/ Total Outside Liabilityb) Total Outside Liability/Total tangible
Asset Fixed Assets/ Long Term Source of fund
c) Proprietor’s Funds/Total Tangible Assets
40. Current Ratio of a concern is 1, its net working capital will be – a) Positive b) Negativec) Nild) None of the above
41. Quick assets does not include –a) Government Fundb) Book Debtsc) Advance for supply of raw materialsd) Inventories
42. The ideal quick ratio is –a) 2 : 1 b) 1 : 1c) 5 : 1d) None of the above
43. A very high current ratio indicates -a) High Efficiencyb) Flabby Inventoryc) Position of more long term fundsd) Either (b) or (c)
44. Financial leverages means –a) Use of more debt capital to increase
profitb) High degree of solvencyc) Low bank finance
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d) None of the above 45. The Capital gearing ratio is high for a
company. It indicates a position of –a) Low debtsb) High preference capitalc) High equityd) Low Debt equity ratio
46. Current liabilities are equal to –a) Working Capital + Current Assetsb) Working Capital – Current Assetsc) Current Assets – Working Capitald) Current Assets + Working Capital
47. The nature of ratio analysis is – a) Quantitative Analysisb) Qualitative Analysisc) Both Quantitative and Qualitative
Analysisd) None of the above
48. Stock is not a quick asset for the purpose of calculating acid test ratio.a) True b) Falsec) Partly True d) Partly False
49. A firm with a very high current ratio and very low liquid ratio has very low level of inventory.a) True b) Falsec) Partly True d) Partly False
50. Quick Ratio is the indicator of _________ position of an enterprise.a) Social b) Financialc) Economical d) Political
51. The net income of company after preference dividend is ` 40,000 and the number of equity shares is 6,000 then EPS = a) ` 0.15 per share b) ` 6.66 per sharec) ` 1.5 per share d) ` 15 per share
52. If a company declares 20% dividend on its share of ` 20 each having a market value of ` 40 each, then the real rate of return is not 20% but is 10%. Dividend yield ratio is – a) 20% b) 5%c) 10% d) 40%
53. If the dividend payout ratio is 0.40 and the P/E ratio is 8, then calculate the dividend yield a) 8% b) 5%c) 7% d) 6%
54. If the net profit margin is 8%, the asset to equity ratio is 3.00 and total asset turnover is 1.5 then calculate the return on equity.
a) 12% b) 24%c) 36% d) 48%
55. Orient Ltd. has financed its assets by taking debt as high as 60% of the value of the assets. If the equity capital of the company is ` 60 lakhs, then calculate the debt.a) ` 90 lakhs b) ` 60 lakhsc) ` 75 lakhs d) ` 85 lakhs
56. The average collection period of a company is 40 days. If the receivables balance is ` 20 lakhs, then calculate the amount of sales.a) ` 182.00 lakhs b) ` 182.50 lakhsc) ` 181.50 lakhs d) ` 181.00 lakhs
57. The equity capital and total debt of Super Industries Ltd. amount to ` 150 lakhs and ` 300 lakhs respectively. The EBIT of the company amounts to ` 90 lakhs. Calculate the return on investment of the company.a) 5% b) 10%c) 20% d) 40%
58. If the stock turnover = 6, cost of goods sold = ` 5,000 and opening stock = ` 8,000, then calculate the value of closing stock.a) ` 5,000 b) ` 15,000c) ` 20,000 d) ` 10,000
59. Working capital of a company is ` 1,35,000 and current ratio is 2.5. Liquid Ratio is 1.5 and the proprietary ratio is 0.75. Bank Overdraft is ` 30,000. There are no long term loans and fictitious assets. Reserves and surplus amount to ` 90,000 and the gearing ratio (Equity Capital/ Preference Capital) is 1.2.i) Current Assets
a) ` 2,25,000 b) ` 1,35,000c) ` 2,70,000 d) ` 60,000
ii) Net Blocka) ` 2,25,000 b) ` 1,35,000c) ` 2,70,000 d) ` 60,000
iii) Proprietary Funda) ` 2,25,000 b) ` 1,35,000c) ` 2,70,000 d) ` 60,000
iv) Quick Liabilitiesa) ` 2,25,000 b) ` 1,35,000c) ` 2,70,000 d) ` 60,000
v) Quick Assetsa) ` 90,000 b) ` 1,35,000c) ` 1,20,000 d) ` 60,000
vi) Stocka) ` 90,000 b) ` 1,35,000
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c) ` 1,20,000 d) ` 60,000vii)Preference and Equity Capital
a) ` 90,000, ` 1,35,000b) ` 1,35,000, ` 1,20,000c) ` 1,20,000, ` 60,000d) ` 60,000, ` 1,20,000
60. Following information are given below: Inventory turnover ratio is 6 times year and debtors are outstanding for 2
months, year and creditors are outstanding for 73 days.
Ratios of cost of goods sold to: (a) Proprietors’ funds 2 : 1, (b) fixed assets is 4 : 1
Ratio of gross profit to sales is 20% Closing stock is greater than the
opening stock by ` 10,000 The gross profit for the year ended
31st march, 2014 is ` 1,20,000 Reserves and surplus appearing in the
balance sheet as at 31st March, 2014 total to ` 40,000
The directors’ of Bharucha enterprises Ltd. ask you to ascertain:i)I Proprietors’ Fund
a) ` 2,40,000 b) ` 1,20,000c) ` 1,00,000 d) ` 98,000
i)II Fixed Assets:a) ` 2,40,000 b) ` 1,20,000c) ` 1,00,000 d) ` 98,000
i)III Closing Debtors:a) ` 2,40,000 b) ` 1, 20,000c) ` 1,00,000 d) ` 98,000
i)IV Closing Creditors:a) ` 2,40,000 b) ` 1,20,000c) ` 1,00,00 0 d) ` 98,000
i)V Closing Stocka) ` 85,000 b) ` 2,00,000c) ` 33,000 d) ` 83,000
i)VI Share Capitala) ` 85,000 b) ` 2,00,000c) ` 33,000 d) ` 83,000
i)VII Cash and Bank Balancesa) ` 85,000 b) ` 2,00,000c) ` 33,000 d) ` 83,000
61. Russell securities has $ 100 million in total assets and its corporate tax rate is 40%. The company recently reported that its basic earning power ratio was 15% and that its return on assets (ROA) was 9%. What was the company’s interest expense?a) $ 0 b) $ 2,000,000
c) $ 6,000,000 d) $ 15,000,00062. Tapley Dental Supply Company has the
following data:Net Income: % 240 Sales: % 10,000Total assets: $ 6,000 Debt Ratio: 75%The Ratio: 2.0 Current Ratio: 1.2BEP ratio: 13.33%If Tapley could streamline operations, cut operating costs, and raise net income to $ 300, without affecting sales or the balance sheet (the additional profits will be paid out as dividends), by how much would its ROE increase?a) 3.00% b) 3.50%c) 4.00% d) 4.50%
63. Q Corp. has a basic earnings power (BEP) ratio of 15% and has a times interest earned (TIE) ratio of 6. Total assets are $ 1,00,000. The corporate tax rate is 0%. What is Q Corp’s return on assets (ROA)?a) 7.5% b) 10.0%c) 12.2% d) 13.1%
64. You are considering adding a new product to your firm’s existing product line. It should cause a 15% increase in your profit margin (i.e., new PM = old PM × 1.5), but it will also require a 50% increase in total assets (i.e., new TA = old TA ×1 .5). You expect to finance this asset growth entirely by debt. If the following ratios were computed before the change what will be the new ROE if the new product is added and sales remain constant?Ratios before new productProfit margin = 0.10Total Assets turnover = 2.00Equity Multiplier = 2.00a) 11% b) 46%c) 40% d) 20%
65. Oliver incorporated has a current ratio = 1.6, and a quick ratio equal to 1.2. The company has $ 2 million in sales and its current liabilities are 1 $ million. What is the company’s inventory turnover ratio?a) 5.0 b) 5.2c) 5.5 d) 6.0
66. The Meridian Company has determined that its return on equity is 15%. Management is interested in the various components that went into this calculation. You are given that following information: Total Debt/ Total assets =
200
0.35 and total assets turnover = 2.8. What is the profit margin?a) 3.48% b) 5.42%c) 6.96% d) 2.45%
67. Traft Technologies has the following relationships:Annual Sales $ 1,200,000Current Liabilities $ 375,000Days sales outstanding (DSO) (365-day year) 40Inventory Turnover Ratio 4.8Current Ratio 1.2The company’s current assets consist of cash, inventories, and accounts receivable. How much cash Taft have on its balance sheet? a) $ 8.333 b) $ 68.493c) $ 125,000 d) $ 200,000
68. Thomas Corp. has the following simplified balance sheet:
Cash $50,000 Current Liabilities
$ 125,000
Inventory 150,000Accounts receivable
100,000 Long-term debt
175,000
Net fixed Assets
200,000 Common Equity
200,000
Total $ 500,000 Total $ 500,000
Sales for the year totaled $ 600,000. The company president believes the company carries excess inventory. She would like the inventory turnover ratio to be 8x and would use the freed up cash to reduce current liabilities. If the company follows the president’s recommendation and sales remain the same, the new quick ratio would bea) 2.4 b) 4.0c) 4.5 d) 3.0
69. Southeast Packaging’s ROE last year was only 5%, but its management has developed a new operating plan designed to improve things. The new plan calls for a total debt ratio of 60% which will result in interest charges of $ 8,000 per year. Management projects an EBIT of $ 26,000 on sales of $ 240,000, and it expects to have a total assets turnover ratio of 2.0. Under these conditions, the average tax rate will be 40%. If the changes are made, what return equity will southeast earn?a) 9.00% b) 11.25%c) 17.50% d0 22.50%
70. Vance Motors has current assets of $ 1.2 million. The company’s current ratio is 1.2, its quick ratio is 0.7, and its inventory turnover ratio is 4. The company would like to increase its inventory turnover ratio to the industry average, which is 5, without reducing its sales. Any reductions in inventory will be used to reduce the company’s current liabilities. What will be the company’s current ratio, assuming that it is successful in improving its inventory turnover ratio to 5?a) 1.33 b) 1.67c) 1.22 d) 0.75
71. Debt Equity Ratio is 3 : 1, the amount of total assets ` 20 lack, current ratio is 1.5:1 and owned funds ` 3 lac. What is the amount of current asset?a) ` 5 lac b) ` 3 lacc) ` 12 lacd) None of the above
72. Current ratio is 4 : 1. Net Working Capital is ` 30,000. Find the amount of current Assets, a) ` 10,000 b) ` 40,000c) ` 24,000 d) ` 6,000
73. Current Ratio is 2:5. Current Liability is ` 30,000. The Net working capital isa) ` 18,000 b) ` 45,000c) ` (-) 45,000 d) ` (-) 18,000
74. The ratio of Current Assets (` 6,00,000) to Current Liabilities (` 4,00,000) is 1.5 : 1. the accountant of the firm is interested in maintaining a Current Ratio of 2 : 1, by paying off a part of the Current Liabilities. Compute the amount of Current Liabilities that should be paid, so that the Current Ratio at the level of 2 : 1 may be maintained.a) ` 2,00,000 b) ` 3,00,000c) ` 2,50,000 d) ` 4,00,000
75. Current Liabilities of a company are ` 3,00,000. Its Current ratio is 3 : 1 and liquid ratio is 1 : 1. Calculate the value of stock assuming that the only other current asset is stock.a) ` 6,50,000 b) ` 7,00,000c) ` 7,50,000 d) ` 6,00,000
76. The Current Ratio of A Ltd. is 4.5 :1 and Liquid Ratio is 3 : 1. Stock is ` 3,00,000. What are the Current Liabilities?a) ` 1,00,000 b) ` 2,00,000
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c) ` 2,50,000 d) ` 3,00,00077. Total Current liabilities of A Ltd. are `
5,00,000 and acid test ratio is 3 : 1. Stock is ` 2,50,000. Find out the Current ratio.a) 4.5 : 6 b) 2.3 : 2c) 4.5 : 1 d) 3.5 : 1
78. Quick Ratio 1.5, Current Assets ` 1,00,000, Current Liabilities ` 40,000. Calculate the value of stock.a) ` 40,000 b) ` 45,000c) ` 50,000 d) ` 30,000
Working Capital of a Company is ` 60,000. Its Current Ratio is 2.5:1.Calculate the value of:
79. Current Liabilitiesa) ` 36,000 b) ` 30,000c) ` 35,000 d) ` 40,000
80. Current Assetsa) ` 2,00,000 b) ` 3,00,000c) ` 1,00,000 d) ` 3,00,000
81. Acid test ratio assuming stock of ` 40,000.a) 1.5 : 1 b) 2.5 : 1c) 3.5 : 1 d) 4.5 : 1
82. Calculate Debt-Equity Ratio from the following data:Total Assets ` 1,25,000Total debt ` 1,00,000Current Liabilities ` 50,000a) 2 : 3 b) 2 : 5c) 2 : 1 d) 1 : 2
` 2,00,000 is the cost of goods sold, inventory turnover 8 times; stock at the beginning is 1.5 time more than the stock at the end.
83. Calculate the value of closing stocka) ` 35,713 b) ` 14,285c) ` 40,713 d) ` 30,713
84. Calculate the value of opening stocka) ` 35,713 b) ` 56,713c) ` 40,713 d) ` 30,713
85. Calculate the value of opening stocka) ` 35,000 b) ` 56,000c) ` 40,000 d) ` 50,000
86. Calculate the value of opening stocka) ` 35,000 b) ` 14,000b) ` 40,000 d) ` 60,000
87. Calculate stock (inventory) turnover Ratioa) 3 times b) 2 times
c) 1 times d) 4 times
From the Following:Closing Debtors ` 40,000, credit sales being 25% of cash sales, Excess of closing Debtors over opening Debtors ` 20,000, Total Sales ` 1,50,000.
88. Calculate Net Credit Salesa) ` 40,000 b) ` 25,000c) ` 30,000 d) ` 20,000
89. Calculate the value of opening stocka) ` 40,000 b) ` 25,000c) ` 50,000 d) ` 20,000
90. Calculate Debtors Turnover Ratioa) 3 times b) 2 timesc) 1 times d) 4 times
91. Calculate current Assets of a company from the following information:Stock Turnover Ratio: 4 timesStock in the end is ` 20,000 more than stock in the beginning.Sales ` 3,00,000Gross Profit Ratio 25%Current Liabilities ` 40,000Quick Ratio 0.75a) ` 90,250 b) ` 80,250c) ` 96,250 d) ` 95,250
92. Ratio Analysis aids in ______________________a) Financial Accountingb) Cost accountingc) Decision makingd) None of the above
93. Which of the following is not the advantage of ratio analysis?a) Forecastingb) Inter-firm comparisonc) Historical analysisd) Clues to further investigation
94. Which of the following is not the limitation of ratio analysis?a) Not free from biasb) Only symptoms and not curec) Only quantitative analysis and not
qualitative analysisd) Simplicity
95. Ratio analysis facilitates __________ comparisons.a) Inter-firm b) Intra-firmc) Patternd) All of the above
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96. Liquidity ratios measure _____________ obligations.a) Short-term b) Long-termc) Very-Short-termd) Both (a) & (b)
97. A very high current ratio will:a) Increase the profitabilityb) have adverse impact on profitabilityc) not affect the profitabilityd) None of the above
98. A very high current ratio may be due to:a) Pilling up inventoryb) inefficiency in collection of debtorsc) high balances in cash and bank without
proper investmentd) all of the above
99. Traditionally, a current ratio of _________ is considered to be a satisfactory ratio.a) 2 : 1 b) 1 : 1c) 1 : 2d) None of the above
100. A firm seeks to increase its current ratio from 1.5 before its closing date of the accounts. The action that would make it possible is:a) Delaying payment of salariesb) Increase charge for depreciationc) Making cash payment to creditorsd) Selling marketable securities for cash at book value.
101. Which of the following is not an absolute liquid asset?a) Cash in handb) Cash at bankc) bills receivablesd) Marketable investments
102. Which one of the following is not a quick liabilities?a) Creditorsb) Outstanding expensesc) Cash creditd) All of the above
103. Which one of the following is not a quick assets?a) Debtorsb) Marketable securitiesc) Cash at bankd) Prepaid expenses
104. Traditionally, a quick ratio of ___________ is considered to be a satisfactory ratio.a) 1 : 2 b) 1 : 1c) 2 : 1d) None of the above
105. In computing quick assets, cost of inventory are excluded while realizable value of inventory (if any) are included.a) True b) Falsec) Either (a) or (b)d) None of the above
106. A very high absolute cash ratio will:a) Increase the profitabilityb) Have adverse impact on profitabilityc) not affect the profitabilityd) None of the above
107. The ratio which measures the average period for which quick assets are available to meet average daily operating expenses is:a) Absolute cash ratiob) Current Ratioc) Quick Ratiod) Internal interval measure ratio
108. A low interval measure ratio is indicator of:a) Short term profitabilityb) Short term liquidityc) Long term profitabilityd) Long term liquidity
109. Which of the following firms would have the least liquidity?a) Current Ratio – 2.2 and Quick Ratio –
1.6b) Current Ratio – 2.2 and Quick Ratio –
1.1c) Current Ratio – 1.2 and Quick Ratio –
0.6d) Current Ratio – 1.2 and Quick Ratio –
0.8110. ______________ is also known as working
capital ratio.a) Quick Ratio b) Current Ratioc) Liquid Ratiod) Debt-Equity Ratio
ANSWERS
1. a 2. a 3. d4. b 5. c 6. b7. d 8. d 9. a10. b 11. a 12. c13. c 14. b 15. c16. c 17. a 18. c19. d 20. d 21. c22. a 23. d 24. d25. c 26. a 27. c
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28. c 29. b 30. a31. d 32. a 33. a34. b 35. b 36. d37. b 38. a 39. d40. c 41. d 42. b43. d 44. a 45. c46. b 47. c 48. a49. b 50. b 51. b52. c 53. b 54. c55. a 56. b 57. c58. d 59.(i) a (ii) b(iii) c (iv) d (v) a(vi) b (vii) d 60.(i) a(ii) b (iii) c (iv) d(v) a (vi) b (vii) c
61. a 62. c 63. a64. b 65. a 66. a67. b 68. d 69. d70. c 71. c 72. a73. d 74. a 75. d76. b 77. d 78. a79. d 80. c 81. a82. c 83. b 84. a85. c 86. d 87. a88. c 89. d 90. c91. c 92. c 93. c94. d 95. d 96. a97. b 98. d 99. a100. c 101. c 102. c103. d 104. b 105. a106. b 107. d 108. b109. c 110. b
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CHAPTER 7
INTRODUCTION
Standard costing system is a costing system that:
(i) Traces direct costs to output produced by multiplying the standard prices or rates by the Standard Quantities of inputs allowed for Actual Output produced (SQAO), and
(ii) Allocates overhead costs on the basis of the standard overhead – costs rates times the standard quantities of the allocation bases allowed for the actual outputs produced.According to ICMA, London, Standard Costing refers to “the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence.”
Standard Costing involves the following steps:
(a) Setting up of standards(b) Ascertainment of Actual Costs(c) Comparison of Actual and Standard Costs to determine variance and (d) Investigation of variance and taking appropriate action thereon wherever necessary.
Installation of standard costing system involves the following preliminary steps:
(a) Establishment of Responsibility Centres: The key areas of operation in the enterprise should be identified into responsibility centres with clearly defined roles e.g. cost control revenue maximization etc. Such responsibility centres may be identified either through (1) Departmentation or (2) Activity Based Costing.
(b) Classification of Accounts: The various heads of expense accounts should be classified and codified for collection and comparison of actual costs with standard costs. This will also help the process of mechanized/ computerized accounting.
(c) Selection of a suitable type of standard: For operational requirements a suitable type of a standard should be selected.
(d) Length of the period of use: The duration for which the standards are to be used should be determined.
OBJECTIVES FOR ADOPTING STANDARD COSTING SYSTEM
(i) Cost Management(ii) Planning and Control(iii) Decision-Making(iv) Product Costing
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Standard Cost: Standard cost is a predetermined cost which is calculated from the management standards of efficient operation and relevant necessary expenditure.
Advantage of Standard Costing:
(i) Measuring Performance: Standards provide a base for measurement of actual performance. Standard costing will eliminate any variations in profit due to changes in the values of stock holding from period to period and will thus provide a true basis for the measurement of profit.
(ii) Cost Control: Variance analysis and investigation of reasons thereof will provide the basis
for appropriate control action. Adverse variances can be controlled and their recurrence avoided.
(iii) Price Fixing: Standard cost will remain stable over a period of time as opposed to actual cost which may fluctuate violently. Hence, where demand for a product is elastic standard cost can be used as a basis for fixing the selling price.
(iv) Management by Exception: If the variance is negligible, it means that performance is more or less in accordance with the standards. Significant variances that warrant the attention of the manager are brought to his knowledge. This facilitates control by exception.
(v) Introduction of Incentives: Standard costing facilitates evaluation of jobs and introduction of incentives job values can be determined by the use of evaluation and scale of wages fixed according to the responsibility involved in each job.
(vi) Quotations and Estimates: Standard costing facilitates the estimation of the cost of new products with greater accuracy. It can also be used for jobbing industries.
RELATIONSHIP BETWEEN STANDARD COSTING AND BUDGETARY CONTROLDistinction Between Standard Costing and Budgetary Costing
Particulars Standard Costing Budgetary ControlMeaning Standard costs are pre-determined
costs representing what the costs should be at the level of efficient conditions of production and operation.
Budgets are financial and/or quantitative statements prepared and approved prior to a defined period of time of the policy to be pursued during that period for the purpose of attaining a given objective.
Coverage They are generally restricted to costs. They include estimates of income costs and employment of capital. These are determined based on management’s plants of what should be done to achieve a certain objective and how to actually achieve it.
Basis These are determined by the collection of technical data related to production and applying costs to each element of production.
Budgeted costs are estimated keeping in view actual conditions and attainable targets of a period under review, in view of the conditions that likely to be prevalent in that year. The effect of short-term changes in cost structure, etc. will be fully in budgeted costs.
Effect of If in a particular year the costs are They are estimated usually for one
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temporary conditions
likely to be high due to certain factors standard costs are not changed unless the factors are permanent in nature. Effects of short-run temporary changes will not be reflected in Standard costs.
year and take into account the practical problems of operations and are kept at a level which the firm hopes to achieve in the year for which the budget is being prepared.
Permanence Standard cost is usually semi-permanent in nature and may not be changed unless and until there are changes in the basic price structure or in the methods of operation.
Relationship Budgeted and standard costs are set up to exercise costs control and judger performance
by setting up targets. Both systems provide benchmarks against which the actual performance and costs are
compared variance are calculated and the reasons for the variance ascertained. A budgetary control system can operate without standard costs. The two systems are not
interdependent i.e., they can exist independently. However, when budgets are being developed standard costs are of immense help since they
are long-term estimates of the same activity and represent management’s view of the level of efficiency that should prevail. Similarly, for determination of standards, information on past budgeted and actual costs is useful.
ESTABLISHING STANDARDSDeveloping and establishing standards requires significant inputs from various sources. Three potential sources of quantitative standards are as follows:(i) Historical experience(ii) Engineering studies(iii) Input from operating personnel
CLASSIFICATION OF STANDARDS Basic/Fixed/Static Standard: Basic standard is a standard which is established for some
base year and remain in use for a long period of time. Current Standard: Current standard is a standard which is established for a limited period
and is related to current conditions. These standards call for periodical review and frequent revisions.
Ideal/ Theoretical Standard: Ideal standard is a standard which is based on perfect performance without making any allowance for unavoidable losses (e.g. Normal Idle time, normal waste/ scrap/ defectives/ spoilage etc.). It is merely a theoretical standard which is unrealistic and unattainable.
Expected/ Attainable/Practical Standard: Expected or practical standard is a standard which is based on expected performance after making a reasonable allowance for unavoidable losses (e.g. Normal Idle Time, Normal Value/ Scrap/ Defectives/ Spoilage etc.). It is realistic and attainable standard. Variances from the expected standard indicate real deviations from the attainable performance.
Normal Standard: Normal standard is a standard which is based on average performance in the past, It is attainable under normal conditions.
Historic Standard: It is the average standard of past achievement. It may not be adopted as past performance including inefficiencies.
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Standard cost is a carefully determined cost of a unit of output. According to CIMA official terminology standard cost is: ‘A predetermined calculation of how much costs should be under specified working conditions. It is built up from an assessment of the value of cost elements and correlates technical specifications and the qualification of minerals, labour and other costs to the prices and/or usage rates expected to apply during the period in which the standard cost is intended to be used. Its main purpose is to provide basis for control through variance accounting for the valuation of stock and work-in-progress and in some cases, for fixing selling prices.”
VARIANCE ANALYSIS AND ACCOUNTINGVariance analysis is the analysis of the cost variances and its component parts and explanation of these variances, Cost variance is the difference between a standard cost and the companies actual cost incurred during a period.
Methods of Cost Variances Disposed off in a Standard Costing SystemThere is no unanimity of opinion among Cost Accountants regarding the disposition of variances. The following are commonly used methods of their disposition:(i) Transfer all variances to profit and loss account. Under this method, stock of work-in-
progress. Finished stock and cost of sales are maintained at standard cost and variances arising are transferred to profits and loss account.
(ii) Distributing variances on pro-rata basis over the cost of sales, work-in-progress and finished goods stocks by using suitable basis.
(iii) Write off quantity variance to profit and loss account and spread price variance over to cost of sales work in progress and finished goods. The reason behind apportioning price variance to inventories and cost of sales is that they represent costs although they are derived as variances
CLASSIFICATION OF VARIANCESThe concern prepares budget for the current period. This budget is based on actual data of previous period then the current period actual operation is current this actual is compared with the standard and variance is found. Standard means budget for actual production and sales.
Example 1: Suppose a budget is prepared as follows:Production unit = 10,0000 unitsRaw material requirement per unit = 2.5 kg/unitLabour hour per unit = 4 hours(i) During the period the actual production was 12,000 units. Standard i.e., budget for actual production Material = 12,000 × 2.5 kg = 30,000 kg Labour = 12,000 × 4 hrs. = 48,000 hrs.(ii) Actual position for 12,000 units products Material sed = 26,000 kgs. Labour required = 52,000 hrs.The actual may be different (varied) from standard. Hence, a variance analysis is carried out for each component of cost: material, labour and overhead and also for sales.
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Standard Cost per unit: The Standard cost of a unit of product as shown on the standard cost card, it is computed by multiplying the standard quantity or hours by the standard price or rate for each cost element.
Variances: The difference between standard prices and quantities on the one hand and actual prices and quantities on the other hand.
Direct Material Price Variance = Actual Quantity (Standard Price – Actual Price)
Direct Material Usage Variance = Standard Price (Standard Quantity – Actual Quantity)
Material Cost Labour Cost Variable Overhead Fixed Overhead
Material Price Variance Material Usage Variance
COST VARIANCE
+ Favourable- Adverse
MATERIALThe material cost consists of quantity and price. Hence, the overall cost variance is calculated as a difference between standard cost of material and actual cost of material.This overall cost variance is subdivided between price variance and usage variance.Material cost variance = (Standard cost of material) – (Actual cost of material)= [(Budgeted Quantity for actual production × Standard price per unit) – (Actual quantity of actual production × Actual price per unit)]Material price Variance = It shows the difference in price of material for actual quantity of material used.= Actual quantity of material × (Standard price per unit – Actual price per unit)= (Standard price per unit × Actual quantity of material used) – (Actual price per unit × Actual quantity of material used)Material Usage Variance: This shows the variance between the standard quantity required for actual production and actual quantity of material used in actual production.= Standard price per unit of material (Standard quantity of material for actual production – Actual quantity of material for actual production)
S.P. × S.Q. S.P. × A.Q. A.P. × A.Q.Usage Variance Price variance
Cost Variance
MATERIAL COST VARIANCE
(Standard price – Actual Price) × Actual Quantity (Standard Quantity – Actual quantity) × Standard price
At the time of Purchase At the time of Consumption(Standard price – actual price) (Standard price – Actual price)× Actual quantity purchased × Actual quantity consumed
If required If Silent
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1. MPV (At the time of purchase) + MUV ≠ MCV2. MPV (at the time of consumption) + MUV = MCV
Causes of material price variance: Change in the market prices of materials. Failure to purchase the specified quality, thereby resulting in a different price being paid. Change in quantity of materials purchased, thereby leading to lower/ higher quantity
discount. Not availing cash discounts, when standards set took into account such discounts. Inefficient purchasing. Change in the delivery costs Rush purchases Purchase of a substitute material on account of non-availability of the material specified. Change in the rate of excise duty, purchase tax etc. Off-season purchasing for certain seasonal products like jute, cotton etc.
Causes of Material Usage Variance Use of non-standard materials. Use of non-standard material mixture Use of substitute material Inefficiency in the use of materials. Change in quality of materials Change in the design or specification of the product Change in the method of production Yield from materials in excess of or less than standard yield Pilferage Detect in plant and machinery
Causes of Direct Material Yield Variance Lack of due care in handling Lack of proper supervision Defective methods of operation Improper equipments, tools etc. Sub-standard quality of materials-fault of purchase department.
TIMING OF PRICE VARIANCE COMPUTATIONThe direct material price variance can be computed at one of two points:(i) When the direct materials are issued for use in production, or(ii) When they are purchased.Computing the price variance at the point of purchase is preferable. It is better to have information on variances earlier than later. The more timely the information, the more the likeliness of a proper managerial action.
TIMING OF THE COMPUTATION OF THE DIRECT MATERIAL USAGE VARIANCEThe direct material usage variance should be computed as direct materials are issued for production. To facilitate this process, many companies use three points:(i) A standard bill of materials.(ii) Color-coded excessive usage forms, and(iii) Color-coded returned – material forms.Direct Labour Rate Variance = Actual Time × (Standard Rate – Actual Rate)Direct Labour Efficiency Variance = Standard Rate × (Standard Time – Actual Rate)
RESPONSIBILITY FOR THE DIRECT MATERIAL VARIANCES
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Material Mix Variance Material Yield Variance
The responsibility for controlling the direct material price variance is usually lies with the purchasing manager. The production manager is responsible for direct material usage. However, at times, the cause of the variance is attributable to other individuals and factors outside the production area. For example, purchase of low quality direct material may give a bad output. In this case, the responsibility should be assigned to purchasing rather than production.
Direct Material Mix and Yield VarianceThe mix variance is the difference in the standard cost of the actual mix of inputs used and the standard cost of the mix of inputs that should ideally have been used.
A yield variance occurs whenever the actual yield (output) differs from the standard yield. For direct materials, the sum of the mix and yield variances equals the direct material usage variance.
Direct Material Mix Variance = Total Actual Quantity × (Standard Cost per Unit of Standard Mix – Standard Cost per Unit of Standard Mix)Or, Standard Price × (Revised Actual Quantity – Annual Quantity)Direct Material Yield Variance = Standard Price of Yield × (Actual Yield – Standard Yield) Or, Standard Price × (Standard Quantity – Revised Actual Quantity)
MATERIAL USAGE VARIANCE
Standard Rate (Standard Ratio for Actual Mix (Standard Ratio for total Standard Mix – Standard - Actual Ratio for Actual Mix) Ratio for Total Actual Mix) Standard Rate
Or(Total Standard Quantity - Total Actual Quantity)
Weighted Average Budgeted Rate
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Material Yield Variance: This is the Sub-variance of material usage variance which results from the difference between actual yield and standard yield.
Material Price Variance: A measure of the difference between the actual unit price para for an item and the standard price, multiplied by the quantity purchased.
Material Quantity Variance: A measure of the difference between the actual quantity of materials used in production and the standard quantity allowed, multiplied by the standard price per unit of materials.
Note: If Budgeted output and actual output are not given, we should presume actual output = Budgeted output = 1. If Budgeted output is given but actual output is not given, actual output = Budgeted output
and vice versa.
Note:If the price variance is calculated on the actual quantity purchased instead of the actual quantity used, the price variance plus the usage variance will agree with the total variance only when the quantity purchased is equal to the quantity which is used in the particular accounting period. Reconciling the price and usage variance with the total variance is merely a reconciliation exercise, and you should not be concerned if reconciliation of sub-variances with the total variances is not possible.
Labour Rate Variance Labour EfficiencyLabour Idle Variance
LABOURThe cost of labour is determined by the price paid for labour and the quantity of labour used. Thus a price and quantity variance will also arise for labour. Unlike materials, labour cannot be stored, because the purchase and usage of labour normally takes place at the same time. Hence the actual quantity of hours purchased will be equal to the actual quantity of hours used for each period. For this reason the price variance plus the quantity variances should agree with the total labour variance.
S.P. × S.Q. S.P. × A.Q. A.P. × A.Q.Efficiency Variance Rate variance
Cost Variance
MATERIAL COST VARIANCE
(Standard Rate – Actual Rate) × (Actual Payment hours - Actual working hours) (Standard hours – Actual working
Actual payment hour × Standard Rate hours) × Standard Rate
Resp. Personnel Manager Always-adverse Production manager
Management’s fault
Specially given in question
Causes for Labour Rate Variance: Change in the basic wage rates Change in the method of wage payment. Use of grades of labour different from the standard grade specified due to non-availability
of the labour grade specified or any other reason. Unscheduled overtime New workers not being paid at full rates.
Causes for Labour Efficiency Variances: Use of non-standard grade of workers Use of standard grade of workers but workers are inefficient Use of defective method of operation Use of defective or non-standard materials. Use of defective tools and plant and machinery Poor working conditions e.g. inadequate lighting etc. Incompetent supervision.
Causes for Idle Time Variance: Break-down of plant and machinery
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Labour Rate Variance: A measure of the difference between actual hourly labour rate and the standard rate, multiplied by the number of hours worked during the period.
Labour Efficiency Variance: A measure of the difference between the actual hours taken to complete a task and the standard hours allowed, multiplied by the standard hourly labour rate.
Super-optimal condition of equipments Inappropriate equipment Poor placement of workers Delay in giving production instructions Changes in methods of production Improper supervision in the factory Too frequent changes in workers work Power failure
RESPONSIBILITY FOR THE DIRECT LABOUR VARIANCESDirect labour rates are largely determined by such external forces as labour market and union contracts. When direct labour rate variances occur, they often do so because an average wage rate is used for the rate standard or because more skilled and more highly paid labourers are used for less skilled task. However, the use of direct labour is controllable by the production manager. For this reason, responsibility for the direct labour rate variance is generally assigned to the individuals who can take good decision for allocation of labour.The same is true of the direct labour efficiency variance. However, as is true of all variances, once the cause is discovered, responsibility may be assigned elsewhere.
DIRECT LABOUR MIX AND YIELD VARIANCEThe direct labour mix and yield variance is calculated in the same way as the direct material mix and yield variance.Direct Labour Mix Variance = Total Actual Time × (Standard Rate of Standard Labour – Standard Rate of Actual Labour)Or, (Revised Actual hours – Actual Hours) × Standard RateDirect Labour Yield Variance = Standard Rate × (Total Standard Time – Total Actual Time)Or, Standard Rate × (Standard Hours – Revised Actual Hours) VARIABLE OVERHEADWhere variable overheads vary with direct labour or machine hours of inputs the total overhead variance will be due to one or both of the following:(i) A price variance arising from actual expenditure being different from budgeted experience.(ii) A quantity variance arising from the actual direct labour or machine hours of inputs being
different from the hours of input, which should have been used.VARIABLE OVERHEAD VARIANCE
(Standard Rate – Actual Rate) × Actual Hours (Standard Hours – Actual Hours) × Standard RateVariance Overhead Efficiency VarianceThe variable overhead efficiency variance is directly related to the direct labour efficiency variance. If variable overhead is truly driven by direct labour hours, then like the direct labour efficiency variance, it is caused by efficient or inefficient use of direct labour. If more (or fewer) direct labour hours are used the standard calls for then the total variable cost will increase (or decrease)
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Note:The similarity between this variance and material price variance: Both variances multiply the difference between the standard price and actual price paid for a unit of a resource by the actual quantity of resources used.
Variable Overhead Expenditure Variance
Variable Overhead Efficiency Variance
Note:If it is assumed that variable overheads vary with labour hours of input; this variance is identical to the labour efficiency variance. Consequently, the reasons for the variance are the same as those described previously for the labour efficiency variance.
RESPONSIBILITY FOR VARIABLE OVERHEAD EXPENDITURE VARIANCE AND VARIABLE OVERHEAD EFFICIENCY VARIANCEAbility to control is a prerequisite for assigning responsibility. Price changes of variable overhead items are generally beyond the control of supervisors. If price changes are small, the expenditure variance is primarily a matter of the efficient use of overhead in production, which is controllable by production supervisors. Accordingly, responsibility for the variable overhead expenditure variance is generally assigned to production departments.
The reasons for unfavorable variable overhead variance are similar to direct labour efficiency variance. Responsibility for the variable overhead efficiency variance should be assigned to the production manager.
Variable Overhead Expenditure VarianceIt is similar to the price variance of direct materials and direct labour though there some conceptual difference. Variable overhead is not a homogenous input- it is made up of a large number of individual items such as indirect materials, indirect labour, electricity, maintenance, and so on.
A variable overhead expenditure variance can arise because prices for individual variable items have increased or decreased. The variable overhead expenditure variance is also affected by how efficiently overhead is used. The waste or inefficiency in the use of variable overhead increases the actual variable overhead cost. This increased cost, in turn, is reflected in an increased actual variable overhead rate. Thus, even if the actual prices of the individual overhead item were equal to the budgeted or standard prices, an unfavourable variable overhead expenditure variance could still take place.
FIXED OVERHEAD
Volume VarianceThe volume variance reflects the fact that the fixed overheads do not fluctuate in relation to output in the short term. Whenever the actual production is less than the budgeted production, the fixed overhead charged to production will be less than the budgeted costs, and the volume variance will be adverse. Conversely, if the actual production is greater than the budgeted production, the volume variance will be favourable.
Volume Efficiency VarianceThe Volume efficiency variance is the difference between the standard hours of output (SH) and the actual hours of input (AH) for the period multiplied by the standard fixed overhead rate (SR):
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Variable overhead Efficiency: The difference between the actual activity (direct labour-hours, machine-hours, or some other base) of a period and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate.
Variable overhead Spending: The difference between the actual variable overhead cost incurred during a period and the standard cost that should have been incurred based on the actual activity of the period.
Variable Variance: It is the variation in manufacturing overheads due to difference in budgeted and the actual volume of activity.
Volume Variance Expenditure Variance
Efficiency Variance Capacity Variance
Calender Variance Balance Capacity Variance
(SH – AH) × SRYou may have noted that the physical content of this variance is a measure of labour efficiency and is identical with the labour efficiency variance. Consequently the reasons for this variance will be identical with those previously described for the labour efficiency variance. Note also that since this variance is a sub-variance of the volume variance, the same comments apply as to the usefulness of attaching a value for fixed overheads because fixed overhead represent sunk costs. The fixed overhead will not change because of the efficiency of the labour. Again it would be better to measure this variance in terms of the lost contribution arising from lost sales.
Volume Capacity Variance The volume capacity variance is the difference between the actual hours of input (AH) and the budgeted hours of input (BH) for the period multiplied by the standard fixed overhead rate (SR):
(AH – BH) × SRA failure to achieve the budgeted capacity may be for a variety of reasons. Machine breakdowns, material shortages, poor production scheduling, labour disputes and a reduction in sales demand are all possible causes of an adverse volume capacity variance. Again it is better to express this variance in terms of lost contribution from lost sales caused by a failure to utilize the capacity. It is not very meaningful to attach fixed costs to the variance, since the total fixed costs will not be affected by a failure to utilize capacity.
FIXED OVERHEAD VARIANCE
(Recovered – Budgeted) or (Budgeted overhead – Actual overhead)(Standard Hours – Budgeted) × Recovery Rate
(Standard Hours – Actual Working Hours) (Actual Working Hours – Budgeted Hours) × Recovery Rate× Recovery Rate
(Actual days - Budgeted days × Recovery rate/ day) (Revised Capacity) (Total Capacity Variance – Calender
variance)
Causes of Fixed Overhead Expenditure Variance: Seasonal conditions
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Things to Remember:(i) Total Fixed Overhead Variance = Absorbed Fixed Overhead – Actual Fixed Overhead(ii) Fixed Overhead Expenditure Variance = Budgeted Overhead – Actual Overhead(iii) Fixed Overhead Volume Variance = Standard Rate of Absorption Per Unit × (Actual
Production – Budgeted Production)(iv) Fixed Overhead Capacity Variance = Standard Rate of Absorption Per Hour × (Actual Hours
Capacity - Budgeted Hours Capacity)(v) Fixed Overhead Efficiency Variance = Standard Rate of Absorption Per Hour × (Standard
Hours Required – Actual Hours)
Improper use of available facilities Use of efficient tools and equipments Improperly set standards Rise in price due to inflation Change in methods of operation
Causes for Fixed Overhead Volume Variance: Power Failure Machine breakdown Waiting for tools, work, instructions, machine, materials etc. Idle or excess capacity Variation in customer’s demands and orders booked Labour strikes or lock-outs etc. working overtime due to rush orders etc. Defective scheduling and routing of production.
Causes for Fixed Overhead Efficiency Variance: Poor working conditions Poor supervision Poor scheduling of production processes Frequent power failures Improperly set standards
Causes for Fixed Overhead Capacity Variance: Chance in scheduling of production process Power failures Labour troubles Lock-out Shortage of materials Machine break-down Slump in customer’s demand Decline in sales volume Inefficient supervision Defective material
CONTROL RATIOS
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Notes: Similarities between materials, labour and overhead variances1. The standard quantity is derived from determining the quantity that should be used for the actual
production for the period so that the principles of flexible budgeting are applied. The price variances (i.e. material price, wage rate and variable overheads expenditure variances) were calculated by multiplying the difference between the standard price (SP) and the actual price (AP) per unit of resources by the actual quantity (AQ) of resources acquired/ used. The price variance can be formulated as
(SP – AP) × AQ This can also be expressed as
(AQ × SP) – (AQ × AP)2. The first term in this formula (with AQ representing actual hours) is equivalent to the budgeted
fixed variable overheads that we used to calculate the variable overhead expenditure variances. The last term represents the actual cost of the resource consumed.
These ratios are generally expressed in terms of percentage. If the ratio is 100% or more, it indicates a favourable position. If the ratio is less than 100%, it indicates unfavourable position. The important control ratios are given below:(a) Efficiency Ratio: It is defined as “the standard hours equivalent to the work produced
expressed as a percentage of actual hours spent in production”. Thus, this ratio shows whether actual time taken in production is more or less than the time allowed by the standard. Its method of calculation is:
(b) Activity Ratio: It is defined as “the standard hours equivalent to the work produced, expressed as percentage of budgeted standard hours”. This ratio shows the extent to which the production facilities have been utilized as compared with that contemplated in budgets. Its formula is:
(c) Capacity Ratio: It shows the relationship between actual hours worked and the budgeted hours. Its formula is:
(d) Calender Ratio: Sometimes calendar ratio is also calculated. This ratio indicates the extent of actual working days availed during the budget period. It is calculate by using the following formula:
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Efficiency Ratio = Standard Hours for actual output
Actual Hours worked × 100
Activity Ratio = Standard Hours for actual output
Budgeted Hours × 100
Capacity Ratio = Acutal HoursWorked
Budgeted Hours × 100
Calender Ratio = Actual working days∈the budget period
Budgeted working days∈the budget period × 100
CLASSROOM PRACTICE – LETS PLAY TOGETHER
Qus1.Standard cost of a product in a factory is predetermined as follows:
`Material (5 units @ `4 each) 20Labour (20 hours @ `1.50 per hour) 30Overhead expenses 10Total 60During a period, 8,000 units were produced whose actual cost was as follows:
`Material (40,500 units @ `5 each) 2, 02,500Labour (1,50,000 hours @ `1.60 each) 2,40,000Overhead expenses 90,000Total 5, 32,500Prepare a statement showing standard cost, actual cost and variances.
Qus2.PQ Ltd. which has adopted standard costing furnishes the following information: Standard:
Material for 7 kg. of Finished Products 10 kgs.Price of materials `10 per Kg.
Actual:Output 21,000 Kgs.Material used 28,000 kgs.Cost of materials `2,52,000
Calculate: (a) Material Usage Variance; (b) Material Price Variance; (c) Material Cost Variance.
Qus3. UV Ltd. presents the following information for November, 2008: Budgeted production of product P = 200 units. Standard consumption of Raw materials = 2 kg per unit of P. Standard price of material A = ` 6 per kg. Actually, 250 units of P were produced and material A was purchased at Rs 8 per Kg and consumed at 1.8 kg per unit of P. Calculate the material cost variances.
Qus4.RS Ltd. has established the following standard mix for producing 9 tonnes of product Z.
`5 tonnes of material A at ` 7 per tonnes = 353 tonnes of material B at ` 5 per tonnes = 152 tonnes of material C at ` 2 per tonnes = 4
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A standard loss of 10% of input is expected to occur. Actual input was as under: 53,000 tonnes of material A at `7 per tonnes.28,000 tonnes of material Bat `5.30 per tonnes.19,000 tonnes of material C at`.2.20 per tonnesActual output for a period was 92,700 tonnes of product Z.
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Compute: (i). Material Mix Variance; (ii). Material Yield Variance.
Qus5.For producing one unit of a product, the materials standard is:
Material X : 6 kg. @ `8 per kg., andMaterial Y : 4 kg. @ `10 per kg.
In a week, 1,000 units were produced the actual consumption of materials was:Material X : 5,900 kg. @ `9 kg., andMaterial Y : 4,800 kg. @ `9.50 per kg.
Compute the various variances.
Qus6.In a manufacturing process, the following standards apply:Standard Price: Raw material A`1 per kg.
Raw materials B `5 per kg.
Standard Mix 75% A; 25% B (by weight)Standard Yield : 90%
In a period the actual costs, usage and output were as follows:Used: 4,400 kgs. of A costing `4,650
1,600 kgs.of B costing `7,850Output: 5,670 kgs. of products
Qus7.The standard material input required for 1,000 kgs. of a finished product are given below:Material Quantity (Kg.) St. Rate per Kg. (`)P 450 20Q 400 40R 250 60
1,100Standard loss 100Standard output 1,000Actual production in a period was 20,000 kg. of finished product for which the actual quantities of materialused and the prices paid therefore were as under:
Material Quantity (Kg.) Purchase price per Kg. (`)P 10,000 19Q 8,500 42R 4,500 65Calculate:
(i) Material cost variance;(ii) Material price variance;(iii) Material usage variance; and(iv) Material yield variance.
Also show a reconciliation of the variances.
Qus8.Time 15 hours per unit Cost `3 per hour
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Actual Performance in a Cost Period Production 500 units Hours taken Production 7,800 hours
Idle Time 200 hours Total Time 8,000 hours
Payment made ` 24,800 (average per hour ` 3.10). Calculate labour variances.
Qus9.100 skilled workmen, 40 semi-skilled workmen and 60 unskilled workmen were to work for 30 weeks to get a contract job completed. The standard weekly wages were ` 60, ` 36 and ` 24 respectively. The job was actually completed in 32 weeks by 80 skilled, 50 semi-skilled and 70 unskilled workmen who were paid ` 65, Rs. 40 and ` 20 respectively as weekly wages. Find out the labour cost variance, labour rate variance, labour mix variance and labour efficiency
Qus10.Compute wage varianceActual hours worked 5,6000Actual wage paid ` 7,840Standard rate per hour `2 Standard hours produced 4,000
Qus11.A factory, working for 50 hours a week, employs 100 workers on a job work. The standard rate is `1 an hour and standard output is 200 units per gang hour. During a week in June, ten employees were paid at 80 p. an hour and five at `1.20 an hour. Rest of the employees were paid at the standard rate. Actual number of units produced was 10,200 Calculate labour cost variances.
VARIABLE OVERHEADS VARIANCESQus12.
Actual variable overhead `. 10,000Budgeted variable overhead ` 12,000Budgeted production 500 unitsActual production 450 unitsActual hours 200HrsStandard time for 1 unit 30 minutes
Qus13.The following data is obtained from the books of a manufacturing company regarding variable overheads:Budgeted production for January 300 unitsBudgeted variable overhead `7,800Standard time for one unit 20 hoursActual production for January 250 unitsActual hours worked 4,500 hoursActual variable overhead `7,000
Qus14.From the following information extracted form the books of a manufacturing company, calculate Fixed and Variable Overhead Variances.
Particulars Budgeted ActualProduction in units 22,000 24,000Fixed overheads `44,000 `49,000Variable Overheads ` 33,000 `39,000
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Number of Day 25 26Number of man hours 25,000 27,000
Qus15.The following information relates to the month of June, 2013
Budgeted ActualOutput 20,000 units 22,000 units
` ``Overheads - Variable 1,00,000 1,07,000- Fixed 1,50,000 1,58,000Compute the overheads variance.
Solution:Variable overheads allowed or budgeted for actual output
`Standard Overhead for actual output (10000/20000 × 22000) 1,10,000Actual amount spent 1,07,000Variable overhead variance 3,000 (F)
Fixed overheads for the period (change in output having no effect on expenditure) 1,50,000Actual fixed overhead 1,58,000Fixed overheads expenditure variance 8,000 (A)Total overheads variance 5,000 (A)
FIXED OVERHEAD VARIANCESQus16.
From the following data, calculate Fixed Overheads Expenditure and Volume Variances: Fixed Overhead budget for November ` 1,00,000Budgeted production for the month (1 hour per unit) 50,000 unitsActual production for the month 54,000 unitsActual fixed overhead incurred ` 1,20,000
Qus17.The following information was obtained from the records of a manufacturing unit using Standard Costing System:
Standard ActualProduction 4,000 units 3,800 unitsWorking Days 20 21Fixed Overheads 40,000 39,000
You are required to calculate the following Fixed Overheads Variances:- 1. Cost Variance 2. Expenditure Variance 3. Volume Variance 4. Efficiency Variance 5. Capacity Variance
Qus18.In Department A the following data is submitted for the week ended 31st October 2013:- Standard output for 40 hours per week 1,400 unitsStandard fixed Overhead ` 1,400Actual output 1,200 UnitsActual hours worked 32 hoursActual fixed overhead ` 1,500
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TRAIN UR BRAIN
1. Standard can be divided into ________ types.a) Two b) Threec) Four d) Five
2. ________ based upon engineering specification.a) Standard Cost b) Product Costc) Prime Cost d) Marginal Cost
3. _________ Is a technique which involves the ascertainment of standard cost and their comparison with actual cost for the purpose of cost control?a) Process costingb) Standard Costingc) Job Costingd) Operation Costing
4. _________ standard is established at a particular point of time.a) Current b) Idealc) Basic d) Normal
5. ________ standard is for a certain period, for certain conditions and for certain circumstances.a) Current b) Expectedc) Ideal d) Normal
6. ________ represents future performance and objectives which are reasonably attainable.a) Basic b) Idlec) Normal d) Expected
7. _________ standard is fixed on the basis of ideal conditions, which are difficult to obtain.a) Expected b) Idealc) Basic d) Current
8. In cost variances, if the standard cost of actual exceeds the actual cost. Then the variance is said to be – a) Favourable b) Unfavourablec) Average d) All of the above
9. Marginal variances, Labour Variances, Variable Overhead Variances and fixed Overhead Variances are the parts of - a) Sales Variance b) Profit Variancec) Cost Variances d) None of the above
10. The difference between the actual cost and the standard cost is known as –a) Profit b) Differential Costc) Variance d) Loss
11. Standard costing help in –
a) Reducing Losses b) Controlling Costc) Measuring efficiencyd) None of the above
12. The formula for calculating material Cost Variance is – a) Standard Cost for Actual Output –
Actual Costb) Standard Cost for Actual Output +
Actual Costc) Standard Cost for Actual Output ×
Actual Costd) Standard Cost for Actual Output ÷Actual Cost
13. Material Usage Variance is calculated by – a) Standard Price (Standard Quantity +
Actual Quantity)b) Standard Price (Standard Quantity -
Actual Quantity)c) Standard Price (Standard Quantity –
Standard Rate)d) Standard Price (Standard Quantity +
Standard Rate)14. The formula for calculating Material Yield
variance is –a) Standard cost per unit of yield ×
(Standard yield in actual quantity + Actual yield)
b) Standard cost per unit of yield + (Standard yield in actual quantity × Actual yield)
c) Standard cost per unit of yield × (Standard yield in actual quantity -Actual yield)
d) None of the above15. Material Mix Variance is calculated by –
a) Standard Rate × (Standard Mix in actual quantity – Actual quantity)
b) Standard Rate + (Standard Mix in actual quantity + Actual quantity)
c) Standard Rate ÷ (Standard Mix in actual quantity × Actual quantity)
d) Standard Rate × (Standard Mix in actual quantity ÷ Actual quantity)
16. Material Price Variance is calculated by – a) Actual quantity + (Standard price –
Actual Price)b) Actual quantity - (Standard price +
Actual Price)c) Actual quantity ÷ (Standard price ×
Actual Price)
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d) Actual quantity × (Standard price ÷ Actual Price)
17. The formula for calculating Material Purchase Price Variance is – a) Actual quantity purchased + (Standard
Price + Actual Price)b) Actual quantity purchased × (Standard
Price - Actual Price)c) Actual quantity purchased × (Standard
Price + Actual Price)d) Actual quantity purchased - (Standard
Price - Actual Price)18. Standard cost is a projection of –
a) Cost Accountsb) Management Accountsc) Financial Accountsd) None of the above
19. Standard costs are scientifically predetermined in respect of – a) Materials b) Labourc) Overheads d) All of the above
20. __________ is a predetermined cost on a scientific basis taking into consideration all the factors relating to costs e.g. raw material consumption rate, labour efficiency, machine efficiency, etc.a) Material Cost b) Standard Costc) Labour Cost d) Overhead Cost
21. An ________ Variance is one which is not amendable to control by individual or departmental action.a) Controllable b) Uncontrollablec) Cost d) Labour
22. Material Yield variance = a) Standard yield of the actual material
input + actual yieldb) Standard yield of the actual material
input - actual yieldc) Standard yield of the actual material
input × actual yieldd) Standard yield of the actual material
input ÷ actual yield23. __________ is a technique where by the
planned activities of an undertaking are quantified in budgets, standard costs, standard selling prices, and standard profit margins, and the differences between these and the actual results are compared.a) Variance Accountingb) Standard Accountingc) Cost Accountingd) None of the above
24. Standard hours/minute means be quality of work achievable at standard performance expensed in terms of a standard unit of work in a standard period of time.a) True b) Falsec) Partly True d) Partly False
25. The technique which uses standards for costs and revenues for the purpose of control through variance analysis is – a) Variance Accounting b) Standard Costingc) Budgetary Controld) Performance Analysis
26. A pre-determined calculation of how much costs should be under specified working conditions is called - a) Standard Costb) Pre-determined costc) Estimated Costd) Actual Cost
27. The management’s time is saved by reporting only the deviations from the pre-determined standards is called - a) Management by objectivesb) Budgetary controlc) Standard costingd) Management by exception
28. _________ can be compared with standard cost in order to evaluate performance.a) Actual Revenue b) Budgeted Costsc) Actual Costsd) Predetermined Costs
29. ___________ are predetermined cost base on past performance adjusted to anticipated changes.a) Estimated Costs b) Standard Costc) Revised Costsb) Revised estimated costing
30. The difference between planned, budgeted, a standard cost and actual costs and similarly in respect of revenues is known as – a) Variance b) Planning Variancec) Operational Varianced) Efficiency Variance
31. Material cost variance is also known as –a) Material Yield Varianceb) Material Price Variancec) Material Usage Varianced) Material total Variance
32. Material cost variance =
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a) Material Price Varianceb) Material Cost Variancec) Material Usage Varianced) Material Yield Variance
33. Hours paid - Hours Worked is known as – a) Labour Rate Varianceb) Labour Efficiency Variancec) Idle Time Varianced) Net Efficiency Variance
34. Labour Cost Variance – a) Standard labour cost – actual labour
costb) Fixed labour cost - Variable labour
costc) Estimated labour cost – Standard costd) None of these
35. ______ is developed using utopian conditions for a given manufacturing process.a) Basic Standardb) Projected Standardc) Ideal Standardd) None of these
36. ________ is a control technique involving study of comparisons of actual costs with standard costs and as a control device it is studied to assign responsibility for deviations and thus to control costs.a) Variance Analysis b) Profit Analysisc) Cost Analysisd) Labour Efficiency
37. If actual hours worked exceed the standard hours allowed, the variance which will occur is known as – a) Favourable labour Efficiency varianceb) Adverse labour efficiency variancec) Adverse labour rate variance d) Favourable labour rate variance
38. The budgeted fixed overheads for a budgeted production of 20,000 units in ` 40,000. For a certain period the actual production was 22,000 units and actual expenditure came to ` 48,000. Then the volume variance is ` _________4,000 (A) b) 2,000 (F)2,000 (A) d) 4,000 (F)
39. In a factory where standard costing is followed, 9,600 kgs of material at ` 10.50 kg. were actually consumed resulting in a price variance of ` 4,800 (A) and usage variance of ` 4,000 (F). The standard cost of actual production is ` _________
a) 1,00,000 b) 96,000c) 1,20,000 d) 1,10,000
40. If the capacity usage ratio of a production department is 90% and activity ratio is 99% then the efficiency ratio of the department is _______ %.a) 120 b) 110c) 90 d) 80
41. The standard variable overhead cost of a product is ` 10 (5 hours @ ` 2/hr). In a certain month it took 1800 hours at a cost of ` 4,200 to manufacture 400 units. The variable overhead expenditure and efficiency variance are _______ and ________ respectively.a) ` 600 (F) and ` 400 (F)b) ` 600 (A) and ` 400 (A)c) ` 600 (F) and ` 400 (A)d) ` 600 (A) and ` 400 (A)
42. In a factory of A ltd. Where standard costing is followed, the budgeted fixed overheads for a budgeted production of 4800 units is ` 24,000. For a certain period actual expenditure incurred was ` 22,000 resulting in a fixed overhead volume variance of ` 3,000 (adv.) then standard material cost of actual production was – a) 5,400 units b) 4,200 unitsc) 3,000 units d) None of these
43. In a factory of XY Ltd. operating standard cost system, 2,000 kgs. of a material @ ` 12 per kg, were used for a product, resulting in price variance of ` 6,000 (fav) and usage variance of ` 3,000 (adv). Then standard material cost of actual production was – ` 24,000 b) ` 27,000` 30,000 d) ` 33,000
44. A company budgets for fixed overhead of ` 12,000 and production of 2,400 units. Actual production is 2,100 units and fixed overhead cost incurred is ` 11,000. The fixed overhead volume variance is -a) ` 3,000 (A) b) ` 1,500 (A)c) ` 1,500 (F) d) ` 3,000 (F)
45. AB Ltd. purchased 3,425 kgs, of materials for ` 10,960. the material price variance was ` 685 (favourable). The standard price per kg. was – a) ` 3.00 b) ` 3.20c) ` 3.40 d) None of these
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46. The budgeted standards hours of a factory are 6,000. The capacity utilization ratio of April, 2013 stood as 45% while the efficiency ratio for the month came to 60%. The actual production in standard hours for april, 2013 was _________.a) 10,800 b) 13,333c) 14,400 d) 12,800
47. In a factory of A ltd. where standard costing is followed, the budgeted fixed overheads for a budgeted production of 2,400 units is ` 12,000. For a certain period actual expenditure was ` 11,000 resulting in a fixed overhead volume variance of ` 1,500 (A). the actual production for the period was - a) 1,500 units b) 2,100 unitsc) 2,700 unitsd) Insufficient information
48. A chemical is manufactured by combining two standard items of input X (Standard price ` 60/kg) and Y (` 45/kg) in the ratio of 60% : 40%. Ten present of input is lost during processing. If during a month 1,200 kg. of the chemical is produced incurring a total cost of ` 69,600, the total material cost variance will be ________.a) ` 2,400 (A) b) ` 2,400 (F)c) ` 3,000 (A) d) ` 2,000 (F)
49. The information relating to the direct material cost of a company is as under:Standard price per unit ` 1.80Actual quantity purchased units 800Standard quantity allowed for actual production units 725Material price variance on purchase `120 (F)What is the actual purchase price per unit?a) ` 1.06 b) ` 1.11c) ` 1.65 d) ` 1.75
50.A factory, operates a standard cost system, where 1000 kgs. Of raw material @ ` 6 per kg. were used for a product, resulting in price variance of ` 3,000 (F) and usage variance of ` 1,500 (A). Then standard material cost of actual production was - a) ` 5,000 b) ` 7,500c) ` 10,000 d) ` 2,500
51. Standard cost is a _________________ cost.a) Predetermined b) Historical c) Actual d) Final
52. The limitations of _________________ has led to the development of standard costing system.a) Cost Accountingb) Historical costing systemc) Management accountingd) None of the above
53 Standard costing is more widely applied in ___________ industries.a) Jobbing b) Constructionc) Process and engineeringd) All of the above
54. Three types of standards are _____________a) Actual standard, base standard and
normal standardb) Currency standard, basic standard and
normal standardc) Expected standard, ideal standard and
normal standardd) Current standard, basic standard and
normal standard55. The deviation of the actual cost or profit
or sales from the standard cost or profit or sale is known.a) Difference b) Variancec) Discrepancy d) Inconsistency
56. Management by exception is exercising control over _____________.a) Costsb) Favorable itemsc) Unfavorable itemsd) All of the above
57. Material price variance is the difference between standard and actual prices of materials used multiplied by _____________.a) Actual quantity of material usedb) Budgeted quantity of material usedc) Standard quantity of material usedd) Either (b) and (c)
58. Labour cost variance is the difference between standard cost of labour and ________________.a) Budgeted cost of labourb) Estimated cost of labourc) Actual cost of labourd) None of the above
59. Idle time variance is ____________.a) Idle time × Actual Labour b) Idle time × Standard labour ratec) Idle time × Budgeted labour rate
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d) Idle time × Historical cost60. Volume variance is divided into
___________.a) Capacity variance, calendar variance
and efficiency varianceb) Capacity variance, calendar variance
and expenditure variance.c) Capacity variance, expenditure
variance and efficiency variance d) Calender variance, expenditure
variance and efficiency variance.61. A standard which assumes efficient level
of operations, but which includes factors such as waste and machine downtime is known as an allowance for ……………….a) Ideal Standardb) Normal standardc) Attainable standardd) None of the above
62. Which of the following would not be an important factor while analyzing sale variance?a) Mix Variancesb) Recovery rate variancesc) Selling price variancesd) Volume variances
63. The reason for favourable materials price variance could be due to ……………….a) Exchange rate depreciation if materials
are importedb) Inferior quality materials being usedc) More wastage of materials incurredd) Higher factory overhead costs.
64. The reason for favourable total sales variance could be due to …………………a) Lower output leading to favorable
total cost variances.b) A fall in sales volume and a price
reductionc) A price cut leading to a proportionally
lower increase in sales volume.d) A price cut leading to a proportionally
higher increase in sales volume65. When calculating cost variances under a
standard costing system we must ……………a) Compare actual cost s with those that
were budgetedb) Compare standard costs with actual
costs at the standard level of activityc) Compare actual costs with standard
costs at the actual level of output
d) Compare actual outputs against budgeted outputs.
66. A primary purpose of using a standard cost system is …………….a) To make things easier for managers in
the production facility.b) To provide a distinct measure of cost
control.c) To minimize the cost per unit of
production.d) (b) and (c) correct
67. An adverse material usage variance together with a favourable materials price variance could suggest that ……………a) We are paying the same for our
materials but we are using more than expected
b) We are using less material than expected but in total we are paying more than we should
c) We are paying less for our materials than expected but we are using more materials
d) We are paying higher prices for our materials than expected.
68. Standard cost may be used by ………………a) Universitiesb) Government agenciesc) Business organizationsd) All of the above
69. Standard cost may be used for ……………..a) Product costing b) Planningc) Controlling d) All of the above
70. Which of the following statements about standard is false?a) A properly set standard should
promote efficiencyb) Standard cost facilitate management
planningc) Standard should not be used in
‘management by exception’d) Standard cost can simplify the costing
of inventories71. Standards set provide yardsticks against
which ______________ are compared.a) Budgeted costs b) Estimated costsc) Actual costsd) None of the above
72. The technique of standard costing may not be applicable in case of:a) Larger concern b) Small concerns
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c) All concernsd) None of the above
73. Total Material cost variance =a) Budgeted cost of materials – actual
cost of materialsb) Standard cost of materials - actual cost
of materialsc) Budgeted cost of materials – standard
cost of materialsd) Actual cost of materials - budget cost
of materials 74. Material Usage Variance = Material Mix
Variance + ___________.a) Material yield varianceb) Material cost variancec) Material price varianced) Material usage variance
75. Material Price Variance = Actual Usage × ______________.a) Standard Price – Budgeted priceb) Standard Price – Actual price c) Actual Price – Standard Priced) None of the above
76. Material usage Variance = Standard Price × ____________.a) Standard usage – Actual usageb) Standard price – Actual pricec) Standard quantityd) Actual quantity
77. Material mix variance = standard cost of standard mix - _________________a) Actual cost of actual mixb) Actual cost of standard mixc) Standard cost of actual mixd) Standard cost of budgeted mix
78. Total Labour cost variance = ________________a) Standard rate (standard time for actual
output – actual time paid)b) Standard cost of labour – actual cost of
labourc) Standard rate (standard time for actual
output – actual time work)d) Actual time taken (standard rate –
actual rate)79. Fixed Overhead Volume Variance =
_____________a) Standard rate per hour (standard
hours produced – actual hours)b) Standard rate (Actual output –
Budgeted output)c) (Actual output × Standard price) –
budgeted fixed overheadsd) All of the above
80. A favourable variance will arise when capital revenues are _________________ than expected.a) More b) Lessc) Lesserd) None of the above
81. An unfavourable material price variance occurs because of:a) Less than anticipated normal wastage in
the manufacturing processb) Price increases in raw materialsc) More than anticipated normal wastage in
the manufacturing processd) Price decrease in raw materials
82. The type of standard best suitable for cost control purpose is ___________________.a) Basic Standardb) Ideal Standardc) Normal Standardd) Expected Standard
83. An unfavourable material usage arises because of:a) Less than anticipated normal wastage in
the manufacturing processb) Price increases in raw materialsc) More than anticipated normal wastage in
the manufacturing processd) Price decrease in raw materials
84. Volume variance arises because of:a) Increase or decrease in actual output
as compared to the budgeted outputb) Increase in overhead rate per hourc) Difference in budgeted overheads and
actual overheadsd) Decrease in overhead rate per hour
85. Labour rate variance is computed by multiplying the:a) Standard Labour rate with the
difference between standard labour hours and actual labour hours
b) Actual Labour hour with the difference between standard labour hours and actual labour hours.
c) Actual labour rate with the difference between standard labour rate and actual labour hours
d) None of the above86. The control ratios used by the management
to know whether the deviations of the actual performance from the budgeted performance are favourable or unfavourable are _____________a) Capacity ratio, activity ratiob) Efficiency ratio, Calender ratioc) Both (a) and (b)
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d) None of the above87. _______________ is a technique which uses
standards for costs and revenues for the purpose of control through variance analysis.a) Standard Costingb) Standard costc) Management by exceptiond) None of the above
88. The management’s time is saved by reporting only the deviations from the predetermined standard is called:a) Standard Costingb) Standard costc) Management by exceptiond) None of the above
89. ______________ is predetermined cost based on past performance adjusted to anticipated changes.a) Estimated costb) Actual costc) Standard costd) None of the above
90. Material cost variance is also called as _________________.a) Varianceb) Material total variancec) Material usage varianced) Material price variance
91. Difference between budget and standard is that ………………a) A budget express what cost were,
while a standard express what cost should be.
b) A budget express management plan, while standard reflects what actually happened
c) A budget express total amount standard express a unit amount
d) Standards are excluded from cost accounting system whereas budget are included in cost accounting system.
92. If more direct materials were used for production than were allowed for the output, then the ………………a) Direct labour efficiency variance will
be unfavorableb) Direct labour rate variance will be
favorablec) Direct materials price variance will be
favorabled) Direct materials usage variance will be
unfavorable
93. Which of the following variances would be least likely if the materials used were of much poorer quality than the standard?a) Unfavorable direct materials price
varianceb) Unfavorable direct materials efficiency
variancec) Unfavorable direct labour efficiency
varianced) All of the above would be equally likely
to Occur94. An unfavourable material usage arises
because of …………….a) Price increase in raw materialsb) Price decrease in raw materialsc) Less than anticipated normal wastage in the manufacturing processd) More than anticipated normal wastage in the manufacturing process
95. Volume variance arises because of ……………….a) Increase in overhead rate per hourb) Decrease in overhead rate per hourc) Increase or decrease in actual output
as compared to the budgeted outputd) Difference in budgeted overheads &
actual overheads96. Consider the following statements and state
which of the following is/are true?1. The standard cost per unit of materials
is used to calculate a materials price variance.
2. The standard cost per unit of materials is used to calculate a materials quantity variance
3. The standard cost per unit of materials cannot be determined until the end of the period
a) (1) only b) (2) onlyc) (1) & (2) only d) (1), (2) & (3)
97. SK Ltd. reported a favourable materials price variance and an unfavourable materials quantity variance. Based on the above data, it can be concluded that _________________.a) More materials were purchased than
were used.b) More materials were used than were
purchasedc) The actual cost per unit of materials
was less than the standard cost per unit
d) The actual usage of materials was less than the standard allowed
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98. If the actual number of direct labour hour worked is less than the standard labour hours allowed for equivalent units produced, this indicates ……………… a) An unfavorable labour rate varianceb) A favorable total labour variancec) An unfavorable labour efficiency
varianced) A favorable labour efficiency variance
99. Which of the following is false?a) A standard is a benchmark or norm
used for planning and controlb) The difference between standard cost
and actual cost is referred to as a variance.
c) In manufacturing, standards are developed for materials, labour and overhead
d) Because of their extensive knowledge of operations, the accountants should be the sole group that sets standards for most organizations.
100. Which of the following is true about standard costs?a) They are the actual costs for
delivering a product or service under normal conditions.
b) They are predetermined costs for delivering a product or service under normal conditions.
c) They are the actual costs for producing a product under normal conditions
d) They are predetermined costs for delivering a product or service under normal and abnormal conditions.
101. Which of the following is true about standard costs?a) Actual hours b) Standard hoursc) Idle hours d) Budgeted hours
102. _____________ represents the difference between hours aid and hours worked.a) Favorable b) Unfavorablec) Either (a) or (b)d) None of the above
103. Idle time variance is always ______________.a) Standard cost b) Actual Costc) Historical costd) None of the above
104. _____________ is a predetermined calculation of how much costs should be under specified working conditions.a) Standard cost b) Actual Cost
c) Historical costd) None of the above
105. Actual costs can be compared with ___________ in order to evaluate performance.a) Material price varianceb) Material usage variancec) Material cost varianced) Material yield variance
106. The difference between standard material cost of actual production and the actual cost of direct material is ___________.a) Favorable varianceb) Unfavorable variancec) Either (a) or (b)d) None of the above
107. Where the actual performance is better that the standard, the extent of the achievement is expressed in financial terms as ___________.a) Expected standardb) Ideal Standardc) Current standardd) Normal standard
108. A standard that is developed using theoretical conditions for a given manufacturing process is known as:a) True b) Falsec) Either (a) or (b)d) None of the above
109. Standard costing may not be suitable for small concerns.a) True b) Falsec) Either (a) or (b)d) None of the above
110. Analysis of variance is done in order to determine the reasons for increase or decrease in profit.a) True b) Falsec) Either (a) or (b)d) None of the above
111. Which of the following is true when recording variances in a standard costing system?a) All unfavorable variance are debitedb) Only unfavorable material variances are creditedc) Only unfavorable material variances are debitedd) Only unfavorable variance are credited
112. Standard costing can be used for …………..a) External reportingb) Internal reportingc) Internal and external reportingd) Stakeholders reporting
113. Standard costing is ………………….
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a) Costing methodb) Costing techniquec) Costing classificationd) Costing absorption
114. Standard may be expressed both in ……a) Quantitative measuresb) Monetary measuresc) Quantitative & Monetary measuresd) Quantitative or Monetary measures
115. If material price variance is zero than which of the following two variance will be same?a) Material cost variance & Material
Usage Varianceb) (a) and (d)c) Material Usage Variance & Material Mix
Varianced) Material Sub-Usage Variance &
Material Yield Variance 116. Standard costs are based on technical
assessments.a) True b) Falsec) Either (a) or (b)d) None of the above
117. An uncontrollable variance is one which is not amendable to control by individual or departmental action.a) True b) Falsec) Either (a) or (b)d) None of the above
118. A favourable material variance is always advantageous for concern.a) True b) Falsec) Either (a) or (b)d) None of the above
119. Material yield variance is the difference between Standard yield specified and the actual yield obtained.a) True b) Falsec) Either (a) or (b)d) None of the above
120. All the variance of major nature, whether favorable or unfavorable are to be reported to management along with the reasons there of is called management information systems.a) True b) Falsec) Either (a) or (b)d) None of the above
121. Equal emphasis should be laid on favorable or unfavorable variances.a) True b) Falsec) Either (a) or (b)d) None of the above
122. Variances analysis and variance accounting is same.
a) True b) Falsec) Either (a) or (b)d) None of the above
123. Standard hour is the standard time required per unit of production.a) True b) Falsec) Either (a) or (b)d) None of the above
124. Standards are arrived at based on past performance.a) True b) Falsec) Either (a) or (b)d) None of the above
125. Labour efficiency variance is due to the different between standard hours for actual output and actual hours for actual output.a) True b) Falsec) Either (a) or (b)d) None of the above
ANSWERS
1. d 2. a 3. b4. c 5. a 6. d7. b 8. a 9. c10. c 11. c 12. a13. b 14. c 16. a17. d 18. b 19. a20. d 21. b 22. b23. b 24. a 25. a26. b 27. a 28. d29. c 30. a 31. a32. d 33. b 34. c35. a 36. c 37. a38. b 39. d 40. a41. b 42. b 43. b44. b 45. b 46. c47. b 48. b 49. b50. c 51. a 52. b53. c 54. d 55. b56. c 57. a 58. c59. b 60. a 61. c62. b 63. b 64. d65. c 66. c 67. c68. d 69. d 70. c71. c 72. c 73. b74. a 75. b 76. a77. c 78. b 79. d80. a 81. b 82. d83. c 84. a 85. d86. c 87. a 88. c89. a 90. b 91. c
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92. d 93. a 94. d95. c 96. c 97. c98. d 99. d 100. c101. c 102 b 103 a104 a 105 c 106 a107 b 108 a 109 b110 b 111 a 112 b113 b 114 c 115 b116 a 117 a 118 b119 a 120 b 121 a122 b 123 a 124 b125 a
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