Notes - Cost Accounting
Category :
25.1 Cost Accounting
Cost accounting is defined as the process of accounting for cost which begins with the recording of income and expenditure or the basis on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling cost.
Cost accounting is basically application of the costing and cost accounting principles.
This application is with specific purpose and that is for the purpose of cost control, ascertainment of profitability and also for presentation of information to facilitate decision-making.
Cost accounting is a combination of art and science, it is a science as it has well defined rules and regulations, it is an art as application of any science requires art and it is a practice as it has to be applied on continuous basis and is not a one time exercise.
25.1.1 Nature of Cost Accenting
The nature of cost accounting are as follow
25.1.2 Functions of Cost Accounting
Function of cost accounting can be summarised as under
25.1.3 Methods of Costing
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Method |
Description |
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Job Costing |
Where all costs can be directly charged to a specific job |
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Batch Costing |
Where all costs can be directly charged to a group of products (batch). |
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Contract Costing |
Similar to job costing, but in this case the job is larger than job costing. |
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Single of Output Costing |
Cost ascertainment for a single product. |
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Process Costing |
The cost of production at each stage is ascertained separately. |
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Operating Costing |
Ascertainment of costs in cases where services are rendered. |
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Multiple Costing |
Combination of two or more methods of costing, used where the nature of the product is complex and method cannot be ascertained. |
25.1.4 Techniques of Costing
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Type |
Description |
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Uniform Costing |
Standardised principles and practices of costing are used by a number of different industries. |
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Marginal Costing |
Only variable costs or costs directly linked are charged to the product or process. |
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Standard Costing |
Standard costs are compared with actual costs, to determine variances. |
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Historical Costing |
Where costs are recorded after they have incurred. |
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Direct Costing |
Direct costs are charged to the product or process, indirect costs are charged to the profit from the product or process. |
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Absorption Costing |
All costs (variable and fixed) are charged to the product or process. |
25.1.5 Meaning of Material/Inventory
Material refers to all the commodities which are consumed in the process of manufacture. The materials are of two types
25.2 Inventory Control
It is the systematic control over the procurement, storage and usage of materials in such a way as to maintain an even flow of production and at the same time avoiding excessive investment in inventories.
25.2.1 Techniques of Inventory Control
The following are the common techniques of inventory control
25.2.2 Various Stock levels
The various stock levels and the formula for their determination are given below
Maximum Stock Level = Re-order Level + Re-order
\[Quantity-\left( Maximum\text{ }Consumption\times Minimum\text{ }Re-order\text{ }Period \right)\]
Minimum Stock Level = Re-order Level\[-\text{ }\left( Normal\text{ }Consumption\times Normal\text{ }Re-order\text{ }Period \right)\]
Re-order Level = Maximum Consumption\[\times \,Maximum\text{ }Re-order\text{ }Period\]
Average Stock Level =Minimum level\[+\frac{1}{2}Re-order\text{ }quantity\]
\[Danger\text{ }level=Normal\text{ }Rate\text{ }of\text{ }Consumption\times Maximum\text{ }Re-order\text{ }Period\text{ }for\text{ }Emergency\text{ }Purchases\]
25.2.3 Economic Order Quantity (EOQ)
It is the quantity of material purchased which will result in the minimum total inventory cost of an item of material. It is also known as re-order quantity. The costs to be considered for computing EOQ are .ordering costs and carrying costs. EOQ can be calculated with the help of the following formula
\[EOQ=\sqrt{\frac{2AP}{C}}\]
Where, A = Annual consumption in units
2.2.ss I Account
varianceot be P = Cost of placing an order
C = Cost of storing one unit of inventory per year
25.2.4 Types of Inventory Control System
There are two types of inventory control system
25.2.5 Pricing of Material Issued
The following methods can be used for pricing of material issued
25.2.6 Material Losses
Losses of material may arise during handling, storage or during production. Losses can be categorised into two categories:
25.3 Labour Costing
It is a human and active factor of production which converts raw materials into finished goods. The cost incurred on this head can be termed as labour cost and can be classified as
25.3.1 Methods of Wage Payment
There are two methods of wage payment
25.3.2 Incentive Schemes
Incentive schemes are introduced to increase the productivity of a labour.
The various incentive schemes are as follow
A Labour’s Total Earnings
\[=Time\text{ }Taken\times Hourly\text{ }Rate+50%\text{ }\left( Time\text{ }Saved\times Hourly\text{ }Rate \right)\]
Total Earnings
\[=Time\text{ }Taken\times Hourly\text{ }Rate+Time\text{ }Saved/Standard\text{ }Time\,\left( Time\text{ }Taken\times Hourly\text{ }Rate \right)\]
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Efficiency |
Piece rate applicable |
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(a) |
Upto 83% |
Basic rate |
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(b) |
From 83% to 100% |
110% of basic rate |
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(c) |
Above 100% |
120% of basic rate |
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Output |
Remuneration |
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(a) |
Output below standard |
Guaranteed time rate |
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(b) |
Output at standard level |
Bonus of 20% of time rate |
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(c) |
Output above standard |
High piece rate on worker’s output |
Total wages
\[=HourlyRate\sqrt{Standard\,Time\times Time\,Taken}\]
\[Total\text{ }Wages=Time\text{ }Taken\times Hourly\text{ }Rate+75%\text{ }of\text{ }Time\text{ }Saved\times Hourly\text{ }Rate\]
25.3.3 Labour Turnover
It is the ratio of the number of persons leaving in a period to the average number employed. The following methods can be used to measure labour turnover
Labour Turnover
\[=\frac{Number\,of\,Separations\,during\,a\,Period}{Average\text{ }Number\text{ }of\text{ }Workers\text{ }during\text{ }the\text{ }Period}\times 100\]
Labour Turnover
\[=\frac{Number\text{ }of\text{ }Replacements\text{ }in\text{ }a\text{ }Period}{Average\text{ }Number\text{ }of\text{ }Workers\text{ }during\text{ }the\text{ }Period}\times 100\]
Labour turnover
\[=\frac{Number\text{ }of\text{ }Separation+Number\text{ }of\text{ }Replacements\text{ during }a\text{ }Period}{Average\text{ }Number\text{ }of\text{ }Workers\text{ }during\text{ }the\text{ }Period}\times 100\]
25.4 Overheads Costing
Overheads may be defined as the cost of indirect material, indirect labour and such other expenses which cannot be economically identified with a specific saleable cost unit.
25.4.1 Allocation and Apportionment of Overheads
Allocation of Overheads It is the process of charging the full amount of an individual item of cost directly to a cost centre for which this item of cost was incurred.
Apportionment of Overheads It is the process of charging the proportion of common items of cost to two or more cost centres on some equitable basis.
25.4.2 Primary Distribution of Overheads
It involves allocation or apportionment of different items of overhead to all departments of a factory.
The common basis used for apportionment are as follows
|
Items of Overhead |
Basis of Distribution |
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(a) |
Rent, rates and taxes, depreciation, repairs of factory building |
Floor space occupied |
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(b) |
Electric power |
Horse-power of machines, KWH |
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(c) |
Electric light |
Number of light points, floor space, hours used |
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(d) |
Depreciation of plant |
Cost of plant |
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(e) |
Supervision |
Number of employees |
25.4.3 Secondary Distribution of Overheads or Re-apportionment of Service Department Overheads
The process of redistribution of the cost of service departments among the production departments is known as secondary distribution.
The common basis which are used for re-apportionment are as follows
|
Service Department Costs |
Basis of Apportionment |
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(a) |
Maintenance department |
Hours worked for each department |
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(b) |
Personal Department |
Number of employees in each department |
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(c) |
Stores keeping department |
Number of requisitions, quantity or value of materials. |
25.4.4 Absorption of Overheads
It refers to charging of overheads from cost centres to individual products or jobs. The common methods used for absorption of overheads are
25.5 Standard Costing
It is one of the cost control techniques in which actual costs are compared with standard costs and the reasons for their variances are analysed.
Formulas used for computing various Variances are as follows
25.6 Job costing
It is that form of specific order costing under which each job is treated as a cost unit and costs are accumulated and ascertained separately for each job. A job may consist of a product, batch of products, contract or a service.
Job costing is applied in those industries where the goods are manufactured or services are rendered against specific orders as per customer’s specifications. It is generally applied in engineering, construction or ship-building industries.
Job costing method can be further classified as follow
(a) Contract Costing (b) Batch Costing (c) Multiple Costing
General Format of Cost Sheet
Cost Sheet
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Particulars |
Total |
Per Unit |
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A. |
Direct Material Cost |
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Opening Stock of Raw Material |
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(+) Purchase of Raw Material ….. |
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(+) Expenses on Purchase |
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(\[-\]) Purchase Return |
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(\[-\]) Closing Stock of Materials |
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(\[-\]) Net Value of Normal Scrap of Direct Materials |
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B. |
Direct Labour Cost Paid |
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(+) Outstanding at the End |
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(\[-\]) Prepaid at the End |
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C. |
Direct Expense (e.g. Royalty on production) |
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D. |
Prime Cost [A+B+C] |
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E. |
Works Overheads / Factory Overheads / Production Overheads |
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(\[-\]) Net Value of Normal Scrap of Indirect Materials |
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Adjustment on Account of Stock of Work-in-progress |
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(+) Opening Stock of Work-in-progress |
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(\[-\]) Closing Stock of Work-in-progress |
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F. |
Works Cost [D+E]/Factory cost |
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G. |
(+) Office and Administration Expenses |
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H. |
Cost of Goods Produced [F+G] |
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I. |
Adjustment an Account of Stock of Finished Goods |
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(+) Opening Stock of Finished Goods |
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(\[-\]) Closing Stock of Finished Goods |
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\[\left( \frac{Cost\text{ }of\text{ }Goods\text{ }Produced\times Closing\text{ }Stock\text{ }(Units)}{Number\text{ }of\text{ }Units\text{ }Produced} \right)\] |
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J. |
Cost of Goods Sold [H+I] |
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K. |
(+) Selling and Distribution Expenses |
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L. |
Cost of Sales [J+K] |
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M. |
(+) Profit |
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N. |
Sales [L+M] |
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25.7 Process costing
It is that method of costing under which all costs are accumulated for each stage of production and the cost per unit of product is ascertained at each stage of production by dividing the total cost of each process by the normal output of that process. It is applied in those industries where manufacturing activity is carried on continuously by means of two or more processes and the output of one process becomes the input of the following process, till completion.
Its generally applied in
(a) Paper industries (b) Chemical industries
(c) Textile industries (d) Sugar industries
Process costing method can be further classified as follows
(a) Operation costing
(b) Unit costing or single/output costing
(c) Operating or service costing
(d) Multiple o
Process I Account
Dr Cr
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Particulars |
Qty |
Rate (`) |
Amounts (`) |
Particulars |
Qty |
Rate (`) |
Amount (`) |
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Direct Materials |
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Output |
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Transferred to |
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Process II |
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Direct Labour |
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Direct Expenses |
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Production Overheads |
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25.7.1 Important Aspects of process Accounts
While preparing process cost accounts, some important aspects are to be taken into consideration. These aspects are given below.
Normal Loss
Normal loss is a loss, which is inevitable, in any process. Thus, if the input is 100, the output may be 95 if the normal loss is anticipated as 5%. Accounting treatment of normal loss is explained and illustrated in the subsequent paragraphs.
Abnormal Loss/Abnormal Gain
If the actual output is less than the normal output [Normal output = Input \[-\] Normal Loss], the difference between the two is the abnormal loss. On the other hand if the actual output is more than the normal output, the difference between the two is abnormal gain. Thus in the example given above, the normal output is 95 which is 100-5% of 100 as the normal loss. If the actual output is 93 units, 2 units will be abnormal loss and if the actual output is 97units, 2 units will be abnormal gain. Abnormal loss/gain is to be treated differently and is illustrated subsequently.
Inter Process Profits
Sometimes, while transferring the cost of one process to the subsequent one, some percentage of profit is added is it .This is called as inter process profits. This is done when a process is treated as profit center. In such cases, unrealized profit is to be computed and shown separately. This is also illustrated separately
25.8 Marginal Costing
It is a technique of costing and is defined by CIMA, London as, “The ascertainment by differentiating between fixed costs and variable costs of marginal costs and of the effect on profit of changes in volume or type of output.”
Note Marginal cost is the cost incurred in producing an additional unit of output.
25.8.1 Key Concepts used in Marginal Costing
\[Contribution=Total\text{ }Sales-Total\text{ }Variable\text{ C}ost\]
Or
Contribution = Fixed Cost + Profit
\[P/V\text{ }Ratio=\frac{Contribution}{Sales}\times 100\]
\[BEP\left( \text{in }units \right)=\frac{Fixed\text{ }Costs}{Contribution\text{ }Per\text{ }Unit}\]
BEP (in `) \[=\frac{Fixed\text{ }Costs}{P/V\,Ratios}\]
Margin of safety is calculated as
(a) Margin of Safety (in units)
\[Actual\text{ }Sales\left( in\text{ }units \right)-Break\text{ }Even\text{ }Sales\left( in\text{ }units \right)\]
Or \[\frac{Profit}{Contribution\text{ }Per\text{ }Unit}\]
(b) Margin of Safety (in value)
\[=Actual\text{ }Sales\left( in\text{ }value \right)-Break\text{ }Even\text{ }Sales\left( in\text{ }value \right)\]
Or \[\frac{Profit~~}{Contribution\text{ }Per\text{ }Unit}\times Selling\text{ }Price\text{ }Per\text{ }Unit\]
Or \[\frac{Profit~~}{Profit\text{ }Volume\text{ }Ratio}\]
Or \[Margin\text{ }of\text{ }Safety\left( in\text{ }units \right)\times Selling\text{ }Price\text{ }Per\text{ }Unit\]
(a) Variable costs at various levels of activity
(b) Fixed costs at various levels of activity
(c) Total cost at various levels of activity
(d) Profit/loss at various levels of activity
(e) Break Even Point
(f) Margin of Safety
(g) Angle of Incidence
(h) Loss Area
(i) Profit Area
Volume of Sales
In simple words, CVP is a management accounting tool that expresses relationship among total sales, total cost and profit. Cost Volume Profit (CVP) relationship is one of the important techniques of cost and management accounting. It is a powerful tool which furnishes the complete picture of the structure and helps in planning of profits. This concept is relevant in all decision-making areas, particularly in the short-run.
25.8.2 Cost Control and Reduction
One of the important functions of cost accounting is cost control and cost reduction.
25.8.3 Cost Control
Cost control implies various action taken in order to ensure that the cost do not rise beyond a particular level. It means keeping the expenses within limits or control. Cost control has the following features.
The following tools or techniques are used to control cost
25.8.4 Cost Reduction
Cost reduction means reducing the existing cost of production. Cost control means attempts to reduce the costs. The goal of cost reduction can be achieved in two ways, first is reducing the cost per unit and the second one is increasing productivity. Reducing wastages, improving efficiency, searching for alternative materials, and a constant drive to reduce costs, can effect cost reduction.
The following tools and techniques are normally used for cost reduction.
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