Financial Accounting and Auditing Paper-VIII – Cost Accounting-munotes

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1 1
INTRODUCTION TO COST ACCOUNTING
Unit Structure
1.0 Objectives
1.1 Definition and Meaning of Cost Accounting
1.2 Concept of Cost
1.3 Objectives of Cost Accounting
1.4 Importanceand Advantages of Cost Accounting
1.5 Limitations of Cost Accounting
1.6 Type of Cost
1.0 OBJECTIVES
After studying this module, you will be able to
 State the meaning and objectives of cost accounting
 Explain the merits and demerits of cost accounting
 Differentiate between cost and financial accounting
 Understand the meaning of co st centers, cost units etc.
 Know the various types of costs
1.1 DEFINITION AND MEANING OF COST
ACCOUNTING
Cost Accounting is the process of accounting for all costs incurred by an
organization. It is a process which begins with the recording of incomes
and expenditures and ends with the preparation of the periodical accounts
and statements. It accounts for cost classification and its analysis which
will assist in finding out the total costs incurred for manufacturing and
producing a particular unit of outpu t with a significant amount of
accuracy. In short, cost accountancy involves the gamut of identifying all
costs, classifying all costs and recording them for appropriate presentation.
In other words, it is the formal mechanism of computing costs incurred i n
the production of units or provision of services.
According to The Chartered Institute of Management Accountants
(CIMA), London, Cost Accounting is ‘the establishment of budgets,
standard costs and actual costs of operations, processes, activities or
products and the analysis of variances, profitability or the social use of
funds’. munotes.in

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Cost Accounting
2 Management is not just interested in finding the total costs incurred in
making of a product or providing of a service. Management is also
interested in knowing the cost incurr ed behind raw materials, the expenses
incurred in conversion of raw materials into finished goods by usage of
labour and all the costs incurred in overhead or miscellaneous expenses
right from start of manufacturing upto the time the goods are sold. To
identify all these elements, cost accounting comes into picture as it exactly
tells the quantitative aspects of the costs. This identification helps the
management to decide the future course of action and proper decision
making with respect to that particula r product.
1.2 CONCEPT OF COST
The Chartered Institute of Management Accountants (CIMA), London
defines cost as ‘the amount of expenditure (actual or notional) incurred on
or attributable to a specified thing or activity’.
Cost is the amount of resources i nvested in exchanging of goods or
services.
The concept of cost consists of ascertaining total cost and also cost per
unit. However, arriving at an exact total or per unit cost is very difficult
and a time consuming process. By the time an exact cost is ar rived at, the
very purpose of finding the cost will lose all its value. Hence, cost
accounting is based on estimates of costs rather than exact costs.
1.3 OBJECTIVES OF COST ACCOUNTING

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Introduction to Cost
Accounting
3 1. Ascertainment of Costs
The main objective of Cost Accounting is cos t ascertainment for each cost
object. This cost object may be a unit of manufacture, a particular job or
an operation or a process of manufacture, or a department or a service.

2. Determination of Selling Price and Profitability
Cost Accounting helps in dete rmining the total cost. Management can then
decide the estimated and expected profits on the costs and arrive at the
selling price. Price fixation becomes possible due to cost accounting.

3. Cost Control
Once the costs are identified, management can maintain a proper
discipline in expenditures. Management can set a bar on expenses and any
deviation from the pre -determined parameter can be controlled
immediately. Desired results can be achieved by controlling of costs.

4. Cost Reduction
Identification of costs w hich are not necessary in the manufacturing
process can help in reducing or totally eliminating these costs. All
activities which do not add value to the process of manufacture can be
eliminated without affecting the basic characteristics of the entire pro duct
or process.

5. Assisting Management in Decision Making
Cost Accounting provides the management with relevant information
thereby assisting them in planning, implementing, measuring, controlling
and evaluating the activities of the concern.
Test Yourself
1. ___________ accounting assists in identifying and controlling costs
a. Financial Accounting
b. Cost Accounting
c. Management Accounting
d. None of the above

2. The objectives of cost accounting are
a. Ascertainment of Costs
b. Identification of Costs
c. Determination of Selling Price
d. All of the above

3. Cost Accounting is based on
a. Actual Costs
b. Estimated Costs
c. Both Estimated and Actual Costs
d. None of the above munotes.in

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Cost Accounting
4 1.4 IMPORTANCEAND ADVANTAGES OF COST
ACCOUNTING

1. Aid to Management
a) Cost Accounting helps in periods of trade depression when the
organization cannot afford to incur losses unchecked.

b) It also helps organisations at the time of stiff competition from peers
which helps in survival and growth of the organization. At this time,
cost control plays a significant role.

c) It helps t he management in making estimates of costs well in
advance so that proper price fixation can be done and profitability be
maintained at all points in time.

d) Wastages can be avoided and unnecessary costs can be eliminated by
the help of cost accounting

e) Intra-firm costs can be compared if there is a robust cost accounting
policy followed by the organization. Costs can be channelized to a
product which gives higher returns to the organization as compared
to those products which yields lesser returns.

f) Efficie ncy of the overall organization can be improved with the help
of cost accounting.


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Introduction to Cost
Accounting
5 2. Aid to Creditors
Creditors and Lenders are interested in cost accounting policies followed
by the organization because that helps them to form a base about the
company’s s tability and practices with regards to costs. A proper decision
can be taken by the creditors and lenders about loans and credit period to
be offered to the organization.

3. Aid to Employees
If the costs in the organization are reduced, the ultimate benefit is reaped
by the employees. It is in the interest of the employees that cost
accounting is followed by all organisations.
1.5 LIMITATIONS OF COST ACCOUNTING


1. Expensive
It is a costly affair because analysis, allocation of costs require a
significant amou nt of extra work which in turn results in excess money.

2. Requirement of Reconciliation
The results shown by cost accountants differ from those shown by
financial accountants as the policies followed by them differ to a great
extent. It is therefore importa nt to reconcile the differences at each stage
of accounting.

3. Duplication
Financial Accountancy and Cost Accountancy are different branches of
accountancy indicating the same things about an organization i.e profits,
costs and efficiency. Hence, introducti on of cost accounting itself leads to
duplication of work by the accounts department. munotes.in

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Cost Accounting
6 4. Inefficiency
Before implementing a robust cost accounting system in the organization,
the employees and the management must be thoroughly trained in cost
accounting. Cost ing itself does not control costs, but proper usage of
costing does. Sometimes, due to lack of expert knowledge about cost
accounting leads to inefficient system in the organization.
Test Yourself
1. What are the advantages of cost accounting from the followi ng?
a. Helps in cost control
b. Helps in inventory control
c. Elimination of wastages
d. All of the above

2. Identify the limitations of cost accounting:
a. Assists creditors in decision making
b. Assists management in decision making
c. Expensive process
d. Is important for the Na tional Economy

3. What are the drawbacks of cost accounting?
a. Results of financial and cost accounting may differ
b. Costing system itself does not control costs
c. There is duplication and multiplicity of work
d. All of the above
Difference between Financial Accounti ng and Cost Accounting
Sr.
No. Point of
Distinction Financial Accounting Cost Accounting
1 Objectives It provides information
about the operational
performance and
financial position of the
business It provides information of
ascertainment of cost to
control it and make
proper decisions
2 Recording of
transactions It classifies, records and
analyses the transactions
in a subjective manner
i.e according to the
nature of expense It records the expenditure
in an objective manner
i.e. according to the
purpose for which the
costs are incurred
3 Recording of
data It records historical data.
It deals with actual facts
and figures. It makes use of both
historical and pre -
determined estimated
costs. It deals with partial
facts and partial
estimates. munotes.in

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Introduction to Cost
Accounting
7 4 Users of
information Financial Accounts is
used by Government,
Shareholders, Creditors,
Financial Analysts etc. Cost Accounts is used by
internal management
generally. However,
there may be instances
when regulatory
authorities may also seek
such information.
5 Anal ysis of
Costs and
Profits It gives the final profits
or losses of the
organization. It provides a detailed
bifurcation of cost and
profit of each product,
process, job, contract etc.
6 Time Period Financial Accounts and
Statements are prepared
usually for a year Cost Accounts and
Statements are prepared
as and when the need
arises.
7 Presentation
of
Information A set format (as
prescribed by the
regulatory authorities) is
used for presentation of
financial information There are no set formats.
The present ation of
information may differ
from organization to
organization, sector to
sector.
8 Valuation of
stock Stocks are valued at cost
or market value,
whichever is lower Stocks are valued at cost
only

Test Yourself
1. Which of the following deals with the ac counts of the entire
business?
a. Financial Accounting
b. Cost Accounting

2. Which of the following provides a detailed system of control for
materials, labour and overhead expenses?
a. Financial Accounting
b. Cost Accounting

3. In which accounting method are accounts ke pt as per Companies
Act, 2013 and Income Tax Act, 1961?
a. Financial Accounting
b. Cost Accounting


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Cost Accounting
8 Cost Object
It is anything for which a separate measurement and analysis of cost is
required. It may be for a service, a project, a customer, a new brand of
product etc.
Cost Unit
It is a device for the purpose of breaking up or separating of costs into
smaller sub -divisions for a particular good or service. It is the unit of
quantity of product or service.
For example, in an automobile sector, number of vehicle s is the cost unit.
In a power company, kilowatt hour is the cost unit. Similarly, for a
hospital, patient days is the cost unit and for cable wires, metres or
kilometres becomes the cost unit.
Cost Centre
Cost Centre refers to a particular area of activit y which adds some cost to
the product. It is like a separate department or sub -department for an
organization. It is a location or an item of equipment or a group of these
for which cost may be ascertained and used for the purpose of cost control.
Cost Dri vers
Total cost of any product depends on cost drivers. It is a factor or variable
which affects the level of cost. There may be different types of cost drivers
such as number of units etc. A slight increase or decrease in a cost driver
will result in incr ease or decrease in the total cost of the product.
For example, number of purchase orders or number of tests performed are
cost drivers since the higher number of orders or tests, higher will be the
cost incurred.
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Introduction to Cost
Accounting
9
1.6 TYPES OF COSTS

Costs based on Beh aviour:
1. Fixed Costs
These costs do not vary with the change in the volume of production in the
short run. They are not affected in the temporary period of time. They are
also known as period costs. For example, rent, depreciation etc. munotes.in

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Cost Accounting
10 2. Variable Costs
These costs vary with the level of output. Any increase or decrease in the
level of activity will lead to simultaneous increase or decrease in costs.
For example, direct material, direct labour etc.

3. Semi Variable Costs
These costs are a mix of both fixed and va riable costs. Thus, they vary
partly due to fluctuations. Fixed component remains unchanged whereas
variable component increases in proportion to the output. For example,
telephone bill, gas and electricity bills etc.
Costs based on Functions:
1. Production C osts
These costs are indirect expenses incurred in the factory and for the
running of the factory. For example, rent of factory, power incurred in the
factory premises etc.

2. Administration Costs
These costs are incurred in conjunction with management and
administration of business. For example, office rent, office electricity bills
etc.

3. Selling and Distribution Costs
These are indirect costs relating to selling and marketing of goods. For
example, salaries and commission to salesman, expenses on
advertisem ents etc.

4. Research and Development Costs
These costs are incurred for undertaking research to make new products or
improvements in the existing products. For example, costs for solving
technical problems in the products, costs for commercialization of a
product etc.
Costs based on Time:
1. Historical Costs
They are costs already incurred in the past in relation to the product.

2. Pre-determined Costs
These are costs estimated in advance of computed well before production
commences.
Costs for Management:
1. Margina l Cost
It is the total of all variable costs. It is the additional cost incurred for one
additional unit of output.

2. Opportunity Cost
Opportunity Cost is the opportunity lost. It is the value of the next best
alternative foregone for manufacturing the for emost alternative. For munotes.in

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Introduction to Cost
Accounting
11 example, if a property is used for production instead of earning money by
giving it on rent, the rent foregone is opportunity cost.

3. Replacement Cost
It is the cost of an asset in the current market for replacing the product. It
is the amount of money a business entity must spend to replace an
essential asset of the organization like a property etc.

4. Sunk Cost
These costs are already incurred in the past and play no significant role
while decision making. However, the management makes an effort to
recover these costs over a span of time to break even.

5. Controllable Cost
Costs that can be typically controlled by a cost accountant are known as
controllable costs. For example, costs incurred on material and labour can
be controlled by the factory or shop manager i.e. the immediate
supervisor.

6. Relevant Cost
It is the cost which is relevant for a specific purpose or a particular
product. Only relevant costs are analysed by management while taking
decisions.

7. Normal Cost
It is the cost which is usually incurred by an organization to manufacture a
given level of output under normal circumstances.

8. Abnormal Cost
It is not normally incurred under normal situations. It is a sudden
unexpected cost incurred by an organization during the process of
manufacturing. Such costs are not usually accounted for, right at the
beginning. It is charged to costing profit and loss account.

9. Avoidable Cost
Avoidable costs are those costs which should not have been normally
incurred if the performance of the compan y is at its optimum level.

10. Unavoidable Cost
Such costs cannot be explicitly avoided. They are incurred even if the
organization works at its optimum level with highest efficiency.

11. Differential Cost
It is the difference between the costs that an organizat ion would incur
between 2 alternative decisions or proposals or due to a change in the
output levels of manufacturing.
Costs based on Nature:
1. Material Costs
Materials which are present in the finished product or which can be
significantly identified in the product is known as material costs. For
example, plastic used in plastic toys. munotes.in

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Cost Accounting
12 2. Labour Costs
Costs paid to the labour force for working directly on the manufacture of
the product is known as labour costs. For example, wages paid to workers.

3. Overhead Costs
These costs may not be directly attributable to the product but incurred to
support the business activity of the product. For example, lighting, oil
expenses etc.
Costs based on cost -center:
1. Prime Costs
It is the sum total of direct materials, direct labo ur and direct expenses
incurred by an organization.

2. Factory Overheads
All costs incurred in the factory premises viz factory rent, factory
electricity etc are factory overheads.

3. Office Overheads
All costs incurred in the administrative office of an organ ization viz office
stationery, office electricity etc. are office overheads.

4. Selling and Distribution Overheads
All costs incurred to sell a product viz. advertisement costs, depreciation
on delivery vehicle etc. are selling and distribution overheads.
Test Yourself:
1. Depreciation is an example of
a. Fixed Cost
b. Variable Cost
c. Semi -variable Cost
d. None of the above

2. Which cost increases with the level of output?
a. Fixed Cost
b. Variable Cost
c. Historical Cost
d. Sunk Cost

3. Office peons salary will fall under
a. Factory Cost
b. Prime Cost
c. Selling and Distribution Cost
d. Administration Cost


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13 2
MATERIAL COST
(INVENTORY CONTROL)
Unit structure
2.0 Objectives
2.1 Material Cost: The Concept
2.2 Material Control Procedure
2.3 Documentation : Material Requistion
2.4 Stock Ledger, Bin Card
2.5 Stock Levels
2.6 Inventory Control Systems : Economic Or der Quantity (EOQ)
2.7 Summary
2.8 Exercise
2.0 OBJECTIVES
After studying the unit the students will be able to
• Define the concept of inventory and material costing and explain the
various costs related to Inventory.
• Explain the material purchase pro cedure.
• Discuss about the function in storing the material.
• Know the techniques of Material Control.
• Solve the practical problems related to Stock Levels, EOQ and
Inventory Turnover Ratio.
2.1 MATERIAL COST: THE CONCEPT
Material means stock of items kept in reserve for certain period of time. It
includes raw materials, work -in-progress or semi -finished goods, finished
goods and spare parts for the maintenance of equipment etc. Raw
materials are those inputs that are converted into finished products. Work
in progress represents semi -finished goods that requires some work before
they are ready for sale. Finished products are those which are ready for
sale.
Inventory is the physical stock of items that a business or production
organisation keeps in hand for e fficient running of its production function.
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Cost Accounting
14 2.1.1 Definition of Inventory
According to Gordon B. Carson , inventory includes raw materials and
component parts. Inventories consist of raw material, component parts,
supplies and finished assemblies which a n organisation purchases from an
outside source and parts, assemblies and finished products which the
company manufactures itself. In simple words inventory means 'stock
items' or items in stock.
It is very essential that material of the correct quantity a nd quality is made
available as and when required, with due regard to economy in storage and
ordering costs, purchase prices and working capital. Inventory control
involves (i) Assessing the items to be held in stock. (ii) Deciding the
extent of stock hold ing of items individually and collectively. (iii)
Regulating the input of stock into the store houses and (iv) Regulating the
issue of stock from the stores houses.
2.1.2 COST OF I NVENTORY / COST OF M ATERIAL
Inventory control is generally concerned wi th the procurement of raw -
materials and purchased parts (i.e. components) and their supply to the
production departments. Supplies and stores are the indirect materials.
They do not form a part of the finished products. They are closely related
to the main tenance services and so they should be controlled by the
maintenance department. Work -in-progress is primarily concerned with
the manufacturing department, because it is results from the various
operations performed on the shop. It is proper to assign the control
functions of work -in-progress to manufacturing department.
Every business organisation, however big or small, has to maintain
inventory and it constitutes as integral part of the working capital. It has
been estimated that inventory in Indian indus tries constitutes more than
60% of current assets. Inventories are significant elements in cost process.
Inventories require a significant investment, not only in acquiring them
but also in holding them. The various types of cost of inventory are as
follow s :

Cost of Inventory


Ordering Stock out Acquisition Start -up Quality
Costs Costs Costs Costs

1. Ordering Costs: Each time we purchase a batch of raw material from a
supplier, a cost is incurred for processing the purchase ord er, expediting,
record keeping, and receiving the order into the warehouse. Each time we
produce a production lot, a changeover cost is incurred for changing
production over from a previous product to the next one. The larger the lot
sizes, the more invent ory we hold, but we order fewer times during the
year and annual ordering costs are lower. munotes.in

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Material Cost
15 2. Stock out Costs: Each time we run out of raw materials or finished -
goods inventory, costs may be incurred. In finished -goods inventory,
stockout costs can include lost sales and dissatisfied customers. In raw -
materials inventory, stockout costs can include the cost of disruptions to
production and sometimes even lost sales and dissatisfied customers.
Additional inventory, called safety stock , can be carried to prov ide
insurance against excessive stockouts.
3. Acquisition Costs: For purchased materials, ordering larger batches
may increase raw -materials inventories, but unit costs may be lower
because of quantity discounts and lower freight and materials -handling
costs. For produced materials, larger lot sizes increase in -process or
finished -goods inventories, but average unit costs may be lower because
changeover costs are amortized over larger lots.
4. Start -up Quality Costs: When we first begin a production lot, th e risk
of defectives is great. Workers may be learning, materials may not feed
properly, machine settings may need adjustment, and a few products may
need to be produced before conditions stabilize. Larger lot sizes mean
fewer changeovers per year and less scrap.
2.1.3 IMPLICA TIONS OF HOLDING INV ENTORIES :
Certain costs increase with higher levels of inventories. The main
implications of holding inventories are as follows : -
1. Carrying Costs : Interest on debt, interest income foregone, warehouse
rent, cooling, heating, lighting, cleaning, repairing, protecting, shipping,
receiving, materials handling, taxes, insurance, and management are some
of the costs incurred to insure, finance, store, handle, and manage larger
inventories.
2. Cost of Customer Responsiveness : Large in -process inventories clog
production systems. The time required to produce and deliver customer
orders is increased, and our ability to respond to changes in customer
orders diminishes.
3. Cost of Coordinating Production : Because large inventories clog the
production process, more people are needed to unsnarl traffic jams, solve
congestion -related production problems, and coordinate schedules.
4. Cost of Return on Investment (ROI) : Inventories are assets, and
large inventories red uce return on investment. Reduced return on
investment adds to the finance costs of the firm by increasing interest rates
on debt and reducing stock prices.
5. Reduced -Capacity Costs : Inventory represents a form of waste.
Materials that are ordered, held, and produced before they are needed
waste production capacity.
6. Large -Lot Quality Cost : Producing large production lots results in
large inventories. On rare occasions, somethings goes wrong and a large
part of a production lot is defective. In such si tuations, smaller lot sizes
can reduce the number of defective products. munotes.in

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Cost Accounting
16 7. Cost of Production Problems : Higher in -process inventories
camouflage underlying production problems. Problems like machine
breakdowns, poor product quality, and material shortage s never get
solved.
2.2 MATERIAL CONTROL PROCEDURE
There is a purchase department which carries out the function of purchases
of materials. The purchase manager is responsible for ensuring the items
ordered are of the standard quality, lower cost and recei ved in time.
2.2.1 MATERIAL PURCHASE PROCEDURE
The purchase procedure vary with different business firms. The purchase
procedure is given below:
a) Purchase Requisition:
Purchase requisition is the formal request made by the storekeeper to the
purchase department for giving order of raw materials or stores. It serves
the dual purpose of authorizing the purchase department to make
purchases and provides a record of the description and quantity of
materials required. It also fixes the responsibility of the department or
personnel making purchase requisition.
b) Purchase order: -
After receiving the duly approved requisition, the purchase department has
to place an order with a supplier. It is an offer to buy certain materials at
stated price and terms. For r outine purchases, the order is placed through
established supplies. In other cases, the purchase department may ask for
bids or send out request for quotation before placing an order. The
purchase order is a formal contract for the supply of materials. Cop ies of
the purchase order are sent to the departments concerned.
c) Receiving and Inspection of materials:
The stores department is responsible for taking delivery of packages and
to get a physical verification of the contents. When the materials are
recei ved, the stores official gets the packages, open them and make a
detailed verification of the contents. After the contents of the packages are
checked, the details are entered into a Goods Received Note. Copies of the
G.R.Note are issued to the supplier, p urchase and accounts department,
where the factory has to test the materials received for quality and
specifications. It has to ensure that the quality of materials is as per
purchase order.
d) Approval of Invoices and Payment
Invoice received by the purch ase department is forwarded to the Accounts
department for payment with their recommendation. Accounts department
has to check the authenticity, arithmetical accuracy and G. R. Note in
order to make sure that the goods are as per purchase order. When it is
found that everything is in order, it is passed for payment by the
Accountant. Then the cashier will draw the cheque as per terms and munotes.in

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Material Cost
17 conditions of the purchase order and invoice and finally payment is made
to the supplier.
2.2.2 STORAGE OF MATERIALS
After purchase, receipt and inspection of materials, the next important step
is storage of materials. It is known as storekeeping. It is physical storage
of materials. The storekeeper is appointed to look after this work in the
stores department. The storekeep er should have the technical knowledge
and experience in stores routine and storekeeping. He has to ensure regular
supply event overstocking and under stocking and minimize the cost of
materials. The storekeeper has to perform the following functions:
i) Receipts of materials.
ii) Issue purchase requisitions.
iii) Maintain proper record of receipt, issue and balance stock of
materials.
iv) Placing and arranging materials at proper place.
v) Issue of materials against proper authorization.
vi) Minimizing st orage handling and maintaining costs.
vii) Ensure that the stock neither exceed maximum level or go below the
minimum level.
2.3 DOCUMENTATION
MATERIAL REQUISITON

Department ………. Serial No………

Job No. ……….. Date …………

Code No. Description Quantity Weight Bin Card No. Stores Ledger
Folio Rate Amount
Rs.
Authorised by …………… Received by…..
Storekeeper’s Signature ….. Checked by …….

2.4 STOCK LEDGER CARDS & BIN CARD
STOCK LEDGER CARD: It is also known as Stores Ledger Cards/
Material Le dger Cards. It refers to tracking the inventory levels in the
company during a given period of time. It provides a complete details as to
the date, time, value, vendor, types of materials flowing in and out of the
company. It is maintained on continuous ba sis by the cost accountant.
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Cost Accounting
18 FORMAT OF STOCK/ STORES/ MATERIAL LEDGER
ACCOUNT:

Source: Image downloaded from https://commerceiets.com/perpetual -
inventory -system/
BIN CARD: It is maintained by the storekeeper providing details where
the material is kept ie. The shelf number, the box number with labelling
codes. It shows the various quantities of the given material of each type
with receipt and issued details. It also refers to sorting of the material into
different categories and bins for easy accessibili ty.
FORMAT OF BIN CARD:

Source: Image downloaded from https://commerceiets.com/perpetual -
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Material Cost
19 NOTE: Stock Ledger Cards are maintained by the cost accountant
involving quantity and value both while Bin Card is maintained by
storekeeper mainta in quantities alone.
2.4.1 METHODS OF STOCK TAKING
Methods of taking inventories / stock Method of Inventory(2) Perpetual inventory Method (1) Periodic inventory method.
1. Periodic inventory method :
Under this method of taking inventories, value of stock is determined by
physical counting of the stock on the accounting date of preparation of the
final accounts. It is possible that stock taking may take a week or so in
large enterprises and purchases and sales may have to be suspended for
that period to get correct figure of closing inventory. This meth od of
ascertaining the value of stock at the end of the year is also known as
annual stock taking. Thus this method is based physical stock taking. It
provides data once in a year is simple and economical method of
stocktaking can be adopted in small conce rns, but it does not provide basis
for control.
2. Perpetual Inventory Method :
Perpetual inventory defined as a system if records maintained by the
controlling department, which reflects the physical movements of stock
and their current balance. Under this m ethod stock registers are
maintained to make a record of the physical movements of stock and their
current balance. Stores ledger is maintained to keep a record of the receipt
and issue of the materials and also reflects the balance in store. Similarly,
work-in-progress ledger is maintained to give the value of work -in-
progress on hand and a finished goods ledger is maintained to know the
value of finished goods on hand. Thus this system provides a running
record of inventories on hand at any time. To ensur e the accuracy of
perpetual inventory records physical verification of the inventory is made
by a program of continuous stock taking.
It is possible that the balance of stock by the perpetual inventory may
differ from the actual balance of stock as ascerta ined by physical
verification. Any difference noted between actual stocks as disclosed by
the physical verification and the stocks shown by stock records should be
investigated and rectification made then and there. If the physical
verification reveals tha t actual balance of stock, is more that the balance
shown by the stores ledger or work -in-progress ledger or finished goods
ledger debit note is prepared and stock record are adjusted accordingly so
that balance may reconcile with actual balance. A Stock A djustment
Accounts is prepared and debited with the shortage of stock and credited
with surplus. munotes.in

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Cost Accounting
20 Continuous stock taking is an essential feature of the perpetual inventory
system. But the two terms, perpetual inventory and continuous stock
taking should no t be taken as one; perpetual means the system of stock
records and continuous stock taking whereas continuous stock taking
means only the physical verification of stock records with actual stocks.
In continuous stock taking, physical verification is sprea d throughout the
year. Every day 10 to 15 items are taken at rotation and checked so that
surprise, element in short verification is maintained and each item is
checked for a number of times during the year. On the other hand, surprise
element is missing i n case of periodical checking because checking is
usually done at the end of the year. In short this method is based on
records. It requires a lot of recording and is thus expensive. It can be
adopted only in big concerns. It provides data on running basis and thus
facilitates the preparation of financial statements at shorter intervals. It
also provides basis for control by investigation the basis for control by
investigation the discrepancies arising from the comparison of physical
stock with their book v alues.
Difference between Periodic inventory and Perpetual inventory.
The following are the main differences between the two methods of taking
inventory.
Periodic Inventory Perpetual Inventory
1. It is based on physical
stocktaking 1. It is based on reco rds.
2. It provides data periodically
i.e. once in year. 2. It provides the data on running
basis and thus facilitates the preparation
of financial statements at shorter
intervals.
3. It does not provide basis
control. 3. It provides basis for control b y
investigating the discrepancies arising
from the comparison of physical stock
with book values.
4. It is simple and economical
method of taking inventory and
can be adopted in small
concern. 4. It is expensive as it requires a lot of
recording due to a n elaborate method of
taking inventory. It can be adopted by
big concerns only.

2.5 STOCK LEVELS
Regular availability of required stocks act as a bridge between production
and sales department. To ensure the company is neither overstocked or
falls under stock at any given point of time maintaining optimum stock
level is important. A manufacturing concern maintains three types of stock munotes.in

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Material Cost
21 i.e raw materials, work in process and finished goods while a trading
concern generally deals with stock of finished goods alone. While
deciding on the stock levels to be maintained factors such as storage
space, cost of inventory, lead time, carrying costs etc too are considered.
The four different stock levels are as follows:
1. Re-Order Level: It refers to that level of point where the required
stock is reordered. It generally lies between the minimum and maximum
stock levels to avoid abnormal situations or stock outs. The formula is as
below -

Reorder level of stock = Maximum Re -Order period x Maximum
Usage
OR
Reorder level of stock = Minimum Level + (Average rate of
consumption x Average lead time)

2. Minimum Level: It refers to that level of stock which needs to be
maintained throughout to ensure there are no hindrances in the
production process.

Minimum Stock L evel = Re -Order Level - (Average rate of
consumption x Average lead time)
OR
Minimum Stock = Reordering Level – (Normal Consumption x Normal
Reordering Period)

3. Maximum Level: As the name itself suggests it is the maximum
level of stock quantity held by t he company at the given point of time.
It is the upper threshold limit. Maximum Stock Level = Reordering
Level + Reordering Quantity – (Minimum Consumption x Minimum
Reordering period)

4. Danger Level: It refers to that level below which the quantity of
stock should not fall. Danger Level = Average Consumption x Lead time
for emergency purchases.

5. Safety/ Buffer Stock: It refers to that contingency stock that
shall be maintained to meet unwarranted or last minute emergencies.

6. Lead Time / Re -order Period: It refers to time gap between
placing an order and receiving an order.
Other Terms:
1. Average Consumption: Minimum Consumption + Maximum Consumption
2
2. Average Lead Time = Minimu m Lead time + Maximum Lead time
2
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Cost Accounting
22 2.5.1 STOCK CONTROL CHART




Source: https://resource.cdn.icai.org/38596bos28170mod1 -cp2.pdf

2.5.2 ILLUSTRATIONS
1. Calculate minimum stock level, maximu m stock level, and re-
ordering level:
a. Maximum Consumption = 450 units per day
b. Minimum Consumption = 270 units per day
c. Normal Consumption =285 units per days
d. Reorder period = 10 -15 days
e. Reorder quantity = 3,000 units
f. Normal reorder period = 13 days.
Solutio n:
1. Reordering Level = Maximum Consumption x Maximum Reorder
period
= 450 units X 15 = 6,750 units
2. Minimum Stock = Reordering Level – (Normal Consumption x
Normal Reordering Period)
= 6,750 – (285 X 13) = 6,750 – 3,705 = 3,045 units
3. Maximum Stock Level = Reordering Level + Reorder Quantity –
(Minimum Consumption x Reorder period)
= 6,750 + 3,000 – (270 X 10) = 6,750 + 3,000 – 2,700 = 7050 units.


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Material Cost
23 2. Calculate for each component: Minimum Stock Level, Maximum
Stock Level, Average Stock.
Component A Compone nt B
Normal Usage 35 units per week 30 units per week
Maximum Usage 50 units per week 40 units per week
Minimum Usage 25 units per week 20 units per week
Re-Order quantity 150 100
Re- order Period 4-6 weeks 2-4 Weeks

Solution:
1. Reordering Level = Maximu m Consumption x Maximum Reorder
period
Component A = 50 units X 6 = 300 units
Component B = 40 units X 4 = 200 units

2. Minimum Stock = Reordering Level – (Normal Consumption x
Normal Reordering Period)
Component A = 300 – (35 X 5)* = 125 units
Component B = 200 units - (30 X 3)= 110units
(Note when normal re -ordering period is not given use average lead
time i.e (Minimum lead time + Maximum lead time)/2 i.e.
Component A (4+6)/2 = 5 weeks.

3. Maximum Stock Level = Reordering Level + Reorder Quantity –
(Minimum Consumption x Reorder period)
Component A = 300 + 150 units – (25 X 5)* = 325 units
Component B = 200 + 100 units - (20 X 3) = 240 units

4. Average Stock = Minimum Stock + Maximum Stock
2

Component A = (125 + 325)/2 units = 225 units
Component B = (110 + 240)/2 units = 175 units
2.6 INVENTORY CONTROL SY STEMS OR
TECHNIQUES:
Various techniques are used in controlling the inventories. Some popular
and important techniques are as under :
A. Re -order Point (ROP).
B. Economic Ordering Quantity (EOQ).
C. ABC Analysis. munotes.in

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Cost Accounting
24 A. RE-ORDER POINT (ROP) :
Receiving and issuing of inventories are the common and recurring
phenomena in a manufacturing organisation. When the inventories fall
below a particular point, they are replenished by the fresh purchases. Re -
order point (ROP) is the point when the inventories have to be replenished
by fresh order. It fundamentally deals with ‘when to order’ or to replenish
the inventories.
Re-order point is a stock level at which fresh supplies of materials should
be ordered. The level is fixed between somewhere between minimum
level and maximum level. It is fixed in such a way that fresh supply of
materials are received before the level reaches the minimum level. The re -
order point also called re -order level depends upon two factors:
(a) Maximum consumption and (b) Lead time i.e. the anticipated time lag
between the dates of issuing orders and receiving supplies. The formula
for calculating re -order level is :
Re-order Level = Maximum usage × Minimum re -order period.
Re-order Quantity : Re-order quantity is the quantity for which an order
is placed when stock reaches the re -order level. The term is used generally
in synonymous with the Economic Order Quantity since order is placed
only in such size which will be economical for the enterprise in all respect.
B. ECONOMIC ORDER QUANT ITY :
The Economic Order Quantity (also known as re -order quantity) refers to
the size of the order which gives the maximum economy in purchasing
any material. It is an optimum or standard order size. When the stock
reaches the recorder level, the company should give a fresh order of
optimum size.
This quantity is also called "Economic Purchase Quantity, or Economic lot
size, or optimum l ot size or Minimum Cost Inventory."
In fixing the economic order quantity, the following costs are considered:
1. Ordering Cost : This is the cost of placing an order with the supplier
and includes cost of stationery, salary of those who are engaged in pla cing
a order and in receiving and inspecting the materials. It is a fixed cost and
therefore cost of placing an order varies from time to time depending upon
the number of order placed and the quantity of items ordered. The number
of orders increase, the o rdering cost goes up and vice -versa.
2. Inventory Carrying Cost : It is the cost of holding the stock in storage
and includes interest on investment, obsolescence losses, store keeping
cost, such as rent of warehouse, salary of store keeper, stationery use d in
maintaining records of stores, etc, insurance cost, deterioration and
wastage of material. The larger the volume of inventory, the great will the
inventory carrying cost and vice -versa. munotes.in

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Material Cost
25 The above two costs are of opposite nature. If for example, an at tempt is
made to reduce of inventory carrying cost by holding the stores as low as
possible, the number of orders will increase and consequently the ordering
cost will go up. On the other hand, if orders are placed for a larger
quantity, the inventory carr ying cost will increase and ordering cost, the
economic order quantity (EOQ) is fixed to keep the aggregate cost to the
minimum.
Assumptions of Economic Order Quantity (EOQ) : The EOQ model is
based on the following assumptions:
(i) There is only one produ ct involved; (ii) Annual usage (demand)
requirements are known; (iii) Usage is spread evenly throughout the year
so that the usage rate is reasonably constant; (iv) Lead time does not vary;
(v) Each order is received in a single delivery and (vi) There are no
quantity discounts.
Precautions in Applying EOQ : The following precautions are necessary
in applying E.O.Q.
1. Simplification of Routine : If the E.O.Q. formula tells us that 13 orders
have to be placed in a year, we may place 12 orders, i.e. once a m onth.
2. Ordering in Package Sizes : Many goods are packed in units of one
gross. If figure shows a quantity of 11 dozens, it should be changed to 12
dozens.
3. Economical Freight Rates : If the mathematical figure gives 9/10th of
a lorry or rail wagon loa d, it is better to increase the quantity to have one
full lorry load or one full wagon load. This would be cheaper, because the
full wagon load rates would be lower than transporting the material as
smalls.
4. Perishable Articles : For perishable articles whose shelf -life is very
low, E.O.Q. should be very much less than the theoretical figure and
should be based on practical considerations.
5. Seasonal Articles : For articles of a seasonal nature, e.g., cotton or
groundnuts or oilseeds, bulk purchases duri ng the season will be cheaper
than purchases based on E.O.Q.
6. Bulk Purchases : In certain cases, considerable discounts would be
available for bulk purchases. This should be compared to the savings as a
result of the application of E.O.Q. formula and a d ecision should be taken
based on which is creeper.
7. Import of Materials : E.O.Q. cannot be successfully applied in the
case of imports of materials which is based on import licences.
Importance of Economic Order Quantity (EOQ) : If re-order quantity
is determined in advance and adjusted it en sures the following advantages
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Cost Accounting
26 1. The cost of storage can be kept at a minimum.
2. Purchase orders can be easily prepared at intervals.
3. The advantages of placing large orders can be derived as far as possible.
Limitations of Economic Order Quantity (EOQ) : The following are
the limitations of EOQ:
(a) Where rate of consumption fluctuates very often ordering a fixed
quantity may lead to over or under stocking.
(b) Very often, consumption rate cannot be anticipated because of certain
unavoidable reasons such as power failure, slackening of customers’
demand etc.
(c) Sometimes, estimating of carrying cost and ordering cost in advance is
not easy.
C. A.B.C. ANALYSIS:
A most useful guide to devising stock control system is often known as
'Pareto Analysis' (after the name of an Italian Philosopher). The term is
also known as ABC analysis because it analyses the range of stock items
held into three sectors, known as A, B and C.
ABC analysis is a new technique of classifying a nd controlling production
and store inventories both purchased and manufactured in accordance with
value of the item. It is the starting point for material management. It is the
basic analytical management tool which enables top management to place
the eff ort where the results will be greatest. The technique is popularly
known as Always Better Control or the Alphabetical approach. The
technique tries to analyse the distribution of any characteristic by money
value of importance in order to determine its pri ority. In materials
management the technique has been applied in areas needing selective
control such as inventory, criticality of items, obsolete stocks, purchasing
orders, receipt of materials, inspection, store -keeping and verification of
bills.
ABC ana lysis or classification is the principle of Selective Control of
inventories and a technique of grouping thousands of stock items handled
by an organisation. The principle involved is that the degree of control on
stock items and amount of safety stock car ried should vary directly with
the consumption value of the item involved.
Advantages of ABC Analysis : The following are the advantages of ABC
Analysis :
1. Selective Control : This approach helps the materials manager to
exercise selective control and fo cus his attention only on a few items when
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Material Cost
27 2. Control Inventories : By concentrating on 'A' class items, the materials
manager is able to control inventories and show visible results in a short
span of item.
3. Ob solete Stocks : By controlling the 'A' items obsolete stocks are
automatically pin pointed.
4. Clerical Cost : The system also helps in reducing the clerical cost and
better planning and improved inventory turnover.
5. Equal Attention : ABC Analysis has to be resorted to because equal
attention to A, B and C items will not be worthwhile and would be very
expensive.
D. H.M.L. Techniques :
H.M.L. (High, medium, low) technique is the opposite of ABC concept of
selective inventory control technique. It also follo ws the same procedure
of distribution of inventory items by money value. The only difference in
the application of ABC (Always Better Control) analysis in H.M.L.
technique is that the unit value is the criterion and not the annual
consumption value. The it ems should be listed out in descending order of
unit value and management may fix limits for deciding the three
categories.
Example : Management may for example decide that all items of the unit
value above Rs.500/ - will be H items, between Rs.100 to 500 w ill be M
items and below Rs.100 will be L items. On this basis, management may
delegate authorities to various subordinate officers to purchase petty cash
items. Management may decide that items of the value above a unit value
of Rs.500 are H items and may decide that all such items will only be
sanction by the purchase manager.
E. V.E.D. Classification
V.E.D. is the acronym for vital (V) essential (E) and (D) desirable. This
type of classification is mostly applicable in the case of spare parts. Spare
parts do not have a materials. The requirements of spare parts are age of
machine. Older machines require frequent maintenance and replacement
of spare parts. To get over this difficulty, V.E.D. classification is used.
Here, the categorisation is made in terms o f the importance or critically of
the part to the operation of the plant. It is very vital, it is given a V
classification and D part. How such a classification is done will depend
upon the machinery or equipment involved and one's own experience, case
of availability of the items etc. For examine, if the items was available off
the shelf from the supplier's showroom, there would be no purpose in
categorising it as V. If on the other hand, a minor imported item might
automatically get a V classification, fo r V items, a reasonably large
quantum of stocks might be necessary, while for D items, no stocks need
perhaps be kept, especially if that item also happens to be in the A or B
classification. For V items of A classification, close control should be kept
on stock levels, but if it is a C item, then large quantities, may be stored. munotes.in

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Cost Accounting
28 F. S.D.E. Classification
This classification is used for source items, those which are difficult to
obtain and those which are fairly easy to obtain. If an item in scarce it is
taken as an A item, we cannot apply the same procedure or yardstick for
its stocking. Take for example, an item which is imported. It would be
quite absurd for anyone to say that it should be procured once in six
weeks. It would be best to obtain it once in a ye ar, considering the time,
effort and expenditure involved in the procedures for import.
A scarce item might be an item which is not easily available in the market
and might require source development, or else it might be an item which is
very difficult to manufacture or there are only one or two manufactures
who have to be given orders several months in advance, and so on.
Let us take an item which is easy to obtain and it is an A item. One can
bestow on it all the care required for treatment of A items. Bu t if it is a C
item, the inventory controller really does not have to bother very much.
G. G.O.L.F. Classification :
This classification is used for Government -ordinary -local and foreign.
There are many imported items which are channelised through the State
Trading Corporation, MMTC, Indian Drugs and Pharmaceuticals Ltd.,
Metals to be followed for procuring such item. As such, ordinary
procedures of inventory control may not work in respect of these materials
and they would require special treatment.
Items whi ch are available within the country could be treated differently if
they were available locally, compared to their being available only in very
distant towns or where they have to be specially manufactured. Imported
items would be a special class by themse lves and have to be accorded a
treatment quite unique.
H. F.S.N. Classification
F-S-N Stands for fast -moving, slow -moving and non -moving. This
classification comes in very handy when we desire to control
obsolescence. Items classified as S and N require very great attention,
especially N items. There may be several reasons why an item has got into
the N category. There might have been a change in technology or change
in the specification of a particular spare part or the item might no longer
be in use. When a n F.S.N. classification is made, all such information
stand out prominently enabling managers to act on the information in the
best interests of the organisation.
I. S-O-S Classification
Some of the item required may be seasonal in nature and may require
special purchasing and stocking strategies. Many commodities, especially
of agricultural origin and seasonal in character, have to be purchased at the
best time. One cannot apply E.O.Q. here for example, inventories at the
time of procurement will be extremel y high but this cannot be helped. munotes.in

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Material Cost
29 A buying and stocking strategy for seasonal items would depend on a
large number of factors and more and more sophistication is taking place
in this matter. Operational research techniques would have to be used to
obtain o ptimum results.
J. X-Y-Z Classification
This classification is based on the value of inventory stored. If the values
are high, special efforts should be made to reduce them. This exercise can
be done once in a year.
The different types of classifications sugg ested would given an executive a
clear idea as to what are the implications and this would give him the
necessary clues as to how to act and what decisions to take. It will also be
clear that none of these classifications should be used in isolation. A
person should take an integrated view and decide the best course that will
give the best overall results.
2.6.1 ILLUSTRATIONS ( EOQ METHOD)
1. Calculate Economic Order Quantity from the following information.
Also state number of orders to be placed in a year.
Consu mption of Material per annum : 20000 kg
Order placing costs per order : Rs. 100
Cost per kg of materials : Rs. 5
Storage Costs : 10% on average
inventory
Solution :
Annual Consumption ( A) = 20,000 kg
Ordering Cost per order(O) = Rs.100
Carrying Cost (C) = Cost per kg x Carrying Cost %
= Rs. 5 x 10 %
= Rs. 0.50p.kg.p.a.
EOQ =

=

= 2,828 units.approx
2. A manufacturer buys certain equipment from outside suppliers at Rs.
60 per unit. Total annual needs are 2400 units. T he following further data
are available. munotes.in

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Cost Accounting
30 Annual return on investment : 15%
Rent, insurance, taxes per unit per year : Rs. 10
Cost of placing an order : Rs. 200
Determine the Economic Order Quantity
Solution :
A = 2400 units
O = Rs. 200
C = Cost x Carrying Cost % + Other costs per unit
= Rs. (60 x 15 %) + 6
= Rs. 15 p. u. p. a.
EOQ =

=

= 252.98 i.e 253 units.
3. Ansemi annualconsumption of a materials is 10,000 units at a price
of Rs. 40 per unit. The storage c ost is 20% on an average inventory and
the cost is placing an order is Rs. 20. How much quantity is to be
purchased at a time?
Solution :
A = 10000 x 2 = 20000 units
(since semi – annual consumption is given , the number of units are to be
multiplied by 2 , in case of quarter requirements multiply by 4, monthly
multiply by 12 and weekly multiply by 52)
O = Rs. 20
C = Cost x Carrying Cost %
= Rs. 40 x 20 %
= Rs. 8 p. u. p. a.
EOQ =

=

= 100 units.
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Material Cost
31 4. A company manufact ures a special product which requires a
component ‘GM’. The following particulars are collected for the year
2021 :
Annual Demand of GM : 16,000 units
Cost of placing an order : Rs. 400 per order
Cost per unit of GM : Rs. 600
Carrying cost % p.a.: 12%
The company has been offered a discount of 4% on the purchase price of
‘GM’, provided the order size is 8,000 components at a time.
Required:
i) Compute the economic order quantity
ii) Advise whether the quantity discount offer can be accepted.
Solution :
A = 16,000 units
O = Rs. 400
C = Cost x Carrying Cost %
= Rs. 600 x 12 %
= Rs. 72 p. u. p. a.
EOQ =

=

= 421.63 i.e. 422 units.
Total Costs: Total Purchase Cost + Total Ordering Costs + Total carrying Cost
= (Ann ual Qty * Cost Per Unit) + (Annual Qty/ Ordering Qty * Cost per Order)
+ (Ordering Qty / 2 * Carrying Cost per unit)
= (16000* 600) + (16000/422 * 400) + (422/2 * 72)
= 96,00,000+ 15165.88 + 15192
= 96,30,358 ---------------------------------------- (I)
(Note at EOQ Level : Total Ordering Costs and Total Carrying Costs are
equal. In this illustration due to round off the slight changes are visible.)
Ordering qty = 8000 units munotes.in

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Cost Accounting
32 Total Costs: Total Purchase Cost + Total Ordering Costs + Total carrying
Cost
= (Annual Qty * Cost Per Unit) + (Annual Qty/ Ordering Qty
* Cost per Order)
+ (Ordering Qty / 2 * Carrying Cost per unit)
= (16000* 576) + (16000/8000 * 400) + (8000/2 * (72 – 4%)
= 92,16,000+ 800 + 276480
= 94,93,280 --------------------------------------- (II)
(Note : When discount is offered on bulk qty purc hase the not only
purchase price reduces but also the carrying cost changes.
When purchase quantity is other than EOQ level, there is tradeoff between
Ordering costs and Carrying Costs.
Evaluating option I & II, the total costs is lower when discount if ac cepted
therefore discount should be accepted.
5. MGM Factory consumes 10,000 units of a component per year. The
ordering, receiving and handling costs are Rs. 2 per order while the
tracking costs are Rs. 4 per order. Further details are as follows :
Interes t cost Rs. 0.25 per unit per year
Deterioration and obsolescence cost Rs. 0.05 per unit per year.
Storage cost Rs. 24,000 per year for 20,000 units.
Calculate the Economic Order Quantity.
Solution :
A = 20,000 units
O = Rs. 2 + Rs. 4 = Rs. 6 per order
(Ordering Receiving and Handling Costs + Tracking Costs)
C = 0.25 + 0.05 + 1.2( 24000/20000)
( Interest Cost +Deterioration and Obsolescence Costs + Storage Costs
= 1.5pu. pa.
EOQ =

=

= 400units. munotes.in

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Material Cost
33 Practical I llustration
1. Calculate Economic Order Quantity from the following information.
Also state number of orders to be placed in a year.
Consumption of Material per annum : 10000 kg
Order placing costs per order : Rs50
Cost per kg of materials : Rs2
Storage Cost s : 8% on average
inventory
Solution :
A = 10,000 kg
O = Rs. 50
C = Cost x Carrying Cost %
= Rs. 2 x 8 %
= Rs. 0.16 p.kg.p.a.
EOQ =

=

= 2, 500 units.
2. A manufacturer buys certain equipment from outside suppliers at
Rs30 per unit. Total annual needs are 800 units. The following further data
are available.
Annual return on investment : 10%
Rent, insurance, taxes per unit per year : Rs1
Cost of placing an order : Rs100
Determine the Economic Order Quantity
Solu tion :
A = 800 units
O = Rs. 100
C = Cost x Carrying Cost % + 1
= Rs. (30 x 10 %) + 1
= Rs. 4 p. u. p. a.
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Cost Accounting
34 EOQ =

=

= 200 units.
3. An average annual consumption of a materials is 18,250 units at a
price of Rs36.50 per unit. The storage cost is 20% on an average inventory
and the cost is placing an order is Rs50. How much quantity is to be
purchased at a time?
Solution :
A = 18,250 units
O = Rs. 50
C = Cost x Carrying Cost %
= Rs. 36.50 x 20 %
= Rs. 7.30 p. u . p. a.
EOQ =

=

= 500 units.
4. A company manufactures a special product which requires a
component ‘Alpha’. The following particulars are collected for the year
2008 :
i) Annual Demand of Alpha : 8,000 units
ii) Cost of placin g an order : Rs200 per order
iii) Cost per unit of Alpha : Rs400
iv) Carrying cost % p.a. : 20%
The company has been offered a quantity discount of 4% on the purchases
of ‘Alpha’, provided the order size is 4,000 components at a time.
Required :
i) Compute the economic order quantity
ii) Advise whether the quantity discount offer can be accepted.

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Material Cost
35 Solution :
A = 8,000 units
O = Rs. 200
C = Cost x Carrying Cost %
= Rs. 400 x 20 %
= Rs. 80 p. u. p. a.
EOQ =

=

= 200 units.
TOC & TCC =

=

= Rs. 16,000
TOC = 8,000
TCC = 8,000
Offer = 4% Discount, if Order size = 4,000 units

EOQ (Offer) = 4,000 units
N = A / EOQ
= 8,000 /4,000
= 2 orders
TOC = N X O
= 2 X 200
= Rs. 400
TCC = EOQ X 1/2 X C
= 4000 x 1/2 x [ (400 - 4%) X 20%]
= 4,000 x 1/2 x 76.80
= 1,53,600


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Cost Accounting
36 Evaluation of EOQ and Offer
Particulars EOQ Offer
Annual Demand (A) 8,000 8,000
(X) Cost p.u. 400 400
Purchase Cost 32,00,000 32,00,000
(-) Discount @ 4% nil 1,28,000
Net Cost 32,00,000 30,72,000
( +) TOC 8,000 400
TCC 8,000 1,53,600

Total Cost 32,16,000 32,26,000

5. A precision Engineering Factory consum es 50,000 units of a
component per year. The ordering, receiving and handling costs are Rs3
per order while the tracking costs are Rs12 per order. Further details are as
follows :
Interest cost Rs0.06 per unit per year
Deterioration and obsolescence cost Rs0.004 per unit per year.
Storage cost Rs1,000 per year for 50,000 units.
Calculate the Economic Order Quantity.
Solution :
A = 50,000 units
O = Rs. 3 + Rs. 12 = Rs. 15 per order
C = 0.06 + 0.004 + 0.02
= 0.084 pu. pa.
EOQ =

=

= 4, 226 units.
6. A company manufactures a product from a raw material, which is
purchased at Rs60 per kt. The company incurs a handling cost of Rs360
plus freight of Rs390 per order. The incremental carrying cost of inventory
of raw material i s Rs0.50 per kg per month. In addition, the cost of munotes.in

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Material Cost
37 working capital finance on the investment in inventory of raw material is
Rs9 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 materi al.
Required :
i) Calculate the economic order quantity of raw materials.
ii) Advise, how frequently should order for procurement be placed.
Solution :
A = 1kg x 1,00,00 units / 2.5 units = 40,000 kgs.
O = Rs. 360 + Rs. 390 = Rs. 750 per order
C = 9 + (0.50 x 12)
= 15 pu. pa.
EOQ =

=

= 2,000 kgs.
Stock Ledger
(1) The stock in hand of a material as on 1st September 2014 was 500
units at Rs1 per unit. The following purchases and issues were
subsequently made.
2019
Purchases September 6 100 units at Rs1.10
September 20 700 units at Rs1.20
September 27 400 units at Rs1.30
October 13 1,000 units at Rs1.40
October 20 500 units at Rs1.50
November 17 400 units at Rs1.60
Issues
September 9 500 units
September 22 500 units
September 30 500 units
October 15 500 units
October 22 500 units
November 11 500 units

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Cost Accounting
38 Prepare the Stores Ledger Account showing how the value of the issues
would be recorded under (i) FIFO method.
Solution :
A) FIFO Method
Receipts Issues Balance
Date
Units Price Amt
Rs. Units Price Amt
Rs. Units Price Amt
Rs
Sept. 19
1 OP - - - - - 500 1 500

6 100 1.1 110 - - - 500 1 500
100 1.1 110

9 - - - 500 1 500 100 1.1 110

20 700 1.2 840 - - - 100 1.1 110
700 1.2 840

22 - - - 100 1.1 110
400 1.2 480 300 1.2 360

27 400 1.3 520 - - - 300 1.2 360
400 1.3 520

30 - - - 300 1.2 360
200 1.3 260 200 1.3 260

Oct, 19
13 1000 1.4 1400 - - - 200 1.3 260
1000 1.4 1400

15 - - - 200 1.3 260 munotes.in

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Material Cost
39 300 1.4 420 700 1.4 980

20 500 1.5 750 - - - 700 1.4 980
500 1.5 750

22 - - - 500 1.4 700 200 1.4 280
500 1.5 750

Nov, 19
11 - - - 200 1.4 280
300 1.5 450 200 1.5 300

17 400 1.6 640 - - - 200 1.5 300
400 1.6 640

Total 4,260
3,820
940
Cost of Goods Sold = OP + Purchases – Clg.
500 + 4,260 - 940
3,820

(2)The following particulars have been extracted in respect of Material X
2019
Receipts
October 1 Opening Stock 200 units at Rs3.50 per unit
October 3 Purchased 300 units at Rs4.00 per unit
October 13 Purchased 900 units at Rs4.30 per unit
October 23 Purchased 600 units at Rs3.80 per unit
Issues
October 5 Issued 400 units
October 15 Issued 600 units
October 25 Issued 600 units munotes.in

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Cost Accounting
40 Prepare a Stores Ledger Account showing the receipts and i ssues, pricing
the materials issued in the basis of Weighted Average
Solution :
Weighted Average Method
Receipts Issues Balance
Date
Units Price Amt Rs. Units Price Amt Rs. Units Price Amt Rs
Oct,
2019
1 Op. - - - - - 200 3.5 700

3 300 4 1,200 - - - 500 3.8 1900

5 - - - 400 3.8 1,520 100 3.8 380

13 900 4.3 3,870 - - - 1,000 4.25 4,250

15 - - - 600 4.25 2,550 400 4.25 1,700

23 600 3.8 2,280 - - - 1000 3.98 3,980

25 - - - 600 3.98 2,388 400 3.98 1,592

Total 7,350 6,458 1,592

COGS = OP + Purchase - Clg
= 700 + 7,350 - 1,592
= 6,458



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Material Cost
41 (3) Enter the following transactions in the Stores Ledger of Material Y
using FIFO method.
2019
January 1 Balance 250 units @ Rs10 per unit
3 Issued 50 units on M.R. no. 61
6 Received 800 units vide G.R. No.13 @ Rs11 per unit
7 Issued 300 units on M.R. No. 63
8 Returned to stores 20 units on M.R. No. 6
12 Received 300 units per G.R. No. 15 @ Rs12 per unit
15 Issued 320 units M.R. No. 83
18 Received 100 units, vide G.R. Note No. 77 @ Rs12
per unit
20 Issued 120 units M.R. No. 102
23 Returned to vendors 40 units from G.R. No. 77
received on 18th instant
26 Received 200 units on G.R. No. 96 @ Rs10 per unit
30 Issued 250 units on M.R. No. 113

Solution :
A) FIFO Method
Receipts Issues Balance Date
Units Price Amt Rs. Units Price Amt Rs. Units Price Amt Rs
2019
Jan. 1 Op. - - - - - 250 10 2,500

3 - - - 50 10 500 200 10 2,000

6 800 11 8,800 - - - 200 10 2,000
800 11 8,800

7 - - - 200 10 2,000
100 11 1,100 700 11 7,700

8 20 11 220 - - - 700 11 7,700
20 11 220 munotes.in

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Cost Accounting
42
12 300 12 3,600 - - - 700 11 7,700
20 11 220
300 12 3,600

15 - - - 320 11 3,520 380 11 4,180
20 11 220
300 12 3,600

18 100 12 1,200 - - - 380 11 4,180
20 11 220
300 12 3,600
100 12 1,200

20 - - - 120 11 1,320 260 11 2,860
20 11 220
300 12 3,600
100 12 1,200

23 - - - 40 12 480 260 11 2,860
20 11 220
300 12 3,600
60 12 720

26 200 10 2,000 - - - 260 11 2,860
20 11 220
300 12 3,600
60 12 720
200 10 2,000

30 - - - 250 11 2,750 10 11 110
20 11 220
300 12 3,600
60 12 720
200 10 2,000


15,820 11,670 6,650



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Material Cost
43 B) Weighted Average Method
Receipts Issues Balance Date
Units Price Amt Rs. Units Price Amt Rs. Units Price Amt Rs
2019
Jan. 1 Op. - - - - - 250 10 2,500

3 - - - 50 10 500 200 10 2,000

6 800 11 8,800 - - - 1,000 10.8 10,800

7 - - - 300 10.8 3,240 700 10.8 7,560

8 20 10.8 216 - - - 720 10.8 7,776

12 300 12 3,600 - - - 1,020 11.15 11,376

15 - - - 320 11.15 3,568 700 11.15 7,808

18 100 12 1,200 - - - 800 11.26 9,008

20 - - - 120 11.26 1,351 680 11.26 7,657

23 - - - 40 12 480 640 11.21 7,177

26 200 10 2,000 - - - 840 10.93 9,177

30 - - - 250 10.93 2,733 590 10.92 6,444


15,816 11,872 6,444

(4) Write a short ledger card in the proper form making use of the
following particulars, pricing issues on the principle of FIFO.
Date Transactions Quantity
Units Rate per
unit `
2020
January 1 Balance 500 20
2 Issues 300
6 Purchases 800 22
8 Issues 400 munotes.in

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Cost Accounting
44 12 Issues 300
14 Purchases 400 25
20 Issues 600
24 Purchases 500 28
25 Issues 300
28 Issues 100

The sto ck verifier found a shortage of 10 units in the 30th and left a note.
Solution :
A) FIFO Method
Receipts Issues Balance
Date
Units Price Amt Rs. Units Price Amt Rs. Units Price Amt Rs
2020
Jan. 1 Op. - - - - - 500 20 10,00 0

2 - - - 300 20 6,000 200 20 4,000

6 800 22 17,600 - - - 200 20 4,000
800 22 17,600

8 - - - 200 20 4,000
200 22 4,400 600 22 13,200

12 - - - 300 22 6,600 300 22 6,600

14 400 25 10,000 - - - 300 22 6,600
400 25 10,000

20 - - - 300 22 6,600
300 25 7,500 100 25 2,500

24 500 28 14,000 - - - 100 25 2,500 munotes.in

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Material Cost
45 500 28 14,000

25 - - - 100 25 2,500
200 28 5,600 300 28 8,400

28 - - - 100 28 2,800 200 28 5,600

30 - - - 10 28 280 190 28 5,320

41,600 40,880 5,320


Inventory Turnover Ratio :
1. From the following date year ended 31st December, 2019 Calculate
inventory turnover ratio of two items.

Particulars Material X Material Y
Opening stock 20,000 18,000
Purchasi ng during the year 1,04,000 54,000
Closing stock 12,000 22,000

Solution :
Computation of Inventory Turnover ratio
Particulars Material X Material Y
Opening stock 20,000 18,000
Add ;Purchase 1,04,000 54,000
1,24,000 72,000
Less : Closing stock 12,000 22,000
Cost of Material Consumed 1,12,000 50,000

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Cost Accounting
46 Material X Material Y
Avg Stock =
=
=

= 16,000 = 20,000
ITR =
=
=

= 7 times = 2.5 times

No. of days the Avg.
Inventory held
=
=
=

= 54.14 Days = 146 Days

2. The following information relates to year 2019 -20.
Particulars Material - I Material - II
Opening stock 5,00,000 20,00,000
Closing Stock 3,00,000 16,00,000
Net Purchases 42,00,000 50,00,000

Solution :
Computation of Inventory Turnover ratio
Particulars Material X Material Y
Opening stock 5,00,000 20,00,000
Add : Purchase 42,00,000 50,00,000
47,00,000 70,00,000
Less : Closing stock 3,00,000 16,00,000
Cost of Material Consumed 44,00,000 54,00,000


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Material Cost
47 Material X Material Y
Avg Stock =
=
=
= 4,00,000 = 18,00,000
ITR =
=
=

= 11 times = 3 times

No. of days the Av g.
Inventory held
=
=
=

= 33.18 Days = 121.67 Days

2.7 SUMMARY

1. Reorder level of stock = Maximum Re -Order period x Maximum
Usage
2. Reorder level of stock = Minimum Level + (Average rate of
consumption x Average l ead time)
3. Minimum Stock Level = Re -Order Level - (Average rate of
consumption x Average lead time)
4. Minimum Stock = Reordering Level – (Normal Consumption x
Normal Reordering Period)
5. Maximum Stock Level = Reordering Level + Reordering Quantity –
(Minimum Consumption x Minimum Reordering period)
6. Danger Level = Average Consumption x Lead time for emergency
purchases.
7. Average Consumption:
8. Minimum Consumption + Maximum Consumption
2
9. Average Lead Time =
Minimum Lead time + Maximum Lead time
2
10. EOQ =

11. Total Purchase Cost = Annual Qty X Cost Per Unit
12. Total Ordering Costs = Annual Qty / Ordering Qty * Cost per Order
13. Total carrying Cost = Ordering Qty / 2 * Carrying Cost per unit

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Cost Accounting
48 2.8 QUESTIONS

2.8.1 Answer in Brief

1. Define Inventory and explain the v arious costs of inventory?
2. What are the selecting techniques of inventory control?
3. What is the significance of Economic Order Quantity?
4. Explain the various stock levels in brief.
5. Write short notes on the following:
(a) Inventory, (b) Inventory control (c) Cos t of inventory, (d) ABC
analysis

2.8.2 Solve the Following
1. From the following information, calculate
a) Economic order quantity b) Total Annual Costs c) Total Carrying and
ordering cost.
a. Semi -Annual consumption - 18,000 units
b. Purchase price of input unit Rs. 50
c. Quarterly carrying cost 2%
d. Order cost per order Rs. 75

2. From the following information, calculate a) Economic order
quantity b) Total Annual carrying and ordering cost.
a) Quarterly consumption 250 units
b) Purchase price of input unit Rs. 100
c) Semi-Annual carrying cost 4%
d) Order cost per order Rs. 20

3. From the following information, calculate a) Economic order
quantity b) Total Annual carrying and ordering cost.
a) Purchase price of input unit – Rs. 20
b) Annual Carrying Cost - 7.5%
c) Ordering Cost per order - Rs. 100
d) Normal Consumption - 450 units per week.

4. A company manufactures a special product that requires a component
‘MGM’. The following particulars are collected for the year 2021 :
a. Annual Demand of GM : 4,500 units
b. Cost of placing an order : Rs. 100 per order
c. Cost per unit of GM : Rs. 300
d. Carrying cost % p.a.: 8%
The company has been offered a discount of 5% on the purchase price of
‘MGM’, provided the order size is 1500 components at a time.
Required:
 Compute the economic order quantity
 Advise whether the quantity discount offer can be accepted. munotes.in

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Material Cost
49
5. A company manufactures a special product that requires a component
‘GM’. The following particulars are collected for the year 2021 :
a. Annual Demand of LGM: 48,000 units
b. Cost of placing an order : R s. 300 per order
c. Cost per unit of L GM: Rs. 200
d. Carrying cost % p.a.: 12%
The company has been offered a discount of 5% on the purchase price of
‘LGM’, provided the order size is 12,000 components at a time.
Required:
 Compute the economic order quantity
 Advise whether the quantity discount offer can be accepted.
2.8.3 Multiple Choice Question
Sr.No QUESTION TEXT A B C D
1 _____ _____
indicates maximum
stock to be
maintained. Maximum
Level Minimum Level Re-Order
Level Danger Level
2 _____ _____ is a
periodic statement of
wages. Pay Roll Pay slip Job Card Job Sheet
3 _____ _____ is
prepared for
individual worker. Job Card Pay Job Sheet Wages
4 _____ labour cannot
be readily identified. Direct Indirect Production Actual
5 _______ is the
application of
costing and cost
accounting
principles, methods
and techniques to the
art, science and
practice of cost
control and the
ascertainment of
profitability. Cost
accounting Cost
accountancy Cost
Control Cost
Ascertainment
6 A cost centre which
is engag ed in
production activity is
called Production
cost centre Process cost
centre Impersonal
cost centre Production
unit munotes.in

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Cost Accounting
50 7 Cost accounting is a
reporting system Internal External Government Financial
8 Cost ascertainment
involves Ascertainment
of cost Control of cost Estimation
of cost Fixation of
price
9 One of the
following is not a
costing system Marginal
costing Uniform
costing Absorption
costing Process
costing
10 Product cost
means____________ Variable cost Fixed cost Prime cost Indirect cost
11 The resources that
have been used for
attaining a particular
objective is Revenue Cost Profit Investment
12 Workers who work
outside the factory
premises are called
as _____ works. Out Job Casual Badli
13 time is paid
by the
employer. Idle Tim e Overtime Normal
time Abnormal
time
14 is decided on the
basis of ordering
cost and carrying
cost. EOQ Maximum
Stock Level Minimum
Stock Level Average
Stock Level
15 A Bill of Material
serves the purpose of
_____ Purchase
order Material
requisition Purchase
requisition Goods
received note
16 A document used for
time keeping Job card Time card Daily time
sheet Labour sheet
17 Annual
demand=12000
units, Ordering Cost
per order=Rs. 45,
Carrying cost per
annum per unit =Rs.
3. EO Q=_______ 6000 units 600 units 12000 units 1200 units
18 Economic order
quantity is a tool for
controlling
___________ Inventory Price Machinery Cost

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Material Cost
51 For Additional Reference Reading Scan the QR Code Below or visit
website :


https://resource.cdn.icai.org/38596bos28170mod1 -cp2.pdf



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52 3
LABOUR COST
Unit Structure:
3.1 Meaning and Classification of Labour Cost
3.2 Time Recording
3.3 Job Evaluation and Merit Rating
3.4 Payroll Department and Overview of Statutory Requirement
3.5 Idle Time
3.6 Overtime
3.7 Wage Payment System
3.8 Exercise (Based on Piece Rate &Time Rate System)
3.9 Labour Turnover
3.10 Calculation of Labour Cost
Learning Objectives:
After studying this unit, student will be able to understand meaning and
classification of Labour Cost, attendance and payroll system, Idle tim e and
Overtime, Methods of Labour Turnover, Remuneration and bonus
methods (based on piece rate & time rate) , this will also help to calculate
labour cost.
3.1 MEANING AND CLASSIFICATION OF LABOUR
COST:
 Meaning:
Labour is an important element of cost . For overall cost reduction and cost
control , Labour Cost is one of the importan tfactor for any company .
Any amount which is paid or payable, directly or indirectly, in cash or in
kind to the workers is called as labour cost for the company. Labour Cost
represe nt the total expenditure incurred by employer for employment of
employee (Labour). The value of labour cost ascertained by taking into
account gross pay including all allowances payable along with the cost to
the employer of all the benefits.
Example: Mr. R aju who is working as worker at ABC Manufacturing
company, with daily wage rate of Rs. 500 and company alsoprovides Tea
of Rs. 10 each everyday than the Labour Cost of Mr. Raju for the
company will be Rs. 510 per day (Wages Rs. 500 + Tea Rs.10).
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Labour Cost
53  Classific ation of Labour Cost:
There are two types of Labour cost:
1. Direct Labour Cost (Direct Wages)
2. Indirect Labour Cost (Indirect Wages)
1. Direct Labour Cost: Labour Cost in respect of labour directly involved
in production process / activity, is called as Direc t Labour Cost. Direct
wages are the wages of the worker whose service can be identified directly
with respective job or process. Direct Labour Cost is the cost that can be
identified with a product unit. Example: Worker working on machine,
Worker of Assemb ly Department, etc.
2. Indirect Labour Cost: Labour Cost in respect of labour not directly
involved / indirectly involved in production process / activity, is called as
Indirect Labour Cost. Indirect wages are the wages of the worker whose
service cannot b e identified directly with respective job or process.
Indirect Labour Cost cannot be identified with a product unit.
Example: Machine Cleaning Worker, Supervisor, etc.
3.2 TIME RECORDING:
It is essential to record the time of worker in factory. Time recor ding
means noting of worker’s time of arrival, working and departure. Time
recording is of Two types:
1. Time keeping (In and Out time)
2. Time booking (Utilisation of time)
1. Time Keeping: Time keeping is nothing but to record the In and Out
time of worker. R ecording of worker’s entry and exit time is example of
time keeping. The function of this department is mainly to maintain the
time for which each and every worker has worked including the check -in
and check -out time. The records are kept separately for dif ferent shift and
irregular working periods like overtime period.
2. Time Booking: Time booking is utilisation of worker’s time in
different department or product. In a day of 8 hours if worker works for 5
hours on product A and 3 hours on product B, so her e the time is recoded
through time booking on the basis of utilisation of time. The analysis of
time spent is not provided under Time Keeping. The recording of time
spent by a worker in each job, process or operation is called as Time
Booking.
3.3 JOB EVALUATI ON AND MERIT RATING:

1. Job Evaluation: It is necessary for the management of any
organization to establish proper wage and salary structure for various jobs.
Job Evaluation is a technique to rank job on a formal basis and measure
the work of job for compens ation purpose.It aims at providing a rational munotes.in

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Cost Accounting
54 and equitable basis for differential salaries and wages for different classes
of workers .

2. Merit Rating: Job evaluation is the rating of job, on the other hand
Merit Rating is concerned with evaluation and analy sis of individual
employee based on their merit and performance for compensation purpose.
Difference between Job Evaluation and Merit Rating :
The difference between the Job Evaluation and Merit Rating are as
follows:
 Job Evaluation is the assessment of the relative worth of jobs within
a business enterprise and Merit Rating is the assessment of the
employees with respect to a job.

 Job Evaluation helps in establishing a rational wage structure. On the
other hand, Merit Rating helps in fixing fair wages for each worker
in terms of his competence and performance.

 Job Evaluation brings uniformity in wages and salaries while Merit
Rating aims at providing a fair rate of pay for different workers on
the basis of their performance.
3.4 PAYROLL DEPARTMENT AND OV ERVIEW OF
STATUTORY REQUIREMENT
 Payroll Department:
The role of payroll department is very crucial in computing the labour cost
and cost control. The responsibility of this department is preparation of
payroll using clock card, job ticket or time sheet. Pa yroll shows the
amountof wages payable to each worker considering the gross wages and
deductions from gross wages to find net wages payable. They also prepare
pay slip at regular interval.
Payroll Procedure:
Following activities and the responsibility to d ischarge such activities is
mentioned as under:
Activity Responsibility
1. Attendance and time details 1. Time Keeping Department
2. List of Employee and other
personal details 2. HR Department
3. Computation of Wages and other
incentives 3. Payroll Dep artment
4. Payment to Worker 4. Cost / Accounting Department
5. Discharge of Statutory Liabilities 5. Cost / Accounting Department
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Labour Cost
55  Overview of Statutory Requirements:
The government has passed various legislations with regards to labour cost
and labour welfare. This may include regulative legislation, wage
legislation, security legislation, etc. The employer must aware about those
legislation which are important for calculation of wages.
Following is the list of selected legislation which can help pay r oll
department:
1. Payment of Wages Act, 1963
2. Payment of Bonus Act, 1965
3. Employee Provident Fund Act
4. Employee State Insurance Act, 1948
5. Maternity Benefit Act, 1961
6. Payment of Gratuity Act, 1972.

3.5 IDLE TIME:
Idle Time Cost represents the wages paid for the time lost during which
the worker does not work, i.e .time for which wages are paid, but no work
is done. When workers are paid on the basis of time, Idle time becomes
important factor. The difference between the time for which they are paid
and the time s pent on production is called as idle time. Time for which
wages are paid by employer but no work achieved (done) is also known as
idle time. As per CAS -7 (Limited Revision 2017), Idle Time is ‘The
difference between the time for which the employees are paid /payable to
employees and the employees time booked against the cost object’.
1. Normal Idle Time ( Unavoidable/uncontrollable)
2. Abnormal Idle Time (Controllable)
1. Normal Idle Time: Normal idle time are those idle time which are
generally unavoidable by manag ement. E xample: Tea Break, Lunch
Break, etc.
2. Abnormal Idle Time: Abnormal idle time are those idle time which
can be avoided/ controllable by management with proper control and due
care. E xample: Machine Breakdown, Raw Material Shortage, Power
Failure, waiting for work etc.
Idle Time Preventive Measures :
Idle Time may be eliminated or reduced to a large extent by taking
suitable preventive measures such as :
(a) proper planning of production in advance, thus reducing imbalances in
production facilities,
(b) timely provisioning of materials,
(c) regular maintenance of machines so as to avoid breakdown,
(d) careful watch over the labour utilization statement. munotes.in

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Cost Accounting
56 3.6 OVERTIME:
If the workers work beyond normal working time, it is called as overtime.
Overtime is t he extra time worked by a worker over and above the normal
working hours. Factories Act provides for payment of overtime wages at
double as compare to normal rate of wages . Even where the Act is not
applicable, the practice is to pay for overtime work at hi gher rate usually.
The additional amount paid for overtime work is called as overtime
premium. Hence, payment of overtime consists of two elements, normal
amount and the extra payment, i.e. premium.
Normal Wages = No. of Hours Worked x Rate per hour
Overtim e Wages = Overtime Hours x Overtime rate per hour
Total Wages = Normal wages + Overtime wages.
Example:
Normal Working Hours = 8 Hours
Standard Rate = Rs. 20 per hour
Overtime Rate = Rs. 40 per hour
In a day of 8 hours Mr. Rohan works for 10 hours. Calculat e Normal
Wages, Overtime Wages and Total Wages of Mr. Rohan.
Normal Wages = No. of Hours Worked x Rate per hour
= 8 hours × 20 per hour
= Rs. 160/ -
Overtime Wages = Overtime Hours x Overtime rate per hour
= 2 hours × 40 per hour
= Rs. 80/-
Total Wages = Normal Wages + Overtime Wages
= 160 + 80
= Rs. 240/-
3.7 WAGE PAYMENT SYSTEM

1. Time Rate System: When worker is paid wages on the basis of time
involved, it is called as Time Rate System. This method is perhaps the
oldest one of paying wages to workers. Time rate system is also known as
time work, day work, day wages, etc. In this method, the worker is paid
specific amount per hour and payment is madeon the basis of time worked
/involved irrespective of output produced. This method is used where the
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Labour Cost
57 Time Rate (TR) = No. of HoursWorked ( Actual Time Taken) x Rate Per
Hour
 Advantages of Time Rate System:
1. Easily understandable by wo rkers.
2. It has less clerical work and easy to calculate.
3. It has inbuilt advantage of ensuring quality work.
4. Easy to operate and economical.

 Disadvantages of Time Rate System:
1. It doesn’t encourage worker as the wages paid to efficient and
ineffi cient workers are same.
2. Sometimes it results into high labour cost.
3. Under this method it is difficult to set standard for labour.

2. Piece Rate System: When worker is paid wages on the basis of
output given (unit produced), it is called as piece rate s ystem. The wages
are paid to worker on the basis of performance. It is also called as payment
by result system. In this method, the payment of the worker is calculated
on the basis of number of units produced irrespective of the time
spent.Thus, if the wor ker produces higher units, he can earn higher wages.
This method is used where quantity is important than the quality.

Piece Rate (PR) = No. of Units Produced ( Actual Output ) x Rate per unit

 Advantages of Piece Rate System:
1. It encourage efficient work ers with incentive, while the inefficient
workers penalised.
2. Wastage and Idle time can be reduced with this method.
3. It helps to increase level of productivity.
4. Under this method wages being paid on the basis of production; it helps
management to i dentify labour cost per unit.

 Disadvantages of Piece Rate System:
1. With view to earn more workers may speed up the work which may
affect the quality of product.
2. Method may cause discontentment amongst those who are inefficient.
3. Workers may attempt to increase production, handle the material and
machine carelessly.

3. Workers Incentive Scheme:

A. Premium Plan (Bonus): Premium Plan / Premium Bonus Plan
which is also known as individual bonus plan. Here bonus is to be paid to
the worker on the basis of ti me saved i.e. difference between time allowed
and time taken.Under this method standard time is set to complete the job
and standard time allowed is determined by work study engineers. The
actual time taken is compared with standard time allowed to find bo nus
payable to worker in addition to normal wages if the time taken is less munotes.in

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Cost Accounting
58 than the time allowed. The individual bonus schemes under Premium Plan
are as follows:

I. Halsey Premium Plan:
The plan was introduced by F. A. Halsey an American engineer. Under
this plan, bonus is paid on the basis of time saved. Under this plan50%
bonus is paid to the worker on time saved. A worker is assured of time
wage on actual time taken and 50% bonus is paid on time saved by him.
The formula to compute wages as per Halsey Plan is:
Halsey Premium Plan = Time Rate + 50% (Time Saved x Rate per
hour)

II. Rowan Premium Plan:
The plan was introduced by Mr. James Rowan in 1898.Under this plan
also bonus is paid on time saved. Here bonus is paid in the proportion of
time saved bears to ti me allowed and it is paid at time rate. The formula to
compute wages as per Rowan Plan is:
Rowan Premium Plan= Time Rate +
(Time Taken x Rate
per hour)

B. Differential Piece Rate Plan (DPRS): Under this method piece rate
increases as the outpu t increases. The increase in rate may be in
proportionate to the increase in output. In other words, a worker is paid
higher wages for higher productivity as an incentive. The main objective
of this scheme is to reward efficient workers and encourage the l ess
efficient workers. To finding the efficiency actual production of worker is
compared with standard production. The following are the major systems
of differential piece rate system:
(i) Taylor (ii) Merrick (iii) Gantt Task
I. Taylor’s Differential Piece Ra te System:
The scheme was introduced by F. W. Taylor in USA.Taylor is father of
scientific management and according to him there are only two class of
workers, efficient and inefficient. He suggests that efficient workers
should be encouraged and inefficie nt worker should be penalized. In order
to do this, according to Taylor if the worker is efficient, he should get
120% of normal piece rate and if the worker is inefficient, he should get
80% of normal piece rate. For measuring the efficiency each worker w ill
be given standard production quantity to be produced in given time and
actual production should be compared with the same.




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Labour Cost
59 Taylor’s DPRS:
Efficiency Differential Piece Rate
(DPR)
< 100% 80% of Normal Piece Rate
≥ 100% 120% of Normal Piece Rate

II. Merrick’s Differential Piece Rate System:
This plan is modification of Taylor’s system. In this system Merrick use
three rates for remuneration and it is less harsh on the worker as Merrick
doesn’t penalise any worker. According to Merrick if the worker produces
outputwhich less than 83.33% of standard output, he should get 100% of
normal piece rate, if the output is between 83.33% - 100% of standard
output he should get 110% of normal piece rate and if the output is above
100% of standard output, he shou ld get 120% of normal piece rate.
Merrick ’s DPRS:
Efficiency Differential Piece Rate
(DPR)
<83.33 % 100% of Normal Piece Rate
83.33 % ≤ 100% 110% of Normal Piece Rate
> 100% 120% of Normal Piece Rate

III. Gantt Task Bonus Plan:
This method is combination o f Time Rate and Piece Rate. This plan
providing incentive to efficient workers and encouraging the less skill
workers who fails to complete the work in given time.Under this plan if
the worker produces output which is less than 100% of standard output, he
should get wages as per Time Rate, if the output is equal to 100% of
standard output, he should get Time Rate plus 20% bonus and if the output
is above 100% of standard output, he should get 120% normal piece rate
(High Piece Rate).
Gantt Task Bonus Plan :
Efficiency Wages / Remuneration
Payable
<100% Time Rate
100% Time Rate + 20% Bonus
> 100% 120% of Normal Piece Rate

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Cost Accounting
60  Formula to Calculate Efficiency and Piece Rate (if not available in
question):

Efficiency =
× 100

Piece Rate (Rate Per Unit) =

3.8 EXERCISE (BASED ON PIECE RATE AND TIME
RATE SYSTEM):
Q.1. You are required t o calculate the wages of Bhavesh and N ilesh under
straight piece rate and T aylor’s differential piece rate system with the help
of following details :
a) Standard output 7 units per hour
b) Normal time rate Rs . 49 per hour
c) Differential to be applied are:
80 % of piece rate below standard. 120 % of piece rate at or above
standard
d) In a 9 hour day, Bhavesh produced 56units whereas Nilesh produced
80units .
Solution:
1. Standard Output for 9 Hours = 9 hours × 7 units per hour = 63 units

2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 49 ÷ 7units =
7 per unit.

3. Straight Piece Rate = Number of Units Produced × Rate Per Unit
(Piece Rate)
Bhavesh = 56 units × 7 = Rs. 392/ -
Nilesh = 80 units × 7 = Rs. 560/ -

4. Taylor’s DPRS = Number of Units Produced × Differential Rate Per
Unit
Bhavesh = 56 Units × 5.6 (7 × 80%) = Rs. 313.6/ -
Nilesh = 80 units × 8.4 (7 × 120%) = Rs. 672/ -
Q.2. From the following particulars, ca lculate the earnings of worker A
and B for a day according to straight piece rate and Taylor ’s differential
piece rate system.
Standard time allowed: 10 units per hour
Normal time rate per hour: Rs. 40 munotes.in

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Labour Cost
61 Differential to be applied
80% of piece rate when b elow standard and 12 0% of piece rate when at or
above standard
Hours of day : 8
Output A : 75 units
B : 100 units .
Solution:
1. Standard Output for 8 Hours = 8 hours × 10 units per hour = 80 units
2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 40 ÷ 10units
= 4 per unit.
3. Straight Piece Rate = Number of Units Produced × Rate Per Unit
(Piece Rate)
A = 75 units × 4 = Rs. 300/ -
B = 100 units × 4 = Rs. 400/ -
4. Taylor’s DPRS = Number of Units Produced × Differential Rate Per
Unit
A = 75 Units × 3.6 (4 × 80% ) = Rs. 240/ -
B = 100 units × 4.8 (4 × 120%) = Rs. 480/ -
Q.3. Calculate earning of workers Ram and Shyam under straight piece
rate and T aylor ’s differential piece rate plan from the following
particulars.
Standard time: One hour 30units
Normal rate: Rs 750 per hour
Differential piece rate:
1. 80% of piece rate below standard.
2. 120% of piece rate at or above standard.
In a day of 8hours ,Ram produced 200units and Shyam produced 300units .
Solution:
1. Standard Output for 8 Hours = 8 hours × 30 units per hour = 240 uni ts
2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 750 ÷ 30units
= 25 per unit.
3. Straight Piece Rate = Number of Units Produced × Rate Per Unit
(Piece Rate)
Ram = 200 units × 25 = Rs. 5,000/ -
Shyam = 300 units × 25 = Rs. 7,500/ -
4. Taylor’s DPRS = Number o f Units Produced × Differential Rate Per
Unit
Ram = 200 Units × 20 (25 × 80%) = Rs. 4,000/ -
Shyam = 300 units × 30 (25 × 120%) = Rs. 9,000/ - munotes.in

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Cost Accounting
62 Q.4. You are furnished with the follow ing information regarding a job :
a) Standard production per hour is 6 units.
b) The normal rate is 240 per hour.
c) During an eight -hour day, output of Hitesh was 32 units, Amit 42 units ,
and Jay 55 units .
You are asked to calculate the wages of all the three workers under
straight piece rate and Merrick DifferentialPiece rate syst em.
Solution:
1. Standard Output for 8 Hours = 8 hours × 6 units per hour = 48 units
2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 240 ÷ 6units
= 40 per unit.
3. Straight Piece Rate = Number of Units Produced × Rate Per Unit
(Piece Rate)
Hitesh = 32 units × 40 = Rs. 1,280/ -
Amit = 42 units × 40 = Rs. 1,680/ -
Jay = 55 Units × 40 = Rs. 2,200/ -
4. Efficiency = (Actual Output ÷ Standard Output) × 100
Hitesh = (32 ÷ 48) × 100 = 66.67%
Amit = (42 ÷ 48) × 100 = 87.5%
Jay = (55 ÷ 48) × 100 = 114.58%
5. Merrick’s DPRS = N umber of Units Produced × Differential Rate
Per Unit
Hitesh = 32 Units × 40 (40 × 100%) = Rs. 1,280/ -
Amit = 42 units × 44 (40 × 110%) = Rs. 1,848/ -
Jay = 55 units × 48 (40 × 120%) = Rs. 2,640/ -
Q.5.Calculate earnings of worker A, B & C under Mer rick’s mul tiple
piece rate system from the following:
Normal rate per hour : Rs . 540
Standard time per unit: 1 minute
Output per day:
X 390 units
Y 450 unit s
Z 600 units
Working hours per day 8 hours .
Solution:
1. Standard Output for 8 Hours: 8 hours × 60 units per hour [60mins × 1
unit per minute] = 480 units munotes.in

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Labour Cost
63 2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 540 ÷ 60units
= 9 per unit.

3. Straight Piece Rate = Number of Units Produced × Rate Per Unit
(Piece Rate)
X = 390 units × 9 = Rs. 3,510/ -
Y = 450 units × 9 = Rs. 4,050/ -
Z = 600 Units × 9 = Rs. 5,400/ -

4. Efficiency = (Actual Output ÷ Standard Output) × 100
X = (390 ÷ 480) × 100 = 81.25%
Y = (450 ÷ 480) × 100 = 93.75%
Z = (600 ÷ 480) × 100 = 125%

5. Merrick’s DPRS = Number of Units Prod uced × Differential Rate Per
Unit
X = 390 Units × 9 (9 × 100%) = Rs. 3,510/ -
Y = 450 units × 9.9 (9 × 110%) = Rs. 4,455/ -
Z = 600 units × 10.8 (9 × 120%) = Rs. 6,480/ -
Q.6. From the following particulars calculate the total earning of the
works under Merri ck DPRS:
Normal rate per hour Rs .300
Standard production per hour 10 units .
In a 8 hours day :
A Produced - 70 units
B Produced - 90 units
C Produced - 60 units
D Produced - 110 units .
Solution:
1. Standard Output for 8 Hours: 8 hours × 10 units per hour = 80 units
2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 300 ÷ 10
units = 30 per unit.
3. Efficiency = (Actual Output ÷ Standard Output) × 100
A = (70 ÷ 80) × 100 = 87.5%
B = (90 ÷ 80) × 100 = 112.5%
C = (60 ÷ 80) × 100 = 75%
D = (110 ÷ 80) × 100 = 137.5%
4. Merrick’s DPRS = Number of Units Produced × Differential Rate
Per Unit
A = 70 Units × 33 (30 × 110%) = Rs. 2,310/ -
B = 90 units × 36 (30 × 120%) = Rs. 3,240/ - munotes.in

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Cost Accounting
64 C = 60 units × 30 (30 × 100%) = Rs. 1,800/ -
D = 110 units × 36 (30 × 120%) = Rs. 3,960/ -
Q.7Calculate the earnings of worker Ramu , Shamu &Tinku as per Gantt
Task Bonus Plan from the following:
Standard Rate per hour Rs.30 per hour
Standard Rate per unit Rs. 1.5 per unit
Normal output per hour 20 units
In a day of 8 hours,
Ramu produced 150 Units
Shamu Produced 160 Units
Tinku Produced 175 Units
Solution:
1. Standard Output for 8 Hours = 8 Hours × 20 units per hour = 160
units
2. Piece Rate = Amount Per Hour ÷ Units Per Hour = Rs. 30 ÷ 20 units
= 1.5 per unit
3. Efficiency = (Actual Output ÷ Standard Out put) × 100
Ramu = (150 ÷ 160) × 100 = 93.75%
Shamu = (160 ÷ 160) × 100 = 100%
Tinku = (175 ÷ 160) × 100 = 109.375%
4. Gantt Task Bonus Plan:
Ramu = Time Rate = No. of Hours Worked × Rate Per Hour = 8
Hours × Rs. 30 = Rs. 240/ -
Shamu = Time Rate + 20% Bonus = Rs. 240 + 20% = Rs. 288/ -
Tinku = No. of Units Produced × 120% of Piece Rate = 175units ×
1.8 per unit = 315/ -
Q.8. From the following particular, you are required to work out the
earnings of a worker for a week under:
1. Straight piece rate
2. Differential piec e rate
3. Halsey premium scheme (50% sharing)
4. Rowan premium plan
Weekly working hours 48
Hourly wage rate Rs. 7.50
Piece rate per unit Rs. 3.00
Norm al time taken per piece 24 minutes
Normal output per week 120 pieces
Actual output per week 150 pieces munotes.in

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Labour Cost
65 Differential piece rate 80% of piece rate when output below normal and
120% o f piece rate when output above normal.
Solution:
1. Straight Piece Rate = No. of Units Produced x Rate per unit (Piece
Rate)
= 150 x 3
= Rs. 450 /-

2. Differential Piece Rate = No. of Units Produced x Differential Piece
Rate
= 150 x 3.6 (3 x 120%)
= 540 /-
3. Standard Time Required for 150 units = 150 Units × 24 Mins per unit
= 3600 mins / 60 mins = 60 Hours

4. Time saved = Time Allowed – Time Taken
= 60 hours – 48 hours
= 12 H ours

5. Halsey Premium Plan = Time Rate + 50% (Time saved x Rate per
Hr.)
= (48 Hrs. x 7.5 per hr. ) + 50% (12 Hrs. x 7.5 per hr. )
= 360 + 50% (90)
= 360 + 45
= 405 /-

6. Rowan’s Premium Plan = Time Rate +
(Time Taken x
Rate Per Hr.)
= (48 Hrs. x 7.5 per hr. ) +
(48 Hrs. x 7.5 per hr. )
= 360 + 0.2(360)
= 360 + 72
= 432 /-
Q.9. A worker wages for a guaranteed 4 5 hour s week i s Rs 15 per
hour.The estimated time to produce one article is 30 minutes and under an
incentive plan, the time allowed is increased by 20%. During a week a
worker produced 100 articles . Calculate the wages unde r each of the
following methods:
A) Time Rate
B) Halsey system
C) Rowan system
Solutions:
1. Time Rate = No. of H oursW orked x Rate per H our
= 4 5 Hrs. x 15 per hr.
= Rs. 675/- munotes.in

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Cost Accounting
66 2. Standard time for 1 article and 100 articles under incentive scheme:
For 1 unit = 30 Mins. + 20%
= 36 Mins per unit

For 100 units = 100 units × 36 mins per unit = 3600 mins / 60 mins
= 60 Hours.

3. Time Saved = Time Allowed – Time Taken
= 60 hours – 45 hours
= 1 5 Hours.
4. Halsey Premium Plan = Time Rate + 50% (Time Saved x Rate Per
Hr.)
= (4 5 Hrs. x 15 per hr. ) + 50% (1 5 x 15 per hr. )
= 675 + 50% ( 225)
= 675 + 112.5
= Rs. 787.5/ -
5. Rowan Premium Plan = Time Rate +
(Time Taken x Rate
Per Hr.)
= ( 45 Hrs. x 15 per hr. ) +
(45 Hrs. x 15 per hr. )
= 675 +
(675)
= 675 + 168.75
= Rs. 843.75/ -
Q.10. In Engineer s India company, the standard time for a job is 1 8 hours
and the basic wage is Rs. 4 0 per hour.Calculate the wages as pe r
Time Rate, Halsey Plan and Rowan Plan if the job is completed in :
A. 10 hours
B. 13 hours
Solution:
1. Time Saved = Time Allowed – Time Taken
A =18 – 10 = 8 Hrs.
B = 18 – 13 = 5 Hrs.
2. Halsey Premium Plan = Time Rate + 50% (Time Saved x Rate per hr.)
A = (10 Hrs. x 40 per hr.) + 50% (8 Hrs. x 40 per hr.)
= 400 + 50% (320)
= 400 + 160
= Rs. 560/ -
B = (13 Hrs. x 40 per hr.) + 50% (5 Hrs. x 40 per hr.)
= 520 + 50% (200)
= 520 + 100
= Rs. 620/ - munotes.in

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67 3. Rowan’s Premium Plan = Time Rate +
(Time Taken x Rate
Per Hr.)
A = (10 Hrs. x 40 per hr.) +
(10 H rs.x 40 per hr.)
= 400 +
(400)
= 400 + 177.78
= Rs. 577.78/ - or Rs. 578/ -
B = (13 Hrs. x 40 per hr.) +
(13 Hrs. x 40 per hr.)
= 520 +
(520)
= 520+ 144.44
= Rs. 664.44/ - or Rs. 664/ -
Q.11. Calculate the total earning and effective rate of earnings per hour of
two operators. Ramesh and Suresh under :
A) Halsey plan
B) Rowan plan
The standard time fixed for producing 100 articles is 50 hours
The rate of wages is Rs 1.50 per unit
The actual time taken for pro ducing 100 articles is as under:
Ramesh 42 hours
Suresh 38 hours
Solution:
1. Standard OutputPer Hour = 100 article × 1 hour ÷ 50 hours = 2
articles .

2. Calculation of Rate per Hour:

Rate Per Unit =


1.5 =

1.5 x 2 = Am ount Per H our
Amount Per H our = Rs. 3 per hour.

3. Times Saved = Time Allowed – Time Taken
Ramesh = 50 Hrs. – 42 Hrs. = 8 hours
Suresh = 50 Hrs. – 38 Hrs. = 12 hours



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Cost Accounting
68 4. Halsey Premium Plan = Time Rate + 50% (Time Saved x Rate Per
Hr.)
Ramesh = (42 Hrs. x 3 per hr. ) + 50% (8 Hrs. x 3 per hr. )
= 126 + 50% (24)
= 126 + 12
= 138 /-
Suresh = (38 Hrs. x 3 per hr. ) + 50% (12 Hrs. x 3 per hr. )
= 114 + 50% (36)
= 114 + 18
= 132 /-

5. Rowan Premium Plan = Time Rate +
(Time Taken x
Rate Per Hr.)
Ramesh = (42 Hrs. x 3 per hr. ) +
(42 Hrs. x 3 per hr. )
= 126 + 20.16
= 146.16 /-
Sure sh= (38 Hrs. x 3 per hr. ) +
(38 Hrs. x 3 per hr. )
= 114 + 27.36
= 141.36 /-

6. Effective Rate of earning per hour:

Employee Name Halsey Premium
Plan Rowan Pr emium
Plan
Ramesh = 138 / 42 hours
= 3.29 per hour = 146.16 / 42 hours
= 3.48 per hour
Suresh = 132 / 38 hours
= 3.47 per hour = 141.36 / 38 hours
= 3.72 per hour

3.9 LABOUR TURNOVER:
Labour Turnover refer to rate of change in labour force of an organi sation
during specific period. In an organisation some of the existing staff leave
and some new staff join the organisation, this phenomenon is known as
labour turnover.
Causes of Labour Turnover:
1. Avoidable Causes: Low pay and allowance, Unsatisfactory wor king
condition, Lack of amenities, etc.
2. Unavoidable Causes: Discharge due to long absence, Discharge on
disciplinary ground, Economic and social factors, etc.
3. Personal Causes: Dislike of Job, Retirement due to age, Death, etc. munotes.in

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Labour Cost
69 Measurement of Labour Turnove r:
1) Separation Method: Under this method, number of employees left /
separated during the period is taken into consideration for computing the
Labour Turnover.

Labour Turnover =
x 100
Where,
Average No. of workers on roll during the year =

2) Replacement Method: In this method number of employee replaced
is taken into consideration for Labour Turnover.

Labour Turnover =
x 100

3) New Recruitment Method: Under this method number of new
employees added for new work is taken i nto consideration for Labour
turnover.

Labour Turnover =
x 100

4) Flux Method: This method is combination of employee separated
and relaced during the year , is taken into consideration for Labour
turnover.

Labour Turnover =
x 100
Separation = No. of workers left whether voluntary or not.
Replacement = New worker in place of existing worker.
New Recruitment = New worker for new job.

Q.12. From the following information calculate labour turnover by
different methods :
No. of work ers as on 01. 04. 2020 = 7,600
No. of workers as on 31. 03. 2021 = 8,400
During the year 80 workers left while 320 were discharged, 1500 workers
were recruited during the year of these 300 were recruited because of exits
and the rest were recruited in acco rdance with expansion plans. munotes.in

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Cost Accounting
70 Solution:
Separation = 80 + 320 = 400
Replacement = 300
New Recruitment = 1200 (1500 – 300)
Average No. Workers on Roll During Year = (Opening Worker + Closing
Workers) ÷ 2
= (7,600 + 8,400) ÷ 2
= 8,000
1) Separation Method:
Labour Turnover =
x 100

=
x 100
= 5%

2) Replacement Method:
Labour Turnover =
x 100

=
x 100
= 3.75%

3) New Recruitment Method:
Labour Turnover =
x 100
=
x 100
= 15%

4) Flux Method:
Labour Turnover =
x 100
=
x 100
= 8.75%

Q.13 During October 2015, the following information is obtained from the
Personnel Department of a manufacturing company. Labour force at the
beginning of the month 1900 and at the end of the month 2100. During the
month, 25 people left while 40 persons were discharged. 280 workers
were engaged out of which only 30 were appointed in the vacancy created munotes.in

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Labour Cost
71 by the number of workers separated and the rest on account of expansion
scheme. Calculate the Labour Turnover by different methods.
Solution:
Separation = 25 + 40 = 65
Replacement = 30
New Recruitment = 250 (280 – 30)
Average No. Workers on Roll During Year = (Opening Worker + Closing
Workers) ÷ 2
= (1,900 + 2,100) ÷ 2
= 2,000
1) Separation Method:
Labour Turnover =
x 100

=
x 100
= 3.25%

2) Replacement Method:
Labour Turnover =
x 100

=
x 100
= 1.5%

3) New Recruit ment Method:
Labour Turnover =
x 100
=
x 100
= 12.5%

4) Flux Method:
Labour Turnover =
x 100
=
x 100
= 4.75%
3.10 CALCULATION OF LABOU R COST:
Labour cost is sum total of all consideration paid, payable and provisions
made for future payments. Consideration includes wages, salary, munotes.in

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Cost Accounting
72 contractual payment, benefits as applicable and any payment made on
behalf of employee.
Element of Wages: Basic Pay, DA, HRA, Overtime Allowance, Other
Allowance, Bonus, Employer’s Contribution to PF / ESI, etc.
Q.14 From the following monthly information prepare a statement
showing cost per day of 8 hours and also find out labour cost per hour:
1) Basic pay Rs. 10,000
2) D. A. 100% of basic
3) Leave salary 10% of basic
4) Employer’s contribution to P. F . 12% of basic & DA
5) Employer’s contribution to ESI 4.75% of basic & DA
6) Pro rata expenditure on labour welfare p.m. Rs. 1000
7) No of working hours in a month 2,000
Solution:
Statement Showing Labo ur Cost

Cost Per Day of 8 Hours = 8 Hrs. x 12.675 per hour
= Rs. 101.4/ -
Q.15Mr.Lokhande an employee of L & T Company gets the following
emoluments :
1) Salary per month Rs. 50 00

2) D.A.
On 1st Rs. 2,000 of salary Rs. 4000
On next Rs.2,000 of salary Rs. 2 000
On Balance every Rs.2000
Rs 1000 or part thereof .

Particulars Rs.
Basic Pay 10,000
DA (100% of Basic) 10,000
Leave Salary (10% of Basic) 1,000
Employers Contribution to PF (12% of Basic & DA) 2,400
Employer’s Contribution to ESI (4.75% of Basic & DA) 950
Pro Rata Expenditure on labour welf are per month 1,000
Total Labour Cost 25,350
÷ No. of Working Hours 2000 Hrs.
Labour Cost Per Hour 12.675 munotes.in

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Labour Cost
73 3) Employer ’s contribution to Provident fund 12% of salary and DA
4) Employer ’s contribution to ESI 4.75 of salary and DA
5) Bonus 20% of salary and DA
6) Other allowances RS 27, 750 p .a.
7) Mr. Lokhande works for 2400 hours p .a. out of which 400 hours are
normal idle time.
Find out the effective hourly cost of Mr. Lokhande .
Solution:
Statement Showing Labour Cost of Mr. Lokhande
Particulars Rs. Rs.
Salary Per Month 5,000
DA:
On 1st2,000 of Salary 4,000
On next 2,000 of Salary 2,000
On balance every 1000 or part thereof 2,000 8,000
Salary & DA per month 13,000
Labour Cost Per Annum
Salary & DA per annum (Rs. 13,000 x 12
months) 1,56,000
Employer’s Contribution to PF (12% of
Salary and DA) 18,720
Employer’s Contribution to ESI (4.75% of
Salary and DA) 7,410
Bonus (20% of Salary and DA) 31,200
Other Allowances 27,750
Total Labour Cost 2,41,080
÷ Effective No. Of Hours (2400 – 400) 2,000
Effective Labour cos t per Hour 120.54

 Exercises (Practical Problem):

1. Calculate labour cost using Halsey Premium Plan (50%) and
Rowan Premium Plan:

Time Allowed: 15 hours
Time Taken: 13 hours
Wage Rate: Rs. 45 per hour
(Answer: Halsey Premium Plan Rs. 630/ -& Rowan Prem ium Plan Rs.
663/-) munotes.in

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Cost Accounting
74 2. A worker is allowed 75 hours to complete job on guaranteed wage of
Rs. 50 per hour. He completes the job in 60 hours. Calculate wages of
worker as per Halsey Premium Plan (50%) and Rowan Premium Plan.
(Answer: Haley Premium Plan Rs. 3,3 75/- and Rowan Premium Plan Rs.
3,600/ -)

3. From the following information calculate the wages of worker A and
B as per Halsey Premium Plan (50%) and Rowan Premium Plan:
Time allowed to complete the Job 100 hours
Wages per hour Rs. 30
Time Taken to comp lete the job:
A 60 hours
B 75 hours
[Answer: Halsey Plan (A – Rs. 2,400/ - & B – Rs. 2,625/ -) and Rowan
Plan (A – Rs. 2,520/ - & B – Rs. 2,812.5/ -)]

4. Using Taylor’s differential piece rate calculate the earnings of X and
Y from the following partic ulars:

Standard time per unit 20minutes
Normal Rate Rs. 9 per unit
In a day of 9 hours:
X Produced 25 Units
Y Produced 30 Units
(Answer: X Rs. 180/ - and Y Rs. 324/ -)
5. From the following particulars, calculate the earnings of A & B using
Straight Piece rate and Taylor’s differential piece rate :

Standard time allowed: 20 units per hour
Normal Time Rate: Rs. 30 per hour
Differential Rate to be applied:
80% of piece rate when below standard
120% of piece rate at or above standard

In a particular d ay of 8 hours, A produces 140 units while B produces 165
units.

(Answer: Straight Piece Rate: A Rs. 210/ -, B Rs. 247.5/ - and Taylor’s
DPRS: A Rs. 168/ -, B Rs. 297/ -)

6. Calculate earnings of worker A, B & C under Merrick’s Multiple
Piece Rate System from th e following:
Normal rate per hour Rs.150
Standard units per hour 50units
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Labour Cost
75 Output per day:
A 320 units
B 380 units
C 450 units
Working hours per day 8 hours.
(Answer: A Rs. 960/ -, B = Rs. 1,254/ - and C = Rs. 1,620/ -)
7. The following particulars apply to a particular job:
Standard production per hour - 6 units
Normal rate per hour –Rs. 120
In a particular day of 8 hours ,
Mohan produced 32 units
Ram produces 42 units
Prasad produces 50 units
Calculate the wages of these workers under Merrick Differential Piece
Rate System.
(Answer: Mohan Rs. 640/ -, Ram Rs. 924/ - and Prasad Rs. 1,200/ -)

8. Calculate the earnings of worker X, Y & C as per Gantt Task
Bonus Plan from the following:
Standard Rate per hour Rs.50 per hour
Standard Rate per unit Rs. 2 per unit
Normal output per hour 25 units
In a day of 9 hours,
X produced 175 Units
Y Produced 225 Units
Z Produced 275 Units
(Answer: X Rs. 450/ -, Y Rs. 540/ - and Z Rs. 720/ -)

9. The following information rel ates to workforce in a factory during
the year 2019 -20:
Number of workers on 01/04/2019 2,350
Number of workers on 31/03/2020 2,850
Number of workers who quit on their own 200
Number of workers availed golden handshake (replacement) 100
Number o f workers employed due to expansion 400

Calculate the Labour Turnover by different methods.
(Answer: Separation Method 7.69%, Replacement Method 3.85%, New
Recruitment Method 15.38% and Flux Method 11.54% )

10. Mr. Bhavesh of XYZ Ltd. Gets the following emolu ments and
benefits:

a. Basic Salary Rs. 75,000 p.a.
b. Dearness Allowance Rs. 1,57,500 p.a.
c. Employer’s Contribution to PF 8% of Basic Salary and DA
d. Employer’s Contribution to ESI 4% of Basic Salary and DA munotes.in

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Cost Accounting
76 e. Bonus 20% of Basic Salary and DA
f. Other Allowan ces Rs. 68,100
Mr. Bhavesh works for 2,200 hours per annum, out of which 200 hours are
non-productive.
Find out the effective hourly cost of Mr. Bhavesh.
(Answer: Total Labour Cost Rs. 3,75,000 and Effective Labour Cost per
Hour Rs. 187.5 )

 Multiple Choi ce Questions:
1. The flux rate method of labour turnover considers ______.
a. Employee Left b. Employee Joined
c. Employee Joined & Left d. Employee Replaced
2. Taylor’s Differential piece rate plan penalised _____.
a. Efficient Workers b. Inefficien t Worker s
c. Average workers d. None of the above
3. The difference between hours paid and hours worked is called ____.
a. Idle Time b. Standard Time
c. Normal Time d. Time Saved
4. A worker is allowed 60 hours to complete a job on a guaranteed wag e
of Rs 10 per hour. He completes the job in 48 hours. How much will he
earn under Rowan Plan?
a. Rs. 450 b. Rs. 640
c. Rs. 576 d. Rs. 700
5. Gantt Task is example of _____.
a. Time Rate System b. Piece Rate System
c. Combination of Time & Piece Rate d. Overheads
6. Under _____ system output of worker is not relevant.
a. Merrick’s Plan b. Time Rate
c. Taylor Plan d. Piece rate
7. The workers who are entitled to wages on the basis of their output are
called as _____.
a. Piece Workers b. Ca sula Workers
c. Time Workers d. Out Workers
8. Wage sheet is prepared by
a. time keeping department b. personnel department
c. payroll department d. engineering department munotes.in

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Labour Cost
77 9. Labour Turnover is
a. Productivity of Labour b. Change in labour force
c. Efficiency of Labour d. Total cost of the labour
10. Halsey premium plan is
a. individual incentive scheme b. group incentive scheme
c. time and piece wage system d. differential piece rate system
 State whether following statements are True or False:
1. In Taylor’s Differential Piece Rate, Time wages are guaranteed to each
worker.
2. When wages are paid on piece basis, the quality of work declines.
3. Job evaluation is the comparative appraisal of workers on different jobs.
4. Idle time is the differen ce between time clocked and time booked.
5. Direct wages if fixed cost.
6. Merrick’s Differential Piece Rate is less punitive (punished) than
Taylor’s Differential Piece Rate.
7. Under Rowan plan, bonus is fixed percentage.
8. Cost of normal idle time is t reated as production cost.
9. Idle time arises when workers are paid on piece rate basis.
10. Efficiency of workers is measured on the basis of Time Taken for
performance of a job.
(Answer: True 2,4,6,8,10 and False 1,3,5,7,9)
 Short Notes:

1. What is Labour Turnover? How do you measure Labour Turnover?
2. What are the various wage payment methods?
3. Job Evaluation
4. Merit Rating
5. Straight Piece Rate v/s Differential Piece Rate
6. Halsey Plan
7. Rowan Plan
8. Time Recording
9. Idle time and types of Idle time.
10. Payroll Accounting and Payroll Procedure.

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78
4
OVERHEADS
Unit structure
4.0 Objectives
4.1 Introduction
4.2 Overheads t he Concept
4.3 Basis of Apportionment or Distribution of Overheads
4.4 Solved Problems
4.5 Exercise
4.0 OBJECTIVES
After studying the unit the students will be able to:
 Understand the meaning and composition of overheads.
 Explain the procedure of Overhead Accounting.
 Discuss about the basics of apportionment and absorption of overheads.
 Solve the practical problems.
4.1 INTRODUCTION
Total cost of product involves direct and indirect cost . Direct Cost can be
directly identified with manufacturing of product. It includes Direct
Material,Labour and expenses. Indirect Cost is identified with non -
production / manufacturing of goods. The indirect cost is referred to as
overheads or loading or s upplementary cost.
4.2 OVERHEADS - THE CONCEPT
4.2.1 MEANING
Overhead Costs are operating cost of business enterprise which cannot be
traced directly to a particular unit of output. The term overhead is used
interchangeably with such terms as ‘burden’, ‘supplementar y costs’,
‘manufacturing expenses’ and ‘indirect expenses’. Blocker and Wellmer.
‘In Cost accounting all indirect, costs are termed as ‘Overhead’. W
W.Bigg . munotes.in

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Overheads
79 “The Aggregate of Indirect Material Costs, indirect wages (labourcost
)and indirect expenses”. The Institute of Cost and Management
Accountants, London.
4.2.2 Composition of Overheads :
Overheads




Indirect Indirect Indirect
Materials Wages Expenses

4.2.3 Overheads Accounting:
Overheads comprises of indirect materials, indi rect wages and indirect
expenses which are not directly identified or allocated to cost object in an
economically feasible way.
Overheads accounting aims at absorbing the overload in product unit
produced by the firm or company. It involves the following:
i) Collection, Classification and Codification of Overheads.
ii) Allocation, Apportionment and Reapportionment of Overheads.
iii) Absorption of Overheads.
1. Collection of overheads: It means the collection of items of
expenses from the Books of account and other recor ds regarding to their
nature and purposes. E.g. Store Issue Note, Purchase Voucher, Pay Roll
Sheet, Time Sheet, Cash Book, Journals other reports.
2. Codification of Overheads: -It means giving a code number to each
item of overheads for easy identification f rom different heads of overhead.
It may be done numerically alphabetically.
For Example -
Turning Department.A1 or A
Grinding Department. A2 or B
Component of Manufacturing - 101
Maintenance - 102
3. Classification of Overh eads: -It means the process of grouping
overheads according their common features or characteristics or nature.
It can be classified in the following ways.
a) On the Basis of Behaviour -
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Cost Accounting
80 b) On The Basis of Function -
- Production Overheads, Selling and Distribution Overheads and
Administration Overheads.
4. Allocation of Overheads : -It means Charging the whole items of
cost to suitable and identifiable cost centers or cost units. It is transfer of
the cost of goods or ser vices from primary account to one or more
secondary accounts.
5. Apportionment of Overheads: - It means distribution of cost over
several periods of time in proportion to anticipated benefits. It consists of
dividing a joint or common cost between two or more cost objectives. It
means distribution of overheads to more than one cost centers on some
equitable basis. This also known as ‘departmentlisation of overheads’.
6. Absorption of Overheads: It means charging of overheads from
cost centers to product or service by means of absorption rate for each cost
centre. Total Overhead of the Cost CentreOverhead Obsorption Rate =Total Quantium of Unit or Base
It means the expensing the cost of Job, products, process or unit, i.e.
recovery by the product. The cost absorption process involves the
recognition of expenses under the condi tions of physical movement,
benefit yielded and period of charges, etc.
4.3 BASIS OF APPORTIONMENT OR DISTRIBUTION
OF OVERHEADS
There are some items of expenses which cannot be allocated easily to a
specific department and it needs equitable apportionment s on the basis of
benefit received. It is done on the basis of floor area occupied, labour
hours, machine hours, kilowatt hours, capital value or value of assets,
technical estimate, etc.
The Table Shows the Apportionment of Overheads.
Overheads / E xpenses Basis of Apportionment
1) Rent, Rates, Taxes, Air
Conditioning Floor Area Occupied
2) LabourWelfare Expenses,
Perquisites, Time Keeping,
Personnel Office, Supervision No. of Workers
3) Compensation to Workers,
Holiday Pay, ESI and PF
Contr ibution Direct Wages
4) Depreciation on P & M, Repair
& Maintenance of P & M Capital Value or Value of
Assets
5) Insurance of Stock Stock Value munotes.in

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Overheads
81 6) Lighting expenses, electric power No. of light points or area
occupied or material unit or
house powe r of machine or
No. of machine hours or value
of machine or consumption of
unit.
7) Material landing and store
overheads Weight of materials or volume
of material or value of
materials or unit of materials
8) Delivery expenses Weight, volume or tone mi le
9) Telephone expenses. No. of Calls or No. of
telephone machine
10) Audit fees Sales or total cost
11) Advertising Actual expenses or % of sales
12) Store keeping Weight or value of materials
13) Recreation No. of employees or total
wages

b) CostofService Department Basis of Apportionment
1) Purchases No. of purchases or value of
purchases
2) Account No. of employees or value of
purchases
3) Maintained, repairs of shop, planning & progress, tool room Direct Labour Hour, Machin e
Hours, Direct Labour Wages
4) Canteen & welfare, hospital
(medical), dispensary, personal
department, time keeping No. of workers, No. of employees
5) Computer Section No. of Card punched, computer
hour, specific allocation to
departments
6) Power House (electric lighting
cost) Floor area, cubic content, No. of
electric points, wattage
7) Power House (electric power
cost) Horse power, KWH,
Horse Power x Machine Hours
KWH x Machine Hours
8) Store Department value or weight of material issu ed
9) Transport Department Crane hours, truck hours, truck
mileage, truck tonnage, truck non -
hours, tonnage handled,No. of
packages of standard size.
10) Fire Protection Capital value of assets
11) Inspection / Quality Inspection labours
12) Purchase Departments No. of purchase order, value of
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Cost Accounting
82 4.4 SOLVED PROBLEMS
Illustration : 1
A Limited Company has Three Manufacturing Departments ‘A’, ‘B’ and
‘C’ and one service Department ‘S’. The following Figures are available
of 25 working day s of 8 hours each day. All These Departments Work for
all the days and with full attendance.
Departments Total
Expenditure A
Rs B
Rs C
Rs S
Rs Rs
Power and Lighting 200 300 360 240 1,100 Supervisor’s Salary - - - - 2,000 Rent - - - - 1,000 Welfare - - - - 900 Other Expenses 200 400 400 200 1,200 Total - - - - 5,400 Supervisor’s Salary 30% 30% 20% 20% 100% No. of Workers 30 40 20 10 100 Floor area (Sq Ft) 600 800 600 500 2500 Service rendered by Service Dept 50% 30% 20% - 100%
Calculate Lab our hour rate for each department A, B & C.
Solution:
Statement Showing Distribution of Overheads
Departments Total
Expenditures
Base A
(Rs`) B
(`Rs) C
(Rs`) S
(Rs`) Rs
Power & Lighting Given 200 300 360 240 1,100 Supervisor’s Salary % age 600 600 400 400 2,000 Rent Floor
Area 240 320 240 200 1,000 Welfare No. of
Workers 270 360 180 90 900 Other Expenses. Given 200 400 400 200 1,200 Total 1,510 1,980 1,580 1,130 6,200 Allocation of Expenses
of Service Dept to
Manu. Dept % age 565 339 226 (1,130) 2,075 2,319 1,806 -- 6,200 munotes.in

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Overheads
83 1) No. of Hours in a Month = 25 x 8 = 200 hours
2) Total Labour hours in each Dept
Dept A = 200 x 30 Hrs = 6000Hrs
B = 200 x 40 Hrs = 8000Hrs
C = 200 x 20 Hrs = 4000Hrs
3) Labour Hour Rat e For Department
2075A - = 0.34586000 = Rs0.35 Paise
2319B - = 0.2898000 = Rs0.29 Paise
1806C - = 0.4514000 = Rs0.45 Paise
Illustration : 2
You are Supplied with the following information and required to work out
the production hour rate of recovery of overhead in Departments, A, B
and C.
Production Dept Service Dept
Particulars Total (Rs) A
(Rs) B
(Rs) C
(Rs) D (Rs) E
(Rs)
Rent 12,000 2,400 4,800 2,000 2,000 800 Electricity 4,000 800 2,000 500 400 300 Indirect Labour 6,000 1,200 2,000 1,000 800 1,000 Depreciation on
Machinery 5,000 2,500 1,600 200 500 200 Sundries 4,500 910 2,143 847 300 300 Estimated
Working Hours 1,000 2,500 1,400 -- --
Expense of Service Departments D and E are apportioned as follows:
A B C D E
D 30% 40% 20% -- 10%
E 10% 20% 50% 20% --

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Cost Accounting
84 Solution:
Statement of Overhead Distribution

Total Production
Department Service Department
Particulars
` A
` B
` C
` D
` E
`
Rent 12,000 2,400 4,800 2,000 2,000 800 Electricity 4,000 800 2,000 500 400 300 Indirect Labour 6,000 1,200 2,000 1,000 800 1,000 Depreciation on
Machinery 5,000 2,500 1,600 200 500 200 Sundries 4,500 910 2,143 847 300 300 Total 31,500 7,810 12,543 4,547 4,000 2,600 Dept. D 1,200 1,600 800 (4000) 400 9,010 14,143 5,347 00 3,000 E 300 600 1,500 600 (3,000) 9,310 14,743 6,847 600 00 D 180 240 120 (600) 60 9,490 14,983 6,967 00 60 E 6 12 30 12 (60) 9,496 14,995 6,997 12 00 D 4 5 3 (12) -- Total 31,500 9,500 15,000 7,000 00 -- Estimated
Working Hrs 1,000 2,500 1,400 -- -- Rate Per Hour
9,5001,000 150002500 70001400 - - Rate per hour 9.50 6.00 5.00 - -





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Overheads
85 Illus tration : 3
In a Light Engineering Factory, Mumbai Andheri (West), a Machine shop
consists of three cost centers (A, B and C) each having three district set of
Machines. Following are the details of estimates for year 2016.
Departments Particulars
A B C Total

No. of Workers 200 200 400 800 No. of Machine Hours 30,000 30,000 40,000 1,00,000 % age of Horse Power 40 25 35 100 Value of Assets (Rs) 10,00,000 16,00,000 14,00,000 40,00,000 Direct Wages (Rs) 8,00,000 10,00,00 0 12,00,000 30,00,000 Depreciation (Rs) 4,00,000 Indirect Labour (Rs) 9,00,000 Insurance Charges (Rs) 2,00,000 Electricity (Rs) 3,00,000 Supervisory Salary (Rs) 1,60,000 Staff Welfare Expens es
(Rs) 3,00,000 Other Expenses (Rs) 6,00,000
Work out a composite machine hour rate for each of the three cost centre
indicate clearly the basis of apportionment of expenses between three cost
centers.
Solution:
Computation of Composi te Machine Hour Rate
Cost Centers
Particulars
Base A (Rs) B
(Rs) C
(Rs)
Total
(Rs)
Direct Wages Given 8,00,000 10,00,000 12,00,000 30,00,000 Depreciation Value of
Assets 1,00,000 1,60,000 1,40,000 4,00,000 Indirect Labour Direct
Wages 2,40,000 3,00,000 3,60,000 9,00,000 Insurance
Charges Value of
Assets 50,000 80,000 70,000 2,00,000 munotes.in

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Cost Accounting
86 Electricity Horse
Power %
age 1,20,000 75,000 1,05,000 3,00,000 Supervisory
Salary No. of
Workers 40,000 40,000 80,000 1,60,000 Staff Welfare No. o f
Workers 75,000 75,000 1,50,000 3,00,000 Other Expenses No. of
Machine
Hours 1,80,000 1,80,000 2,40,000 6,00,000 Total a) 16,05,000 19,10,000 23,45,000 58,60,000 No. of Machine
Hours b) 30,000 30,000 40,000 1,00,000 Machine Hour
Rate a ÷ b 53.50 63.666 or 63.67 58.625 or 58.63 - -
Illustration : 4
In a factory there are three production departments and two service
departmentsi.e. A,B,C, Rand S respectively. In a March 2015, the
departmental expenses were as follows:
Production Departmen t
A B C Service Department
R S ( Rs) 46,000 12,000 13,000 9,000 4,000

The service departments are charged o ut on the basis of percentage as
follows a:
particulars Production Dept.
A B C Service Dept.
R S

Service Dept R
Service Dept S 40% 30% 20%
30% 30% 20% -- 10%
20% --
You are required to apportion the cost of service department to production
department under Repeated Distribution Method.
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Overheads
87 Solution:
Particulars Base of
allocation Prod.
Dept. A
Rs Prod.
Dept. B
Rs Prod.
Dept. C
Rs Service
Dept. R
Rs Service
Dept. S
Rs
Primary Distribution
of Overheads
Dept. ‘R’ Overhead
Dept. ’S’ Overheads
Dept, ‘R’ Overheads
Dept. ‘S’ overheads
Dept.’ R’ Overheads

4:3:2:1
3:3:2:2
4;3;2;1
3:3:2:2
4:3:2:1
46,000

3,600
1,470
396
30
8

12,000

2,700
1,470
294
30
6 13,000

1,800
980
196
20
4
9,000

-9,000
980
-980
18
-18 4,000

900
-4900
98
-98
-
Total 51,500 16,500 16,000 _ _

4.5 EXERCISES: -
01. The overhead expenses of a company are recovered by the cost
accountant according to the production departments ‘X’ and ‘Y’ and
service department ‘S’.From the following information prepare aprimary
distribution schedule.
Expenses Rs .
Indirect Wages 8,000
Rent and Rates 15,000
Power 4,500
Light 3,200
Depreciation on Machinery 24,000
Sundries 20, 000
Following information is also available for department :
Particulars ‘X’ ‘Y’ ‘S’
Working Hours 4,000 3,500 3,600
H.P.of Machine 15 25 05
Direct Wages (Rs) 12,000 4,000 4,000
Value of Machinery (Rs) 100,000 80,000 60,000
Floorspace area (Sq. ft.) 600 500 400
Light Points 10 05 05
(Ans :Dept. X -Rs.35,900; dept. Y - Rs 21,900 and Dept. S - Rs 20,900) munotes.in

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Cost Accounting
88 02. A Ltd. furnish you the f4ollowing half yearly budgeted data for for
the half year ended 31st March 2015. Distribute the overheads by m ost
equitable method.
Particulars Production Dept. Service
Dept.
A B C D
E
Direct Wages (Rs) 40,000 60,000 80,000 20,000
40,000
Direc t Materials (Rs in lacs) 1 2 4 2 1
No. of em ployees 10 15 15 05 05
Electrici ty ( MWH) 8,000 6,000 4,000 2,000 2,000
Light Point 5 8 2 3 2
Asset V alue (Rs in lacs) 12 8 6 2 2
Area occupied, (Sq. meters.) 150 25 0 100 50 50

The overheads for the above period were :
Particulars Rs Particulars
Rs
Motive Power 17,500 Lighting
1,600
Store Expenses 20,000Staff Welfare Expenses 4,000
Depreciation 30,000 Repairs 15,000
Rent, Rates and Taxes 12,000 General Expenses 12,000

03. A company is having two production departments namely A and B
and two service departments S -1 and S -2. The expenses incurred during
the of March,2014 are as following :
Expenses Rs
Electricity 3,600
Insurance on Assets 9,000
Power 15,000
Rent and Taxes 28,000
Depreciation 18,000
Canteen expenses 5,400

The following information is also available for the above departments.

Particulars A B S-1 S-2
Floor Space (sq. ft.)
No. of W orkers
H. P. of Machine
Direct wages
Value of Assets ( Rs.
in thousands )
Direct Materials
No. of Light Points
6,000 100 120 10,000 10 15,000 30 4,000 50 30 10,000 4 10,000 15 2,000 50 30 5,000 3 5,000 15 2,000 25 15 3,000 1 - 5 Prepare statement showing primary distribution of overheads. munotes.in

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Overheads
89 04. The following data were obtained from the books of Four Square
Engineering for the following half year ended 30th June , 2014. Prepare
overhead distribution summary.

ItemsProduction Dept. Service Dept.
A B C X Y
Dire ct Wages (Rs) 7,000 6,000 5,000 1,000 1,000
Direc t Materials (Rs) 3,000 2,500 2,000 1,500 1,000
Employe es (Nos.) 200 150 150 50 50
Electricit y(kwh) 8,000 6,000 6,000 2,000 3,000
Light Poin ts (Nos) 10 15 15 5 5
Asse ts Value (Rs) 50,000 30,000 20,000 10,000 10,000
Area Occupied (Sq. Mtrs.) 800 600 600 200 200

Expenses for the 6 months we re as follows:

Expenses Rs Expenses Rs
Stores overheads 400 Depreciation 6,000
Motive power 1,500 Repairs and Maintenance 1,200
Electric Power 200 General Expenses 10,000
Labour Welfare 3,000 Rent and Taxes 600
Apportion the expenses of Department X in the ratio of 4:3:3 and that of
Department Y i n proportion to direct wages, to department A, B and c
respectively.

( Answer : Dept. A – Rs 11,396; Dept. B - Rs 8,663 ; Dept. C - Rs 7,341)

4.6 COMPUTATION OF OVERHEAD RATES

OBJECTIVES
After studying the unit the students will be able to:
 Calculate the overhead absorption rate.
 Understand the methods of absorption of overheads.
 Solve the related practical probles.
INTRODUCTION
We have seen the methods of apportionment of overheads in the earlier
chapter. The next step is to see how overheads are abs orbed in the cost of
production. Absorption of overheads means recovery of overhead in the
cost of production.
It means charging of overheads to cost centers in such a manner that are
the cost of production of such unit includes an appropriate or equal sh are
of overheads of cost centers.
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Cost Accounting
90 OVERHEADS ABSORPTION RATES
The overhead absorption rate is determined for the purpose of absorption
of overheads in cost of job, products, etc. There are several methods of
determination of overheads absorption rate.
Overhead absorption rate is the relation between amount of overheads and
total numbers of units of the base selected. Amount of OverheadsOverhead Absorption Rate =Quantile or Value Base
Actual Rate:
Actual Rate is determined by dividing actual overheads incurred during
the period by actual quantity or value of base selected.
Actual Overhead Expenses Incurred Diving the Period∴Actual Rate =
Actual Quantity or Value of The Base Related to Production during the period
Pre - Determined Rate:
This is rate is decided on the basis of budgeted overheads and the
budgeted base for the certain period. Budgeted Overhead for The PeriodPre -Determined Rate =Budgeted Base for The Period
This ratio facilitates calculation of cost in advance and helps while
preparing bills promptly. No extra clerical staff is required.
Blanket Rate:
This is the single or general overheads rates applicable to the whole
factory. This rate is suitable in those fortifies where several products
passes through many departments. Overhead Cost for Entire FactoryBlanket Rate =Total Quantum of Base Selected
Multiple Rate: -
A concern may use multiple overhead rates separately for each producing
department, for each service department for each cost centers and for each
product line. It is determined where th e product lines are varied or
machinery is used for varying degrees in different department. It means
the incidents of overhead cost each department is different.
This calculated as follows. Each Depatment Cost Centres or ProductMultiple Overhead Rate =Corresponding Base munotes.in

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Overheads
91 METHODS OF ADSORPTION OF OVERHEAD
Following are the various method adapted for absorption of overhead.
1. Machine Hour Rate:
It is the cost of running a machine for one hour. Under this method,
machines are used as the basis of overhead absorption rate. Production OverheadMachine Hour Rate =Machine Hours
This metho d is suitable where major portion of production of goods is
performed with the help of machine. Machine Hour Rate facilitates the
calculation of correct and reliable cost. Relative efficiencies of Machines
can be compared. It helps management to understand the difference
between usefulness of machine and Manual Work.
It is not suitable where major work is done by manual labour. It requires
detailed reward of machines for each job. It is difficult to understand and
operate and also difficult to calculate ma chine hour in advance.
Computation of Machine Hour Rate:
Computation of Machine Hour Rate involves the following:
i) Consider each machine or a group as a separate cost centre.
ii) Compute fixed or Standing Charges which vary with line and not
with Mac hine.
Fixed / Standing Charges Base of Apportionment
a) Rent Area Occupied
b) Healing & Lighting No. of Light Point or Flour
Area Occupied
c) Supervision Charges Time devoted by Supervisor
d) Insurance Insured Value of each
Machine
e) Cleaning Materials No. of Machines
f) Miscellaneous Expenses Based on the fats

iii) Computation of Machine Hours
a) No. of Effective Working Days xxx
b) No. of Working Hours Per Day xxx
c) Total Working Hours (a x b) xxx
d) Less: No Hours required for mac hine and repairs xxx munotes.in

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Cost Accounting
92 e) Effective Machine Hours (c - d) xxx
f) Unproductive setup time xxx
g) Effective Machine Hours (e - f) xxx

iv) Standing Charges per hour II / III xxx
v) Running Charges for Each Machine
Running Charges Base of Apportio nment
a) Depreciation Value / Useful Life
b) Repairs and Maintenance Machine Hours
c) Power Meter Reading / HD / Machine
Hours
d) Miscellaneous expenses Equitable basis based on
factor.

vi) Hourly Running Charges for each Machine. Total Running ChargesHourly Running Charges Per Machine =Machine Hours
vii) Machine Hour Rate (IV + VI) xxx
Format for Computation of Machine Hour Rate
` `
A) Standing Charges: i) Rent & Rates xxx ii) Healing & Lighting xxx iii) Supervision Charges xxx iv) Insurance xxx v) Miscel laneous Expenses / Overheads xxx xxx Standing ChargesStanding Changes Per Hour =Effective Machine Hours xxx B) Running Charges / Expenses Per Hour i) Depreciation xxx ii) Power xxx munotes.in

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Overheads
93 iii) Repair &Maintenance xxx iv) Consumers & Lubricants xxx v) Miscellaneous Expenses xxx C) Machine Hour Rate xxx
2. Labour Hour Rate:
This method is referred to production hour rate method and adopted in
those factors where labour prominent. This rate express the relation
between the expenses incurred other than wagespaid to worker s and
number of machine hours put by the workers during the period.
Budgeted or Actual Overheads(Expenses)Labour Rate =Budgeted or Actual Labour Hours
     No - 4 workers No. Hours for
Budgeted Labour Hour = employed during × whi ch factorthe period workes each day
3. Percentage of Prime Cost Method:
This method shows relationship between budgeted actual overheads and
prime cost. This method is u sed where standard product requires constant
quality of materials and number of labour hour produced.
Budgeted Actual OverheadsPercentage on Prime Cost = ×100Budgeted Prime Cost
4. Percentage of Direct Material Cost Method: -
Under this method, the cost of Material consumed in production is
considered as b ase of overhead absorption. This method gives relationship
between actual budgeted overheads and budgeted or actual direct materials
cost in percentage.
Budgeted or Actual OverheadDirect Materi Cost Rate = ×100Actual Direct Materials
5. Percentage of Direct Labour Method: -
Under this method, Labour Overheads a re recovered on the basis of actual
rate. This method is useful where production is in uniform nature and all
workers are more or less the same hourly rate and Labour is predominant.
Factory OverheadsDirect Labour Rate = ×100Direct Labour munotes.in

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Cost Accounting
94 6. Combined Machine Hour and Labour Hour Rate:
This method is useful where company having various department in which
work is completed by Machine work and Labour work (Manual). This
method is used where separate allocation of running charges in not
possible and are allocated on the basis of machine la bour rate and other
expenses, which are not directly related to machines,are allocated on the
basis of labour rate.
SOLVED PROBLEMS
Illustration : 1
Calculate the Machine Hour Rate from the following:
Particulars Rs
Cost of Machine 12,000 Cost of Installation 3,.000 Scrap Value 3,000 Rent, Rates for a quarter for the shop 300 General Lighting 20 P.M. Supervisor’s Salary for Shop 600 per quarter Insurance Premium for Machine 60 p.a. Estimate Repairs 400 p.a.
Power 2 units per hour @ Rs 5 per 100 units. Estimate working hours p.a.
2,000. The machine occupies 14th of the total area of the shop. The
supervisor is expected to denote 1/6th of his time for supervising the
machine. General lighting expense s are to be apportioned on the basis of
the floor area.








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Overheads
95 Solution:
Statement Showing Machine Hour Rate
Particulars Working P.A. ` Per Hour `
Standing Charges
Rent & Rates 1300 44 300 General Lighting 120 124 60 Shop Supervisor’s
Salary 16000 46 400 Insurance Premium 60 820 Standing Charges = 8202000 Hrs 0.41 Running ChangesDepreciation 12000 +3000 -300020000 Hrs 0.60 Repairs 4002000 0.20 Power 2 units×05100 0.10 Machine Hour Rate 1.31
Illustration : 2
From the following information, Calculate Machine Hour Rate.
Cost of Machine Rs 45,000
Scrap Value Rs 5,000
Rent for workshop Rs 30,000
General Lighting Rs 200 PM.
Power C onsumption 20 Units Per Hour @ Rs 20 per every 100 units
Administrative Expenses Rs 4,000 p.a.
Repairs and Maintenance 75% of Depreciation
Workshop Supervisor’s Salary Rs 4,000 P.M.
Estimated Working Time per year 50 weeks of 40 hours each
Selling up time for production 200 hours per year
Effective Life of Machine 10 Years
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Cost Accounting
96 The Machine Occupies 1/4th area of workhop. The supervisor is expected
to 1/4th of time in supervising the machine.
Solution:
Calculation of Machine Hour Rate
Partic ulars Working P.A.
Rs Per
Hour
Rs
Standing Charges
Rent 30,000 4 7,500
General Lighting 200 12 4 600
Administrative
Expenses 4000 for years 4,000
Workshop
Supervisor’s
Salary 4,000 12 4 12,000
24,100
Standing Charges
Per Hours 24,100 2,000 12.05
Running Charges
Depreciation 45, 000 5, 000 40, 000 4, 00010 10 2, 000 2.00
Repairs
&Maintenance 75 14,000100 2,000 1.50
Power 20 20 1,800100 200 3.60
_____ __ Machine Hour
Rate 19.15

Note:
Machine Hours = wH50 ×40 = 2000 Hrs. It is pressured that no current is
used by the machine devising setting up time.





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Overheads
97 Illustration : 3
Computer the Machine Hour Rate from the following data.
Particulars Rs
- Cost of Machine - 1,10,000 - Installations Charges - 10,000 - Estimated Scrap value after expire of 15 years
life - 5,000 - Rate and Rates for the shop per month in - 200 - Governal Lighting for the shop per month - 800 - Insurance Premium for Machine per annum - 1,000 - Repairs and Maintenance Expenses per annum - 1,000 - Consumption of Power to units per hours - 10
- Rate of Power per 100 units - 30 - Estimated Working Hours Per Annum - 2,200 - This includes non -productive setting up time of
200 hours. - Shop Supervisor Salary P.M. - 600
The Machine occupies 1/4th of the total area of the shop: Supervisor is
expected to devote 1/5th of hi s time for supervising the machine.
Solution:
Computation of Machine Hour Rate
Particulars Working P.A.
Rs Per
Hour
Rs
a) Standing Charges
Rent and Rates 200 12 4 600
General Lighting 800 12 4 2,400
Insurance Premium - 1,000
Shop Supervisor’s
Salary 1600 125 1,440
5,440
Standing Charges Per
Hour 5,440 2,000 2.72
b) Running Charges
Power 30 10 100 3.00
Repairs & Machine 1,000 2,000 0.50
Depreciation 1,10,000 10,000 5,0002,000 15 3.83
Machine Hour Rate 10.05
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Cost Accounting
98 Note:
Machine Hour = 2,200 Hrs. - 200 Non - Productive Selling Time
= 2,000 Hrs.
Illustration : 4
From the following figures, compu te the machine Hour Rates for
Machines A, B and C for a 4 -week prior sepeatedly. Each machine is
expected to be working 200 hours.
Particulars Per
Annum
Rs
Rent and Taxes 3,000 Lighting and halting 400 Depreciation 1,000 Indirect Wages 1,500 Power 600 Sundries 1,750 Canteen Expenses 1,200 Repairs and Maintenance 500
Four the above three machine in the factory, the necessary particulars are
as follows:
Particulars Machine
A Machine B Machine
C
Area Space Occupied (Sq. ft.) 100 200 300 No. o f Light Points 1 3 -- Cost of Machine (Rs) 25,000 15,000 10,000 No of Workers 1 2 3 Power (Rs) 250 150 200 Direct Wages (Rs) 2,000 3,000 5,000



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Overheads
99 Solution:
Machine Hour Rate
Machines Part iculars Base of
Apportionment A
Rs B
Rs C
Rs
a) Standing Charges
Rent and Taxes (1:2:3) 500 1,000 1,500 Lighting and Heating (1:3:0) 100 300 - Indirect Wages (2:3:5) 300 450 750 Sundries (2:3:5) 350 525 875 Can teen Expenses (1:2:3) 200 400 600 Total 1,450 2,675 3,725 b) Running Charges Depreciation (5:3:2) 500 300 200 Power (Actual) 250 150 200 Repairs& Maintenance (5:3:2) 250 150 100 Total 1,000 600 500 c) Total Charges (a + b) 2,450 3,275 4,225 Machine Hour Rate =
CMachine Working Hour 12.25 16.25 21.13
Illustration : 5
The following expenses have been incurred in respect of a shop having
four indelicate machine.

Rent and Rates Rs 6,000 p.a. Power Consumed by the shop at 10 paise
per unit Rs 4,800 p.a. Repairs for 4 Machine Rs 2,500 p.a. Lighting for shop per machine Rs 150 p.a. Lubricants etc. Rs 150 p.a. Depreciation per machine Rs 600 p.a. munotes.in

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Cost Accounting
100
Supervisor’s Salary: Working after 4 Mach ines and Paid Rs 650 p.m. Attendants : 2 attendants looking after
five machines paid Rs 60 p.m.each
Each Machine consumes 10 units of power per hour.
Calculate Machine hour rate.
Solution:
W. Note: -

i) No. of Units Consumed = .4800 100100Rs = 48,000 units
No. of units per
machine = 48000/4 = 12,000 units
Hours in a year = 12000/10 = 1,200 hours

ii) Wages to attendant 5 Machine = 2 attendant x Rs 60 each
= (60 x 2) x 12
= 1440
Wages for 4 Machines = 1440 x 45= Rs.1152

Particulars P.A.
Rs
a) Standing Charges Rent & Rates 6,000 Wages to attendant (Note. II) 1,152 Supervisor’s Salary (650 x 12) 7,800 14,952 munotes.in

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Overheads
101 b) Running Charges Power 4,800 Repairs 2,500 Lighting (150 x 04) 600 Lubricants 150 Depreciation (600x4) 2,400 10,450 c) Total Expenses (a + b) 25,402 d) Machine Hour Rate = C2 5 , 4 0 2=Working Hours 1,200 21.17
Illustrations : 6
The following information is extracted from the budget of Amar Co. Ltd
for the 2016.
Factory Overheads Rs 93,000
Direct Labour Cost Rs1,50,000 Directed Labour Hours 2,32,500 Machines Hours 75,000 Direct Material Cost Rs3,00,000 The following details are available for job 205:
Direct Material Cost Rs 45 Direct Labour Cost Rs 50 Direct Labour Hours 40 Machine Hours 30 You are required to workout overhead application rates and ascertain the
cost of Job 205 by using the following methods of overhead application.
i) Direct Lab our Hour Rate.
ii) Direct Labour Cost.
iii) Machine Hour Rate.
iv) Prime Cost.
v) Direct Material Cost munotes.in

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Cost Accounting
102 Solution:
i) Direct Labour Hour Rate = Overhead of the DeptLaour Hours
= 93,0002,32,500
= Rs0.40 per hour
ii) Direct Lab our Cost = Overhead of the Dept×100Direct Labour Cost
= 93,0001001,50,000
= 62%
Overhead of the Dept
iv) Machine Hour Rate = ______________
Machine hou rs
= 93,00075,000
= Rs 1.24 Per Hour.
iv) Prime Cost = Overhead of the Dept×100Prime Cost
= 93,0001001,50,000 3,00,000
= 93,0001004,50,000
= 20.67%
v) Direct Material cost = Overheads of the dept×100Direct Material Cost
= 93,0001003,00,000
= 31%



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Overheads
103 Statement Showing Job Cost of Job No.205
Particulars 1 2 3 4 5
Material Cost 45.00 45.00 45.00 45.00 45.00
Labour Cost 50.00 50.00 50.00 50.00 50.00
Overheads Cost 16.00 31.00 37.20 19.63 13.95
111.00 126.00 132.20 114.63 108.95

Working Notes Overheads:
1) D L H x D L R = 40 x 0.40 = Rs 16
2) 62% of LabourCost =50 62100 = Rs 31
3) Machine Hours x MHR = 30 x 1.24 = Rs 37.20
4) Prime Cost x 20.67 95 20.67100 100 = Rs19.63
5) Material Cost 31 45 31100 100 = Rs13.95
UNDER AND OVER ABSORPTION OF OVERHEADS
MEANING
Under absorption of Overhead means the amount of overheads absorbed in
production is less than the actual overheads incurred and over absorption
of overheads means the overheads absorbed in the production is more than
the actual overheads incurred. This is made understand by the following
example.
Overheads Recovered in
Costing ` Actual
Incurred ` Over/Under
Absorption `
Factory Overheads 50,000 75,000 25,00 0 under Office Overheads 80,000 60,000 20,000 Over
Over or under absorption may arises due to the following reasons.
a) Errors in estimation of overhead expenses.
b) Errors in estimation of production level.
c) Errors in estimation of machine hours. munotes.in

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Cost Accounting
104 d) Sudden Changes in method of productive.
e) Seasonable changes in overhead expenses.
ACCOUNTING TREATMENT:
Under or over absorption of overheads may be disposed by following any
one of the methods stated:
a) Use of Supplementary Rate:
This method is used when the amount of over or under absorption of
overheads is quite large and is due to normal circumstances i.e. increase in
material price and labour rate. This can be calculated by the following
formula. Amount of Under or Over Obsorting of OverheadsSupplimentary Rate =Actual Base
b) Writing Off to Cost ing Profit and Loss A/c:
This method is used where the amount of under or over absorption of
overhead is not large or arises due to abnormal circumstances i.e.
defective planning, idle capacity. Under absorbed overhead amount is
debited to costing P & L A/ c and over absorbed amount of overhead is
credited to costing P& L A/c.
c) Carry Forwarded to Next Accounting Period:
Logically this method is not recommended as it is inconsistent with
accounting standard. Amount of under absorption of overhead is
transf erred to debit side of Reserve A/c or Suspense A/c and amount of
over absorption of overhead is created to suspense A/c or Reserve A/c.
Illustration
Factory Overhead Cost of Four Production Department of ABC Ltd as are
as follows .
Depts. Overheads
R s
P 18,300
Q 4,300
R 4,000
S 1,900
Overheads has been applied as under:
P - 15000 Machine hour @ Rs 1.50 per hour.
Q - 3000 Labour Hours @ Rs1.30 per hour munotes.in

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Overheads
105 R - 80% of Direc t Labour Cost of Rs6,000
S - 950 Pieces @ Rs 2 per piece
Calculate department wise under or over absorbed overheads.
Solution:
Calculation of Overhead absorbed
P -14000 Hrs @ Rs1.50 per hour = Rs21,000
Q -3000 La bour hours @ Rs1.30 per L. H. = Rs 3,900
R-80% o f Rs 6,000 = 6,000 x 80/100 = Rs 4,800
S -950 Piece s @ Rs 2 per Piece = 950 x 2 = Rs 1,900
Statement showing under over absorption of overheads.
Overheads
Insured
(Actual) Absorbed
Overhead
Absorption Departments
Rs Rs Under
Rs Over
Rs
P 18,300 21,000 - 2,700 Q 4,300 3,900 400 - R 4,000 4,800 - 800 S 1,900 1,900 - -
EXERCISE
1. Calculate the machine hour rate, from the following particulars.
Cost of machine - Rs 42,000
Estimated scrap v alue - Rs 2,000
Estimated w orking life -10 years 0f 2,000 hours each
Running time for a 4 week period -150 hours
Estimated r epairs for life - Rs 10,000
Standing charges allocated to this machine for a period -Rs 300
Powe r consumed per hour -5 units @ 10 paise per unit
(Ans. :Rs 11.00)



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Cost Accounting
106 2. Compute the machine hour rate from the following data .
Cost of machine : Rs 1,00,000
Installation char ges : Rs 10,000
Estimated scrap value after the expiry of its life (15 y ears : Rs 5,000
Rent and rates for the shop per month: Rs 200
General lighting for the shop per month : Rs 300
Insurance premium for thr machine per annum : Rs 960
Repairs and maintenance expenses per annum : Rs 1,000
Power consumption – 10 units per hour : -
Rate of power per 100 units : 20
Estimated working hours per annum : 2,200
(This includes non - setting up time of 200 hrs)
Shop supervisor’s salary per month : Rs 600
The machine occupies 1/4th of the total area of the shop. The supervisor is
expected to devote 1/6th of time for supervising the machine.
(Ans. :Rs 7.83 )

3. From the following data of a factory machine room, compute an
hourly machinr rate, assuming that machine room will work on 90%
capacity throughout the year and that a breakdown of 10% is reasonable.
There are three daysholiday at Deepavali, 2 days at Holi and 2 days
Christmasexclusive of holidays. The factory works 8 hours a day and 4
hours on Saturday. Number of Machines( each of the same type) – 40.
Expenses per annum Rs
Power 3,12,000
Light 64,000
Salaries to foreman 1,20,0 00
Lubrication oil ( Assumed fixed) 6,600
Repairs to machine 1,44,600
Depreciation 78,560
( Delhi University 2006)
(Ans : 9.00)

Working Notes: Hrs
 Total hours ( 365 X 80 ) 2,920
Less : Saturday only 4 weeks (52X 4 ) 208
Sundays holiday (52x8) 416
Holidays on Deepawali, Holi an d Christmas( 3+2+2) ___56__
Total 680
Machine hours worked 2,240
Less : 10% breakdown ( Normal) 224

Effective Machine Hours per Machine 2,016
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Overheads
107  Total machine hours = Effective machine hours per machine X
Number Of machines
= 2,016 x 40
= 80,640 Hrs.

4. Compute the machine hour rate from the following details.
Particulars Rs
Cost of machine1,00,000
Installation chargers 10,000
Scrap value of machine (10 yrs life ) 5,000
Rent and taxes p.m. 2,000
General lighting for the shop p. m. 3,000
Insurance premium for shop per quarter 2,400
Repairs and maintenance p.m. 1,000
Power – 10 units per hour – rate per 100 units 20
Estimated working hours p.a.2,000
Supervisor’s salary p.m. 600
Machine occupies 1/4th of the shop area and supervisor gives 1/5th of his
time for the looking after the machine.
(AnsRs 29.15)

5. The following information relates to the activities of a production of a
factory for a period.

Direct material used Rs 3,000
Direct wages Rs 7,000
Direct lahour worked 12,000 hours ( including 2,000 hours on machine)
Overcharged to the department Rs 5,000
For a particular order No. 1.2 carried out in the production department, the
relevant data were ;
Direct material used Rs 1,000
Direct wages Rs 1,500
Direct labour wor ked 240 hours
Calculate the overhead chargeable to Order No. 102 by different cost
rates.

(Ans. Prime cost method - 50%, Direct labour rate Rs - o.417 per hour,
Direct labour cost method – 71.43%, Machine hour rate -Rs. 2.50 per
hour )

6. The factory ove rhead cost of four production department of a
company engaged in executing job orders, for an accounting year, are as
follows : -



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Cost Accounting
108 Department Rs
A. 19,800
B. 4,500
C. 4,000
D. 2,000
Overhe ad has been applied as under : -
i) Dept. A Rs 3.00 per Machine Hour for 7,000 hours.
ii) Dept. B Rs 1.30 per Direct labour rate for 3,000 hours.
iii) Dept. C 70 % of Direct labour cost of Rs 7,000.
iv) Dept. D Rs 2/ - per piece , for 950 pieces.
Find out the amount of department wise Under or Over absorbed factory
overheads.
( Dept. A - Over - absorption Rs 1,200 ;
“ B - Under - absorption Rs 600;
“ C - Over - absorption Rs 900;
“ D - Under absorption Rs 100)
7. Objective Questions :
A) Multiple Choice Question:
1. Selling and distribution overheads are absorbed on the basis of
a) Rate per unit
b) Percentage on works cost
c) Percentage on selling cost
d) Any of these
2. Charging overheads to individual unit i s known as
a) Allocation
b) Apportionment
c) Absorption
d) Collection
3. Assigning code numbers to a group of overheads is called as
a) Classification munotes.in

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Overheads
109 b) Codification
c) Analysis
d) None of the above
4. Store keeping expenses are allocated on the basis of
a) No. of material requisition s
b) Area
c) Direct labour hours
d) None of the above
5. The process by which cost items are charged directly to a cost is
called
a) Absorption
b) Apportionment
c) Allocation
d) Allotment
6. Insurance is apportioned on machine on the basis of
a) Insured value of each machine
b) Invoice p rice of each machine
c) Area
d) Cost of machine
7. Office overheads are recovered as a % of
a) Direct materials
b) Direct wages
c) Factory cost
d) None of the above
8. Labour rate is followed when most of the work is done by
a) Labour
b) Machine
c) Different group of machine
d) None of th e machine
9. Which of the following is service department munotes.in

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Cost Accounting
110 a) Refining department
b) Machining department
c) Receiving department
d) Finishing department
10. When the amount of under or over absorption is significant, it
should be disposed off by
a) Transferring to costing p rofit and loss account
b) The use of supplementary rates
c) Carrying over as a deferred charge to the next accounting year
d) Either of the three
11. Factory overheads should absorbed on the basis of
a) Relationship to cost incurred
b) Direct labour hour
c) Direct labour cost
d) Machine hours
12. When the amount of overhead absorbed is less than the amount of
overhead incurred, it is called
a) Under absorption of overhead
b) Over absorption of overhead
c) Proper absorption of overhead
d) None of the above
13. What is the basis for distribution of indi rect material cost to various
department ?
a) Direct allocation
b) Cost of direct materials consumed
c) Machine hour worked
d) Either of the above




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Overheads
111 B. Fill in the blanks :
1. ___________ rate is calculated by dividing the overhead by the
aggregate of the produ ctive hours of direct workers. (The labour
hour rate)
2. _____ is the loss in value of asset due to its supervision at a date
earlier than that foreseen. (Obsonesence)
3. When amount of 0ver/0nder absorbed overheads is negligible, it is
disposed of by Transferring it to__________( Costing Profit and
Loss Account)
4. The process of grouping costs according to their common
characteristics is called________ ( Cost classification)
5. __________means allotment of whole items of cost to cost centers or
cost units.(Allocation)
6. Under /over absorption of overheads takes place when rate ______rate
of absorption is Used. ( predetermined )
8. The difference between actual and recovered overhead is termed as
_____. ( under/over Absorbed overheads)
9. Cost which can be controlled is____ cost. (controllable)
10. Repairs and maintenance is _____ expenses. ( Machine )
11. Machine hour rate is suitable when machine is a ______factor of
production. ( dominant)
12. Office overhead rate are recovered as a %age of _____ cost. ( factory
cost)
13. Percentage of direct is suitable when direct ____ is major factor of
production. ( Labour)
14. Production is suitable when output is _____.( uniform)
15. ______ cost is the aggregate of all kind o f consideration paid
payable fo r the service rendered by an e mployeeof an enterprise.
(Employee cost)
16. ______deals with principle and method of determining employee
cost . ( Cost Accounting Standard -7)
C) True or False :
1. Cost of packing is production overheads.
2. Power cost is allocated over the department on the basis of H.P. of
machine.
3. Employee welfare expenses are allocated on the basis of light points. munotes.in

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Cost Accounting
112 4. Supervisors salary is allocated on the basis of time spent.
5. Overheads includes indirect materials , labour and expenses.
6. Depreciation should be excluded from cost acco unts.
7. Factory overhead includes all production costs other than direct
materials and salaries.
8. Carriage inwards is not really an overheads at all, but is a direct cost.
9. The application of predetermined overheads rates is a reason for the
difference in cost ing and financial profit .
10. Cash discount is completely excluded from the the cost.
11. Overhead absorption is the allotment of overhead to cost unit.
12. The use of actual overhead absorption rates results in delay in
determining cost of products.
13. Direct labour co st method of absorption of factory overhead is
suitable only in those departments where work is done by manual
labour.
14. The principle base used for applying factory overhead are ; units of
production , material cost, direct wages, direct labour hours and
machine hours.
15. Administration overheads are usually absorbed as a %age of prime
cost.
16. Time factor is ignored when the cost of material is used as the basic
for absorption of overhead.
17. Predetermined rate of absorption of overhead helps in quick
preparation of cost of estimates and quoting prices.
18. Machine hour rate is not suitable for absorption of overheads if the
work is done mainly by the machine.
19. Departmentalization of overheads facilitates the control objective of
cost accounting.
20. A blanket overhead rate i s a single overhead rate computed for the
entire factory.

( Ans. - True - 2,5,8,9,10,11,12,14,16,17,19,20
False - 1,3,4,6,7,13,15,18)




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Overheads
113 D) a) Match the following
Column ‘A’ Column ‘B’
i) Rent
ii) Power
iii) Depreciation
iv) Adver tising
v) CSA -7
vi) Office salary
vii) Lighting and heating
viii) Indirect material

a) Percentage of sales
b) Capital value
c) H.P. of machine
d) Employee expenses
e) Indirect labour
f) No. of light points
g) Floor space area
occupied by each machine
h) Cost of catalogue
i) Insurance

( Ans. i) -g, ii)- c, iii) -b, iv) -a, v) –d. vi) -e, vii) -f, viii) -h)
b) Match the following
Column ‘A’ Column’B’
1) Telephone charges
2) Compensation of workers
3) Stationery
4) Repeated distribution method
5) Insurance
6) Supervision
7) Rent and rates
8) Repairs and maintenance
9) power
10) Depreciation a) Semi -variable overheads
b) Cost of each machine insured
c) Time spent on machine by
workers
d) On the basis of wages
e) Indirect material
f) Method of reapportionment of
same dept. cost
g) Floor area occupied
h) Mac hines hour
i) Meter reading
j) Sales of goods
k) Useful life of assets
l) Factory cost


(Ans. : 1) -a, 2)-c, 3)-e, 4)-f,5)-b, 6) -d, 7) -g, 8)- h, 9) -i, 10) - k
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Cost Accounting
114 c) Match the following
Column ‘A’ Column ‘B’
1. Absorption
2. Depreciation of machine
3. Under absorption of o verhead
4. Machine hour rate
5. Labour hour rate
6. Apportionment
7. Service cost centre
8. Personnel Department
9. ESI and P F contribution
10. Store Department
a. Cost Accounting Standard -3
b. Cost Accounting Standard -13
c. No. of employee
d. Direct wages
e. Weight of material issued
f. Charg ing overheads to cost unit
g. Machine expenses process
h. Recovery of less overhead
i. Recovery of more overhead
j. Machine intensive industry
k. Labour intensive industry
l. Light points

( Ans. :1 -f, 2-g, 3-h, 4-i,5- k, 6-a,7-b, 8-c,9-d,10-e )






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115 5
CLASSIFICATION OF COSTS AND COST
SHEET
Unit Structure
5.1 Background
5.2 Introduction
5.3 Definitions
5.4 Objectives of Cost Accounting
5.5 Problems with Solutions
5.1 BACKGROUND
When a person goes to any shop or groceries and he/she likes something
and shows willingness to purchase. What will be the most common
Question of that person to shopkeeper?
“Wh at’s the cost of this?”
Even if a person is asking “What’s the Cost?” the shopkeeper will tell that
person the Price and not the Cost.
You might be wondering what is the difference between Price and Cost.
Simply, Price is the value at which Seller is willi ng to Sell its Product and
Cost is the value at which Seller buys or makes that 500. Price is the one
which Customer pays to Seller and Cost is the one which Seller incurs or
pays. The difference between Selling Price and Cost is called Profit or
loss.
Let’s take an example,
A shopkeeper buys readymade product at wholesale price ` 500 per unit
and sells it to Customers at ` 700 per unit. Here ` 500 is the Cost for
the shopkeeper and ` 700 is the selling price of that product. On one
hand Seller is spending (cost) ` 500 and on the other hand he is receiving
` 700. His net gain or p rofit is ` 200 per unit.
Therefore, Sales – Cost = Profit.
5.2 INTRODUCTION:
There are broadly two types of businesses for physical goods, namely
Manufacturing business and Trading business. In manufacturing business,
Raw materials are converted into Finishe d goods using certain process,
such process/activity is called as manufacturing activity. Secondly, in munotes.in

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Cost Accounting
116 Trading business, readymade finished goods are purchased and sold by the
business entity.
Now we will look at similar but slightly differences words of C ost,
5.3 DEFINITIONS:
Cost:
According to CAS -1 (Cost Accounting Standard 1 on ‘Classification of
Cost’ issued by ICWA, India) defines Cost as, “Cost is a measurement, in
monetary terms, of the amount of resources used for the purposes of
production of goods an d rendering services”. In other words, Cost means
all the expenses that the company incur right from buying raw materials,
making finished goods and selling them and also includes after sales
services cost.
Costing:
Costing means the technique and process of ascertainment of cost
(ICMA). In simple words, the process or techniques used by business
firms are called as Costing. Costing can be done by identifying different
types of cost such as Material cost, labour cost, other overheads etc.
Cost Accounting:
The Chartered Institute of Management Accountants in England (CIMA)
has defined Cost Accounting as, 'the process of accounting for cost from
the point at which expenditure is incurred or committed to establishment
of its ultimate relationship with cost cen tres and cost units .
Cost accounting is bigger concept than Costing. It covers Costing,
Recording, Classification, reporting, controlling and analyzing.
5.4 OBJECTIVES OF COST ACCOUNTING:
1. Cost control : Theprimary an most important function of Cost
accountin g is to control the cost within the budgetary limitations as set by
management for a particular product or service. It is importantbecause
management allocates limited resources to specific projects and
production processes and every company will always tr y for controlling
the wasteful expenditure.
2. Cost computation : Cost computation is the main source of all the other
functions of cost accounting as one can calculate the figures of cost of
production or cost of sales per unit for a particular product.
3. Cost reduction : Cost computationassist the company in knowing
irrelevant or wasteful expenditure and in turn will focus on reducing those
irrelevant cost. Reduction in costs means more profits since the margin
will naturally increase. Precautions should be taken while reducing cost.
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Classification of Costs and Cost Sheet globalization. This
117 4. Fixing Selling price : One of the main reasons for calculating cost is to
calculate Selling price or to provide quotations or tenders etc. Any
businessmen wi ll try cover his cost and add some profit margin to it in
order to finalize selling price.
5. Controlling burden of inventory : Every company tries to get rid of its
inventory mainly of Finished goods. This is because Stocks are not getting
sold easily for many companies due to competition or any other reason.
Classification of Cost:
Classification of Cost by Variability or Behavior:
1. Fixed cost: Cost or expenses which remains fixed irrespective of level
of output are called as Fixed cost. E.g. Rent, Salar ies etc
2. Variable cost: Cost or Expenses which changes with change in
production is said to be as Variable cost. E.g. Raw Material, Wages
etc.
3. Semi -variable costs are costs that changes with changein the production
or sales, but which do not change in a direct proportion to units. These
costs have the features of both fixed and variable costs. It remains
fixed upto certain level, then it becomes variable. E.g. Electricity
charges, Telephone bill etc.
Classification of Cost by Element:
Material cost ref ers to the cost of commodities supplied to an undertaking
for converting those commodities into usable items i.e. Final Goods (e.g.,
in the case of a textile mill, the cost of cotton or yarn, in case of Furniture
maker wood can be called as Raw materials)
Labour cost refers to the cost of paying employees in the company, which
includes salaries, wages,commission etc.
Expenses refer to the cost of services provided to an undertaking and
include the notional cost of owned assets (e.g., rent for a building,
telephone expenses, depreciation of the owned factory building,
depreciation of delivery van, and so on).
Classification of Cost by Time:
1. Historic Cost: Costs which are incurred in past are simple called as
Historic cost.
2. Pre -determined Cost: Costs are which are determined or estimated in
advance are known as pre -determined cost. Pre -determined cost is further
classified into a. Standard Cost and b. Estimated Cost

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Cost Accounting
118 Classification of Cost for Management:
1. Imputed cost
2. Sunk cost
3. Controllable Cost
4. Uncontroll able cost
5. Avoidable Cost
6. Unavoidable cost
7. Marginal cost
8. Opportunity cost
9. Normal Cost
10. Abnormal cost etc.
OUTPUT COSTING & UNIT COSTING:
MEANING AND APPLICABILITY
When the company produces only a single item the costing method is
called output costing or sin gle costing, which is a type of unit costing.
Unit costing is used by the company when the manufacturing activity is
continuous and the units produced are homogeneous in nature. It is most
helpful and important method of costing used by concerns to know th e
CPU (Cost Per Unit of Production). Unit costing is used by many
industries where the output is expressed in various units such as numbers,
Litres, Metres, Tonnes, Kilograms etc. Thus, unit costing methods are
applicable to various concerns such as Paper Mills, Textiles, Spinning
Mills, Sugar Mills, Steel, Mines, Brick Making, Kilns, Cement Works,
Flour Mills, Breweries etc. Unit costing method is quite similar to process
costing methodbecause in both methods, identical or same item is
produced. But, pract ically Process costing is more complex in nature as
compared to unit costing.
DIFFERENT UNITS
Unit Industries Product
Kilograms (KG) Paper Mill
Sugar Mills
Spinning Mills Paper
Sugar
Yarn
Sacks Wheat Flour mills Flour
Barrels Breweries
Oil Beer, Wines
Oil
1,000 No. (1k) Brick Making Bricks
Metre/ Yards Textile Mills Cloth
Tonnes Steel
Collieries
Quarries
Mines
Kilns
Sugar Mills
Cement Steel Bars, Ingots
Coal
Stone
Mineral Ore
Lime Stones
Sugar
Cement
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Classification of Costs and Cost Sheet globalization. This
119 cost per unit
The cost per unit is obtained as f ollow:


What is an Investment Center?
An investment center is a unit of businessin a firm that can employ capital
for investment, to enhance company's profitability. It gives an additional
responsibility for capital investment and gain returns on it. Com panies can
evaluate the performance of an investment center according to the incomes
it brings in through investments in capital assets compared to the relevant
expenses. Investment Center will be allotted to a dedicated manager. He
will have to take the d ecisions regarding past, current as well as future
investment.
What is Profit centre?
Profit Centre is an individual business unit that is accountable for costs
and revenues. Logically, Revenue minus Cost is equal to profit. Some
concerns call it profit ce ntre and some call it as cost centre. Many a times,
several cost centres are linked with one Profit centre. Profit centre
manager will be liable to take the decision regarding purchases and sales
and will be expected to do both profitable manner.
An invest ment center is sometimes called an investment division.
METHODS OF COSTING

METHODS OF COSTING JOB COSTING PROCESS 1. Job Order Costing 2.Contract Costing 3. Batch Costing 1. Process Costing 2. Unit Costing 3. Operating Costing COMBINATION COMPOSITE COSTING munotes.in

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Cost Accounting
120 Treatment of Scrap
In certain manufacturing companies, scraps arisein the form of cuttings,
threading, trimmingclothes, metals or timber, etc. Scrap ge nerally can be
sold at a price. The realisable value of scrap is deductedfrom factory
expenses after recording WIP (if any) while preparing the cost sheet.
ITEMS EXCLUDED while preparing COST SHEET
Following items are not included while preparin g Cost sheet:
Purely financial items such as non -operating incomes and expenses/
losses/ appropriations like transfer to reserve, dividend). Interest paid or
received are also not recorded in Cost sheet.
Other items are as follows:
1. Any capital expenditure or receipts
2. Any abnormal/irregular items
3. Discounts
4. Cash discount
5. Transfer to reserves
6. Interest paid
7. Donations
8. Preliminary expenses writ ten off
9. Income -tax paid
10. Dividend paid
11. Provision for taxation
12. Profit / loss on sale of fixed assets
13. Provision for bad de bts
14. Damages payable at law, etc.
ADVANTAGES/MERITS OF COST SHEET
A cost sheet has the following advantages:
1. Selling price: Selling prices can be decided more accurately with the
help ofcost data provided by the cost sheet. Determination of Selling
prices can help the firm to decide on the profit margin to be kept.

2. Cost estimates: Cost estimationpossible on the basis of cost data
provided by the cost sheet, and the cost estimation may be used in a
profitable manner for the preparation and submission of pric e
quotations or tenders.

3. Cost comparisons: Comparison can bring various positive changes in
the concern. Cost sheet provides the scope for comparisons of current
costs with the costs of previous periods or with the pre -determined
standards costs.Comparison between departments or firms can also be
done with the help of cost sheet. Comparison will lead to identification
of discrepancies and appropriate action can be taken at the discretion
of management.
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Classification of Costs and Cost Sheet globalization. This
121 4. Cost per Unit (CPU) : It helps to know the cost of tot al output and the
cost per unit for the period.

5. Element -wise cost: It reveals the break -up or components of the total
cost i.e., the different elements or items of cost comprised in the total
cost.
FORMAT: COST SHEET
The Format of cos t sheet based on the latest, mandatory cost accounting
standards would appear as follows:
COST SHEET
Particulars RS. RS.
I. DIRECT EXPENSES
1. Direct materials:
Opening stock of raw materials
Add: purchases of raw materials
Carriage inwards
expenses on fr eight etc.
Less: closing stock of raw materials Raw
materials consumed (RMC)
2. Direct wages
3. Other Direct expenses
PRIME COST (1+2+3) xx xx xx xx (xx)



xx xx xx xxx II. INDIRECT EXPENSES:

1. Works/Factory overheads
Less: sale of scraps/ wa ste/ recoveries
Work in progress:
Add: opening stock
Less: closing stock
WORK COST (Prime Cost + Factory)
2. Office/Administrative Expenses
COST OF PRODUCTION
Add: Opening Stock of Finished Goods
Less: Closing Stock of Finished Goods
COST OF GOODS SOLD

3. Selling & Distribution Overheads
Total Cost
+ Profit / - Loss
Net Sales (Gross sales – Sales returns) xx (xx) xx xx (xx)






xx xx xx xx xx (xx) xx xx xx x xxx
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Cost Accounting
122 5.5 PROBLEMS WITH SOLUTIONS:
Problem No.: 1
From the books of accounts of M/s. Bejaan E nterprises, the following
details have been extracted for the year Ending 31 -3-2022:
Particulars Amt.
Opening Stock ofR`aw Materials
Octroi Duty on Raw materials
Closing Stock of Materials
Purchases Of Materials
Direct Labour
Direct Expenses
Indirect Mate rials
Salaries
Buying expenses for Raw materials
Advertisements
Director’s Salary
General expenses
Depreciation on office building
Legal Charges for Criminal case on the enterprise
Commission
Fuel
Electricity Charges (Factory)
General Manager’s Remuneratio n
Repairs To Machinery
Rent, Rates and Taxes – Factory
Rent, Rates and Taxes – Office
Depreciation On Machinery
Depreciation On Furniture
Salesmen’s Salaries
Audit Fees
Catalogue printing charges
Depreciation on Delivery Van 2,30,000 10,000 3,00,000 12,78, 000 3,20,000 1,57,600 24,000 60,000 48,000 30,000 72,000 37,200 10,000 20,000 28,000 96,000 72,000 36,000 63,000 18,000 9,600 45,000 3,600 50,000 18,000 10,000 10,000
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Classification of Costs and Cost Sheet globalization. This
123 1) The Director’s time is shared between the factory and the office in
the ratio of 1:4.
2) Selling price is 120% of the cost price.
From the above details prepare detailed cost sheet for the quarter ending
31-12-2022 and ascertain sales:
Solution 1:
In the Books of M/s. Bejaan Enterprises
Cost sheet for the year ended 31st March, 2022
Particul ars Rs. Rs.
I. DIRECT EXPENSES
1. Raw Materials
Opening Stock of Materials 2,30,000
Octroi Duty on Raw materials 10,000
Purchases Of Materials 12,78,000
Buying expenses for Raw materials 48,000
15,66,000
Less: Closing Stock of Ma terials 3,00,000
RMC 12,66,000 2. Direct Labour 3,20,000 3. Direct Expenses 1,57,600 PRIME COST 17,43,600
II. INDIRECT EXPENSES
1. Works Overheads
Indirect Materials 24,000
Director’s Salary (1/5th) 14,400
Fuel 96,000
Electricity Charges (Factory) 72,000
Repairs To Machinery 63,000
Rent, Rates and Taxes – Factory 18,000
Depreciation On Machinery 45,000
3,32,400 WORKS COST 20,76,000 2. Administrative Overheads
Salaries 60,000
Director’s Sal ary (4/5th) 57,600
Depreciation on office building 10,000
General expenses 37,200 munotes.in

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Cost Accounting
124 General Manager’s Remuneration 36,000
Rent, Rates and Taxes – Office 9,600
Depreciation On Furniture 3,600
Audit Fees 18,000
2,32,000 COST OF PRODUCT ION / COGS 23,08,000 3. Selling and Distribution Overheads
Advertisements 30,000
Catalogue printing charges 10,000
Depreciation on Delivery Van 10,000
Commission 28,000
Salesman Salaries 50,000
1,28,000 TOTAL COST/ COST OF SALES 24,36,000 Add: Profit 6,09,000 Sales (125% of 24,36,000) 30,45,000
Problem No. 2: (Reverse calculation to find sales)
M/S. Chauhan manufacturing company manufacturing two types of
products viz. A and B. The information for the year ended on 31st March,
2022 is as under.
Particulars Products
A Rs. B Rs.
Direct material per unit 120 100 Direct labour per unit 50 60 Direct expenses per unit 80 40
Additional information:
1. Factory expenses are charged at 25% of prime cost.
2. Office expenses are char ged at 20% of work cost
3. 2,000 units of product A were produced of which 1,500 units were
sold and 5,000 units of product B were produced of which 4,500
unit were sold.
4. Selling expenses are Rs. 15 per unit for product A and Rs. 20 per
unit for product B.
5. Company wants to charge profit at 20% on sales for both the
products A and B.
Prepare a cost sheet showing the cost and profit in total as well as in
per unit. munotes.in

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Classification of Costs and Cost Sheet globalization. This
125 Solution 2 :
M/S CHAUHAN MANUFACTURING COMPANY
Cost Sheet For The Year Ended 31 -3-2022,,




Particulars PRODUCT A PRODUCT B
Calculations Rs. Cost
Rs. Unit
Cost
Rs. Calculations Rs. Cost
Rs. Unit
Cost
Rs.
Direct Materials
Direct Wages
Direct Expenses
PRIME COST
Factory
Overheads
(25% Of
Prime Cost)
WORK COST
Office Overheads
(20% Of
Work Cost)
COST OF
PRODUCTION
Less: Closing
Stock
Of Finished
Goods
COST OF
GOODS
SOLD
Selling
Overheads
COST OF
SALES
PROFIT
(20% On Sales
i.e.
5,85,000x20/80
&
14,40,000x20/80) SALES 120x2000
50x2000
80x2000









375x500


15x1500 2,40,000 1,00,000 1,60,000 5,00,000 1,25,00 0
6,25,000 1,25,000

7,50,000
1,87,500
5,62,500 22,500
5,85,000


1,46,250 7,31,250 120.00 50.00
80.00
250.00 62.50

312.50 62.50


375.00


375.00 15.00
390.00


97.5
487.50 100x5000
60x5000
40x5000









300x500


20x4500 5,00,000
3,00,000
2,00,000
10,00,000
2,50,000

12,50,000
2,50,000


15,00,000

1,50,000

13,50,000
90,000
14,40,000



3,60,000
18,00,000 100.00 60.00
40.00
200.00 50.00

250.00 50.00


300.00


300.00 20.00
320.00


80.00
400.00 munotes.in

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Cost Accounting
126 Problem No. 3:
The Trading & Profit and Loss Account of Vilas Manufacturing
Company for the year ending 31 -12-2022 was as Follows:
Trading Profit & Loss A/c For the Year Ended 31 -12-2022
Dr. Cr.
Particulars Amt Particular Amt
To Raw Material
Purchased
To Direct Wages
To Direct Expenses
To Factory Expenses
To Gross Profit c/d

To Office Salaries
To Office Rent
To Selling Expenses
To Preliminary
Expenses Written Off
To Goodwill Written
Off
To Net Profit c/d 80,000
30,000
25,000
40,000
80,000
2,55,00 0
25,000
12,000
12,500

22,500
25,500
40,000
1,37,500
By Sales (2500 Units)
By Closing Stock Of
Raw Material



By Gross Profit B/D
By Dividend
Received
By Discount Received 2,50,000

5,000


2,55,000
80,000
40,000
17,500




1,37,500
For The Year 2023, It Is Estimated That –
1. Units produced and sold will rise by 10%.
2. Prices of raw material per unit will rise by 10%.
3. Direct wages per unit will increases by 25%.
4. Direct expenses will increase by Rs.5,000 in total.
5. Works overheads per unit will increase by 2 5%.
6. The office premises which was on rental basis in 2022 would be
purchased by the company, on which depreciation would be
Rs.6,000 in 2023.
7. Selling expenses per unit will remain same. munotes.in

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Classification of Costs and Cost Sheet globalization. This
127 You are required to prepare a statement showing estimated cost and pro fit
for the year ended 31 -12-2023 considering that company shall charge a
profit at 20% on sale.
Solution 3:
VILAS MANUFACTURING COMPANY
Cost sheet showing present and estimated cost

Working notes:
1. Units To Be Produced In 2022 will rise by 20% i.e. 2,500+500 =
3,000.
2. Per unit cost of raw material in 2022, will increases by 10% in 2023
i.e. 30+10% of Rs. 30 = Rs. 33.
3. Per unit direct wages will increases by 25% i.e 12+25% = 15
4. Per unit cost of factory expenses will increase by 25% in 2023 i.e Rs.
16 = Rs. 20.
5. Salary is assumed to be the same in 2023 as in 2022.

Particulars 2022
2500 Units 2023
3000 Units
Total
Cost
Rs. Unit Cost
Rs. Total
Cost
Rs. Unit Cost Rs.
A. Direct M aterials
B. Direct Wages
C. Direct Expenses
D.PRIME COST
E.WorkOverheads
F.FACTORY
COST
G.Administrative
Exp.
Office Salaries
Office Rent
Depreciation

H. COST OF
PRODUCTION
I.Selling Expenses
J. COST OF
SALES
K. PROFIT
L. SALES 75,000 30,000 25,000 1,30,000 40,000 1,70,000 25,000 12,000 --- 37,000 2,07,000 12,500 2,19,500 30,500 2,50,000 30.00 12.00 10.00 52.00 16.00 68.00 14.80 82.80 5.00 87.80 12.20 100.00 99,000 45,000 30,000 1,74,000 60,000 2,34,000 25,000 -- 6,000 31,000 2,65,00 0 15,000 2,80,000 70,000 3,50,000 33.00 15.00 10.00 58.00 20.00 78.00 10.33 88.33 5.00 93.33 23.33 116.66 munotes.in

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Cost Accounting
128 6. The premises which was on rental basis in 2022 is assumed to be
purchased in 2023 and hence office rent will not appear in 2023.
Instead, depreciation of Rs. 6,000 would be charged.
7. Preliminary expenses written off and goodwill written off are financial
expenses/ loses and hence ignored in the cost sheet.
8. Dividend received and discount received are financial incomes and
hence ignored in the cost sheet.
9. Profit for year 2022 is a balancing figure. For year 2023 profit is 20%
on sa les i.e 80 (cost) + 20 (profit) = 100 (S.P.). Profit is ¼ or 20% of
cost in 2023.
Problem No. 4:
Trading and Profit and Loss Account of AK & co.
For the year ended 31stMarch 2022.
Dr. Cr.
Particulars Amt Particulars Amt
To Raw Materials
Consumed
To Direct Wages
To Works Overheads
To Gross Profit c/d

To Office Rent
To General Expenses
To Management
Expenses
To Goodwill W/Off
To Advertisement
To Salesman
Commission
To Interest on Loan
To Net Profit c/d 3,75,000 2,25,000 3,00,00 6,00,00 15,00,000 90,000 75,000 60,000 32,500 1,31,250 1,50,000 24,500 76,750 6,40,000 By Sales (15,000
Units)




By Gross Profit b/d
By Dividend
Received
By Interest On
Investment 15,00,000 15,00,000 6,00,000 23,500 16,500 6,40,000
For the year ending 31st march, 2023 the following Assumptions have
been made:
A. Production and sales units will be doubled.
B. Direct material cost per unit will rise by 20%.
C. Direct wages per unit wi ll increase by 40% munotes.in

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Classification of Costs and Cost Sheet globalization. This
129 D. Of the factory overheads, Rs. 1,50,000 are fixed and would remain
at the same level but variable thereof would be in same proportion
to direct wages as in 2022.
E.Total office and administrative overheads would increase by 40%.
F. Selling and distribution overheads per unit will increase by 20%.
G. Selling price per unit would rise by 10%.
You are required to prepare:
I. Cost sheet for the year ended 31st march,2022 showing cost per unit
and total cost and
II. Projected cost sheet for the year ending 31st march,2023 showing
cost per unit and total cost.
Solution 4:
Cost sheet


Particulars 31-3-2022
Units: 15,000 31-3-2023
Units: 30,000
Rs. Rate per
Unit
Rs. Rs. Rate per
Unit
Rs.
Direct Materials
Direct Wages
PRIME COST
Add: factory overheads
Fixed
Variable
Total Works Overheads
WORKS COST
Add: Office
/Administrative
Overheads
Office Rent
General expenses
Management expenses
Total administrative
overheads
COST OF
PRODUCTION
Add: Selling Overheads
Advertisements
Salesmen Commission
Total Selling Overheads
TOTAL COST
Add: Profit
SALES 3,75,000 2,25,000 25.00 15.00 9,00,000 6,30,000 30.00 21.00 6,00,000 1,50,000 1,50,000 40.00 10.00 10.00 15,30,000 1,50,000 4,20,000 51.00 5.00 14.00 3,00,000 20.00 5,70,000 19.00 9,00,000 90,000 75,000 60,000 60.00 - - - 21,00,000 - - - 70.00 - - - 2,25,000 15.00 3,15,000 10.50 11,25,000 1,31,250 1,50,000 2,81,250 14,06,250 93,750 15,00,000 75.00 8.75 10.00 18.75 93.75 6.25 100.00 24,15,000 3,15,000 3,60,000 6,75,000 30,90,000 2,10,000 33,00,000 80.50 10.50 12.00 22.50 103.00 7.00 110.00 munotes.in

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Cost Accounting
130 Problem No.: 5
From the Following Particulars prepare cost sheet showing various
elements of cost.
Particulars
Opening Stock of Raw Material 1,10,000 Purchase of Raw Materials 8,25,000 Carriage outwards 25,000 Direct Wages 4,20,000 Direct Power 25,000 Technical Directors Salary 40,000 Factory Rent Rates and Insurance 20,000 Sale of Factory sc rap 10,000 Depreciation on Factory Buildings 25,000 Factory Stationery 30,000 Closing Stock of Raw Material 1,00,000 Opening Stock of Finished Goods 1,50,000 Stationery and Printing 20,000 Staff Salaries 2,50,000 Office rent 50,000 Free Sa mple 12,000 Closing Stock of Finished Goods 1,00,000
Sales are made to earn a profit @ 10 % on Cost Price




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Classification of Costs and Cost Sheet globalization. This
131 COST SHEET
Particulars Rs. Rs.
I. DIRECT EXPENSES
1. Raw Materials
Opening Stock of Materials 1,10,000
Purchases Of Materi als 8,25,000
9,35,000
Less: Closing Stock of Materials -1,00,000
RMC 8,35,000
2. Direct Labour 4,20,000 3. Direct Expenses (Direct power) 25,000 PRIME COST 12,80,000
II. INDIRECT EXPENSES
1. Works Overheads
Technical Directors Salary 40,000
Factory Rent Rates and Insurance 20,000
Depreciation on Factory Buildings 25,000
Factory Stationery 30,000
1,15,000
Less: Sale of Scrap -10,000
1,05,000 WORKS COST 13,85,000 2. Administrative Ove rheads
Stationery and Printing 20,000
Staff Salaries 2,50,000
Office rent 50,000
3,20,000 COST OF PRODUCTION / COGS 17,05,000 Opening Stock of Finished Goods 1,50,000 Less: Closing Stock of Finished Goods -1,00,000 COST OF GOOD S SOLD 17,55,000 3. Selling and Distribution Overheads
Carriage outwards 25,000
Free Sample 12,000
37,000 TOTAL COST/ COST OF SALES 17,92,000 Add: Profit 1,79,200 Sales 19,71,200 munotes.in

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Cost Accounting
132 PRACTICE PROBLEMS:
Problem No. 6:
Following de tails are furnished by AIKALtd. Of expenses incurred during
the year ended 31st March, 2022.
Particulars Amt.
Direct material
Opening stock of finished goods (5,000 units)
Closing stock of finished goods (1,000 units)
Depreciation on Machinery
Loss on sal e of Fixed Assets
Trade fair expenses
Direct expenses
General manager’s salary
Dividend paid
Direct wages
Advertisement
Depreciation on computers
Drawing and designing expenses
Purchase of machinery
Depreciation on delivery van
Office maintenance charges
Factory maintenance
Sales (24,000 units) 3,00,000 80,000 ? 96,000 17,500 87,000 1,60,000 4,00,000 7,800 2,40,000 1,50,000 1,70,000 84,000 1,90,000 1,14,000 1,98,000 1,45,000 22,80,000
Closing stock of finished goods to be valued at cost of production.
You are required to prepare cost sheet showing various elements of cost
both in total and per unit and also find out total profit and per unit profit.
Problem No. 7:
From the following details prepare COST SHEET showing Cost per unit
and Total cost column.
Bharat Engineering Company manufactured and sold 1,000 machines in
2022. Following are the particulars obtained from the records of the
company:
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Classification of Costs and Cost Sheet globalization. This
133 Cost of materials 80,000
Wages paid 1,20,000
Manufacturing expenses 50,000
Salaries 60,000
Rent , rates and insurance 10,000
Selling expenses 30,000
General expenses 20,000
Sales 4,00,000
The company plans to manufacture 1,200machines in 2023.
You are required to submit a statement showing the price at which
machines would be sold so at to show a profit of 10% on the selling price.
It was estimated that:
(a) The price of materials will rise by 20%.
(b) Wage rates will rise by 5%.
(c) Manufacturing expenses will rise in proportion to the combined cost of
materials and wages.
(d) Selling exp enses per unit will remain unchanged.
(e) Other expenses will remain unaffected by the rise in output.
Problem No. 8:
From the Following information prepare detailed cost statement showing
various elements of cost.
Particulars
Opening Stock of Finished goods 80,000 Purchase of Raw Materials 7,50,000 Carriage outwards 15,000 Direct Power 1,20,000 Direct Wages 2,25,000 Directors Fees 2,00,000 Rent, Rates and Insurance 26,000 Workmen Salaries 10,000 Depreciation n Fa ctory Buildings 25,000 Fees paid to Brand ambassador 89,000 munotes.in

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Cost Accounting
134
Interest on Loan (Outstanding) 45,000 Assets Loss by fire 30,000 Closing Stock of Raw Material 1,00,000 Opening Stock of Raw Materials 1,25,000 Raw materials returned to suppliers 10,00 0 Stationery and Printing 25,000 Staff Salaries 2,50,000 Maintenance of Factory building 85,000 Office rent 50,000 Goodwill Written off 12,345 Advertisements 12,000 Closing Stock of Finished Goods 1,00,000
Director devotes his time equally b etween Factory and Office.
Sales are made to earn a profit @ 20 % on Cost Price.
Hint: Drawing office Salary is a Factory expenses.
Problem No. 9:
From the following details prepare Cost Sheet showing Cost per unit and
Total cost column.
M/s. 360 Company manufactured and sold 2,000 units of Finished goodsin
the year 2020 -2021.
Following are the particulars obtained from the records of the company:

Cost of materials 1,20,000 Wages paid 80,000 Factory Rent 50,000 Repairs and Depreciation of
Computer s 25,000 Royalties 10,000 Indirect Materials 15,000 Salaries 10,000 Salesmen Salaries 80,000 Rent, rates and insurance 60,000 Other Selling expenses 10,000 Other office Expenses 25,000 munotes.in

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Classification of Costs and Cost Sheet globalization. This
135

Sales are made to earn 15% profit on cost.
Prepare cost sheet a nd show:
Prime Cost, Works Cost, Cost of Production, Cost of Sales and Profit.
Problem No. 10:
Prepare Cost sheet from the following particulars.
Raw Material
Direct Wages
Direct Expenses
Factory Rent
Factory Manager salaries
Depreciation on Machinery
Office Salaries
Printing & Stationery
Advertisement
Sales Commission
Profit
Sales 35,000 20,000 15,000 5,000 2,000 3,000 4,000 5,000 4,000 7,000 ??? 1,30,000 Ignore Units and CPU.
Problem No.: 11
ABCD Ltd. supplies you the following information and require s you
to prepare a cost sheet.
Stock of raw materials 65,000
Stock of raw materials 90,500
Direct wages 32,500
Indirect wages 12,750
Sales 2,50,000 Factory lighting 15,000 Telephone charges 2,000 General ex penses 20,000 Loose tools written off 12,000 Selling commission 8,000 Purchase of Machinery 2,50,000 Bad Debts 20,000 Legal charges criminal Suits 15,000 Advertising 12,000 Sales ? munotes.in

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Cost Accounting
136 Work -in-progress 26,000
Work -in-progress 35,000
Purchases of raw materials 67,000
Factory rent, rates and power 12,000
Depreciation of plant and machinery 2,500
Expenses on purchases 3,500
Carriage outward 2,500
Advertising 5,500
Office rent and taxes 12,500
Travellers’ wages and commission 10,500
Opening stock o f Finished Goods 54,000
Closing Stock of Finished Goods 45,000
Problem No.: 12
From the following information for the month of December, prepare a cost
sheet to show the following components: (a) Prime Cost , (b) Factory Cost
, (c) Cost of Product io n, (d) Total Cost. (e) Profit
Direct material 37,000
Direct wages 1,18,500
Factory rent and rates 2,500
Office rent and rates 2,500
Plant repairs and maintenance 1,700
Plant depreciation 1,250
Factory heating and lighting 4,000
Factory manager’s salary 3,000
Office salaries 12,600
Director’s remuneration 11,500
Telephone and postage 2,200
Printingand stationery 8,100
Legal charges 1,050
Advertisement 2,200
Salesmen’s salaries 2,500
Showroom rent 5,100
Sales 1,66,000

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Classification of Costs and Cost Sheet globalization. This
137 Problem No.: 13
From the following particulars of M/s Rama Raju, prepare a cost sheet:
Stock, 01 -04-2022: Raw materials 30,500 Finished goods 20,400
Stock, 31 -03-2023: Raw materials 48,500 Finished goods 10,000
Purchase of raw materials 45,000
Work -in-progress, 1 -4-2022 18,000
Work -in-progress, 31 -3-2023 19,000
Net Sales 1,15,000
Direct wages 22,400
Factory Rent 8,500
Office Rent 4,400
Showroom Rent 5,800
Distribution expenses 12,500
Also calculate the percentage of works expenses to dire ct wages and the
percentage of officeexpenses to works cost.


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138 6
RECONCILIATION OF COST AND
FINANCIAL ACCOUNTS
Unit Structure
6.0 Objectives
6.1 Introduction
6.2 Need for Reconciliation
6.3 Importance of Reconciliation
6.4 Methods of Reconciliation
6.5 Solved Problems
6.6 Exercises
6.7 References
6.0 OBJECTIVES
After studying the unit the students will be able to:
• Ascertain the difference between Profit as shown by FinancialProfit and
Loss Account and Profit appearing in Costing Profit &Loss Account.
• Identify and quantify the cost components, which contribute t othe
difference in profit figures.
• Prepare a statement reconciling the two profit figures reportedby
financial and cost records.
6.1 INTRODUCTION
The word ‘Reconcile’ means to tally, conciliate, harmonize, bring together
or equate. The term reconciliatio n applies to the reconciliation of the
results of the business profit or loss as shown by the financial accounting
records and the cost accounting records. Cost accounts and financial
accounts are maintained in two different sets of books, there will be
prepared two profit and loss accounts - one for costing books and the other
for financial books. The profit or loss shown by costing books may not
agree with that shown by financial books. Such a system is termed as,
‘Non - Integral System’. where two sets of accounting systems are being
maintained, the profit shown by the two sets of accounts may not agree
with each other. The difference in purpose and approach generally results
in a different profit figure thus arises the need for the reconciliation of
profi t figures given by the cost accounts and financial accounts. In
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Reconciliation of Cost and
Financial Accounts
139 cost and financial accounts are maintained separately, the difference
between the result of these two are required to be re conciled.
Reconciliation of cost and financial accounts mean tallying the profit
orlossrevealed by both set of accounts. The chief aim is to find out the
reasons for the difference between the results shown by Cost Accounts
and FinancialAccounts.
6.2 NEED FOR RECONCILIATION
The various reasons which create difference between cost and financial
profit or loss shown by the two set of books may be listed under the
following heads:
(1) Items shown only in FinancialAccounts
(2) Items shown only in CostAccounts
(3) Absorptio n of Overheads
(4) Methods of StockValuation
(5) Abnormal Loss andGains
(1) Items shown only in Financial Accounts: Some items of income and
expenses which are included only in financial accounts but are not shown
in cost accounts and vice versa. The following ite ms are shown in
financial accounts but not in cost accounts:
(A) Income:
(1) Profit on sale of fixedassets
(2) Interest received oninvestment
(3) Dividend received oninvestment
(4) Rent, brokerage and commissionreceived
(5) Premium on issue ofshares
(6) Transfer feesreceived.
(B) Expendi ture:
(1) Loss on sale of fixed assets, e.g., Plant, Machinery, Buildingetc.
(2) Interestpaid
(3) Discountpaid
(4) Dividendpaid
(5) Losses due to scrapping of plant andmachinery
(6) Penalties and,fines munotes.in

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Cost Accounting
140 (7) Expenses of shares' transferfees
(8) Preliminary expenses writtenoff
(9) Damages payab le atlaw.
(2) Items shown only in Cost Accounts: There are some items which are
recorded only in Cost Accounts but are not included in financial accounts,
national interest on capital, notional rent of premises owned, salary to
proprietor etc. are not recorded in financial account because the amount is
not actuallyspent or paid. These expenses reduced the profit in cost
account while in financial account it may be the reverse effect.
(3) Absorption of Overheads: In financial accounts actual amount of
expenses paid are recorded while in cost accounts overheads are charged
at predetermined rates. If overhead charged are not equal to the amount of
overhead incurred the under or over absorption of overhead leads to
difference in profits of two accounts.
(4) Methods of Stock Valuation: The term stock refers to opening or
closing stock of raw materials, work in progress and finished goods. In
financial accounts stocks are valued at cost price or market price
whichever is lower. In Cost Account; stock of raw materials can be va lued
based on FIFO, LIFO and Simple Average Method etc., and workin g
progress maybe valued at Prime Costor Work Cost. Finished stocks are
generally valued on the basis of cost of production. Thus, the adaptation of
different method of valuation of stock le ads to difference in profits of two
sets ofaccounts.
(5) Abnormal Losses and Gains: Different items of abnormal wastages,
losses or gains which are included in financial accounts but are not
recorded in cost accounts. Thus, the figures of abnormal losses and g ains
may affect the results in financial accountsalone.
6.3 IMPORTANCE OF RECONCILIATION
Reconciliation of cost and financial account is necessary for the following
reasons :
(1) To ensure arithmetical accuracy of both set of accounts for effective
cost ascert ainment and cost control.
(2) To identify the reasons for different results in two sets ofaccounts.
(3) To evaluate the reasons for variations for effective internalcontrol.
(4) To enable the smooth co -operation and co -ordination between the
activities of cost and fin ancial accountingdepartments.
(5) To ensure the standardization of policies relating to stock valuation,
depreciation and absorption ofoverheads.
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Reconciliation of Cost and
Financial Accounts
141 6.4 METHODS OF RECONCILIATION
Reconciliation of financial accounts and cost accounts can be presented
using any of th e following two methods i.e.
(1) Statement of Reconciliation or Reconciliation statement
(2) Memorandum Reconciliation Account.
6.4.1 Reconciliation Statement - Reconciliation statement is a statement
which exhibits the items to be added or subtracted to bring the balance
profit/loss of cost books in agreement with the profit/loss as disclosed in
financial books. So, the purpose of preparing reconciliation statement is to
reconcile the profit/loss as per cost accounts with the profits/loss as per
financia l accounting by ascertaining and adjusting all causes of differences
between the two.
6.4.2 Procedure of Preparing reconciliation Statement –
This procedure consists of the following steps :
Step 1 - Start with taking any one of the figure of profit/loss (either as per
cost books or financial books) which may be called base profit figure.
Step 2 - Secondly, the various reasons of disagreement (as discussed in the
preceding section) between the profits disclosed by two sets of books in a
particular case are ascertained.
Step 3 - Add those items of difference which have the effect of increasing
profits in other set of books to the base profit figure (from which we
started in step 1) (such items may be called '+' items)
Step 4 - Subtract those items of disagre ement from the base profit figure
which have the effect of lowering profits in other set of books. (such items
may be called ‘ -’ items).
The resultant figure after making all the above mentioned adjustments (if
all the calculations are computably and arith metically correct) will be the
profit or loss as per other set of books.
Proforma Reconciliation Statement - Suppose we start taking the profits as
per cost accounts as base profits figure, the reconciliation statement can be
exhibited / presented as given below.





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Cost Accounting
142 6.4.3 Proforma Reconciliation Statement
(When profits as per Cost Accounts is taken as Starting point or base
figure).
Particulars Amount (`) Amount
(`)
A. Profits as per cost accounts
B. Add : items having the effect of
higher profits in financial accounts
(a) over-absorption of factory, office and
selling and distribution over -heads
(b) Items charged in cost accounts only
eg.
- Notional Rent
- Notional Interest or Salaries
(c) Over -valuation of opening stocks in
cost a/cs
(d) Under -valuation of closing stocks in
cost a/cs
(e) Purely financial incomes excluded
from cost a/cs
- Interest & dividends received
- Rent or transfer fees received
C. Less : items having the effect of lower
profits in fina ncial accounts
(a) Under absorption of factory, office
and selling and distribution overheads
(b) Under -valuation of opening stock in
cost a/cs
(c) Over -valuation of Closing stock in
cost a/cs
(d) Purely financial charges excluded
from cost a/cs eg Legal charges,
donations, preliminary expenses
written off
(e) Depreciation under - charged in cost
accounts
D. Profits as per financial accounts.

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Reconciliation of Cost and
Financial Accounts
143 Tutorial Note :
In cases we have losses in cost accounting records then the figure of lo ss
as a starting point can be put as ‘minus’ or ‘ -ive’ figure. The implication
of this will be that sum of ‘+’ items (items to be added) will be deducted
and sum of ‘ -’ items (items to be subtracted) will be added to the base
figure of loss to arrive at th e resultant figure (which is the profit/loss as per
financial books).
Proforma Reconciliation Statement (When profits as per financial
accounts are taken as base profits figure)
6.4.4 Memorandum Reconciliation Account
Memorandum Reconciliation Account perf orms the same function of
reconciling two figures of profits disclosed by financial accounts and cost
accounts as is accomplished by preparing reconciliation statement.
Memorandum Reconciliation Account, basically, is the presentation of
reconciliation sta tement in ‘T’ shape account form. It is called
memorandum account because it does not form part of double entry.
Steps in preparation of Memorandum Reconciliation Account
Four basic steps of preparing the Memorandum Reconciliation Account
are encapsulated in the following lines:
Step 1. At first, base profit figure, say, profits as per cost account is placed
on the credit side of the account and if costing books reveal a loss, it is to
be put on the debit side of the memorandum reconciliation account.
Step 2. All items which are to be added for reconciliation purpose will be
shown on the credit side of the account. For instance, if we are starting
from costing book's profits, the following items will be shown on the
credit side :
(a) Purely financial income s included in financial accounts
(b) Over -absorption of overheads in cost accounts
(c) Over -valuation of opening stock in cost accounts
(d) Under valuation of closing stock in cost accounts.
Step 3. All those items which are to be subtracted from base p rofit figure
will be shown on the debit side of Memorandum Reconciliation Account.
A list of the items to be shown on debit side in case, we start the procedure
from profits as per cost accounts is given below :
(a) Purely financial charges (as lis ted in the preceding section)
excluded from cost accounts.
(b) Under absorption of overheads in cost accounts
(c) Over -Valuation of closing stock in cost accounts
(d) Under -Valuation of opening stock in cost accounts. munotes.in

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Cost Accounting
144 Step 4. The balancing figure after placing all the items as described in first
3 steps is determined and should match with the figure of profits/loss as
per financial accounts (if all the computations are arithmetically correct).
If sum of credit side items > sum of debit side, items, balan cing figure is
profit. If sum of debit side > sum of credit side items, balancing figure is
loss, as per financial accounts.
Proforma of Memorandum Reconciliation Account, if starting Point of the
procedure is profits as per cost books, is given below :
DR. Memorandum Reconciliation A/c CR.
Particulars Amount
(`) Particulars Amount
(`)
To Loss as per cost
accounts By profits as per cost
accounts
To purely financial
charges By purely financial
income
Discount on issue of
shares written off Rent Received
Preliminary expenses
written off Interest Received
Underwriter's
Commission Profits on sale of fixed
assets
Fines & Penalties Dividend
Donation Transfer fee received
Bank interest By items cha rged in
cost accounts only.
To depreciation under
charged in cost a/cs By Excess of
depreciation charged in
cost books.
To under -absorption of
overheads By over -absorption of
overheads
To under -valuation of
opening stock in cost
a/cs By over -valuation of
opening stock in cost
a/cs.
To over -valuation of
closing stock in cost a/cs By under -valuation of
closing stock in cost
a/cs.
To profits as per
financial a/cs By Loss as per financial
a/c.
(Balancing figure when
sum of credit items >
sum of debit items) (Balancing figure when
sum of Debit items >
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Reconciliation of Cost and
Financial Accounts
145
The following table will help to prepare the reconciliation of cost and
financial accounts:
Treatment of Causes for Differences
Suitable Adjust ments



S. No.

Reasons For Differences Base is Costing
Pmfit or Financial
Loss (+) or ( — ) Base is Financial Profit or Costing loss (+) or ( — )
l. Over absorption of overhead in Cost Account Add
Add
Add
Add

Add



Less Less
2. Over valuation of closing stock in Financial Less ( —) 3. Account
4. Over valuation of opening stock in Cost Account Excess provision for depreciation of building
5. plant & machinery etc., charged in Cost Account Items of expenses charged in Cost Account
but not in Financial Accounts (Example
6. Notional interest on Capital, Notional rent on Premises) Items of income recorded in

7.
8.
9. Financial Account but not in Cost Account Under absorption of overhead in Financial
Account
Over valuation of opening stock in Financial Account Add (+)
Add (+)
Add (+) 10. Over valuation of closing stock in Cost Account
Item of income tax, dividend paid, preliminary expenses written off, goodwill written off, under writing Add (+)
commission and debenture discount written off and any
appropriation of profit included in Financial Account
only.

6.5 SOLVED EXAMPLES
1 The book of Cost accounts of Ms. D Bros shows profit of Rs.
1,20,000 for the year ending 31 -3-2020, some of the expenses and
incomes are given. Describe what effects they would have in
reconciliation statement.

Here – profit as per financial accounts is not given, we will start with cost
books and will show the effect on the basis of books of cost accounts so
our book is Cost accounts.






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Cost Accounting
146 Solution

Particulars Cost
Books Financial
Books Difference Effect
Factory
Overheads 15,000 16,000 1,000 Expenses are less
in our b ooks,
hence Rs1,000
will be deducted
Office
Overheads 25,000 23,500 1,500 Expenses are
more in our
books, hence
Rs.1,500 will be
added
Selling
Overheads 36,700 36,700 0 Expenses are
equal in both
books, hence
there will be no
effect
Opening
Stock 10,500 10,000 500 Opening stock
shown on debit
side, so effect
will be same as in
case of expense,
it is more Rs.500
will be added
Closing
Stock 36,500 35,000 1,500 Closing stock
shown on credit
side, so effect
will be same as in
case of income, it
is more Rs.1 ,500
will be deducted.
Debenture
Interest -- 3,000 3,000 No expenses are
recorded in our
books, so full
difference of Rs
3,000 will be
deducted
Interest on
Investment -- 26,000 26,000 No Incomes are
recorded in our
books, so full
difference of Rs
26,000 will be
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Reconciliation of Cost and
Financial Accounts
147
2 From the following particulars prepare a reconciliation statement: -
Particulars Rs. Net Profit as per financial records
Net Profit as per costing records
Works overheads under recovered in costing
Administrative Overheads recovered in excess in costing Deprecation charged in financial accounts
Depreciation recovered in Cost Accounts
Interest received but not included in Cost Accounting
Obsolescence loss charged in financial records
Income tax provided in financial books
Bank in terest credited in financial books
Stores adjustment credited in financial books
Depreciation of stock charged in financial books 154506 206880 3744 2040 13440 15000 9600 6840 48360 900 570 8100
Solution
RECONCILIATION STATEMENT

Particulars Rs. Rs.
Net Profit as per costing records
Add:
1. Administrative Overheads over absorbed
2. Depreciation excess charged
3. Income not credited in costing - Interest received 15,000 Bank interest 900
Stores adjustment 470
Total

Less
1. Works overheads under recovered
2. Expenses not charged in costing books9600
3. Income tax provided in Financial Book 48360
4. Depreciation of Stock charged in Financ ial Book
8100 2040 1560 16470 3744 66060 206880 20070 226950 69804 Net Profit as per financial books 157146 munotes.in

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Cost Accounting
148 3 from the following particulars Prepare :
A) Statement of cost of Manufacture for the year ended 31stMarch,
2021.
B) Statement of Profit as per cost accounts.
C) Profit and Loss Account in the financial books and
D) Show how you would attribute the difference in the profit as shown
by (b) and (c)
Particulars Rs.
Opening stock of Raw materials 2,88,000
Opening stock of Finished goods 5,76,000
Purchase of Raw materials 17,28,000 Stock of Raw materials at the end 4,32,000
Stock of Finished goods at the end 1,44,000
Wages 7,20,000

Calculate Factory on cost at 20% on prime cost, and office on cost at 80%
on factory on cost. Actual wo rk expenses amounted to Rs. 4,54,300 and
office expenses amounted to Rs. 3,71,900. The selling price was fixed at a
profit of 20% on cost.
Solution:
Notes :
A) Cost of Materials used, wages and sales are shown at the same
amount both in Cost and Financial Acc ounts.
B) If no other information is given, under that the value of closing stock
of finished goods are considered at the same amount in both types of
books.





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Reconciliation of Cost and
Financial Accounts
149 Statement of cost of Manufacture (COST SHEET)
Particulars Rs. Rs.
Opening stock of Raw materi als 2,88,000 Add : Purchase of Raw materials 17,28,000 20,16,000 Less: Closing stock of Raw materials 4,32,000 Materials consumed 15,84,000 Wages 7,20,000 Prime cost 23,04,000 Factory on cost (20% of Prime cost) 4,60,800 Factory cost 27,64,800 Office on cost (80% of Factory on cost) 3,68,640 Cost of Production 31,33,440 Opening stock of Finished goods 5,76,000 37,09,440 Closing stock of Finished goods 1,44,000 Cost of sales 35,65,440 Sales (cost + 20% profit) 42,78,528 Prof it 7,13,088
Profit and Loss Account in Financial Books
Particulars Rs. Particulars Rs.
To opening stock: By Sales 42,78,528 Raw materials:
2,88,000 Closing Stock:
Finished Goods :
5,76,000 8,64,000 Raw materials:
4,32,000
Purchase of Raw
materials 17,28,000 Finished goods: 1,44,000 5,76,000
Wages 7,20,000
Work expenses 4,54,300
Office expenses 3,71,900
Net profit 7,16,328
48,24,528 48,24,528

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Cost Accounting
150 Reconciliation Statement
Particulars Rs.
Profit as per cost accounts 7,13,088 Add : Factory on cost charges over recovered in cost accounts (4,60,800 -4,54,300) 6,500 7,19,588 Less : Office on cost charges under recovered in Cost Accounts (3,71,900 – 3,68,640) 3,260 Profit as per financial Accounts 7,16,328
3 From the f ollowing Profit & loss account draw up a Memorandum
Reconciliation account showing the Profit as per Cost Accounts: -

4 Particulars Amt
Rs Particulars Amt rs.
5 To Office Salaries
6 To Office Expenses
7 To Salary to
Salesmen
8 To Sales Expenses
9 To Distribution Exp.
10 To Loss on Sale of
Machinery
11 To Fines
12 To Discount
13 To Net Profit c/d
14
15
16 To Income Tax
17 ToTransfer to
Reserves
18 To Dividend
19 ToBalance c/d 11282 6514 4922 9304 2990 1950 200 100 17936 55198 8000 1000 4800 4136 17936 20 By Gross Profit
21 By Dividend
received
22 By Intere st on
Bank FD











23 By Net Profit
b/d
54648 400 150 55198 17936 24
25
26 17936
The cost accountant has ascertained a Profit of Rs.19636 as per his books.
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Reconciliation of Cost and
Financial Accounts
151 Solution
MEMORENDUM RECONCILIATION A/C

PARTICULARS AMT
RS. PARTICULARS AMT
RS.
To Expen ses not debited
toCost accounts:
Fines
Discount
Loss on sale of
Machinery
Income Tax
Tr. to Reserves
Dividend
To Net Profit c/d


200 100 1950 8000 1000 4800 4136 By Profit as per cost
account
By Income not credited
in
Cost accounts:
Dividend Receiv ed
Interest on Bank FD

19636 400 150 20186 20186
6. The following figures are extracted from the financial accounts of a
manufacturing firm for the first year of its operation :
Particulars Amt rs.
Direct material consumption
Direct wages
Factory overheads
Administration overheads
Selling and Distribution overheads Bad debts
Preliminary expenses written off
Legal Charges
Dividends received
Interest on Deposit received
Sales – 1,20,000 units
Closing stock :
Finished stock 4,000 units
Work-in-progress 50,00,000 30,00,000 16,00,000 7,00,000 9,60,000 80,000 40,000 10,000 1,00,000 20,000 1,20,000 3,20,000 2,40,000 munotes.in

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Cost Accounting
152 The cost accounts for the same period reveal that the direct material
consumption was Rs.56,00,000;
Factory overhead is recov ered at 20% on Prime Cost:
Administration overhead is recovered @ Rs. 6 per unit of production;
Selling and Distribution overheads are recovered @ Rs. 8 per unit sold.
You are required to prepare Costing and Financial Profit and Loss
Accounts and reconcile the difference in the profits as arrived at in the two
sets of accounts.
Solution cost sheet
Particulars Amt rs.
Direct Materials
Direct Wages
Prime cost
Factory overhead 20% on Prime cost

Less Work -in-progress (Closing stock)
Works Cost
Administ ration overhead Rs. 6 per unit
of production: 1,20,000 + 4,000
Cost of Production
Less Closing stock

Add Selling and distribution expenses @ Rs. 8per
unit i.e. 1,20,000 × 8
Cost of Goods sold
Profit
Sales 56,00,000 30,00,000 86,00,000 17,20.000 1.03,20,000 2,40,000 1,00,80,000 7,44,000 1,08,24,000 3,49,161 1,04,74,839 9,60,000 1,14,34,839 5,65,161 1,20,00,000

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Reconciliation of Cost and
Financial Accounts
153 Profit and Loss A/c
Particulars Rs. Particulars Rs.
To Direct Materials
To Direct Wages
To Factory overheads
To Gross Profit 50,00 ,000 30,00,000 16,00,000 29,60,000 By Sales
By Closing
stock:
Finished Stock
WIP 1,20,00,000 3,20,000 2,40,000 1,25,60,000 1,25,60,000 To Administration
Overheads
To Selling and Distribution
To Bad debts
To Preliminary Expenses
To Legal Charges
To Net Profit 7,00,000 9,60,000 80,000 40,000 10,000 12,90,000 By Gross Profit By Dividends
By Interest
29,60,000 1,00,000 20,90,000 30,80,000 30,80,000
Reconciliation Statement
Particulars Rs. Rs.
Profit as per cost accounts
Add
Dividend no t taken in costing.
Interest not take in costing
Excess of Direct materials consumed.
Over -absorbed in Costing:
(a) Factory overheads
(b) Administration overheads

Less
Bad Debts taken in Financial
Accounts but not in costing
Preliminary expenses ta ken in Financial
Accounting, but not in costing
Legal charges taken in financial but not in costing Different in closing stock
(3,49,161 -3,20,000)
Profit as per Financial Accounts
1,00,000 20,000 6,00,000 1,20,000 44,000 80,000 40,000 10,000 29,161 5,65,161 8,84,000 14,49,161 1,59,161 12,90,000

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Cost Accounting
154 6.5 EXERCISE
1. What is the need for reconciliation of cost and financialaccounts?
2. Discuss the main sources of difference between Profit shownby cost
accounts and that as per financial ac counts.
3. Objective type questions;
A. Multiple choice questions:
1. Dividend received is shown in _________
i) costing profit and loss A/c iii) Ignored
ii) financial profit and loss A/c iv) None of the above
2. Over valuation of closing stock in Cost A ccounts ---------------- .
i) Increases costing profit iii) Decreases costing profit
ii) Increases financial profit iv) Decreases financial profit
3. Over absorption of overheads in financial accounting
i) Decreases financial profit iii) Increases costin g profit
ii) Increases financial profit iv) Both (i) & (ii)
4. Under valuation of opening stock in costing
i) Increases costing profit iii) Decreases costing profit
ii) Decreases financial profit iv) Both (i) & (ii)
5. Donations paid is
i) Debited to c osting P & L A/c iii) Ignored in costing
ii) Debited to financial P & L A/c iv) (ii) & (iii)
Answers: ii, i, i, iii, ii.
B. True or false
1. Under absorption of overheads in cost accounting decreasescosting
profit.
2. Interest received on Bank Deposit is ignored in cost accounting.
3. Interest on investment increases Costing profit.
4. Dividend paid on share capital is debited to financial P & L A/c.
5. Over absorption of overheads in financial accounting decreasesthe
costing profit. munotes.in

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Reconciliation of Cost and
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155 6. Cost accounting co nsiders the Loss or profit on sale of capitalassets.
7. Abnormal loss has considered in costing.
8. Fines and penalties reduce the financial profit.
9. Interest or Dividend received increases financial profit.
10.Overvaluation of opening stock in Financial Accounting
reducesfinancial profit.
11.Under valuation of closing stock in costing increases costingprofit.
12.Difference in Depreciation in costing and financial
accountingdistinguishes costing profit from financing profit.
Answers:
False, True, False, T rue, False, False, true, true, true, true, false, true.
C Fill in the blanks
1. Premium on issue of shares is shown in -------------- accounts only.
2. Transfer to General Reserve is purely -------------- item.
3. Interest on Bank Deposits is Credited in ----------------- .
4. Overheads recovered more than actual in costing is called as_________.
5. Overheads recovered less than actual in financial accounting is called as
_________.
6. Interest on capital reduces _________ profit.
7. Under absorption of overh eads in costing increases _________profit.
8. Over valuation of closing stock in financial accounting
increases_________ profit.
9. Under valuation of closing stock in costing decreases_________ profit.
10.Over absorption of overheads in financial accounti ng decreases
_________ profit.
11.Under absorption of overheads in costing increases _________profit.
12.Dividend paid on shares is debited to _________ P & L A/c.
Answers:
financial accounts, financial, financial P&L A/c., over absorption
ofoverheads in c osting, under absorption of overheads in
financialaccounting, financial profits, costing profit, financial profits,
costingprofits, financial profits, costing profits, financial.
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Cost Accounting
156 Practical Questions
1 The following particulars are available from financial a ccounts of
Big Beng Manuf. Co. for the year ending 31st March 2021:
Particulars Rs.
Materials consumed Direct Wages
Factory expenses
Office expenses
Selling expenses 3,00,000 1,80,000 1,20,000 1,50,000 30,000 7,80,000
In cost accounts materials and wa ges are charged at actual cost but factory
overheads are recovered at 70% of direct wages and office overheads are
recovered at 30% of the factory cost, while selling overheadsare recovered
at Rs.12 per unit sold.
There was no stock of finished goods at th e beginning of the years. During
the year 1,200 units were produced, out of which 1,000 units were sold at
Rs.10,00,000.
You are required to prepare :
1) Statement showing Profit and Loss a/c as per Financial Accounts.
2) Statement showing Profit and Loss a/c as per Cost Accounts
3) Statement showing Reconciliation of Profit and Loss
2 Profit and Loss a/c of Dev Ltd. For the year ended on 31st March 2021 :
Profit and Loss Account
Particulars Amount -
Rs Particulars Amount –
Rs.
To opening
stock(1000 units)
Direct M aterials
Direct Labour
Factory overheads
Office overheads
Selling overheads
Penal interest
Discount on shares
To net profit 26,000 4,00,000 2,30,000 1,45,000 1,60,000 85,000 7,000 9,000 60,000 By sales (15,500
units)
By Closing stock
(500 units)
Interest i ncome
Brokerage 10,85,000 20,000 1,000 16,000 11,22,000 11,22,000 . munotes.in

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Reconciliation of Cost and
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157 Direct Labour and Materials are charged on actual basis in cost accounts.
Factory overheads are recovered at 70% of direct labour and office
overheads at 25% of factory cost. Selling expenses are recovered at Rs.7
per unit.
Opening stock is valued at Rs.25 per unit in cost accounts. Closing stock
consists of units produced during the year.
Prepare:
1) Cost sheet for the year ended 31st March 2021
2) Factory, Office and Sales overheads acco unts
3) Reconciliation Statement of net profit as per financial and cost accounts
[Ans. Loss as per cost sheet Rs.4,292 and Closing stock Rs. 32,958
(9,88,750 X 500/15,000)]

3 The following figures are extracted from the financial accounts of
Mumbai Ltd. For t he year ending 31st March 2021:
Particulars Amt Rs.
Sales (20,000 units)
Materials
Wages
Factory overheads
Administrative overheads
Selling and Distribution overheads Closing Stock :
Finished goods (1,230 units)
Work – in – progress
Goodwill written off
Interest on debentures 50,00,000 20,00,000 10,00,000 9,00,000
5,20,000
3,60,000

3,00,000
1,40,000
4,00,000
40,000

In the cost records factory overheads is charged at 100% of wages,
administrative overheads at 10% of factory cost and selling and
distribut ion overhead at the rate of Rs.20 per unit sold.

Prepare a Statement of Reconciling the profit as per cost records with the
profit as per financial records.
[Ans. Profit as per cost accounts Rs. 6,00,000, Profit as per financial
accounts Rs.2,20,000, clos ing stock as per cost accounts Rs.2,46,000]

4 The following is the Trading and Profit and Loss Account of ABC
Ltd. For the year ending 31st March 2021. munotes.in

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Cost Accounting
158 Trading and P & L A/c

Particulars Rs. Particulars Rs.
To opening stock
(1,200 units)
Direct Materials
Direct Labour
Production expenses
Gross profit 48,000 2,00,000 1,50,000 1,80,000 4,38,600 By sales
Closing stock of
(2,200 units) 9,00,000 1,16,600 10,16,600 10,16,600 Administrative
expenses
Selling and
distribution expenses
Bad debts
Loss on sale of assets
Penalty
Debenture interest
Preliminary expenses
written off
Net profit 1,35,000 14,000 18,000 3,000 35,000 15,000 1,75,000 Gross profit
Interest and
dividend
Profit on sale of
investments 4,38,600 11,400 30,000
4,80,000 4,80,000
In cost ac counts materials and labours are charged at actual cost. The cost
accounts present the following information :
Direct materials per unit Rs.20
Direct labour per unit Rs.15
Opening stock of finished goods Rs. 58,500
The production overheads are re covered at 50% of prime cost while
administrative and selling and distribution overeads are recovered at Rs.15
per unit.
You are required to prepare
1) Find out profit as per cost accounts
2) A statement reconciling profit disclosed by Cost accounts and
Financia l accounts.
[Ans. Profit as per cost accounts Rs. 1,80,000, Factory overheads
Rs.1,75,000, Admin exp. Rs.1,50,000, closing stock Rs.1,48,500
Start with profit as per cost accounts add rs. 1,16,900 (int &divi
Rs.11,400 + Profit on Sale of investments Rs.30, 000 + Admin exp over munotes.in

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Reconciliation of Cost and
Financial Accounts
159 recovered Rs.15,000 + diff in op. stock Rs. 10,500 + Selling exp over
recovered Rs.50,000) = Rs2,96,600 Less Rs 1,21,900 (Bad debts
Rs.14,000 + Loss on Sale of assets Rs.18,000 + penalty Rs.3,000 + Deb
interest Rs.35,000 +Prelim exp Rs .5,000 + Diff in closing stock
Rs.31,900)]
5 The following is the cost per unit of XYZ ltd. Per unit cost is Rs.810
which is allocated as follows:
Rs
Materials 400
Wages 200
Factory overheads (based on prime cost) 150
Administrativ e overheads 40
Selling overheads 20

The following is the profit and loss a/c of company
Particulars Rs. Particulars Rs
Opening stock
(Finished goods
1,000 units)
Materials
Labour
Factory expenses
Gross profit 4,00,000 60,00,000 30,00 ,000 16,00,000 42,40,000 By sales (10,000
units)
Closing stock
(Finished goods
6,000 units) 1,10,00,000 42,40,000 1,52,40,000 1,52,40,000 Office expenses
Selling expenses
Provision for tax
Goodwill written
off
Net profit 2,80,000 2,20,000 1,40,000 40,000 37,60,000 By gross profit
Interest and
discount 42,40,000 2,00,000 44,40,000 44,40,000 Prepare Cost Statement and Reconciliation Statement
[Ans. Production units 15,000 (10,000+6,000 -1,000), Profit as per cost
A/cs Rs.32,90,000, closing stock as pe r cost a/c Rs.47,40,000 (6,000
units x per unit Rs.790). Start with profit as per cost A/c. Add: over
recovery of factory exp Rs.6,50,000 + Over recovery of office exp
Rs.3,20,000 + Int and discount received Rs.2,00,000: Less : Selling
Exp under recovered Rs.20,000 + Goodwill written off Rs.40,000 + munotes.in

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Cost Accounting
160 Provision for Tax Rs.1,40,000 + Diff in closing stock Rs.5,00,000 =
37,60,000 Profit as per financial A/c]
6 Suppose works expenses are absorbed at 60% of labour and office
expenses at 20% of works cost.
Actual to tal expenditure incurred is as follows :

Rs.
Materials 1,00,000
Labour 75,000
Factory expenses 50,000
Office expenses 40,000
Assuming that 10% of output is still in stock and sales amounts to
2,50,000

Prepare :
a) Profit as per Financial Statement
b) Profit as per cost statement
c) Reconciliation statement
[Ans. As per cost accounts : net profit Rs. 12,400, works exp Rs.
45,000, office exp Rs. 44,000 and closing stock of finished goods
Rs.26,400 (10% of p roduction cost Rs. 2,64,000), profit as per
financial a/c : net profit Rs. 7,500, closing stock of finished goods Rs.
22,500 (10% of works cost Rs. 2,25,000). Start Reconciliation
Statement with profit as per cost a/c : Add Office overheads Rs. 4,000
less : Factory overheads Rs. 5,000 and difference in value of closing
stock Rs. 3,900]
6.7 REFERENCES
1) Cost Accounting : Principles & Practice M N Arora Vikas Pub House.
2) Practical Costing :N.K.Sharma : Shree Niwas Pub
3) Cost Accouting : Dr P C Tulsian : S Chand
4) Cost A ccounting : Dr Murthdy& S Gurusamy : The McGraw Hill Co.

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