UA&FFSI.2 – Cost Accounting – Introduction and Elements of Cost – I-munotes

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INTRODUCTION TO COST ACCOUNTING
Unit structure
1.0 Objectives
1.1 Evolution
1.2 Objectives and Scope of Cost Accounting
1.3 Importance and Advantages of Cost Accounting
1.4 Difference between Cost Accounting and Financial Accounting
1.5 Limitations of Financial Accounting
1.6 Definitions: Cost, Costing and Cost Accounting
1.7 Classification of Cost on Different Bases
1.8 Cost Allocation and Apportionment
1.9 Coding System
1.10 Essentials of Good Costing System
1.11 Cost Centre and Units
1.12 Element s of Costs
1.13 Summary
1.14 Exercise
1.0 OBJECTIVES
After studying this unit students will be able to:
Understand the need and importance of Cost Accounting
Know the meaning of Cost, Costing and Cost Accounting
Explain the objectives of Cost Accounting
Understand the classification of Cost
Discuss about the Elements of Cost
Know the methods of Costing
1.1 EVOLUTION:
Introduction
Cost Accounting is the system of accounting which is concerned
with determination of costs of doing something which can be
manufacturing or rendering service or even conduc ting any activity or
function. The objective of Cost Accounting is to render detailed and useful
information for guidance to the Management.munotes.in

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2Financial accounting is developed over the time to record,
summa rise and present the financial transaction or events which can be
expressed in terms of money. This function was primarily concerned with
record keeping, leading to preparation of Profit and Loss Account and
Balance Sheet. The information obtained throug h financial statements is
useful to the Management or Owner in several respects. However, the
information provided by financial accounting is not sufficient for several
purposes of decision making in many areas such as : determining output
level, determin ing product selection –addition or dropping or changing
product combination in the case of multi product company, determining or
revising prices of products, whether Profit earned is optimum as compared
with competitors and in comparison to earlier years. The need of data for
such details lead to the development of Cost Accounting.
The age of the industrial revolution resulted in the first swept of
large businesses and organizations. So these organizations were more
complex and dynamic. So the origin and evolution of cost accounting can
be traced back to the industrial revolution. The idea was to help the
businessmen to record and keep a track of their costs and expenses. This is
what lead to the invention of what is now the modern cost accounting
process in use. The period 1880 AD -1925 AD saw the development of
complex product designs and the emergence of multi activity diversified
corporations like Du Pont, General Motors etc. It was during this period
that scientific management was developed which led the accountants to
convert physical standards into Cost Standards, the latter being used for
variance analysis and control. During the World War I and II the social
importance of Cost Accounting grew with the growth of each country’s
defence expenditure. I n the absence of competitive markets for most of the
material required for war, the governments in several countries placed
cost-plus contracts under which the price to be paid was cost of production
plus an agreed rate of profit. The reliance on cost esti mation by parties to
defence contracts continued after World War II.
In addition to the above, the following factors have made
accountants to find new techniques to serve the industry:
(i) Limitations placed on financial accounting
(ii) Improved cost cons ciousness
(iii) Rapid industrial development after industrial revolution and world
wars
(iv) Growing competition among the manufacturers
(v) To control galloping price rise, the cost of computing the precise cost
of product / service
(vi) To control cost s everal legislations passed throughout the world and
India too such as Essential Commodities Act, Industrial
Development and Regulation Act...etcmunotes.in

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3Due to the above factors, the Cost Accounting has emerged as a
speacialised discipline from the initial years of 20th century i.e after
World War I and II.
1.2 OBJECTIVES AND SCOPE OF COST ACCOUNTING
1.2.1 Objectives of Cost Accounting are as follows:
1)To Ascertain the Cost : To ascertain the cost of product or a services
reveled and enable measurement of pro fit by proper valuation of
inventory.
2)To Analyse Costs : To analysis costs or to classify the expenses under
different heads of accounts viz. material, labour, expenses etc.
3)To Allocate and Apportion the Costs : To allocate or charge the
direct ex penses or specific costs such as Raw Material, Labour to
particular product, contract or process and to distribute common
expenses to each product, contract or process on a suitable basis.
4)Cost Reporting : Cost Reporting or presentation includes :
a) What to report i.e. what is the nature of information to be
presented?
b) Whom to Report i.e. to whom the report is to be addressed.
c) When to Report i.e. when the report is to be presented i.e. Daily
weekly monthly yearly etc.
d) How to Report i.e. i n what format the report is to be presented.
5)To Assist the Management : Cost Accounting assist the management
in:
a)Indicating to the management any inefficiencies and extent of
various forms of waste of Raw Material, Time, Expenses etc.
b)Fixing of selli ng price.
c)Providing information to enable management to take decision of
various types.
d)Controlling Inventory of Raw Material, goods in process, finished
goods, spares and consumables etc.
6)Cost Control : Cost Accounting assist the management in cost
control. Cost control includes the following stages.
a)Setting up of targets of cast and production for each period.
b)Measuring the actual figures of performance relating to cost,
production etc. for the period concerned.munotes.in

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4c)The figures of actual performance are to be compared with the
targets to find out the variation.
d)Analysing the variance, whether favourable or adverse.
e)Immediate action has to be taken in case of adverse variation.
7)Optimum Product Mix : Advise the management in deciding
optimum product mix merits and demerits of alterative courses of
action viz. make of buy decisions, introduction or Automation
mechanization, rationalization, system of production etc.
8)Future Policies : Advise management on future policies regarding
Expansion, growth, ca pital investment, etc.
1.2.2 Scope of Cost Accountancy
The scope of Cost Accountancy is very wide and includes the following: -
(a) Cost Ascertainment: The main objective of Cost Accounting is to find
out the Cost of product/services rendered with reason able degree of
accuracy.
(b) Cost Accounting: It is the process of Accounting for Cost which begins
with recording of expenditure and ends with preparation of statistical
data.
(c) Cost Control: It is the process of regulating the action so as to keep the
element of cost within the set parameters.
(d) Cost Reports: This is the ultimate function of Cost Accounting. These
reports are primarily prepared for use by the management at different
levels. Cost reports helps in planning and control, performance
appra isal and managerial decision making.
(e) Cost Audit: Cost Audit is the verification of correctness of Cost
Accounts and check on the adherence to the Cost Accounting plan. Its
purpose is not only to ensure the arithmetic accuracy of cost records
but also t o see the principles and rules have been applied correctly.
To appreciate fully the objectives and scope of Cost Accounting, it
would be useful to examine the position of Cost Accounting in the
broader field of general accounting and other sciences. i.e Fi nancial
Accounting, Management Accounting, Engineering and Service
Industry.
1.3 IMPORTANCE AND ADVANTAGES OF COST
ACCOUNTING
The importance and advantages of cost accounting are presented
below:munotes.in

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51. Helps in controlling cost: Cost accounting helps in con trolling cost by
applying some techniques such as standard costing and budgetary
control.
2. Provides necessary cost information: It provides necessary cost
information to the management for planning, implements and
controlling.
3. Ascertains the total per unit cost of production: It ascertains the total
and per unit cost of production of goods and services that helps to fix
the selling prices as well.
4. Introduces cost reduction programs: It helps to introduce and implement
different cost reduction progra ms.
5. Discloses the profitable and non profitable activities: It discloses the
profitable and non profitable activities that enable management to
decide to eliminate or control unprofitable activities and expand or
develop the profitable activities.
6. Pr ovides information for the comparison of cost: It provides reliable
data and information which enable the comparison of cost between
periods, volume of output, determent and processes.
7. Checks the accuracy of financial accounts: It helps checking the
accuracy of financial accounts. This is done by preparing cost
reconciliation statement.
8. Helps investing and financial institutions: It is also advantageous to
investment and financial institutions since it discloses the profitability
and financial positio n in which they intend to invest.
9. Beneficial to workers: It is beneficial to workers as well since it
emphasizes the efficient utilization of labour and scientific systems of
wages payment.
1.4DIFFERENCE BETWEEN COST ACCOUNTING
AND FINANCIAL ACCOUNTINGMeaningThe cost accounting
system is an accounting
system that captures the
profitability of different
products, processes or
projects, etc.Financial accounting is anaccounting system thatcaptures the overallprofitability of the companyand the financial position ofthe company and maintainsthe transparency of business.DependencyIt is depending on the
information provided by
financial accounting.It does not depend on theinformation provided by costaccounting.munotes.in

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6Type of
data usedIt is used both ty pes of
data historical cost and
pre-determined cost.It uses historical cost only.ObjectiveThe main objective of
cost accounting is to find
out per unit cost of
product, projects, or
process.The main objective offinancial accounting is toprovide accurate financialresults and financial positionof the company to externalstakeholders.EstimateCost accounting is based
on a comparison of
estimate and actual data.Financial accounting recordsthe only actual transaction.There is no place forestimatio n.Reporting
periodThe reporting period of
cost accounting is done
as per the requirement of
management.The reporting period offinancial accounting is at theend of each financial year.The reporting period offinancial accounting is usuallyyearly.Valuation
of inventoryInventory should be
valued at always cost
under the cost
accounting.Inventory should be valued at‘cost or market pricewhichever is less’.Fixation of
the selling
priceCost accounting provides
sufficient information
which helpful for setting
up the selling price of
products and services.Fixation of the selling price isnot an objective of financialaccounting.End resultsThe end result of cost
accounting is the cost
sheet of the product.The end result of financialaccounting isthe incomestatement (also known asprofit and loss account) andthe balance sheet of thecompany.UsersUsers of the information
provided by cost
accounting are used by
only internal
management such asUsers of the informationprovided by financialaccounting are used byinternal management as wellas external users such asmunotes.in

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7employees, directors,
managers, and
supervisors, et c.shareholders, bankers,suppliers, and customers.ForecastingUnder cost accounting,
forecasting is possible
using budgeting
techniques.There is no technique forforecasting.MandatoryCost accounting is not
compulsory for all
companies. It is
applicable to the only big
company.Financial accounting iscompulsory for all companies.
1.5 LIMITATIONS OF FINANCIAL ACCOUNTING
1.Historical in Nature: Financial accounting is based upon historical cost
method, which means that financial accounting requires recording of the
financial transactions at the cost of purchase or acquisition of the product
or asset.
It fails to recognize the fact that the product or asset may have a
completely different market value as on date. The products or assets may
fetch a little value if disposed of at the current date or vice versa.
This limitation ends up providing an inaccurate picture to the user
of the financial statement.
2.Overall Profitability: Moving on to the profitability aspect, it is crucial
to understand that financial accounting gives financial information on an
overall entity basis.
In other words, it provides information concerning the business of
the entity as a whole; it does not give financial information per product or
department or job.
3.Segmental Reporting: An entity could also be doing business under
several different segments. Consequently, the entity earns revenue from
these segments and incurs costs to run these businesses.
Financial Accounting does not provide any information or inputs,
i.e., the profit margin per segment and the costs specific to those segments,
respectively.munotes.in

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8Financial accounting fails to consider t he fact that all types of
businesses have differentiable profit margins and also that each business
has a unique requirement of costs under various heads.
Additionally, it becomes a cumbersome process to trace which
segment is the most profitable unit an d which is the least profit earning or
a sick unit.
4.Inflation Impact: Financial accounting requires recording assets on a
historical cost basis. The same applies to long term wealth -generating
assets as well.
In an economy with relatively high inflati on, financial accounting
entails risk by not adjusting such assets towards inflation changes, thus
exhibiting a not so strong balance sheet of the entity to the extent of these
long-term assets.
5.Fixed Period Financial Statements Information: Financial a ccounting
requires the preparation of financial statements for a specific period.
The user may not get a correct view of the financial information by
merely referring to the specific period financial statement. Also, the
business cash flows vary on accou nt of any sudden changes or the
business being seasonal.
Thus, the user will be required to refer to financial reports about
different periods along with to get the correct picture of the business.
6.Fraud and Window Dressing: To showcase a powerful fin ancial net
worth, the accountant or the management may resort to window dress the
financial statements.
In such a scenario, it will be difficult for the user to know this fact,
and the user may make the decision based on such financial statements
that do not give an accurate and fair view of the state of a business carried
on.
7.Non-Financial Aspects: The first and foremost important aspect of
financial accounting is that it records only those transactions which can be
measured in monetary terms.
It has no scope for the recording transactions, which are, although
non-monetary, but have an important effect on running the business.
Factors such as employee efficiency, market competition, laws,
and statute governing the business, economic and political s cenarios,
affect the business operations. However, they find no place in financial
accounts of the entity.munotes.in

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98.Intangible Assets: Financial accounting does not recognize many
intangible assets. Intangible assets such as brand value, goodwill, and
developmen t of new assets find no place in financial statements.
On the contrary, it requires creating a charge towards the
expenditure incurred on generating these intangible assets.
This gives a very weak picture of the balance sheet and impacts the
net worth of those organizations which are highly invested in assets but
low on sales.
It is a major problem for many start -ups being IT -based companies
invested heavily in intellectual property.
9.Audit Concerns: Various business entities are working on a small and
medium level considering the level of operations of such businesses, and
avoiding unnecessary hardships, the audit is not mandatory, provided they
fall under the specified category.
This small and medium business, however, does have to prepare
financ ial statements but are simply not required to be audited.
In the absence of an audit, it is not just that they have followed the
policies and principles appropriately. Thus, leading to the question of
whether the financial statements are reliable?
10.Future’s Prediction: The whole financial statements theory is
formulated on the historical cost basis and specific to the period as
required by statute.
In simple words, all the financial data is based on past transactions
and provides no scope for analyzi ng on what shall be the expected or
future viability of the business.
It does not provide any information on the stability or growth
aspects of the business in the years to come.
11.Comparability: To compare the financial statements of different
compani es, the accounting policies followed by the companies must be the
same.
However, that’s not the case practically, as accounting policies
involve the use of judgments and experience, and the same can vary from
entity to entity based on different business models and different
accountants having unique expertise and competence.
12.Personal Biases: Although the books of accounts are prepared to keep
in mind the accounting principles, a lot of these principles require the
accountant to use his judgment and ex perience in practical cases.munotes.in

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10Thus, the basis on which the principles have been applied may
differ based on the varied experience and competence of the accountant
involved in the preparation of the financial statements.
1.6 DEFINITIONS: COST, COSTING AND COST
ACCOUNTING
1.6.1 Cost:
Institute of Cost and Works Accountants of India, defines cost as
“measurement, in monetary terms, of the amount of resources used for the
purpose of production of goods or rendering services”.
Thus the term cost means the a mount of expenditure, actual or notional
incurred or attributable to a given thing. It can be regarded as the price
paid for attaining the objective. For e.g. Material cost is the price of
materials acquired for manufacturing a product.
1.6.2 Costing:
The term costing has been defined as “the techniques and
processes of ascertainment of costs. Whelden has defined costing as, “the
classifying recording and appropriate allocation of expenditure for the
determination of costs the relation of these costs to sale value and the
ascertainment of profitability.”
Therefore costing involves the following steps.
1.Ascertaining and Collecting of Costs
2.Analysis or Classification of Costs
3.Allocating total costs to a particular thing i.e. product, a contract or
a process.
Thus costing simply means cost finding by any process or technique.
1.6.3 Cost Accounting:
Cost Accounting is a formal system of accounting by means of which
cost of products or service, are ascertained and controlled.
Whelden defines Cost Acc ounting as, “Classifying, recording and
appropriate allocation of expenditure for determination of costs of
products or services and for the presentation of suitably arranged data for
the purpose of control and guidance of management.”
Therefore, Cost A ccounting is the application of costing principles,
methods and techniques in the ascertainment of costs and analysis of
savings or / and excesses as compared with previous experience or with
standards. It provides, detailed cost information to various le vels of
management for efficient performance of their functions. The information
supplied by Cost Accounting as a tool of management for makingmunotes.in

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11optimum use of scarce resources and ultimately add to the profitability of
business.
1.7 CLASSIFICATION OF COS T:-
Classification is the process of grouping costs according to their
common characteristics. It is a systematic placement of like items
together according to their common features. There are various ways of
classifying costs, according to their commo n features as given below.
Chart showing classification of cost :
Classification of Cost
Manufacturing
CostAdministrationCostSelling and
Distribution
CostResearch andDevelopment
CostDirect
Cost
Fixed
CostOn the basis of
behaviour of c ost
Variable
CostSemi -Variable
CostOnthe basis of
Identification
Indirect
CostOn the basis of
Control liability
ControllableCostUncontrollableCostOn the basis
of Time
Historical
CostPredetermined
Cost
On the basis of
function
ConversionCostOther Basis
Norm al
CostAvoidable
CostUnavoidable
CostProduct
CostPeriod
Costmunotes.in

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12IOn the basis of Identification:
On the basis of identification of cost with cost units or jobs or
processes, costs are clas sified into –
1.Direct Costs : These are the costs which are incurred for and
conveniently identified with a particular cost unit process or
department. These are the expenditures which can be directly
allocated to a particular job, product or an activity . E.g. Cost of Raw
Material used, wages paid to labourers etc.
2.Indirect Costs : These are general costs and are incurred for the benefit
of a number of cost units, processes or departments. These costs can
not be conveniently identified with a particul ar cost unit or cost centre.
Example : Depreciation of Machinery, Insurance, Lighting, Power,
Rent of Building, Managerial Salaries, etc.
II On the basis of behaviour of Cost
Behaviour means change in cost due to change in output. Costs
behave differen tly when the level of production rises or falls. Certain
costs change in direct proportion with production level while other costs
remain unchanged. As such on the basis of behaviour of cost –costs are
classified into
1)Fixed Costs : It is that portio n of the total cost which remain constant
irrespective of output upto the capacity limit. It is the cost which does
not very with the change in the volume of activity in the short run.
These costs are not affected by temporary fluctuation in the activity of
an enterprise. These are also known as period costs as it is concerned
with period. Rent of premises, tax and insurance, staff salaries, are the
examples of fixed cost.
Characteristics of Fixed Cost are :
a.Large in value
b.Fixed amount within an output range
c.Fixed cost per unit decreases with increased output
d.Indirect Cost
e.Lesser degree of controllability
f.Influence Variable Cost and Working CapitalCost(Rs.)Total Fixed CostFixedCostperUnit
Output (Units)Y
X O
Behaviour of Fixed Costmunotes.in

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132)Variable Cost : It is that cost which directl y very with the volume of
activity. In other words, it is a cost which changes according to the
changes in the volume of output. It tends to very in direct proportion
to output. It means when the volume of output increases, total variable
cost also incr eases when the volume of output decreases, total variable
cost also decreases. But the variable cost per unit remains same.
Direct material, Direct Labour, Direct Expenses are the examples of
variable costs.
Characteristics of Variable Cost are :
a.Total cost changes in direct proportion to the change in total output.
b.Cost per unit remains content.
c.It is quite divisible.
d.It is identifiable with the individual cost unit.
e.Such costs are controlled by functional manager.Cost(Rs.)TotalVariableCostVariable Cost per UnitOutput (in Units)YX
O
Beha viour of Variable Cost
3)Semi -Variable Cost : This is also referred as semi -fixed costs. These
costs include both a fixed and a variable component. i.e. These are
partly fixed and partly variable. They remain constant upto a certain
level and register s change afterwards. These costs vary in some
degree with volume but not in direct or same proportion. Such costs
are fixed only in relation to specified constant condition.
For example: Repairs and maintenance of machinery, telephone
charges, maintain ance of building, supervision, professional tax,
compensation for accidents, light and power etc.munotes.in

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14Cost(Rs.)Semi Variable Cost
Output (in Units)
Behaviour of Semi -Variable Cost
III. On the basis of Controllability
On the basis of controllability, costs are classifie d into two types :
1)Controllable Cost
2)Uncontrollable Cost
1)Controllable Cost : These are the costs which can not be influenced
or controlled by the concerned cost centre or responsibility centre.
These costs may be directly regulated at a given le vel of management
authority.
2)Uncontrollable Cost : These are the costs, which can not be
influenced or controlled by the action of a specific member of an
enterprise. For eg. it is very difficult to control costs like factory rent,
managerial salaries etc.
The important points to be noted regarding this classification. First,
controllable cost can not be distinguished from non -controllable costs,
without specifying the level and scope of management authority. It
means cost which is uncontrollable at one level of management may
be controllable at another level of management. Eg. Rent and Factory
Building may be beyond control for the production department but can
be controlled by the administrative department by negotiations.
Secondly all costs ar e controllable in the long run and at the some
appropriate management level.
IV On the basis of Functions
An organisation performs many functions. On the basis of
functions costs can be classified as follows :
1)Manufacturing Costs : It is the cost o f all items involved in the
manufacturing of a product or service. It includes all direct costs and
all indirect costs related to the production. It includes cost of directmunotes.in

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15materials, direct labour, direct expenses, and overhead expenses
related to produ ction. Overhead expenses, means all indirect costs
involved in the production process. This is termed as factory overhead
or manufacturing overheads. Eg. Salaries of staff for production
department, technical supervision, Expenses of stores department,
Depreciation of Plant and Machinery, Repairs and maintainance of
Factory Building and Machineries etc.
2)Administration Cost : These are costs incurred for general
management of an organisation. It is the cost which is incurred for
formulating the poli cy, directing the organisation of controlling the
operations. These are in the nature of indirect costs and are also
termed as administrative overhead. Eg. Salaries of Administrative
Stall, General Office expenses like rent, lighting, telephone, statione ry,
postage etc.
3)Selling and Distribution Costs : Selling costs are the indirect costs
relating to selling of products or services. They include all indirect
cost in sales management for the organisation. Selling costs include
all expenses relating to regular sales and sales promotion activities.
Examples of expenses which are included in selling costs are :
1)Salaries, Commission and traveling expenses for sales personnel
2)Advertisement cost
3)Legal Expenses for debt realization
4)Market researc h cost
5)Show room expenses
6)Discount allowed
7)Sample and free gifts
8)Rent on Sales room
9)After sale services
Distribution costs are the costs incurred in handling a product from
the time it is completed in the works until it reaches the ultima te
consumer. Distribution expenses include all these expenses which are
incurred in connection with making the goods available to customers.
These expenses include the following.
1)Packing charges
2)Loading charges
3)Carriage on Sales
4)Rent of ware house
5)Insurance and lighting of warehouse
6)Transportation costs
7)Salaries of godown keeper, driver, packing staff etc.
4)Research and Development Cost : Research and development costs
are incurred to discover new ideas, processes, products by exper iment.
It includes the cost of the process which begins with the
implementation of the decision to produce or improved product.munotes.in

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16V On the basis of Time
On the basis of time of computation, costs are classified into
historical costs and predetermin ed costs.
1)Historical Costs : These are the costs which are ascertained after
these have been incurred. Historical costs are then nothing but actual
costs. They represent the costs of actual operational performance.
These costs are not available unti l after the completion of
manufacturing operations.
2)Pre determined Costs : These are the future costs which are
ascertained in advance of production on the basis of a specification of
all the factors affecting cost and cost data. Predetermined costs ar e
future costs determined in advance on the basis of standards or
estimates. These costs are extensively used for the purpose of
planning and control.
VI Other Basis
1)Normal Cost : Normal cost may be defined as a cost which is
normally incurred on exp ected lines at a given level of output, in the
condition in which that level of output in normally attained. This cost
is a part of production.
2)Abnormal Cost : Abnormal cost is that cost which is not normally
incurred at a given level of output, in th e condition in which that level
of output is normally attained. Such cost is over and above the normal
cost and is not treated as a part of the cost of production.
3)Avoidable Cost : The cost which can be avoided under the present
conditions is an avoid able cost. These are the costs which under given
conditions of performance efficiency should not have been incurred.
They are logically associated with some activity and situation and are
ascertained by the difference of actual cost with the happening of the
situation and the normal cost. Eg. when spoilage occurs in
manufacturing in excess of normal limit, the resulting cost of spoilage
is avoidable cost.
4)Unavoidable Cost : The cost which can not be avoidable
under the present condition is an unavoid able cost. They are
inescapable costs which are essentially to be incurred within
the limits or norms provided for. It is the cost that must be
incurred under a programme of business restriction.
1.8 COST ALLOCATION AND APPORTIONMENT
Cost Allocation: When items of cost are identifiable directly with
some products or departments such costs are charged to such cost centres.
This process is known as cost allocation. Wages paid to workers of servicemunotes.in

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17department can be allocated to the particular department. Indirect
materials used by a particular department can also be allocated to the
department. Cost allocation calls for two basic factors -(i) Concerned
department/product should have caused the cost to be incurred, and (ii)
exact amount of cost should be computable.
Cost Apportionment: When items of cost cannot directly charge to
or accurately identifiable with any cost centres, they are distributed
amongst the cost centres on some predetermined basis. This method is
known as cost apportionment. Thus we s ee that items of indirect costs
residual to the process of cost allocation are covered by cost
apportionment. The predetermination of suitable basis of apportionment is
very important and usually following principles are adopted -(i) Service
or use (ii) S urvey method (iii) Ability to bear. The basis ultimately
adopted should ensure an equitable share of common expenses for the cost
centres and the basis once adopted should be reviewed at periodic
intervals to improve upon the accuracy of apportionmentBasis of
differenceAllocation of
overheadsApportionment of overheadsMeaningAllocation is the
process of
identification of
overheads with
cost centers.Apportionment is done in
case of those overhead items
which cannot be wholly
allocated to a particular
department.Nature of
costsAssignment of
particular cost to a
particular
department or cost
center is called as
allocation.These costs are common to
various departments and
cannot be charged to a
particular department or cost
center.Proportio
ns of cos tsAllocation deals
with whole items
of costs.Apportionment deals with
proportions of items of costs.Basis for
apportion
ment or
allocationNo base is required
for allocation of
cost to a
department, it is a
direct process.An equitable base is requ ired
for Apportionment of cost to
the production or services
department.munotes.in

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18AppliesWhen the overhead
costs are related to
specific or single
departments.When the overhead costs are
related to different
departments.ExamplesSalary paid to the
employees of the
maintenance
department, can be
allocated to that
department.Wages paid to the head of
the factory, rent of factory,
electricity, etc. cannot be
charged to a particular
department, and then these
can be apportioned amongst
various departments.
1.9 CODING SYSTEM
Classification and Codification of Material:
In case of large organizations the number and types of materials
used is considerable and unless each item is distinguished and stored
separately it would be impossible to find them out when they are required
for production or any other operation. It may happen that either one type
of material is in excess or another type may be altogether non -existent. It
is therefore, essential that a proper system of classification and
codification.
Classifi ed into different categories according to their nature or
type, viz., mild steel, tool steel, brass, bronze, copper, glass, timber, etc.,
and then again within such broad classification into rounds; bars, strips;
angles, etc. There are two steps in the cla ssification and codification of
materials -determination of the number of items, their nature, other
characteristics and classification of the items of comparable nature or type
into suitable groups or classes.
Various classes of coding are in practice and the common types are
stated below:
(a) Alphabetical Scheme: Alphabetics are only used for codification. Like
Mild Steel Sheets are coded as MSS.
(b) Numeric Scheme : In this scheme numericals are used instead of
alphabets, For example If steel is give n main code of 300 mild steel
may be coded as 310 and mild steel sheet may be coded as 311, mild
steel bar may be coded as 3112.
(c) Decimal Scheme: It is similar to the numeric scheme in which the
groups are represented by number and digits after the deci mal indicate
sub-groups of items. For example, where the steel is coded as 3.00munotes.in

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19mild steel may be coded as 3.10 and mild steel sheet can be coded as
3.11 and mild sheet bar as 3.12 and so on.
(d) Block Scheme: In this case block of number are allotted for
classification of specific groups such as for material classification the
block of number 1 to 999 may be reserved, for raw materials; 1000 to
1999 for stores and spares; 2000 to 2999 for finished goods.
(e) Combination Scheme : Here the code structure tak es in account both
alphabetic and numeric schemes and strikes a balance between the
two. Mild steel by coded as MS and the sheets, bars, strips, rounds of
mild steel may be coded as MS01, MS02, MS04 and so on. This code
is most commonly used because this s ystem has got the advantage of
both the alphabetic and numeric systems and is quite flexible in nature.
1.10 ESSENTIALS OF GOOD COSTING SYSTEM
1. Flexibility: A codification system, should last a long time to derive
proper benefits from it. It is not some thing which we change every quarter
or every other year. Therefore, the long term requirements of materials for
the organization should be kept in mind while providing the digits or
alphabets for the items.
2. Precision: The codification system should ensu re a unique code for
reach item. A proper dictionary or vocabulary for the decoding should be
made while installing a codification system. The number of letters or
digits should be the same for all items.
3. Brevity: The total number of letters or numbers should not be too large
so as it lose its immediate meaning to the user of the material. 7 -10 digits
or spaces are adequate for many of the coding systems.
4. Comprehensiveness: While classifying and sub classifying the items
for coding purposes, the natur e of the item, its specifications, its end use
and the suppliers etc should all be comprehensively taken into account;
and therefore, for the codification system to work, prior consultations with
the concerned departments such as the operations department, purchasing
department, engineering department and finance department, etc. should
be absolutely necessary.
5. Standardization: A good system of codification helps in the
standardization of items in the inventory. Standardization consists of
reducing the v ariety of items stocked in the inventory to a workable
minimum, by fixing sizes, shapes, dimensions and other quality
characteristics of the item. For instance, paint may be bought from a
number of suppliers in different sizes of containers and different s hades of
colour. All of these might blow up the inventory of paints considerably.
The same could be reduced if the number of suppliers is cut down, if the
variety in the sizes of the containers is reduced and if the number of
shades of colour is also reduc ed.munotes.in

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201.11 COST CENTRE ANDCOST UNITS:
1.11.1 Cost Centre :
It is a location, person or item of equipment for which cost may be
ascertained and used for the purpose of cost control. It is a convenient
unit of the organisation for which cost may be ascert ained. The main
purpose of ascertainment of cost is to control the cost and fill up the
responsibility of the person who is incharge of the cost centre.
Types of cost centers :
I.Personal Cost Centre :
It consists of a person or group of persons.
e.g. machine operator, salesmen, etc.
II.Impersonal Cost Centre :
It consists of a location or an item of equipment or group of these. E.g.
Factory, Machine etc.
III.Operational Cost Centre :
This consists of machines or persons carrying on similar op erations.
IV.Process Cost Centre :
This consists of a continuous sequence of operation or specific
operations.
V.Production Cost Centre :
This is the centre where actual production takes place or these include,
those departments that are directly engaged in manufacturing activity
and contribute to the content and form of finished product.
e.g. Cutting, Assembly and Finishing Departments etc.
VI.Service Cost Centre :
This is the Centre which renders services to production centres. These
contri bute to the production process in an indirect manner.
e.g. Stores department, Repairs and Maintenance department, H.R.
Department, Purchase Department etc.
1.11.2 Cost unit :
It is a unit of product, service or time in terms of which cost are
ascertai ned or expressed. It is basically, a unit of quantity of product or
service in relation to which costs may be ascertained or expressed.
Few examples of cost unit are given below.munotes.in

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21Name of Industry Cost unit
Textiles
Transport
Power
Paints
Iron and Steel
Canteen
Chemical
Readymade Garments
PetrolMeter, yards
Passenger km
Kilowatt –hour
Litre
Tonne
Per meal
Litre, kilogram
Number
Litre
CHECK YOUR PROGRESS
Draw the chart showing Classification of Cost.
Define the following terms:
1.Costing
2.Cost Accounti ng
3.Impersonal cost center
4.Service Cost center
5.Direct Cost
6.Uncontrollable cost
7.Predetermined cost
Give Examples:
1.Fixed cost
2.Variable cost
3.Semi variable cost
4.Manufacturing cost
5.Administration cost
6.Selling cost
7.Distribution Cost
1.12 ELEMENTS OF COST : -
Amanufacturing organisation converts raw materials into finished
products. For that it employs labour and provides other facilities. While
compiling production cost, amount spent on all these are to be ascertained.
For this purpose, cost are primarily class ified into various elements. This
classification is required for accounting and control.
The elements of cost are (i) Direct material (ii) Direct labour (iii)
Direct expenses and (iv) Overhead expenses.
The following chart depicts the broad headings of costs and this
acts as the basis for preparing a Cost sheet.munotes.in

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22Elements of cost
Materials Labour Other Expenses
Direct Indirect Direct Indirect Direct Indirect
Overhea ds
Factory Administrative Selling & Distribution
1.12.1 Material Cost
It is the cost of material of any nature used for the purpose of
production of a product or a service. Materials may be Direct Material or
Indirect Material.
Direct material : It is the cost of basic raw material used for
manufacturing a product. Direct materials generally became a part of
the finished product. No finished product can be manufactured
without basic raw material. This cost is easily identifiable and
chargeable to the product. For e.g. Leather in leather products, Steel in
steel furniture, Cotton in textile etc. Direct material includes the
following.
Examples -
i)Material specially purchased for a specific job or process.
ii)Materials passing from one process to another.
iii)Consumption of materials or components manufactured in the same
factory.
iv)Primary packing materials.
v)Freight, insurance and other transport costs, import duty, octroi duty,
carriage inward, cost of storage and handli ng are treated as direct costs
of the materials consumed.
In certain cases direct materials are used in small quantities and it
will not be feasible to ascertain their costs and allocate them directly. For
instance, nails used in the manufacture of chai rs and tables, glue used in the
manufacture of toys, thread used in stitching garments etc. In such cases
cost of the total quantity consumed for the period will be treated as Indirect
costs.munotes.in

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23Indirect material : It is the cost of material other than direc tm a t e r i a l
which cannot be charged to the product directly. It can not be treated
as part of the product. These are minor in importance. It is also
known as expenses materials. It is the material which cannot be
allocated to the product but can be appo rtioned to the cost units.
Examples : Lubricants, Cotton waste, Grease, Oil, Small tools, Minor
items like thread in dress making, nails in furniture (nuts, bolts in
furniture) etc.
Therefore, indirect materials can not be easily identified with
specif ic job. They may not vary directly with the output. It is considered
as a part of overheads.
1.12.2 Labour Cost
This is the cost of remuneration in the form of wages, Salaries,
Commissions, Bonuses etc. paid to the workers and employees of an
organis ation.
Direct Labour Cost : Direct Labour Cost is the amount of wages paid
to those workers who are engaged on the manufacturing line. It
consists of wages paid to workers engaged in converting of raw
materials into finished products. The amount of wage s can be
conveniently identified with a particular line, product, job or process.
These workers directly handle machines on the production line. Direct
wages include payment made to the following group of workers.
1)Labour engaged on the actual product ion of the product
2)Labour engaged in aiding the operation viz. supervisor, foremen, shop
Clerks and worker on internal transport.
3)Inspectors, Analysts, needed for such production.
Example : Carpenter in furniture making unit, tailor in readymade wea r
unit, Labour in construction work etc.
Indirect Labour Cost : It is the amount of wages paid to those workers
who are not engaged on the manufacturing line. It is of general
character and can not be directly identified with a particular cost unit.
This indirect labour is not directly engaged in the production
operations but such labour assist or help in production operations. It
can not be easily identified with specific job, contract of work order.
It may not vary directly with the output. It is tr eated as part of
overheads.
Example : Labour in Human Resource department, Labour in payroll
department, Labour in stores, Labour in Securities Department, Labour in
power house department etc.munotes.in

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241.12.3 Expenses
All costs other than material and labour are termed as expenses. It
is defined as the cost of services provided to an undertaking and the
notional cost of the use of owned assets.
Direct Expenses : It is the amount of expenses which is directly
chargeable to product manufactured or which may be allocated to
product directly. It can be easily identified with the product. These
are the expenses which are specifically incurred in connection with a
particular job or cost unit. They are also called as chargeable
expenses.
Example : Hire of spec ial plant for a particular job, Travelling expenses
in securing a particular contract, Carriage paid for materials purchased for
specific job, Royalty paid in mining or production etc.
Indirect Expenses (Overheads): All indirect costs other than indirect
materials and indirect labour costs, are termed as indirect expenses. It
is the amount of expenses which can not be charged to the product
directly. These can not be directly identified with particular job,
process or work order and are common to cost un its’ or cost centers.
Indirect expenses / Overheads can be sub -divided into following
main groups.
1. Factory or Works Overheads: Also known as manufacturing or
production overheads it consists of all costs of indirect materials, indirect
labour and ot her indirect expenses which are incurred in the factory.
Examples :
Factory rent and insurance. Depreciation of Factory building and
machinery.
2. Office or Administration overheads: All indirect costs incurred
by the office for administration and mana gement of an enterprise.
Examples:
Rent, rates, taxes and insurance of office buildings, audit fees,
directors fees.
3. Selling and Distribution overheads: These are indirect costs in
relation to marketing and sale.
Examples :
Advertising, Salary an d Commission of sales agents, Travelling
expenses of salesmen.munotes.in

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251.13 SUMMARY
Cost Accounting is the process of accounting for costs from the
point at which expenditure is incurred or committed to the establishment of
its ultimate relationship with cost center and cost units. Cost accounting
profession got recognition in 1939 in India. It has been made compulsory
for specified manufacturing companies. Cost Accounting has the objectives
of determining Product costs, facilitate planning and control of regul ar
business activities and supply information for taking short term and long -
term decisions. Cost Accounting is useful in different areas such as
materials, labour, overheads, stock valuation etc.
1.14 EXERCISE
1.What is cost Accounting? What are its objec tives?
2.What are the various elements of costs?
3.What is meant by Cost Accounting? Explain in brief different ways of
Cost Classification.
4.Write short notes on:
a.Cost centers
b.Cost units
c.Elements of costs
5.Choose the correct alternative
1.Cost accounting is an important system developed for
i)shareholders ii) government
iii)management iv) financial institutions
2.The costing which determines cost after it has been actually incurred is
i) historical ii) standard
iii) Estimated iv) marginal
3.A cost cen ter is a
i)location for which cost is incurred ii) an organisation
iii)a unit of cost iv) profit center
4.A cost center which is engaged in production activity is called
i)production cost center ii) process cost center
iii)impersonal cost centre iv) production unit
5.Variable cost per unit remains ______.
i)Constant ii) flexible
iii)(i) & (ii) iv) none of the abovemunotes.in

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266.Cost which is related to capacity iscalled :
i)Fixed cost ii) Capacity cost
iii)Plant cost iv)none of theabove
7.Cost which is unaffected by the change in output is called as :
i)Fixed cost ii) Variable cost
iii)Period cost iv) None of the above8. Variable cost per unit remains ______.
i) Constant ii) flexible
iii) (i) & (ii) iv) none of the above
9. Cost which is related to capacity is called :
i) Fixed cost ii) Capacity cost
iii) Plant cost iv) none of the above
10. Cost which is unaffected by the change in output is called as :
i) Fixed cost ii) Variable cost
iii) Period cost iv) None of the above

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272
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 Order 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 t o Inventory.
•Explain the material purchase procedure.
•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 busin ess or production
organisation keeps in hand for efficient running of its production function.munotes.in

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282.1.1 Definition of Inventory
According to Gordon B. Carson , inventory includes raw materials
and component parts. Inventories consist of raw material, com ponent
parts, supplies and finished assemblies which an 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 isvery essential that material of the correct quantity and 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 b e held in stock. (ii) Deciding
the extent of stock holding 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 MATERIAL
Inventory control is generally concerned with 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 maintenance 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
opera tions 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 capi tal. It has
been estimated that inventory in Indian industries 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 t hem. The various types of cost of inventory are as
follows :
Cost of Inventory
Ordering Stock out Acquisition Start -up Quality
Costs Costs Costs Costs
1. Ordering Costs: Each time we p urchase a batch of raw material from a
supplier, a cost is incurred for processing the purchase order, 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 inventory we hold, but we order fewer times during the
year and annual ordering costs are lower.munotes.in

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292. Stock out Costs: Each time we run out of raw materials or finis hed-
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 provide
insurance against excessive stockouts.
3. Acquisition Costs: For purchased materials, ordering larger batches
may increase raw -materials inventories, bu t 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, the 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 IMPLICATIONS OF HOLD ING INVENTORIES :
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 incu rred 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 resp ond 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 reduce 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. Redu ced-Capacity Costs : Inventory represents a form of waste.
Materials that are ordered, held, and produced before they are needed
waste production capacity.munotes.in

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306. Large -Lot Quality Cost : Producing large production lots results in
large inventories. On rare occ asions, somethings goes wrong and a large
part of a production lot is defective. In such situations, smaller lot sizes
can reduce the number of defective products.
7. Cost of Production Problems : Higher in -process inventories
camouflage underlying product ion problems. Problems like machine
breakdowns, poor product quality, and material shortages never get
solved.
2.2MATERIAL 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 received in
time.
2.2.1 MATERIAL PURCHASE PROCEDURE
The purchase procedure vary with different business firms. The
purchase procedure is given below:
a) Purcha se 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 routine purchases, the order
is placed through established supplies. In other cases, the purchase
department may ask for bids or send out request for quo tation before
placing an order. The purchase order is a formal contract for the supply of
materials. Copies of the purchase order are sent to the departments
concerned.
c) Receiving and Inspection of materials:
The stores department is responsible for t aking delivery of
packages and to get a physical verification of the contents. When the
materials are received, the stores official gets the packages, open them and
make a detailed verification of the contents. After the contents of the
packages are checke d, the details are entered into a Goods Received Note.
Copies of the G.R.Note are issued to the supplier, purchase and accounts
department, where the factory has to test the materials received for quality
and specifications. It has to ensure that the quali ty of materials is as per
purchase order.munotes.in

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31d) Approval of Invoices and Payment
Invoice received by the purchase department is forwarded to the
Accounts department for payment with their recommendation. Accounts
department has to check the authenticity, ar ithmetical 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
conditions o f 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 st orage of materials. The storekeeper is appointed to look after
this work in the stores department. The storekeeper 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)Placi ng and arranging materials at proper place.
v)Issue of materials against proper authorization.
vi)Minimizing storage 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 Amo unt
Rs.
Authorised by …………… Received by…..
Storekeeper’s Signature ….. Checked by …….munotes.in

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322.4 STOCK LEDGER CARDS & BIN CARD
STOCK LEDGER CARD: It is also known as Stores Ledger Cards/
Material Ledger 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 basis by the cost accountant.
FORMAT OF STOCK/ STORES/ MATERIAL LEDGER ACCOUNT:
Source: Image downloaded from https://commerceiets.com/p erpetual -
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 receip t and issued details. It also refers to sorting of the material into
different categories and bins for easy accessibility.
FORMAT OF BIN CARD:
Source: Image downloaded from https://commerceiets.com/perpetual -
inventory -system/munotes.in

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33NOTE: Stock Ledger Cards ar e maintained by the cost accountant
involving quantity and value both while Bin Card is maintained by
storekeeper maintain quantities alone.
2.4.1 METHODS OF STOCK TAKING
Methods of taking inventories / stockMethod 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 enter prises and purchases and sales may have to be suspended for
that period to get correct figure of closing inventory. This method of
ascertaining the value of stock at the end of the year is also known as
annual stock taking. Thus this method is based physic al stock taking. It
provides data once in a year is simple and economical method of
stocktaking can be adopted in small concerns, 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 method stock registers are
maintained to make a record of the physical movements of stock and their
current balance. Stores ledg er 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 ensure the accuracy of
perpetual inventory records physical verification of the inventory is made
by a program of continuous stock t aking.
It is possible that the balance of stock by the perpetual inventory
may differ from the actual balance of stock as ascertained 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 that 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 Adjustment
Accounts is prepared and debited with the shortage of stock and credited
with surplus.munotes.in

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34Continuous stock taking is an essential feature of the perpetual
inventory system. But the two terms, perpetual inventory and continuous
stock taking should not be taken as one; perpetual means the system of
stock records and continuous stock taking whereas continuous stock
takin g means only the physical verification of stock records with actual
stocks.
In continuous stock taking, physical verification is spread
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 in 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 contro l by investigation the basis for control by
investigation the discrepancies arising from the comparison of physical
stock with their book values.
Difference between Periodic inventory and Perpetual inventory.
The following are the main differences b etween the two methods of
taking inventory.
Periodic Inventory Perpetual Inventory
1.It is based on physical
stocktaking1. It is based on records.
2.It provides data periodically
i.e. once in year.2.It provides the data on running
basis and thus f acilitates the
preparation of financial statements
at shorter intervals.
3.It does not provide basis
control.3.It provides basis for control by
investigating the discrepancies
arising from the comparison of
physical stock with book values.
4.It is s imple 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 an 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 concer n maintains
three types of stock i.e raw materials, work in process and finished goodsmunotes.in

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35while 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 in ventory, 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 l evels 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: I t refers to that level of stock which needs to be
maintained throughout to ensure there are no hindrances in the
production process.
Minimum Stock Level = Re -Order Level -(Average rate of
consumption x Average lead time)
OR
Minimum Stock = Reordering Le vel–(Normal Consumption x
Normal Reordering Period)
3.Maximum Level: As the name itself suggests it is the maximum
level of stock quantity held by the company at the given point of
time. It is the upper threshold limit. Maximum Stock Level =
Reordering Le vel + 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 = Minimum Lead time + Maximum Lead time
2munotes.in

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362.5.1STOCK CONTROL CHART
Source: https://resource.cdn.icai.org/38596bos28170mod1 -cp2.pdf
2.5.2ILLUSTRATIONS
1.Calculate minimum stock level, maximum stock level, and re-
ordering level:
a.Maximum Consumption = 450 units per day
b.Minimum Consumption = 270 un its 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.
Solution:
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.
2.Calculate for each component: Minimum Stock Level, Maximum
Stock Level, Average Stock.
Component A Component 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 2-4Weeksmunotes.in

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37Solution:
1.Reordering Level = Maximum Consumption x Maximum Reorder
period
Component A = 50 units X 6 = 300 units
Component B = 4 0 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) = 110 units
(Note when normal re -ordering period is not given use a verage 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 unit s
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
2.6INVENTORY CONTROL SY STEMS OR
TECHNIQUES
Vario us 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.
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. I t 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 i n 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:munotes.in

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38(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 reache st h er e -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 (al so 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 lot size or Minimum Cost Inventory."
In fixing the economic order quantity, the following costs are
considered:
1. Ordering Cost : This is the cost of placi ng an order with the supplier
and includes cost of stationery, salary of those who are engaged in placing
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 up on
the number of order placed and the quantity of items ordered. The number
of orders increase, the ordering 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, obso lescence losses, store keeping
cost, such as rent of warehouse, salary of store keeper, stationery used 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.
The above two costs are of opposite nature. If for example, an attempt
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 carrying 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:munotes.in

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39(i) There is only one product involved; (ii) Annual usage (demand)
requirements are known; (iii) Usage is spread evenly throughout the year
so that the usage rate is reasonably con stant; (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 month.
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 load, 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 wou ld 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 A rticles : For articles of a seasonal nature, e.g., cotton or
groundnuts or oilseeds, bulk purchases during 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 pur chases. This should be compared to the savings as a
result of the application of E.O.Q. formula and a decision 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 whi ch is based on import licences.
Importance of Economic Order Quantity (EOQ) : If re -order
quantity is determined in advance and adjusted it ensures the following
advantages :
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:munotes.in

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40(a) Where rate of consumption fluctuates very often ordering a fi xed
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 orderi ng 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 s tock items
held into three sectors, known as A, B and C.
ABC analysis is a new technique of classifying and controlling
production and store inventories both purchased and manufactured in
accordance with value of the item. It is the starting point for mat erial
management. It is the basic analytical management tool which enables top
management to place the effort 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
priority. 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 analysis or classification is the principle of Selective Control of
inventories and a technique of grouping thousands of stock items handled
by an organ isation. The principle involved is that the degree of control on
stock items and amount of safety stock carried should vary directly with
the consumption value of the item involved.
Advantages of ABC Analysis : The following are the advantages of ABC
Analy sis :
1. Selective Control : This approach helps the materials manager to
exercise selective control and focus his attention only on a few items when
he is concerned with lakhs of store items.
2. Control Inventories : By concentrating on 'A' class items, t he materials
manager is able to control inventories and show visible results in a short
span of item.
3. Obsolete 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.munotes.in

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415. 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 follows the same
procedure of distribution of inventory items by money value. The only
difference in the application of ABC (Always Better Control) ana lysis in
H.M.L. technique is that the unit value is the criterion and not the annual
consumption value. The items should be listed out in descending order of
unit value and management may fix limits for deciding the three
categories.
Example : Management m ay for example decide that all items of the
unit value above Rs.500/ -will be H items, between Rs.100 to 500 will be
M items and below Rs.100 will be L items. On this basis, management
may delegate authorities to various subordinate officers to purchase pe tty
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 spa re parts. To get over this difficulty, V.E.D.
classification is used. Here, the categorisation is made in terms of 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, for 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.
F.S.D.E. Classification
This classification is used for source item s, 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 quit e absurd for anyone to say that it should be procured once inmunotes.in

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42six weeks. It would be best to obtain it once in a year, considering the
time, effort and expenditure involved in the procedures for import.
A scarce item might be an item which is not easily a vailable 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. But 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
proced ures of inventory control may not work in respect of these materials
and they would require special treatment.
Items which 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 themselves 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 ch ange in technology or change
in the specification of a particular spare part or the item might no longer
be in use. When an F.S.N. classification is made, all such information
stand out prominently enabling managers to act on the information in the
best in terests 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 extremely high but this
cannot be helped.
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 optimum results.munotes.in

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43J.X-Y-Z Classification
This classification is based on the value of inventory stored. If the
values are high, spec ial efforts should be made to reduce them. This
exercise can be done once in a year.
The different types of classifications suggested would given an
executive a clear idea as to what are the implications and this would give
him the necessary clues as to h ow 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.
2.6.1ILLUSTRATIONS ( EOQ MET HOD)
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 : 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. 0.50 p.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. The following further data
are available.
Annual return on investment :15%
Rent, in surance, 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.munotes.in

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44EOQ =
=
= 252.98 i.e 253 units.
3.Ansemi annual consumption of a materials is 10,000 units at a price of
Rs. 40 per unit. The storage cost 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.
4.A company manufactures a special product which requires a
component ‘GM’. The following particul ars 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’, prov ided 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 1 2%
= Rs. 72 p. u. p. a.munotes.in

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45EOQ =
=
= 421.63 i.e. 422 units.
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* 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
Total Costs: Total Purchase Cost + Total Order ing 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 purchase the not only
purchase price reduces but also th e 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
accepted therefore discount should be a ccepted.
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 :
Interest 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.munotes.in

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46Solution :
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
= 1.5 pu. pa.
EOQ =
=
= 400 units.
2.7SUMMARY
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 lead time)
3.Minimum Stock Level = Re -Order Level -(Average rate of
consumption x Average lead time)
4.Minimum Stock = Reordering Leve l–(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 Consumpt ion:Minimum Consumption + Maximum Consumption
2
8.Average Lead Time = Minimum Lead time + Maximum Lead time
2
9.EOQ =
10.Total Purchase Cost = Annual Qty X Cost Per Unit
11.Total Ordering Costs = Annual Qty / Ordering Qty * Cost per Order
12.Total carrying Cost = Ordering Qty / 2 * Carrying Cost per unitmunotes.in

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472.8QUESTIONS
2.8.1Answer in Brief
1.Define Inventory and explain the various 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) Cost of inventory, (d) ABC
analysis
2.8.2Solve the Following
1.From the following information, calculate
a) Economic order q uantity b) Total Annual Costs c) Total Carryingand ordering cost.a.Semi -Annual consumpti on-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 Dem and 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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485.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 : Rs. 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 ti me.
Required:
Compute the economic order quantity
Advise whether the quantity discount offer can be accepted.
2.8.3 Multiple Choice Question
Sr.
NoQUESTION
TEXTA B C D
1 _____ _____
indicates
maximum
stock to be
maintained.Maximum
LevelMinimum
LevelRe-
Order
LevelDanger
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
SheetWages
4 _____ labour
cannot be
readily
identified.Direct Indirect Producti
onActual
5 _______ is the
application of
costing and
cost accounting
principles,
methods and
techniques to
the art, scienceCost
accountin
gCost
accountanc
yCost
ControlCost
Ascertain
mentmunotes.in

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49and practice of
cost control
and the
ascertainment
of profitability.
6 A cost centre
which is
engaged in
production
activity is
calledProductio
n cost
centreProcess
cost centreImperso
nal cost
centreProductio
n unit
7 Cost
accounting is a
reporting
systemInternal External Govern
mentFinancial
8 Cost
ascertainment
involvesAscertain
ment of
costControl of
costEstimati
on of
costFixation
of price
9 One of the
following is not
a costing
systemMarginal
costingUniform
costingAbsorpti
on
costingProcess
costing
10 Product cost
means_______
_____Variable
costFixed cost Prime
costIndirect
cost
11 The resources
that have been
used for
attaining a
particular
objective isRevenue Cost Profit Investmen
t
12 Workers who
work outside
the factory
premises are
called as _____
works.Out Job Casual Badli
13 Time is
paid by
the
employer.Idle Time Overtime Normal
timeAbnormal
timemunotes.in

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5014
is
decided on the
basis of
ordering cost
and carrying
cost.EOQ Maximum
Stock LevelMinimu
m Stock
LevelAverage
Stock
Level
15 A Bill of
Material serves
the purpose of
_____Purchase
orderMaterial
requisitionPurchase
requisiti
onGoods
received
note
16 A document
used for time
keepingJob card Time card Daily
time
sheetLabour
sheet
17 Annual
demand=1200 0
units, Ordering
Cost per
order=Rs. 45,
Carrying cost
per annum per
unit =Rs. 3.
EOQ=_______6000 units 600 units 12000
units1200 units
18 Economic
order quantity
is a tool for
controlling
___________Inventory Price Machine
ryCost
For Additional R eference Reading Scan the QR Code Below or visit
website :
https://resource.cdn.icai.org/38596bos28170mod1 -cp2.pdf
munotes.in

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513
LABOUR COST
Unit Structure:
3.0 Introduction
3.1 Time Keeping
3.1.1 Meaning
3.1.2 Importance
3.1.3 Procedure
3.2 Time Booking
3.2.1 Objectives of Time Booking
3.2.2 Methods of Time Booking
3.3 Reconciliation of Book Time with attendan ce Sheet
3.4 Piece Workers, Casual Workers and Out Workers
3.0 INTRODUCTION
Labour represents the human contribution to production and it is the
main second element of cost of Material Cost. The Labour in the process
of production can not be under -estimated even in the organization which
goes though fully automatic technology in the process of production of
goods and services. Therefore, it needs to properly account, organise and
control the labour cost.
Labour Cost is divided into two following cate gories:
3.1 DirectLabour Cost:
The Direct Labour cost is the cost which is directly emerged in the
production cost and can conveniently identified to a particular cost unit,
job or process.
3.2 IndirectLabour Cost:
The Indirect Labour cost is the cost which is indirectly ????in the
process and covering we raw materials into finished goods. It does not
convertienly identified with a particular job, produce a cost unit.munotes.in

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523.1 TIME KEEPING
3.1.1 Meaning:
Time Keeping means recording the attend ance of the workers and
time spent by them (idle time, overtime, etc.) on actual work.
3.1.2 Importance :
The importance of time keeping is a following:
a) Payment of Wages:
The Timekeeping is importance while computing wages due to them
which dep ends upon the time spent by the workers on work.
b) Legal record of attendance / Service:
The record of attendance of the workers are important at the time of
computation and determination of legal benefits such as Provided Fund,
Bonus, Workmen’s Co mpensations, Maternity Leaves, Pension, etc.
c) Discipline:
Record of Time of workers acts as a check on the movement of the
workers. It ensures punctuality and regularity among the workers and
avoids idle time or waste of time.
d) Calculation and Co ntrol of Labour Cost:
Time Keeping helps the department of cost while a) Calculating Labour
Cost ii) Controlling Labour Cost. It helps is finding the time spent spent
by the worker on work / job. Labour cost allocation to job is possible.
Sometimes Labou r overheads are also apportioned to each job on the basis
of labour hour rate. It helps in fixing the labour hour rate.
3.1.3 Procedure:
Each and every organization has its own procedure of recording the
attendance and time keeping produce covers the following aspects:
1)Who Maintains the Time Keeping Records:
The time keeping department keeps the records of time keeping
depends up on the number of workers size of organization ,method of
payment of wages.
(03)munotes.in

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532) Place of Time Keeping record:
The Time Keeping is recorded at the factory gate or at each
department of factory.
3) How Time Keeping records are kept:
The Time Keeping is recorded manually or mechanically by the
following methods.
a) Manual Time Keeping Records:
This method covers the following method of maintain time keeping
records.
i)Attendance Register:
Under this method the details of attendance of the workers are
recorded in the attendance register or muster. It may be kept at the gate of
the factory or at each department. The entries, in the register, of workers is
made by an assistant or the employee themselves who signs the register
whenever they enter and leaves the premises.
This method is simple to understan d and to operate. It does not
creates complications while operating the punching cards. It creates
misuse and frauds in records of timekeeping.
ii)Token, Disk or Check Method:
In this method, each employee is given a Token or a Metal Disk on
which id entity number is printed or written. At the opening time of office
,all disks or tokens are hung on the board at the factory gate. As and when
employee arrives at the gate, her/she pick up their taken and hangs on
another board. This indicates that the em ployees has been arrived in time
in the factory. Remaining all tokens or disks are collected from the box
and assumed that all the employees are late or absent. They will be
recorded as late or absent on the daily attendance register / sheet. Same
procedu re is followed at the lunch breaks or departure time. Sometimes
workers takes the taken with them in the department, instead of putting the
taken box at factory gate. Then he/ she hangs the token on the board at the
factory gate. It indicates that they are present at his department Further
checking movement of the employees is done within the factory premises.
This is called the check system of timekeeping.
This method is simple to understand. It leads mistake and fraud in
record. It is not possible to mark overtime , Idle time under this method.munotes.in

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54b) Mechanical / Time clock Method:
In this method, Time of arrival and department is recorded
mechanically i.e. Time Clock. Each worker is given an identify number.
All cards are kept on the board at the entrance of factory gate. Every time
a worker arrives and leaves the factory gate, they take cards from the box
and insert into the time clock. As soon the card inserts into the Time
Clock, the clock mechanically prints or records the time on the card. So me
cards may print late arrivals in red ink. The cards still having on the board
after scheduled time are treated as absent.
It is very accurate system of recording time. It avoids recurring
expenses on remuneration payable to the assistants. It doesn’ t open fraud
or misuse. This provides Printed evidence of record of attendance. This
method is useful in obtaining legal benefit of P.F., Maternity benefit, leave
enhancement, etc without any problem.
3.2TIME BOOKING
Time Booking means record of tim e spent by the workers on jobs
during his/her attendance at factory / factory department. Recording the
working time is commonly known as time booking. It is important to
know the actually time spent on job, or for job or operation or process. It
is the p rocess of recording of time actually spent by the workers for job or
operation. This is useful for calculation of wages or remuneration payable
to the workers.
3.2.1 Objectives of Time Booking: -
The objectives of time books are stated below:
i)FullUtilization of Work Time:
It ensures that each worker is physically present in the factory and he has
spent fulltime for job. It leads efficiency of workers.
ii) Ascertainment of Labour Cost:
If facilitates the ascertainment of labour cost of each jo b of cost centre or
each unit. Sometimes overheads are absorbed on the basis of labour hour
rate. It helps in fixing the labour rate for absorption of overheads.
iii) Computation of Incentives:
Many times incentives are paid to the workers with good p roductivity,
efficiency, and time spent on job, etc. It help in the process of calculation
of such incentives.munotes.in

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55iv) Determination of Wage or Bonus:
It helps in the process to calculating the wage and bonus payable to
workers on the basis of actual time required for completion of job.
The method of Time booking are as follows:
1) Daily Time Sheet:
In this method daily Time Sheet or Daily Record Card is provided to
each worker for recording details of time spent by him on work a during
day. It m ust be agree with clock card. It is suitable for small works. It is
easy to understand and operate. The foremen can know the worker’s
performance from this sheet. It needs less paper work as compared to
other method. It is suitable for the workers who have to work in different
departments.
It requires lot of paper work when workers is required to work on
same or different jobs on several days. The time is recorded by the
workers in the daily time sheet. It is not reliable method.
2) Weekly Time Sheet:
In this method, the weekly time sheet is supplied to each workers
and they have to write the details of work and time spent on Job for a
week period. This card is suitable where very limited works or jobs are to
be completed by the workers in a week. I t enables the foreman to know
the weekly performance of the worker. It is convenient method where
small or limited job to be completed which requires very less paper work.
It is inaccurate method because sheet cards can be prepared from
memory. It is r eliable method.
3) Job Cards:
A job or a job ticket is a card which shows details of time spent by a
worker or a group of workers for each operation. It is given to a worker
which gives the details of job performed. He has to record manually time
(hours) worked by him / her on the job card. In big organization the
provided job cards are made available which are punched for recording
required details.
Normally job card is printed giving detail of job, order number and
other details. This method ena bles co -ordination between the production
control and cost department.
Preparation of job card becomes burdone some because separate
job cards needs to prepare for separate job. It is possible of wrong record
information. It is not suitable for which involves last minute alterations.munotes.in

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563.3RECONCILIATION OF BOOK TIME WITH
ATTENDANCE SHEET
Organization adopts deferent method of time booking and recording
in attendance sheet time to time which will be convenient as per their
nature, size, etc. However ,irrespective of adapted method, it is necessary
to exercise the control on labour. The Labour control could be possible
from the reconciliation of time booked with attendance sheet. It means the
care has to be taken while recording time spent on job and idle time should
confirm to the total time for which payment has mode.
3.4PIECE WORKERS, CASUAL WORKERS AND OUT
WORKERS
1. Piece Workers:
Piece workers are paid wages on the basis of piece rate. When this
method is adopted, it is advised to prepare job report separately to each
job. They are paid wages on the basis of actual output. The time record is
important for payment if actual amount of wages and avoiding late arrival
and early leaving the job premises by the workers.
2. Casual Workers:
The workers who works in the organization on in place of absent
workers. Commonly these workers are known as substitute or bodies. It
need to be taken special care while recording the attendance time and
payment of works to such casual workers.
The cas ual works should be given job cards should be signed by the
foreman. At the end of the day these cards are supplied to the pay roll
department for making payment of wages of such workers.
The casual workers are hired on the circumstance of execut ion of
such order, increase of purchase, etc.
3. Out Workers:
Out worker who perform their works at site or customer’s premises
or at their residence. It is necessary to exercise close control on
outworkers since they are normally paid at higher rate of wages and for
this purpose attendance record of outworkers should be kept carefully.
Pay Roll Accounting:
Pay roll accounting is The Part of Accounting which is relating to
computation of gross wages and deduction from gross wages for the
purpose o f wages payable to each employees.munotes.in

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57Periodic Statement of Pay Roll and Pay slip shows gross wages
earned by the worker, deductions from gross wages and net wages payable
to each worker or employees.
Following deductions are allowed as per the paym ent of wages Act
1963,
a) Penalty for absence from duty
b) Absence from duty
c) Deduction for damage
d) House Rent
e) Cost of amenities and Services
f) Recovery of advance
g) Income Tax
h) P.F. amount
i)Insurance Premiums
k)ESI, etc.
Pay Slip:
It is a statement which prepared for each workers individually. It
shows gross deductions form gross wages and net wages payable.
Labour Turnover
Labour turnover in an organization is the rate of exchange in the
composition of labour fo rce during a specified period measured against a
suitable index. It has a perpetual existence. The working force in an
organization does not remain constant. Some of the existing staff may
leave, new people join the organization. This phenomenon is known a s
Labour Turnover.
Cost of Labour Turnover:
There aretwo types of Labour cost which leads to high cost and lower
productivity.
a) Preventive Cost:
The preventice cost which includes the cost includes the cost
incurred to keep labour turnover at a low level. For example cost of
medical services, welfare schemes and pension schemes, etc.
i)Personal administrative cost:
The firms have personal administrative department which is entrusted
with recruitment, trading and maintaining good relationship w ith the
labour force i.e. between firms and employees.munotes.in

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58ii)Medical Services:
The firms provided preventive and medical services to the employees
and their family . In fact the employees prefers a firms provides free
medical and other services to the employ ees and their families. It means
healthy employees are the assets of the firms who enhance the
productivity of the firms.
iii)Welfare Services:
The firm provides welfare services to the employees and includes
expenditure on the labour welfare activiti es. e g. sport canteens, house,
transport, educating facilities, etc.
iv)Miscellaneous Schemes:
The firms normally can for employee’s future. Therefore firms provides
pension scheme, good scales, bonus, providend fund schemes etc.
b) Replacement C ost:
Replacement Cost are the cost which arises due to high labour
turnover. It refers to those cost which are associated with replacement.
These casts are included for recruitment, training and absorption of new
workers. If the work is new, it results into losses, wastages and lower
productivity due to inefficiency and lack of experience to new workers.
It means a company will incur very high replacement costs if labour
turnover is high.
Measurement of Labour Turnover / Method of Measurement of
Labo ur Turnover.
There are different methods for measurement of Labour turnover.
The method of Labour Turnover adopting by the firm is depending upon
the conception of Management and the definition of Labour turnover.
Once the organization has adopted parti cular method, then it should be
consistently followed which enable comparisons of data from the year to
year.
Following are the methods of Labour Turnover adopted.
1) Separation Method: -
In this method, Labour turnover is considere d as a relationship
between total number of separation for given period and the average
number of workers on the pay roll during the period.
Therefore, Labour Turnover Rate= Number of separation in a period /Average
Number of workers during the period x100munotes.in

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592) Replacement Method:
This method is also known as Net Turnover Method. Under this
method, labour turnover is measured / considered as relationship between
the actual replacement of lab our during the period and average number of
workers during the period.NumberofWorkersReplaceinaPeriodLabourTurnoverRate= ×100AverageNumberofworkersinaPeriod
3) Basis of Accession Method:
Under this method the experts view is considered logically to
measure the labour turnover. It is a relationship between acc essions and
the average number of workers during the period. It is calculated as
follows:
Labour Turnover Rate=Assessions /Average number of workers
during the period x
4) Available Separation Method:
There is an argument made that in any organiza tion certain amount
of Labour turnover is inevitable. The percentage of separation can be high
due to some unavoidable circumstance or reasons. Eg. Sickness, old age,
death, family conditions, seasonal and cyclical conditions or fluctuations
in the busin ess.
Therefore, separation should be avoidable and unavoidable. The
Labour turnover is calculated by considering the relation of avoidable
separation and average working force (workers) during the period.AvoidableSeparationintheperiodLabourTurnoverRate= ×100Averageworkingforceworkersduringtheperiod
5) Fulxy Method:
Under this method, the separations and replacements for the period
are considered for calculation of Labour turnover. It is the relationship
between the sum of separations and replacement during the period and
Average Number of Workers during the period.
Separation+Replacementduringtheperiod∴Labour Turnover Rate= ×100AverageNumberofWorksduringtheperiod
Practical Questions:
Illustration No: 01
From the following information, Calculate Labour turnover rate and
Labour Fluxy rate:munotes.in

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60No of Workers as on 01 -01-2014 -3,800
No of Workers as on 31 -12-2014 -4,200
During the year 60 workers were left while 180 workers were
discharged, 1000 workers were recruited during the year of these 200 were
recruited because of existing and the rest were recruited in accordance
with expansion plans.
Solution :
Average No of workers =3800 4200 8000400022
a) Replacement Method :
Labour Turnover Rate =No.ofworkersReplaced×100AverageNo.ofWrorkers
=2001004000
=200004000= 5%
b) Separation Method:(No.ofWorkersleft+No.ofWorkers)DischargedLabourTurnoverRate= ×100AverageNo.ofWorkers
(11)
=40 1801004000= 4.5%
c) Fluxy Method:(No.ofSeperation+No.ofaddition)LabourTurnoverRate=
AverageNoofWrorkersX 100
=(220 1000)1004000
= 122
= 30.5%
REMUNERATION SYSTEM / METHODS :
Labour is rewarded by making payment of wag es. Wages may be
paid either on the basis of Time spent on work or on the basis of output
from work. There are following methods / System of payment of
remuneration to the Labour.munotes.in

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61a) Time Rate System:
This method is related to the number of working ho urs spent by a
worker on work. As per Time Rate System , wages means the product of
Labour and Labour Work. The payment of wages calculation is depends
upon the time spent on work irrespective of the quantity of output.
Normally over time if any is paid a t higher rate 1.5 time of the rate. The
wages rate may be determined as per hour, week, fortnightly per month.
Wages=Actual time devoted X Time Rate
This case is suitable in case of the following:
1)Where attendance and quality of work are more impor tant than output.
2)Where it is difficult to measure quality.
3)Where highly skilled and unskilled workers including apprentices and
learners.
4)Where the work requires close supervision which ensure “fair day’s
work”.
Advantages:
1) This System is easy to understand and operate.
2) This system assures study and regular income.
Disadvantages
1)This System does not motivate the workers to produce more output.
More Efficiency is ignored.
2) This System Leads high labour cost because idle time rem uneration
is also paid.
3) It needs to home strict supervision to ensure that the workers spend
their time in productive activities through the day.
b) Piece Rate System:
Under this system, each unit, job, operation or process is known as
a piece. A piece rate is fixed for each unit or job or operation or process.
The workers are paid on the basis of the number of pieces completed
irrespective of the time spent by the worker on the job. Payment of
overtime or idle time are not arised in this case. Rec ord of work time and
attendance is recorded on time card, piece work ticket records the out put
by the workers.
Wages = Pieces Completed X Piece Rate .munotes.in

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62Advantages:
1)It is Simple to calculate wages because Piece Rate is fixed first.
2)The wages is calculated on the basis of Pieces of output. Management
has not to loose on account of inefficiency or workers.
3)The wages is directly inked with output. The workers are motivated to
make good and greater effort of assuring higher income.
4)The L abour cost are lower due to higher labour productivity and
efficiency and minimization of idle time or overtime.
Disadvantages
1)It is very difficult is fix the piece rate. Many time it is difficult to
establish standard output and hence to fix piece r ate.
2)The worker is neither assured of regular income nor can enjoy social
benefit like leave, allowances, etc.
3)This method is not suitable in case of job like research repairs, quality
control, inspection etc.
4)This method is expensive as it requ ires additional expenditures for
installation and operation.
5)If the wages are not guaranteed, the worker, may lose earnings
specially when continuous flow of work can notbe maintained.
c) Incentive Plans
An incentives can be defined as the of B onus. Non -monetary
incentives may improve living and working conditions of the worker or
employees. The incentives may be provided to the worker individually or
collectively to the group.
Good Incentive Schemes
Following are the feature of good incen tives schemes:
1) It should be Simple to operate and understand.
2) It should be economical.
3) It should facilitate fix wages.
4) If should be given to efficient workers.
5) The scheme should be approved by the workers.
6) It should reduce absentee ism and Labour Turnover.
7) It should be flexible in nature.
8) It should be supported by the management.munotes.in

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63a) Wage Payment:
1) High Wage Plan: -
The Ford Motor Company, USA has introduced this plan in order to
induce the workers put extra effor ts in their work. Under this plan the
worker is paid at higher rate prevailing in the industry and they are
expected to perform well but high qualitatively and quantitatively.
2) Measured Day Work:
Under this method the hourly rate of line is made up of two parts viz,
fixed and variable rate. The fixed rate is based on the requirement of job
and the variable rate for each worker depending upon the merit rating and
cost of living index. The total of Fixed and variable part of a day is called
as measured day’s work rate of workers.
3) Differential Time Rate:
Under this method different rates are fixed for different level of
efficiency. The rate is depends upon the efficiency and performance of the
worker. Up to certain limit of efficiency, normal rate for day is paid and
gradually hourly rate increases on the basis of efficiency level of worker.
The differential rates are as follows.
Upto 75% efficiency Normal (Rs100 per hour)
From 76% to 80% efficiency (Rs110 per hour)
From 81% to 90% efficiency (Rs120 per hour)
From 91% to 100% efficiency (Rs130 per hour)
From 101% to 120% efficiency (Rs140 per hour)
4) Taylor’s Differential Piecework System:
This system aims of rewarding efficient worker by providing piece
rate more than certain lev el of limit of output. This method is introduced
by F.W. Taylor in USA. Day wages is not guaranteed in this method.
There are Two rates of wages. i.e. low piece rate for output to below
average and high piece rate for standard / more output, more reward at
high rate is given to the workers who shows standard performance and
below average performing workers are ignored for reward.
The lower rate is 80% Normal Piece rate and the higher rate is 120%
of the normal rate.
5) Merick differential Rate System :
Under this method, there is some modification have been taken place
of taylor’s differential piece rate system. Merick has three rate ofmunotes.in

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64remuneration. First rate is for the beginners, the second for developing
workers and third for highly skilled wor kers.
These piece rate as follows.
83% of efficiency -Normal rate from 83% to 100% efficie ncy-10%
above the Normal rate from 100% & above efficiency -20% above the
normal rate.
6) Gantt Task Bonus Plan:
Under this method, the combination of t ime rate bonus and piece rate
is considered. This plan aims at providing an incentives for efficient
workers to attain the high level of output and at the same time ported and
encourage the less or unsalted workers who can not complete their work at
standa rd time given. These are as follows.
Production below Standard Guaranteed Time Rate
(15)
Production Equal to Standard 120% of Normal rate or
20% Bonus of time or Piece Rate
Production above Standard High Piece Rate or
120% of Piece rate
7) Emer son’s Efficiency System:
This system guarantees minimum wages payable to the workers. But
he cross certain limit of efficiency, bonus in addition to minimum wages is
paid. A worker who attain efficiency equal to 2/3 of the standard
efficiency, or abov e, is declared as efficient worker and deserves
incentives. The efficient worker is paid bonus at raising rate at various
level of efficiency, raising from 66.67% to 150%. If worker shows
performance below 66.67% then only time rate wage is paid. But if
performance is above 66.67% to 100%, efficiency bonus increases from
0.01% to 20% and above 100% efficiency, bonus of 20% of wages (basic)
plus 01% for each 01% increase in efficiency paid.
8. Hayne’s System:
In this system standard is set in minutes. Th e standard time for job is
expressed in terms of the standard man minutes called “MANIT”. In this
case saved time is shared between the workers and foreman in the ratio of
5:1. If non -reparative work is there, then saved time is shared among the
worker, employees and foreman in 5:4:1 ratio.
9. Accelerated Premium System:
Under this system, earnings increases with output, infact the earning
increases in greater proportion than the increase in production. Thismunotes.in

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65system acts as a strong incentives for sk illed workers to earn high wages
by increasing output and production beyond standard.
INDIVIDUAL BONUS PLANS
In case of individual bonus plan, the bonus to be paid to each
individual worker is calculated on the basis of saved hours difference
between time allowed and time taken. It is the Standard time fixed by
conducting time and motion study by the work study engineers.
The actual time taken is compared with the standard time and bonus
is payable to the workers if time taken is less than the sta ndard time.
Methods of Individual Bonus Plan:
1) Halsey Premium Plan:
This plan has been introduced by F.A. Haisey, an American
Engineer. Under this method, bonus is paid on the basis of time saved.
Bonus is paid at 50% of the line saved.
A worke r is assured of time wages if he takes longer time than actual
time allowed.
Total wages is calculate by using the following formula.
Total Earnings = Time Wages + [50% of Time Saved x time Rate] = (H x
R) + [50% (S -H) x R]
where, H = hours worked , R= rate per hour, S=standard time.
2) Halsey Weir Premium Plans:
Under this method, there is only one difference as compared to
Halsey Plan and that is inboards of 50% bonus for the time saved, it is1333% of the time saved. Tota l earnings as per this plan is calculated by
using the following formula.
Total Equal = (H x R) +1333[S-H] R
Where, H = Hours Worked, R = Rate Per Hour, S = Standard Time.
3) Rowan Premium Plan:
This premium bonus plan was intro duced by Mr. James Rowan. It is
similar to that of Halsey plan in respective of time saved, but bonus hours
are ascertained as the proportion of time taken which the time saved bears
to time allowed and they are paid for at the rate.
Total earning is calc ulated as follows, Total = (H x R) +[(S -H) / S x H x R]
where, H = Hours Worked, R = Rate Per Hour, S = Standard Time.munotes.in

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664) Barth Variable Sharing Plan:
Under this system, the total earning is calculated by following the
formula given below:
Total E arnings = R xS×Hwhere R= Rate Per hour, S = Standard Time, H = Hours worked.
Illustration : 2
Calculate the earnings of worker A and B under straight Piece Rate
System and Taylor’s Differential Piece Rate System from the follo wings
particulars:
Normal Rate per hour –Rs 1.80
Standard Time per unit = 20 seconds
Differentials to be applied are:
80 % of Piece rate below the standard,
120% of the Piece rate above standard.
A produced 1400 unit per day of 8 hours and B 1 800 units per day of
8 hours.
Solution:
Basic Calculations:
Pieces per minute = 60/20 = 3 minutes
Unit per hour = 60 x 3 = 180 units
Normal Piece Rate = Rs 1.80/180 units= Rs 0.01
Standard Production in actual time = 8 hrsx 180 units = 1440 Units.
Earnings under Straight Piece Rate:
Earnings of A = 1400units x Rs 0.01 = Rs14
Earnings of B = 1800unitd x Rs0.01 = Rs18
Earnings under Taylor’s Differential Piece Rate
A’s efficiency =1400 1001440= 97.22% = < 100%
B’s Efficiency =1800 1001440= 125% = > 100%A’s Earning = 1400 units x Rs 0.01 x 80% = Rs11.20B’s Earning = 1800 units x Rs 0.01 x 120% = Rs21.60
Illustration : 3
A worker’s basic wages is `2/ -per day o f 8 hours and is paid under
the Rowan Premimum Bonus Scheme. He also get D.A. of `12/ -per week
of 45 hours. His time sheet of a week is summarized below:munotes.in

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67(18)
Job No. Time allowed Time Taken
248 25 hours 20 hours
448 30 hours 20 hours
Idle Time (Waiting) - 8 hours
48 hours
Calculate the gross wages he has earned for the week and indicate
accounts to which the wages amount will be paid.
Solution:
Rate = R = 2/8 Hrs. = 0.25 Pa ise
Statement Showing Earnings of A Worker.
Particulars Rs Rs
1)Amount to be paid to Job No. 248.
Wages =S-TT×R+ ×T×RS
=25 2020 0.25 20 0.2525 
= 5 + 0.2 x 5 6 .00
=5+1
DA=2512555.45 11.45
2)Amount to be paid to Job No.248
Wages =S-TT×R+ ×T×RS
=30 2020 0.25 20 0.2530 
= 5 + 0.333 x 5 6.67
= 5 + 1.655
DA =12 X 25 /55 6.55 13.22
3)Idle Time to be paid to overheads.
Wages 8 hours x 0.25 paise 2.00
Gross Wages of a workers for the week 26.67
Illustration : 4
A workman’s wage for a guarantee 44 hours week is Rs0.19 per
hour. The estimated time to produce one article is 30 minutes and undermunotes.in

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68incentive scheme the time allowed is increased by 20%, During one week
the workman manufactured two articles.
Calculate his gross wages under each of the following method of
remuneration.
a) Time rate.
b) Piece -work, with a g uaranteed weekly work workly.
c) Rowan Premium Bonus.
d) Halsey Premium Bonus 50% to workman.
Solution:
a) Wages Under Time Rate Method
44 hours x Rs0.19 Rs8.36
b) Wages Under Piece Rate Method
Estimated Time for on Article -30 Minute
Time allowed increased by 20%2030 30100-36 Minute
Time allowed for 100 articles at 36 minutes -60
minutesWages = 60 hours x Rs 0.19 Rs11.40
c) Wages Under Rowan Premium Bonus
Wages for 44 hrs @ Rs0.19 Rs 8.36
(+) Bonus =60 4444 0.1960STTR
S  Rs 2.23
Where S = Standard Time,
T = Time Taken
R = Rate Per hours
Wages Paable Rs 10.59
d) Wages Under Halsey Premium
Wages for 44 hrs x `0.19 Rs8.36
(+) Bonus =
2STR=60 440.192Rs1.52
Wages Payable Rs 9.88
Illustration : 5
The following are the particulars applicable a process.
Time rate -Rs 8 per hour
High Task -200 units per week
In a 40 hours week, the production of the worker was:
A-180 units, B -200 units, C -205 units
Calculate the total earnings of ea ch worker under Gandhi Task
Bonus System.munotes.in

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69Solution:
a) Actual Output < High Task ie. below StandardA’s earnings = 40 hours x Rs 8= Rs320/ -
b) Actual Output = High Task ie. at StandardB’s Earning = 40 hrs x Rs 8 + 20% of (40 x 8)
(21)
= 320 + 20% of 320
= 320 + 64 = Rs384/ -
c) Actual Output > High Task ie above & StandardC’s earning = 205 x Rs2.00 = Rs4.10
Illustration : 6
In a manufacturing company the daily wages rate is Rs 3.00. The
standard output in a 6 days week is 200 units representing 100%
efficiency. The daily wages rate is paid without bonus to those workers
who show up to2663% efficiency Standard. Beyond this there is a bonus
payable on a graded scale as below:
82% efficiency -5% bonus
90% efficiency -9% bonus
100% efficiency -20% bonus
Future increase of 1% for every 1% future every in efficiency. In a 6
days week produced the following:
.
Mr.A180 units, Mr. B 164 units Mr. C -200 un its, Mr. D. 210 units.
Calculate the earnings of each workers.
Solution: Earning of workers is as follows:
Mr. A’s efficiency =180100200= 90%
Mr. A’s earning = (6 x 3) + 90% of (6 x 3)
= 18 + 90% of 18 = 18 + 1.62 = Rs19.62
Mr. B’s efficiency =164100200= 82%
Mr. B’s earning = 6 x 3 + 5% of (6 x 3)
= 18 + 0.9 = Rs18.90
Mr. C’s efficiency =200100200= 100%
Mr. C ‘ earning = 6x3+20% of 18 =
= 18 + 3.6 Rs21.60
Mr. D’s efficiency =210100200 = 105%
Mr. D’s earning = 6 x 3 + 25% of 18 =
= 18 + 4.5 Rs 22.5munotes.in

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70Illustration : 7
From the following information available you are required to calculate
the Net Wages Bill as well as total wages cost.
a) As per the time card the gross earnings of the workmen Rs
4,50,000/ -.
b) Various deductions from the goods earnings are as follows:
Particulars Rs
Employees Contribution to P.F. 37,500
ESI Employees Contribution 6,000
Aeolians against wages 12,000
Co-operative Society’s dues 9,000
Canteen charges 2,000
Income Tax 8,000
c) Company’s contribution to P.F. and ESI Rs 30,000 and Rs 38,000
respectively.
Solution:
Calculation of Earnings and Lost to Company
Particulars Rs Rs
a) Gross earnings of Employees
Less : Deductions4,50,000
Employees contributing to P.F. 37,500
Employees Contribution & ESI 6,000
Advance Against Wages 12,000
Dues of Coop Society 9,000
Canteen Charges 2,000
Income Tax 8,000 74,500
Net Earnings to Employees 3,75,500
b) Total Cost to Company
Workman’s Gross earning 4,50,000
Add: Employers Contrib ution to Provided
Fund 30,000
ESI 8,000 38,000
Cost to Company 4,88,000
Illustration : 8
Ajay an employee of Amardeep & Co. gets the following employments
and benefits:munotes.in

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71a) Salary Rs3,000 P.M.
b) Dearness Allowance Rs5,250 P.M.
c) Employees Contribution to
P.F. 9 % Salary & DA
ESI 4% of Salary & DA
d) Bonus 20% of Salary & DA
e) Other Allowances Rs28,250 P.M.
f) Medial Allowance Rs5,000 P.M.
Ajay works for 25,00 hours p.m., out of which 400 hours are non -
productiv e but treated as normal idle time.
Your are requested to find out the effective hourly cost of Ajay.
Solution:
Company of Labour Cost per hour Earnings of Ajay.
Particulars Rs Rs
a) Salary 30,000
b) D.A. 5,250
8,250 x 12 = 99,000
c) Employ ees Contribution to
PF 9% of 99,000 8,910
ESI 4% of 99,000 3,960
d) Bonus 20% of 99,000 19,800
e) Other Allowance 28,250
f) Medical Allowance 5,000
Total Cost to Company Per Month 1,64,920
Total Working Hours 2,500
(-) Idle Hours (N ormal) 400
Effective Working Hours 2,100
Effective Hourly Cost of Ajay1,64,9202,100Rs 78.53 Per Hours
Illustration : 9
Calculate the earnings of worker Amar, Akbar and Anthoney under
Matrik’s Multiple Piece Rate System from the foll owing:
Normal rate Rs 6.60
Standard Time Per Unit -1 minute
Output per day by
Amar -390 units
Akbar -450 units
Anthoney -550 units
Working hour per day 8 hours.munotes.in

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72Solution:
a) Efficiency Level
Worker Actual Output Standard Output Efficiency % age
(Unit) (Unit)
Amar 390 480 81.25%
Akbar 450 480 93.75%
Anthoney 550 480 114.50%
Or 115.00%
b) Straight Piece Rate System
Wages of - Output x N.R / Piece
Rate(Rs)Rs
Amar - 390 x 160 = 429.00
Akbar - 450 x 1.10 = 495.00
Anthoney -550 x 1.10 = 605.00
c) Multiple Piec e Rate:
-Upto1833% efficiency-Normal Piece Rate
-Above1833to100%
efficiency-110% of Normal Piece Rate
-Above 100% efficiency -120% of Normal Piece Rate
d) Wages Payable to Rs
Amar -390 x Rs1.10 = 429.00
Akbar -110450 1.10100   = 450 x 1.21= 544.50
Anthoney -120550 1.10100   =550 x 1.32= 726.00Normal Rate Per Hour = Rs 6.60
Standard Output Per Hour
(1 minute = 1 units) = 60 units
Normal Wage Rate Per Unit =
Rs6.60/60 units = Rs 1.10 per unitStandard Out Put = 60 unit is per hour x 8 hrs
= 480 units
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733.5 EXERERCISES
1)A factory works for 9 hours per day and has a 5days week .A worker
requires 9 hours for completion of a job on daily wages. However, under
incentive schemes, he completes the job in 6 hours . A worker is entitled
day rate of Rs 7/ -per hour.
You are asked to calculate his earnings to be charged under the
following plans :
a)Piece Work Plan.
b)Halsey Premium Plan.
c)Rowan Plan.
(Ans : a) Rs 63/ -,b) Rs 52.50 c) Rs 56/ -)
2) Calculate the earnings of a worker a) Halsey Plan and b)Rowan Plan
from the following particulars :
i)hourly rate of wages guarante ed 0.50 paise per hour.
ii)standard time for producing one dozen articles -3 hours.
iii)Actual time taken by the worker to produce 20 dozens articles -48
hours.
(Ans Halsey Plan -Rs 27/ -, Rowan plan -Rs 28.80)
3) The following particulars app licable to a particular job –B
Standard production per hour –8 units
Standaed working hours -7
Normal rate per hour -Rs 1.50
Maqdhavi produced 35 units, Ram produced 45 units and Prasad
produced 60 units.
Calculate wages payable to these workers under Me rrick’s
Differential Piece Rate System.
( Ans : Madhavi -Rs 6.5625,Ram -Rs 9.28 and Prasad -Rs 13.50)
4) Calculate earnings of workers of Nilesh and sureshunder Taylor’s
Differential Piece Rate System:
Standard Time –one hour 125 units.
Normal Rate -Rs 10 per hour.
Differedntial Piece Rate:
i)80 % piece rate below standard.
ii)120% of piece rate at or above standard.
In a day of 6 hours Nilesh produced 800 units and Suresh produced
990 units.
(Ans : Nilesh -Rs 51 .20 and Suresh -Rs 95.04)
5) Ashok an employee of R & T company gets the following emoluments:
Particulars Rs
i) Basic pay 2,500 p.m.
ii) D.A. 4,500 p.m.
iii)Employer’s contribution to P. F. 12% of D. A. and salarymunotes.in

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74iv)Employer’s contribution to ESI 4.75 % of Salary and D.A.
v)Bonus 20 % of Salary and D.A.
vi)Other allowance 27,750 p.a.
vii)Ashok works 2,500 hours out of which 400 hours are normal idle
time.
viii)Find out the effective hourly cost of Ashok.
( Ans Rs. 67.91)
6) From the f ollowing information, find out net wages payable in cash
and also find out cost of wages for March 2015.
a) Basic salary p.m. Rs 60,000
b) D.A. 100% of basi c
c) Total amount deposited to P.F. Rs 12,000
d) Amenities Rs 4,500
e) Employer’s contribution to P.F. is equql employee’s
contribution.
f) The ratio of emp loyer’s and employee’s share in to the
contribution to ESI is 2:1.
g) Recovery of staff quarter Rent Rs 6,000.
i) Recovery of provisions supplied Rs 5,000.
( Ans : Rs 1,01,500 ; Rs 1,33,000)
7) From the following information prepare statement showing employee
cost.
i)Basic pay Rs 7,00,000.
ii) Lease re4nt paid for accommodation provided to an employee
Rs 2,00,000, amount recovered fro m the employees Rs 40,000
iii)Employer’s contribution to P F Rs 75,000.
iv) Employee’s contribution to P F Rs 75,000.
v)Reimbursement of medical expenses Rs 67,000.
vi) Hospitalization expenses o9f employe e’s family member borne
by the Employer Rs 18,000.
vii) Festival bonus Rs 20,000.
ix)Festival advance Rs 30,000.
OBJECTIVE QUESTION :
A)Multipule Question:
1.Cost of idle time arising due to non -availabilit yo fr a wm a t e r i a li s ------
a) Charged to costing profit & loss A/c
b) Charged to factory overheads
c) covered by inflating the wage rare
d) ignored
2. Wages sheet is prepared by --------------- .
a) Time keeping department b) Personnel department
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753.Time and Motion study is conducted by ----------- .
a) Time keeping department b) The personnel department
c) Engineering department d) Pay roll department
4. Productivity of labour is measured by comparing -----.
a) Ac tual time with standard time
b) Total output with total man hours
c) Added value for the product with total wages cost
d) All of the above.
5. Labour turnover is --------------- .
a) Productivity of labour b) Chan ge in labour force
c) Efficiency of labour d) Total cost of labour
6.Idle time is time spent by workers ---------- .
a) in factory b) Off their work
c) on their job d) in office
7. Time wages are paid ------------------------ .
a) on the basis of actual time
b) on the basis of standard time
c) on the basis of time saved
d) on the of overtime
8.Time keeping refers to time spent by the workers ----------- .
a) on their job b) in factory
c) off their job d) without job
9.Difference between attendance time and job time is-------- .
a) overtime b) idle time
c) standard time d) Actual time
10. Differential piece wages means -------------- .
a) Different wages for different level of perfo rmance
b) Different wages for different level time consumed
c) Different wages for different of workers
d) Different wages for different types of industries
11.Normal idle time is ------------------ .
a) can be avoided b) can not be avoided
c) can be minimized d) can be controlled
12. Labour turn over measured by,
a) Replacement Method b) Seperation method
c) Flux method d)All of the abovemunotes.in

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7613. Salary of foremen should classified as,
a) Fixed overhead
b) Variable method
c) Semi -fixed or semi -variable method
d) None of the above
14.How many rate are used to calculate wages under Taylor’s differential
piece rate system
a)Two b) Three c) Four d) Five
15. The card which records idle time is
a) Idle time Card b) Job Card
c) Job Sheet d) I Card
16. Pay roll accounting is concerning with
a) Computation of wages b) Appointment of workers
c) Termination of workers d) All of the above
17. Labour turnover can be reduced by
a) Exit interview b) Better facilities c) Better pay d) All of the above
18.The method if time booking include
a) Daily time sheet b) Attendance Register
c) Time clock d) None of the above
19. Casual workers work in place of
a)Absentees b) Retrenched workers
c) Sincere workers d) None of the above
20. Deductions allowed as per payment of wages Act include
a) House Rent b) Income Tax
c) P.F. Deductions d) All of the above
21. Replacement cost is associated with
a) Replacement of labour b) Appoint of labour
c) Treminatio0n of labour d) All of the above
22. The met5hod acceptable to labour union is
a) Time rate b) Piece rate c0 Rowan rate d) None of the above
23.Over time is paid to the worker who for extra time than -----working
hours Specified.
a)Extra b) Add itional c) Normal d) Idle
24. Travelling time from one job to another job is
a) Normal idle time b) Abnormal idle time
c) Over time d) None of the above
25.Over time paid due to negligence of a worker is char ged to the
concerned Worker
a)Worker b) Department
b)Overheads d) All of the abovemunotes.in

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77(Ans:1-a, 2-d,3-c, 4-d, 5-b,6-b, 7-a,8-b, 9-b,10-a,11-b 12-d,13-c, 14 -b,
15-a,16-a,17-d,18-a, 19-a, 20-d, 21 -a, 22-a, 23-b, 240a, 25-b)
B)Fill in the blanks :
1)_____means keeping a record of the attendance of the workers and
time spent by them in actual work, idle time, over time, etc. ( Time
Keeping)
2)_____is the time spemt beyond the normal working hours which is
usually paid at hig her rate than the normal time rate. ( Over Time)
3)If the over time is abnormal, it is debited to_____. ( Costing P & L
Account)
4)Under ____ rate system , worker assured of a stead and regular
income. ( Time rate)
5)Labour in percentage =(Time allowed as per st andard/_____) X100. (
Time taken)
6)Cost of welfare service _____cost. ( Preventive)
7)Muster roll is kept at the ____of the factory. ( Gate)
8)Workers who works out side factory premises is called as____.( Out
work)
9)Piece workers are paid on the basis of ____ _. ( Piece rate)
10)Under _____ plan thrice piece are paid. ( Merrick Differencial Piece
Rate)
11)Under ___ plan bonus is to the workers on the basis of time saved.
( Halsey Plan)
12)Under piece rate system wages are paid at a _____per unit. ( Fixed
Rate)
13)Over premium increases _____ of plant and machinery. (
Depreciation)
14)Normal idle time are charged to ______overheads. ( Factory)
15)Time booking means recording of _______ time.( attendance)
16)Cost of normal idle time is charged to _______. ( Costing P and L
Account)
17)In Halsey Plan , a worker gets bonus equal to ____of the time saved.
( 50%)
18)Idle time arises only when workers are paid on ____basis. ( Time
Rate)
19)Under Gantt Task and Bonus Plan, no bonus is payable to worker , if
his efficiency is le ss than _____. ( Standard output)
20)The formula for computing wages under time rate is _____. ( Hours
worked x Time taken)munotes.in

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7821)_____ time is the diffrerence between the time for which the
employees are paid and the employees’ time booked against the cost
object. ( Idle)
22)_____helps in the preparation of labour requirement budget. (
Efficiency Rate)
23)According to _______plan time rate wages are guaranteed.(Rowan
Bonus)
24)______ is the combination of the wages by time rate and wages by
piece rate method. ( Time and Pie ce Rate)
25)Under ____method (system),the minimum wages are not guaranteed
.(Piece work )
C)True or False
1)Overtime wages are to be paid at double the normal wage rate.
2)Cost of idle time due to labour strike should be treated as factory
overhead.
3)In Taylor’s Piece Rate Plan, time wages are guaranteed to each
worker.
4)Earning under Halsey and Rowan plan is the same.
5)The cost of labour turnover is recovered through departmental
overhead recovery rate.
6)Time booking means recording of attendance time.
7)Productivity of workers can be improved on if they are supervisesd
closely.
8)The wages paid to a worker (joiner) who construct wooden mould for
concrete laying on building contract should be as direct labour cost of
the contract.
9)Labour productivity is automatically im proves( increases) when
production increases.
10)Cost of normal idle time may be treated as production overheads.
11)Idle time arises when workers are paid on time basis or pieces basis.
12)Increase in production may or may not be accompanied by increase in
labour productivity.
13)Job evaluation is a comparative appraisal of jobs ant of workers.
14)Time -cum-job card shows the attendeence records as well as effective
time work of each.
15)Bonus is payable at efficiency of 66 2/3 %.
16)Cost of abnormal idle time is transferred to costing profit and loss
account.
17)Labour turnover may be caused due to low wages.munotes.in

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7918)Pay roll accounting is concerned with calculation of wages.
19)The objective of time booking is ascertainment of labour cost.
20)Overtime premium is always treated as factory ov erheads.
21)Tea and lunch break is normal idle time.
22)Overtime increases depreciation of Plant and Machinery.
23)Strike and lock out time is abnormal idle time.
24)Abnormal idle time wages is included in in cost of production.
25)Machine setting time is abnormal idle time.
(Answer : True –1,5,6,7,8,10,14,17,18,19,21,22,23:
False -2,3,4,9,11,12,13,15,16,20,24,25)
D)Match the following:
a)
Column ‘A’ Column ‘B’
1)Clock card
2)Out workers
3)Net wages
4)Daily time sheet
5)Pay slip
6)Casual worker
7)Piece workers
8)Job carda)Reconcili ation of time
b)Workers who works out side
c)Individual worker
d)Gross wages less deductions
e)Paid at piece rate
f)At the entrance of factory
g)In place of absentees
h)Method of time book
i)160 holes
j)Time rate
( Answers : 1 -f, 2-b, 3-d, 4-h, 5-c, 6-g, 7-e, 8-a)
b)
Column_ ‘A’ Column ‘B’
1)Labour Turnover
2)Medical service
3)Low wages
4)Halsey plan
5)Rowan plan
6)Time rate plan
7)Merrick Differential Plan
8)83% of Normal Piece rate
9)Piece rate plana)Provides incentives to
efficiency
b)Taylor’s Piece Rate Plan
c)Turnover of worker
d)Three r ates fixed
e)Preventive cost
f)Cause labour turnover
g)Equal treatment
h)Bonus for time saved
i)No incentives to efficiency
j)Proportion of actual time to
standard time
k)Merick’s piece rate
( Answer : 1 -c, 2-e, 3-f, 4-h, 5-j, 6-I, 7-d, 8-b, 9-amunotes.in

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80c)
Column ‘A’ Column ‘B’
1)Normal idle time
2)Power failure
3)The Factories Act
4)Abnormal idle time cost
5)Tea and Lunch break
6)Idle Time
7)Salary leave as direct
laboura)Difference3 between Total
time and actual time spent
by worker
b)Normal idle time
c)Controllable
d)Causes excess labo ur cost
e)Costing profit & loss A/c
f)Abnormal idle time
g)Annual with full pay
h)Direct cost method
i)Overhead method
( Answer : 1 -d, 2-f, 3-g, 4-e, 5-b, 6-a, 7-h)

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814
OVERHEADS
Unit Structure :
4.1 Introduction
4.2 Definition of Overheads
4.3 Composition of Over heads
4.4 Basis ofApportionment or Distribution of Overheads
4.5 Solved Problems
4.1INTRODUCTION
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 supplementary cost.
4.2DEFINITION OF OVERHEADS
a) Overhead Costs are operating cost of business enterprise which can
not be traced directly to a particular unit of output. The term overhead is
used interchangeably with such terms as ‘burden’, ‘suppleme ntary costs’,
‘manufacturing expenses’ and ‘indirect expenses’.ByBlocker and Wellmer.
b) ‘In Cost accounting all indirect, costs are termed as ‘Overhead’.By W W.Bigg.
c) “The Aggregate of In direct Material Costs, indirect wages (labour
cost )and indirect expenses”.By The Institute of Cost and
Management
Accountants,
London.
01.Composition of Overheads :
verheads
Indirect Indirect Indirect
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821.Overheads -the Concept :
Overheads comprises of indirect materials, indirect wages and
indirect expenses which are not directly identified or allocated to cost
object in an economically feasible way.
Accounting : 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.
Collection of overheads means the collection of items of expenses
from The Books of account and other records regarding to their nature and
purposes. eg. 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 from 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
Maintaince -102
3.Classification of Overheads: -
It means the process of grouping overheads according their common
features or characteris tics or nature.
It can be classified in the following ways.
a) On the Basis of Behaviour -
-Fixed and Variable Overheads
b) On The Basis of Function -
-Production Overheads, Selling and Distribution Overheads and
Administration Overheads.
This classification is already stated earlier.
3.1 Allocation of Overheads : -
It means Charging of whole items of cost of suitable and identifiable
cost centers or cost units. It is the transfer of the cost of a goods or
services from primary account to o ne or more secondary accounts.
3.2 Apportionment of Overheads: -
It is the distribution of cost over several periods of time in proportion
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83between 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’.
3.3 Absorption of Overheads:
It is charging of overheads from cost centers to product or service by
means of absorption rate for each cost centre.TotalOverheadoftheCostCentreOverheadObsorptionRate=TotalQuantiumofUnitorBaseIt is 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 conditions of physic al movement,
benefit yielded and period of charges, etc.
4.4. BASIS OF APPORTIONMENT OR DISTRIBUTION
OF OVERHEADS
There are some items of expenses which can not be allocated easily
to a specific department and it needs equitable apportionments on the bas is
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 Showing the Apportionment of Overheads.
a) Overheads Expenses Basis of Apportionment
1) Rent, Rates, Taxes, Air
ConditioningFloor Area Occupied
2) Labour Welfare Exps,
Perquisites, Time Keeping,
Personnel Office, SupervisionNo. of Workers
3) Compensation to Workers,
Holiday Pay ESI and PF
ContributionDirect Wages
4) Depreciation on P & M, Repair
& Maintenance of P & MCapital Value or Value of
Assts
5) Insurance of Stock Stock Value
6) Lighting expenses, electric power No. of light points or area
occupied or material unit or
house power of machine or
No. of machine hours or value
of machine or consumption of
unit.
7) Material landing and store
overheadsWeight of materials or volume
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848) Delivery expenses Weight, volume or tone mile
9) Telephone expenses. No. of Calls or No. of
telephone machine
10) Audit fees Sales or total cost
11) Advertising Actual expenses or % age of
sales
12) Store keeping Weight or value of materials
13) Recreation No. of employees or total
wages
b) Cost ofService 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 roomDirect Labour Hour, Machine
Hours, Dire ct Labour Wages
4) Canteen & welfare, hospital
(medical), dispensary, personal
department, time keepingNo. of workers, No. of employees
5) Computer Section No. of Card punched, computer
hour, specific allocation to
departments
6) Power House (elec tric 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 issued
9) Transp ort 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 Departmen ts No. of purchase order, value of
purchases
4.4COMPUTATION OF OVERHEAD RATES
We have seen the methods of apportionment of overheads in the
earlier chapter. The next step is to see how overheads are absorbed in the
cost of production. Absorption of overheads means recovery of overhead
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85It 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 share of overheads of cost centers.
Overheads Absorption Rates:
The overhead absorpti on 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 numbe rs of units of the base selected.AmountofOverheadsOverheadAbsorptionRate=QuantileorValueBaseActual Rate:
Actual Rate is determined by dividing actual overheads incurred
during the period by actual quantity or value of base selected.
ActualOverheadExpensesIncurredDivingthePeriod∴Actual Rate=
ActualQuantityorValueofTheBaseRelatedtoProductionduringtheperiodPre-Determined Rate:
This is rate is decided on the basis of budgeted overheads and the
budgeted base for the certain period.BudgetedOverheadforThePeriodPre-DeterminedRate=BudgetedBaseforThePeriodThis 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.OverheadCostforEntireFactoryBlanketRate=TotalQuantumofBaseSelectedMultiple Rate: -
Aconcern 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 the product lines are
varied or machinery is used for varying degrees in d ifferent department. It
means the incidents of overhead cost each department is different.
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86EachDepatmentCostCentresorProductMultipleOverheadRate=CorrespondingBase
4.5METHODS 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.ProductionOverheadMachineHourRate=MachineHoursThis method is suitable where major portion of production of
goods is perf ormed 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 machine 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
Machine.
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 fatsmunotes.in

Page 87

87iii) 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 machine and repairs xxx
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 Apportionment
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.TotalRunningChargesHourlyRunningChargesPerMachine=MachineHoursvii) 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) Miscellaneous Expenses / Overheads xxx
xxxStandingChargesStandingChangesPerHour=EffectiveMachineHoursxxx
B) Running Charges / Expenses Per Hour
i) Depreciation xxx
ii) Power xxx
iii) Repair &Maintenance xxx
iv) Consumers & Lubricants xxx
v) Miscellaneous Expenses xxx
C) Machine Hour Rate xxxmunotes.in

Page 88

882.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 wages paid to workers
and number of machine hours put by the workers du ring the period.BudgetedorActualOverheads(Expenses)LabourRate=BudgetedorActualLabourHours          No-4workers No.Hoursfor
BudgetedLabourHour=employedduring×whichfactortheperiod workeseachday3.Percentage of Prime Cost Method:
This method shows relationship between budgeted actual
overheads and prime cost. This method is used where standard product
requires constant quali ty of materials and number of labour hour
produced.BudgetedActualOverheadsPercentageonPrimeCost= ×100BudgetedPrimeCost
4.Percentage of Direct Material Cost Method: -
Under this method, the cost of Material consumed in production is
considered as base of overhead absorption. This method gives rel ationship
between actual budgeted overheads and budgeted or actual direct materials
cost in percentage.BudgetedorActualOverheadDirectMateriCostRate= ×100ActualDirectMaterials5.Percentage of Direct Labour Method: -
Under this method, Labour Overheads are recovered on the basis
of actual rate. This m ethod is useful where production is in uniform nature
and all workers are more or less the same hourly rate and Labour is
predominant.FactoryOverheadsDirectLabourRate= ×100DirectLabour6.Combined Machine Hour and Labour Hour Rate:
This method is useful where company having var ious 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 labour rate and other
expenses, which are not di rectly related to machines, are allocated on the
basis of labour rate.munotes.in

Page 89

894.6UNDER 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 25,000 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.
d) Sudd en 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 u sed when the amount of over or under absorption
of overheads is quite large and is due to normal circumstances i.e. increase
in material piece and labour rate. This can be calculated by the following
formula.AmountofUnderorOverObsortingofOverheadsSupplimentaryRate=ActualBaseb) Writing Off to C osting 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 i s
transferred 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.munotes.in

Page 90

90Illustration:1
Factory Overhead Cost of Four Production Department of ABC
Ltd as are as follows .
Depts. Overheads
Rs
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 @ Rs 1.30 per hour
R -80% of Direct Labour Cost of Rs 6,000
S -950 Pieces @ Rs 2 per piece
Calculate department wise under or over absorbed overheads.
Solution:
Calculation of Overhead absorbed
P-14000 Hrs @ Rs 1.50 per hour = Rs 21,000
Q-3000 Labour hours @ Rs 1.30 per L. H. = Rs 3,900
R-80% of Rs 6,000 = 6,000 x 80/100 = Rs 4,800
S-950 Pieces @ Rs 2 per Piece = 950 x 2 = Rs 1,900
Statement showing under over absorption of overheads.
Overheads
Insured
(Actual)Absorbed
Overhea dAbsorption Departments
Rs Rs Under
RsOver
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 value -Rs 2,000
Estimated working life -10 years 0f 2,000 hours each
Running time for a 4 week period -150 hours
Estimated repairs for life -Rs 10,000
Standing charges allocated to this machine for a period -Rs 300munotes.in

Page 91

91Power consumed per hour -5 units @ 10 paise per uni t
Ans : Rs 11.00)
2.Compute the machine hour rate from the following data .
Cost of machine : Rs 1,00,000
Installation charges : Rs 10,000
Estimated scrap value after the expiry of its life (15 years : 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 occupi es 1/4thof the total area of the shop. The
supervisor is expected to devote 1/6thof 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 wor k on 90%
capacity throughout the year and that a breakdown of 10% is
reasonable . There are three days hholidy at Deepavali, 2 days at Holi
and 2 days Chrstimasexclusive of holidays. The factory works 8 hours
a day and 4 hours on Saturday. Number of Mach ines( each of the
same type) –40.
Expenses per annum Rs
Power 3,12,000
Light 64,000
Salaries to foreman 1,20,000
Lubrication oil ( Assumed fixed) 6,600
Repairs to machine 1,44,600
Depreciation 78,560
( Delhi University 2006)
(Ans : 9.00)
Working Not es: Hrs
Total hours (365 X 80 ) 2,920
Less : Saturday only 4 weeks (52X 4 ) 208
Sundays holiday (52x8) 416
Holidays on Deepawali, Holi and Chrismas ( 3+2+2 )____56__
Total 680
______
Machine hours worked 2,240
Less : 10% breakdown ( Normal) 224
______
Effective Machine Hours per Machine 2,016munotes.in

Page 92

92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 machine 1,00,000
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 units20
Estimated working hours p.a. 2,000
Supervisor’s salary p.m. 600
Machine occupies 1 /4thof the shop area and supervisor gives 1/5thof
his time for the looking after the machine.
(Ans Rs 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 worked 240 hours
Calculate the overhead chargeable to Order No. 102 by different cost
rates.
Ans Prime cost met5hod -50%, Direct labour rate Rs -o.417 per hour,
Direct labour cost method –71.43%, Machinrn hour rate -Rs 2.50 per hour
6.The factory overhead co st of four production department of a company
engaged in executing job orders, for an accounting year, are as follows : -
Department Rs
A. 19,800
B. 4,500
C. 4,000
D. 2,000munotes.in

Page 93

93Overhead 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 rat e 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 over heads.
( Dept. A -Over -absorption Rs 1,20 0;
“B -Under -absorption Rs 600;
“C -Over -absorption Rs 900;
“D -Under absorption Rs 100)
4.6SOLVED 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 days of 8 hours each day. All These Departments
Work for all the days and with full attendance.
Departments Total
Expenditure A
RsB
RsC
RsS
RsRs
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 Labour hour ra te 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 %a g e 600 600 400 400 2,000
Rent Floor 240 320 240 200 1,000munotes.in

Page 94

94Area
Welfare No. of
Workers270 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%a g e 565 339 226 (1,130)
2,075 2,319 1,806 -- 6,200
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 = 6000 Hrs
B = 200 x 40 Hrs = 8000Hrs
C = 200 x 20 Hrs = 4000Hrs
3)Labour Hour Rate For De partment2075A- =0.34586000= Rs0.35 Paise2319B- =0.2898000= Rs0.29 Paise1806C- =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
Machinery5,000 2,500 1,600 200 500 200
Sundries 4,500 910 2,143 847 300 300
Estimated
Working Hours1,000 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% --munotes.in

Page 95

95Solution:
Statement of Overhead Distribution
TotalProduction
DepartmentService 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
Machinery5,000 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 Hrs1,000 2,500 1,400 -- --
Rate Per Hour9,5001,00015000250070001400- -
Rate per hour 9.50 6.00 5.00 - -
Illustration : 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 100Value of Assets(Rs)10,00,000 16,00,000 14,00,000 40,00,000munotes.in

Page 96

96Direct Wages(Rs)8,00,000 10,00,000 12,00 ,000 30,00,000
Depreciation
(Rs)4,00,000Indirect Labour(Rs)9,00,000Insurance Charges(Rs)2,00,000
Electricity
(Rs)3,00,000Supervisory Salary(Rs)1,60,000
Staff Welfare Expenses
(Rs)3,00,000Other 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 Composite 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
Assets1,00,000 1,60,000 1,40,000 4,00,000
Indirect Labour Direct
Wages2,40,000 3,00,000 3,60,000 9,00,000
Insurance
ChargesValue of
Assets50,000 80,000 70,000 2,00,000
Electricity Horse
Power %
age1,20,000 75,000 1,05,000 3,00,000
Supervisory
SalaryNo. of
Workers40,000 40,000 80,000 1,60,000
Staff Welfare No. of
Workers75,000 75,000 1,50,000 3,00,000
Other Expenses No. of
Machine
Hours1,80,000 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
Hoursb) 30,000 30,000 40,000 1,00,000munotes.in

Page 97

97Machine Hour
Ratea÷b 53.50 63.666 or
63.6758.625 or
58.63-
-
Illustration : 4
In a factory there are three production departments and two service
departments i.e. A,B,C, Rand S respectively. In a March 2015, the
departmental expenses were as follow s:
Production Department
A B CService Department
RS
(Rs) 46,000 12,000 13,000 9,000 4,000
The ser vice departments are charged out on the basis of percentage as
follows a:
particulars Production Dept.
AB CService Dept.
RS
Service Dept R
Service Dept S40% 30%20%
30%30%20%--
10%20%--
You are required to apportion the cost of service department to production
department under Repeated Distribution Method.
Solut ion:
Particulars Base of
allocati
onProd.
Dept. A
RsProd.
Dept. B
RsProd.
Dept. C
RsService
Dept. R
RsService
Dept. S
Rs
Primary Distribution of
Overheads
Dept. ‘R’ Overhead
Dept. ’S’ Overheads
Dept, ‘R’ Overheads
Dept. ‘S’ overheads
Dept.’ R’ Overhe ads4:3:2:1
3:3:2:2
4;3;2;1
3:3:2:2
4:3:2:146,000
3,600
1,470
396
30
812,000
2,700
1,470
294
30
613,000
1,800
980
196
20
49,000
-9,000
980
-980
18
-184,000
900
-4900
98
-98
-
Total 51,500 16,500 16,000 _ _
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’.Fro m the following information prepare
aprimary distribution schedule.
Expenses Rs.
Indirect Wages 8,000
Rent and Rates 15,000munotes.in

Page 98

98Power 4,500
Light 3,200
Deprec iation 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
Floor space 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)
02.A Ltd. furnish you the f4ollowi ng half yearly budgeted data for for the
half year ended 31stMarch 2015. Distribute the overheads by most
equitable method.
Particulars Production Dept. Service Dept.
AB C DE
Direct Wages (Rs) 40,000 60,000 80,000 20,000 40,000
Direct Materials (Rs in lacs) 1 24 2 1
No. of employees 10 15 15 05 05
Electricity ( MWH) 8,000 6,000 4,000 2,000 2,000
Light Point 5 82 3 2
Asset Value (Rs in lacs) 12 8 6 2 2
Area occupied, (Sq. meters.) 150 250 100 50 50
The overheads fo r the above period were :
Particulars Rs Particulars Rs
Motive Power 17,500 Light ing 1,600
Store Expenses 20,000 Staff 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 expense s 5,400munotes.in

Page 99

99The following information is also available for the above departments.
Particulars A B S-1 S-2
Floor Space (sq. ft.)
No. of Workers
H. P. of Machine
Direct wages
Value of Assets( Rs.
in thousands )
Direct Materials
No. of Light Points6,000
100
120
10,000
10
15,000
304,000
50
30
10,000
4
10,000
152,000
50
30
5,000
3
5,000
152,000
25
15
3,000
1
-
5
Prepare statement showing primary distribution of overheads.
04.The following data were obtained from the books of Four Square
Engineering for the following half year ended 30thJune , 2014.
Prepare overhead distribution summary.
Items Production Dept. Service Dept.
A B CX Y
Direct Wages (Rs) 7,000 6,000 5,000 1,000 1,000
Direct Materials (Rs) 3,000 2,500 2,000 1,500 1,000
Emplo yees (Nos.) 200 150 150 50 50
Electricity(kwh) 8,000 6,000 6,000 2,000 3,000
Light Points ( Nos) 10 15 15 5 5
Assets 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 w ere 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 in 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)
Illustration : 1
Calculate the Machine Hour Rate from the following:
Particulars Rs
Cost of Machine 12,000
Cost of Installation 3,.000
Scrap Value 3,000munotes.in

Page 100

100Rent, 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 occupies14th of the total area of the shop.
The supervisor is expected to denote 1/6thof his time for supervising the
machine. General lighting expenses are to be apportioned on the basis of
the floor area.
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
Salary16000 46400
Insurance Premium 60
820
Standing Charges=   8202000Hrs0.41RunningChangesDepreciation12000+3000-300020000Hrs0.60
Repairs40020000.20
Power   2units×051000.10
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 Consumption 20 Units Per Hour @ Rs 20 per every 100 unitsmunotes.in

Page 101

101Administrative 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
The Machine Occupies 1/4tharea of workhop. The supervisor is
expected to 1/4thof time in supervising the machine.
Solution:
Calculation of Machine Hour Rate
Particulars Working P.A.
RsPer
Hour
Rs
Standing Charges
Rent30,000 47,500
General Lighting200 12 4600
Administrative
Expenses4000foryears4,000
Workshop
Supervisor’s
Salary4,000 12 412,000
24,100
Standing Charges
Per Hours24,100 2,000 12.05
Running Charges
Depreciation45, 000 5, 000 40, 000 4, 00010 10 2, 000    2.00
Repairs
&Maintenance75 14,000100 2,000   1.50
Power20 20 1,800100 200   3.60
_______
Machine Hour
Rate19.15
Note:
Machine Hours =w H50×40=2000Hrs. It is pressured that no
current is used by the machine devising setting up time.
Illustration : 3
Computer the Machine Hour Rate from the following data.munotes.in

Page 102

102Particulars 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 -produc tive setting up time of
200 hours.
-Shop Supervisor Salary P.M. - 600
The Machine occupies 1/4thof the total area of the shop:
Supervisor is expected to devote 1/5thof his time for supervising the
machine.
Solution:
Computation of Machine Hour Rate
Particulars Working P.A.
RsPer
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
Salary1600 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
Depreciation1,10,000 10,000 5,0002,000 15   3.83
Machine Hour Rat e 10.05munotes.in

Page 103

103Note:
Machine Hour = 2,200 Hrs. -200 Non -Productive Selling Time
= 2,000 Hrs.
Illustration : 4
From the following figures, compute the machine Hour Rates for
Machines A, B and C for a 4 -week prior sepeatedly. Ea ch 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
AMachine
BMachine
C
Area Space Occupied (Sq. ft.) 100 200 300
No. of Light Points 1 3 --
Cost of Machine (Rs) 25,000 15,000 10,00 0
No of Workers 1 2 3
Power (Rs) 250 150 200
Direct Wages (Rs) 2,000 3,000 5,000
Solution:
Machine Hour Rate
Machines Particulars Base of
Apportionment A
RsB
RsC
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
Canteen Expenses (1:2:3) 200 400 600munotes.in

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104Total 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 Hour12.25 16.25 21.13
Illustration : 5
The following expenses have been incurred in respect of a shop
having four indelicate machine.
Rent and RatesRs6,000 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.
Supervisor’s Salary:
Working after 4 Machines 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 x45= Rs.1152munotes.in

Page 105

105Particulars 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
b) Running Charges Powe r 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 =C 25,402=WorkingHours1,20021.17
Illustrations : 6
The following information is ex tracted 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 Labour Hour Rate.
ii) Direct Labour Cost.
iii) Machine Hour Rate.
iv) Prime Cost.
v) Direct Material Cost
Solution:
i) Direct Labour Hour Rate =OverheadoftheDeptLaourHoursmunotes.in

Page 106

106=93,0002,32,500= Rs 0.40 per hour
ii) Direct Labou r Cost =OverheadoftheDept×100DirectLabourCost=93,0001001, 50, 000
= 62%
Overhead of the Dept
iii)Machine Hour Rate = ______________
Machi ne hours
=93,00075,000= Rs 1.24 Per Hour.
iv) Prime Cost =OverheadoftheDept×100PrimeCost=93,0001001,50,000 3,00,000
=93,0001004,50,000
= 20.67%
v) Direct Material cost =Overheadsofthedept×100DirectMaterialCost=93,0001003,00,000
= 31%
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 x20.67 95 20.67100 100 = Rs 19.63munotes.in

Page 107

1075) Material Cost31 45 31100 100= Rs 13.95
Objective Questions :
A)Multiple Choice Question:
1.Indirect cost can not be identified with a particular cost centre shared
between centre using
a)A method of apportionment
b)A method of allocation
c)A recovery rate
d)None of the above
2.The allotment of whole items of cost to cost unit is called
a)Number of employees
b)Machine hours
c)KWH
d)Floor area
3.Administrat ive overheads are recovered as a percentage of
a)Direct materials
b)Prime cost
c)Works cost
d)Direct labour
4.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
5.Charging overheads to individual unit is known as
a)Allocation
b)Apportionment
c)Absorption
d)Collection
6.Salary of works manager is a
a)Office overheads
b)Factory overheads
c)Selling overheads
d)All of the abovemunotes.in

Page 108

1087.Assigning code numbers to a group of overheads is called as
a)Classifi cation
b)Codification
c)Analysis
d)None of the above
8.Store keeping expenses are allocated on the basis of
a)No. of material requisitions
b)Area
c)Direct labour hours
d)None of the above
9.Research cost should treated as
a)Production overheads
b)Period cost
c)variable cost
d)None of the above
10.The process by which cost items are charged direct to a cost is called
a)Absorption
b)Apportionment
c)Allocation
d)Allotment
11.Machine expenses are
a)Depreciation on machine
b)Rent of premises
c)Salary of supervisors
d)All of the above
12.Insurance is apporti oned on machine on the basis of
a)Insured value of each machine
b)Invoice price of each machine
c)Area
d)Cost of machine
13.Office overheads are recovered as a % age of
a)Direct materials
b)Direct wages
c)Factory costmunotes.in

Page 109

109d)None of the above
14.Labour rate is followed when most o f the work is done by
a)Labour
b)Machine
c)Different group of machine
d)None of the machine
15.Which of the following is service department
a)Refining department
b)Machining department
c)Receiving department
d)Finishing department
16.When the amount of under or over absorpt ion is significant, it should
be disposed off by
a)Transferring to costing profit 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
17.Factory overheads should absorbed on the bas is of
a)Relationship to cost incurred
b)Direct labour hour
c)Direct labour cost
d)Machine hours
18.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 absorpti on of overhead
d)None of the above
19.What is the basis for distribution of indirect material cost to various
department ?
a)Direct allocation
b)Cost of direct materials consumed
c)Machine hour worked
d)Either of the abovemunotes.in

Page 110

11020.Rent of the business is
a)Fixed cost
b)Variable cost
c)Semi -variable cost
d)None of the above
B. Fill in the blanks :
1. ___________ rate is calculated by dividing the overhead by the
aggregate of the productive
hours of direct workers. (The labour hour rate)
2. _____ is the loss in value of a sset 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 pro cess 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 p lace when rate ______rate
of absorption is
Used. ( predetermined )
7.The difference between actual and recovered overhead is termed as
_____. ( under/over Absorbed overheads)
8.Cost which can be controlled is____ cost. (controllable)
9.Repairs and maint enance is _____ expenses. ( Machine )
10.Machine hour rate is suitable when machine is a ______factor of
production. ( dominant)
11.Office overhead rate are recovered as a %age of _____ cost. ( factory
cost)
12.Percentage of direct is suitable when direct ____ is major factor of
production. ( Labour)
13.Production is suitable when output is _____.( uniform)
14.______ cost is the aggregate of all kind of consideration paid payable
fo9r the service rendered by an employee of an enterprise. (Employee
cost)munotes.in

Page 111

11115.______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.
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 accounts.
7.Factory overhead includes all production costs othe r than direct
materials and salaries.
8.Carriage inwards is not really an overheads at all, but is a direct cost.
9.The application o0f predetermined overheads rates is a reason for the
difference in costing and financial profit .
10.Cash discount is completely e xcluded 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 cost 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 absorb ed 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 is a single overhead rate computed for the
entire factory .
( Ans -True-2,5,8,9,10,11,12,14,16,17,19,20
False -1,3,4,6,7,13,1518munotes.in

Page 112

112D)a) Match the following
Column ‘A’ Column ‘B’
i) Rent
ii) Power
iii)Depreciation
iv)Advertising
v) CSA-7
vi)Office salary
vii)Lighting and heating
viii)Indirect materiala)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) Depreciationa)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)Machines hour
i)Mete r 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 munotes.in

Page 113

113c) Match the following
Column ‘A’ Column ‘B’
1.Absorption
2.Depreciation of machine
3.Under absorption of overhe ad
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 Departmenta)Cost Accounting Standard -3
b)Cost Accounting Standard -13
c)No. of employee
d)Direct wages
e)Weight of material issued
f)Charging 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)

munotes.in