Study Notes on Cost Accounting

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Compilations of study notes from different chapters of cost accounting! The

below given notes will help you for prepare for various competitive
examination. If you are preparing for Civil Service Examination, these notes
will definitely help you to get an overall idea about the subject.
Contents:
1.
Notes on Cost and Cost Accounting
2.
Notes on Management Accountancy in Relation to Cost
3.
Notes on Prerequisites of Costing System
4.
Notes on Classification of Methods of Costing
5.
Notes on Material Control in Cost Accounting
6.
Notes on Departments Involved in Controlling Labour Cost
7.
Notes on Classification of Overhead of Costs
8.
Notes on Contract Costing
9.
Notes on Process Cost
10.
Notes on Motor Transport Costing
11.
Notes on Integrated Accounting System
12.
Notes on Reconciliation of Cost and Financial Accounts
13.
Notes on Cost Volume Profit Analysis
14.
Notes on Standard Costing

1. Notes on Cost and Cost Accounting:

Aspects of Cost:
Costs may be ascertained:
ADVERTISEMENTS:

(i) Historically; i.e. after they have been incurred; or

(ii) By predetermined standards combined with subsequent analysis of
variances between these standards, and the actual cost incurred; and
(iii) By the use of marginal methods of presentation for either (a) or (b),
involving the differentiation between fixed and variable costs.
ADVERTISEMENTS:

In the light of the above definitions we may define Cost Accounting as a

process or mechanism by means of which costs of products and services are
ascertained with a reasonable degree of accuracy. In a broader view, cost
accounting is concerned with the field of responsibility for advising the
management in both historical and future costs and, thereby, helping
managerial planning, control and decision making.
It provides the management with a variety of information to plan, control and
make decisions. The following table gives us the examples of the information
provided by a typical costing system and how it is used for different purposes
by the management.

The examples provided by the table are not exhaustive. In practice, much
more information is produced and used. The usefulness of costing information
is enhanced when the actual results and costs are compared with some target
or standard figure.
ADVERTISEMENTS:

Need for Cost Accounting:

The following are the purposes of Cost Accounting:
(i) Submission of quotations and tenders: To provide information with the
supply of cost data upon which estimates and tenders are based. It provides
the scope for price adjustment to meet market conditions, so as to ensure that
no orders for supply of products are lost.
(ii) Management tool for identifying and controlling efficiency: It is used as a
management tool to indicate to the management inefficiencies of various
departments, plants and machinery. The managementthrough cost analysis
can identify the weak areas of operations and can take proper and prompt
action and, thus, can lead the business unit to its desired goal.

ADVERTISEMENTS:

(iii) Preparation of budgets and standard costs: It provides data to the

management for the preparation of budgets and standard costs. An analysis
of variances between budgeted figures and actuals or standard and actuals
throw light on the weak areas of business operations and guides the
management in taking corrective action to remove the unfavorable cost
variances.
(iv) Preparation of Financial Statements: It is used to provide data for the
preparation of periodical Profit and Loss Account and Balance Sheet at such
intervals as may be desired. It also provides a perpetual inventory of stores
and other materials, so that interim financial statements can be prepared
without stock taking.
So, an important objective of cost accounting is the creation of useful cost
data and information for the purpose of planning and control. They influence
and facilitate both short and long-run decisions.
Cost accounting provides for a basis for operating policies like:
(a) Determination of cost-volume-profit relationship,
(b) Whether it would be economical to buy certain articles or components from
outside,
(c) Whether to replace the existing plant and machinery, or
(d) Whether to continue the business or to shut it down.

Thus, there is a direct relationship between information needs of

management, cost accounting objectives, and techniques and tools used for
the analysis.
Financial Accounting and Cost Accounting:
Financial Accounting is concerned with historical cost. It consists of recording,
classification (ledger) and analysis of the business transactions in a subjective
manner. It presents income statements showing the financial result of the
business for a particular financial year and a Balance Sheet on a specific date
to exhibit the state of affairs of a business unit.
It fails to throw light on the aspects of planning, control and decision making.
For these purposes, we need Cost Accounting. To achieve the above
objectives Cost Accounting records business expenditures in an objective
manner, i.e. according to the purpose for which costs are incurred.
Cost Accounting and Management:
Cost Accounting provides useful data to management for taking managerial
decisions in the following areas:
(i) Establishing business units profit goal;
(ii) Determining departmental goals;
(iii) Measuring and controlling business performance with the help of
budgetary control;
(iv) Making decisions about improvements and adjustments in the operation of
the business for achieving predetermined business objectives; and

(v) To coordinate the entire organisational efforts and tasks.

In doing so, cost accounting performs the following tasks:
(a) Cost Accounting helps in determination and analysis of costs and income
of a business unit. This facilitates comparison of costs of one period with
those relating to a different period in order to evaluate the operating efficiency
of each division or segment or product.
Control of Materials:
(b) It helps management in controlling cost. In every type of cost accounting,
materials and supplies are accounted forin terms of departments and
processes. A rational and scientific system of receiving, handling and issuing
materials is strictly observed. The perpetual inventory method is used to
control properly the materials in stores. Control of raw materials and of parts
follows production until goods are completed.
Control of Wages and Salaries:
Labour cost is controlled through proper accounting for labour by jobs and by
operations. In many manufacturing concerns, daily summary reports are
prepared to show the number of hours and wage rate for each worker, per job
or operation.
In cost accounting, costs are classified into direct and indirect items, indirect
costs are generally termed as overheads. Overheads are further classified as
controllable and uncontrollable items. This classification allows the cost
accountant to concentrate his attention on those costs which can be reduced
or eliminated.
(c) Curtailment of losses due to seasonal conditions:

In many industries higher costs and lower profits arise due to seasonal
changes in activities. The cost accountant may make an attempt to alleviate
the situation by presenting figures showing costs and losses that result from
irregular employment of labour, plant and machinery.
The cost reports can exhibit the idle time of workers and machinery, cost of
storing raw materials and finished products, unabsorbed overhead costs and
general decay in the morale of personnel that result from subnormal
operations. The use of budgetary control combined with cost accounting may
go a long way to bring about stability in industrial activity which will ultimately
benefit the shareholders, employers and the society at large.
(d) Cost Accounting and expansion policy:
Every business unit has to face national and international changes that occur
frequently due to changes in governments political and economic policies.
These changes have considerable effect on costs. Moreover, the
management has to adopt policies to face the ever growing competition, to
develop new markets for its products. The cost accountant is required to
investigate and to prepare reports to keep the management abreast of the
relative advantages and profitability of one policy as compared to others.
(e) Budgeting:
Participation of cost accounting in the formulation and execution of budgets
and standards:
Cost information for managerial decision making and planning is the most
important justification of a sound cost accounting system.

The following diagram shows the accounting cycle by which information

reaches the decision makers:

The use of budget helps the management to correct inefficiencies. It helps to

identify the weak areas by making a comparative study of estimated figures
with the actuals. Variances are studied carefully and corrective measures are
taken in time to avoid wastage and losses.
We may now conclude that cost accounting is so closely linked with
management that it becomes difficult to indicate where the work of the
cost accountant ends and managerial control begins. In brief, it may be
said that:
Cost accounting is to serve management in the execution of policies and in
the comparison of actual and estimated results in order that the value of each
policy may be appraised and changed to meet future conditions Blocker.

2. Notes on Management Accountancy in Relation to

Cost:

The American Accounting Associations (AAAs) Committee on Management

Accounting has defined Management Accounting as the application of
appropriate techniques and concepts in processing the historical and
projected economic data of an entity to assist management in establishing
plans for reasonable economic objectives and in the making of rational
decisions with a view towards achieving these objectives. It includes the
methods and concepts necessary for effective planning for choosing among
alternative business actions and for control through the evaluation and
interpretation of performance. Its study involves consideration of ways in
which accounting information may be accumulated, synthesized, analyzed
and presented in relation to specific problems, decisions and day to day tasks
of business management.
Management Accounting embraces both Financial and Cost Accounting.
Management Accounting emphasizes the preparation of reports of an
organisation, for its internal users such as Board of Directors, Managing
Director and for other top level management for the formulation of business
policies.
Thus, management accounting reports attempt to fill the information needs of
managers with respect to a specific problem, situation, or decision.
Management Accounting is generally indistinguishable from Cost Accounting.
They are closely linked as both of them use common basic data and reports.
Cost Accounting largely uses data about production, sales, wages, overheads.
Management Accounting uses the same data to prepare budgets,
performance reports, control reports for making decisions in different areas.

Gray and Ricketts establish the relationship of Management Accounting

with Cost Accounting in the following language:
The historical data on labour cost might be used to estimate the labour cost
for the coming year, to determine the size of work-force needed to meet
anticipated production requirements and to estimate the cash requirements to
meet weekly pay rolls. This represents the use of cost accounting data to
develop managerial accounting data for planning decisions.
The historical data on labour costs might be compared with the estimated
labour costs to determine if labour is being used effectively and efficiently. This
represents the use of cost accounting data to develop managerial accounting
data for control decisions.
There is an intimate relationship between Cost Accounting and Management
Accounting. Management Accounting communicates various information
useful to the management for making decisions for the efficient running of the
business.
For this purpose, management accounting uses various techniques which
include standard costing, marginal costing, uniform costing, budgetary control,
break even and cost benefit analysis. In fact, management accounting is an
extension of the managerial aspects of cost accounting; it utilizes the
principles and practices of both cost accounting and financial accounting in
the best interests of the business.
Financial Accounting determines the financial results for a period and the state
of affairs on the last day of the period. From this point of view financial
accounting may be treated as Stewardship Accounting. Cost Accounting, on

the other hand, generates information for controlling operations with a view to
maximising efficiency and profit.
So, it may be termed as Control Accounting. Since Management Accounting
communicates necessary information to the management for efficient running
of the business, it is known as Decision Accounting.

3. Notes on Prerequisites of Costing System:

(i) Determination of objectives:
The objectives for which the costing system is installed are to be determined.
In fact, if the objectives are not predetermined and well defined, the costing
system will fail to accomplish the desired goal.
(ii) Size layout and nature of the business:
A close study of the size, layout and nature of the business is very much
essential to design the costing system. The choice of method of costing
largely depends upon the nature of the business.
(iii) Production stages:
Every costing system should follow the production stages because the cost at
each stage of production is to be determined. The costing system should be
designed in a way so that it can determine the cost at each significant stage.
(iv) Organizational structure of the business:
The organizational set up of the business is to be closely studied. The
methods of purchase, receipt of materials, issue and storage of materials
should be examined and changes, if required, are to be made so that these

departments can feed the costing department with the supply of accurate cost
data. The maximum amount of required information should flow to the system.
(v) Easy, simple, economical and flexible:
The system to be introduced should be simple and easy to operate. For this,
form and records of original entry should be designed in such a way as to
minimise clerical work and expenditure. The cost of the system to be installed
should be considered. It should be kept in mind that the installation and
operation of the system should be economic.
(vi) Coordination and cooperation:
Various departments that are involved in the system should be well
coordinated so that they can function harmoniously and with a sense of
cooperation to make the system effective. The benefits that accrue from the
system should be explained to various persons concerned and the sense of
awareness should be created.
(vii) Cost Control:
The system should be so designed that cost control can effectively be
exercised.
(viii) Communication of information:
The costing system should incorporate a suitable procedure for
communicating required information with promptness to the various levels of
management for making appropriate decisions.
(ix) Interlocking of financial and cost accounts:

The cost and financial accounts could be interlocked into a single integral
accounting system. If, that is done, the results of separate sets of accounts
could be reconciled by means of control accounts for accuracy.

4. Notes on Classification of Methods of Costing:

A. Classification of Methods on the Basis of Manufacturing Process:
(a) Job Costing:
This is a method of costing by which the cost of a definite job, or of a specific
order or a batch of finished products is determined. This method of costing is
applied in those business concerns where production is carried out as per
specific order.
Under this method, costs are collected and recorded under a specific
production order. When an order is received, production control allots a

number to it. In job costing all costs of direct materials, direct labour and other
direct expenses are directly charged to the specific job or product.
Job cost sheets are used for the accumulation of job costs. The job cost
sheets serve a control function. This method is very much popular in
enterprises engaged in house building, ship building, production of machinery
and repairs. Batch costing, contract costing and composite costing are the
other variations of job costing.
(i) Batch Costing:
Batch costing refers to that method of costing which determines the cost of a
group of identical products. This method is applied to general engineering
factories which produce components in economical batches for subsequent
assembly. Batch costing can conveniently be applied to companies engaged
in manufacturing radios, televisions, watches, cars, electronic goods,
medicines, biscuits, confectionery, etc.
(ii) Contract Costing:
This method of costing is based on the principle of job costing. A specific
contract becomes the cost unit. A particular contract is treated as a whole job
and the cost of the contract is ascertained. It is also known as Terminal
Costing since the job cost is completed with the completion of the work.
Contract costing is used in building and civil engineering works, ship building
and aircraft manufacture.
(iii) Composite Costing or Multiple Costing:
Under this method of costing, costs for each component or each group of
components to be assembled into a final product are ascertained separately.

Industries which manufacture radios, televisions, motor car, aircraft, etc. make
use of this method of costing.
(b) Process Costing:
Process costing is a system which applies costs to like products that are mass
produced in continuous fashion through a series of production steps known as
processes. The finished goods of earlier processes become the raw materials
of the latte processes.
Costs are identified for each process and charged to that process. Cost of
each process is ascertained separately. Chemical industries, oil refineries, gas
and electricity generating concerns, textiles, paints, flour, food processing,
paper, mining and cement industries etc. make use of this system of costing.
Other variations of process costing are: operating cost, operation cost and
single or output cost.
(i) Operation Cost:
The cost unit is the operation instead of the process. This system is used by
the manufacturing concern where methods of production consist of a number
of distinct operations. The per unit cost is arrived at the end of each
accounting period by dividing the cost of an operation by the number of units
completed in the operation centre.
(ii) Operating Cost:
Operating cost is used for finding out the cost of the appropriate cost unit for a
particular service. It is used by those organisations which render services
such as transport, power house, schools, catering, hospitals, boiler houses
etc.

(iii) Single or Output Cost:

This method is employed where production is uniform and consists of a single
product or two or three types of similar products. The per unit cost is obtained
by dividing the total cost by the total number of units manufactured.
B. Classification on the Basis of Time:
(a) Historical Cost:
These costs represent the cost of actual operational performance. It is a
method of costing under which costs are determined after they have been
incurred. Historical costs are post-mortem costs. Historical data are
considered for predicting estimated costs of the alternative actions under
consideration.
By making comparisons, one of these alternative actions is selected and the
decision is translated into action. So, in a decision-making process, historical
costs play an important role.
(b) Predetermined Cost:
(i) Standard Costing:
It is a technique where standard costs are prepared in advance and used.
Standard costs are fixed on the historical data. After the production, actuals
are compared with the standard costs and variances are identified.
Once the variances are determined, the management finds out the reasons
for such variances for taking remedial measures. So, it is a tool in the hands
of the management to control cost and ensures accountability, as also
efficiency in the use of factors of production. It is an extension of budgetary

control. This system of costing is useful in repetitive industries and jobbing

industries.
I.C.M.A.s definition of standard costing summarizes its concept and
purposes:
A pre-determined calculation of how much costs should be under specified
working conditions.
It is built up from an assessment of the value of cost elements and correlates
technical specifications and the qualification of materials, labour and other
costs to the prices and/or wage rates expected to apply during the period in
which the standard cost is expected to be used.
Its main purposes are to provide bases for control through variance
accounting, for the valuation of stocks and work-in-progress, and in some
cases, for fixing selling prices.
C. Classification for Making Managerial Decisions:
(a) Marginal Costing:
In marginal costing, costs are classified into fixed and variable costs. The
fundamental approach of marginal costing is to relate variable costs to cost
units; while fixed costs are attributed to the business in general. Variable costs
are charged to production; fixed costs will be written off in full in the period to
which they are attributable.
Marginal costing assumes that the excess of sale price over variable cost
contributes to a fund which will cover the fixed costs and provide the
undertakings profit. In other words, fixed overhead is not allocated to cost
units.

(b) Uniform Costing:

Uniform costing is not a system of costing. This system refers to a system
used by several undertakings. They use the same costing principles or
practices to enable them to enjoy benefits of a uniform system. This method of
costing is useful to make inter-firm comparisons.
(c) Opportunity Costs:
These costs refer to costs which result from the use of material, labour and
other facilities, in a particular manner and which have been discarded in
favour of an alternative use. In other words, the benefit from resources which
has been foregone for not being used in the manner originally planned.
So, opportunity cost is the foregone benefit which might have been drawn
from the resources had they been used in an alternative manner.
For example, a saving of Rs.50,000 may earn an interest of Rs.6,000 if
deposited with a bank for two years or more. Now, this amount is invested in a
business for earning profit. Here, the opportunity cost will be the amount of
interest, i.e. Rs.6,000 which has been foregone for its alternative use.
(d) Replacement Costs:
This cost refers to the cost of replacement of an asset at current market price.
Suppose, the written down value of a particular machine is Rs.30,000. If the
machine is bought at current market price, it would cost, say, Rs.35,000. So,
the amount of Rs.35,000 is the replacement cost of the machine. In
replacement cost, the current market price of an asset or materials is
considered but not its original cost or written down cost.
(e) Imputed Costs:

These are notional costs. They do not involve cash outlay. From this point of
view, it is similar to opportunity cost. These costs are computed only for the
purpose of decision making. They are also used for evaluating the
performance of profit centres.
Chart showing the method of costing applicable to industry:

5. Notes on Material Control in Cost Accounting:

Objectives of Material Control:
A good system of material control should have the following objectives:
(i) Supply of the desired quality and quantity shall be ensured for efficient and
uninterrupted production.

(ii) Materials should be purchased in economic quantities to enjoy the benefits

of economic purchases.
(iii) Materials are to be properly stored to preserve quality and quantity arid to
avoid pilferage and obsolescence.
(iv) The investment in materials shall be maintained at lowest level to avoid
unnecessary blockage of working capital.
(v) Purchase of materials must be made at the most favourable prices under
the best possible terms.
(vi) Issues of materials should be properly authorised and accounted for.
(vii) Materials received should be properly inspected to test the quality of
materials.
(viii) Payment should be made only when .payment vouchers have been
properly passed by authorised officer.
(ix) Payment should be made for those materials which have been received
after proper inspection.
Importance of Material Control:
In an effective cost accounting system there must be a proper system for the
control of material from the time an order is placed until the material is issued
to production.
Since materials represent an important asset and is the largest single item of
cost in almost every manufacturing concern, the success or failure of a

concern may depend largely upon efficient materials purchasing, storage,

utilisation and proper accounting.
Where materials are not systematically controlled, excess stocks of some
items are likely to occur as a result of which unnecessary tying up of capital
and loss through obsolescence and deterioration take place. Further more,
haphazard buying and lack of control of materials is bound to result in the
purchase of material of too good or too poor a quality for the purpose for
which it is intended.
An efficient buyer makes a valuable contribution to the success of a business
by ordering the right quality and quantity of material at the most favourable
price and by ensuring the continuous flow of materials to the production
departments.
Efficient material control cuts out losses and forms of wastes. So, incoming
materials should be checked against orders to ensure that the correct quantity
and quality have been received. Theft, breakage, deterioration, and the use of
excessive floor space can be reduced to a minimum by proper controls.
Finally, the most important thing to the cost accountant is that, it is impossible
to produce reliable costing information system if the records of material issues
are unsatisfactory. So, an efficient purchase officer should know when to
purchase, how much to purchase, where to purchase.
Therefore, effective material control is very important in order to:
(i) Provide better quality of goods to the customers at reasonable price by
eliminating wastage and by reducing cost,

(ii) Produce goods at the maximum efficiency,

(iii) Manage inventories to control investment in inventories,
(iv) Avoid abnormal wastage by exercising direct control, and
(v) Avoid over-stocking of materials by making proper planning of materials
and fixation of levels well in advance. The stock should be maintained at such
a level so that materials can be supplied to production departments as and
when they require. It is also to be seen that working capital is not blocked
unnecessarily in stock of materials.
Essentials of Materials Control:
The essentials of materials control from the costing viewpoint can be
summarised as follows:
(i) Materials of appropriate quality and specification should be purchased.
(ii) The suppliers of materials chosen should represent an appropriate balance
between quality, price and delivery.
(iii) Materials should be properly inspected and received.
(iv) Appropriate storage facilities should be provided to preserve the quality of
materials.
(v) There must exist co-ordination and co-operation between the various
departments like Purchase, Inspection, Storage, Accounts and Cost.
(vi) Efficient purchase organisation.

(vii) The documentation, accounting systems and controls at each stage

should be well designed and effective.
(viii) Planning of requirement of materials is to be done very carefully.
(ix) Well organised system of reporting to management regarding materials
purchase, storage, utilization, returns, spoilage, defective goods, obsolete
stocks and inventory balances should be introduced.
(x) Direct materials used in production should be charged to production on an
appropriate and consistent pricing basis.
(xi) Stock taking must be well organised to ensure that sufficient quantities of
stock on hand are available when required.
(xii) There must be efficient system of internal checks and internal audit.
Materials control consists of controls at two levels:
(i) Quantity controls and
(ii) Financial controls.
The production department in a manufacturing organisation aims at quantity
controls while the finance department aims at keeping the investment on
materials at the lowest point. So, in materials control an equilibrium has to be
maintained between the two opposite needs.
In the opinion of A. Matz, O. J. Curry and George W. Frank A basic
objective of good materials control is to be able to place an order at

right time from the right source to acquire the right quantity at the right
price and quality.
Inefficient materials control results in loss through misuse, and waste of
resources may be caused by many factors like buying the wrong articles,
buying materials of inadequate quality, buying too much, buying too little.
Financial loss results from materials stolen, pilfered, spoilage and damage to
materials before use, scrap and spoilage during use. All these lead to
Ineffective employment of working capital. An inadequate system of material
control proves to be costly to the business firm and reduces competitiveness
in the market because of high cost of the product.
Advantages of Material Control:
The following are the advantages of material control:
(i) Efficient material control eliminates wastages in course of purchases,
storage handling and production;
(ii) It ensures continuous flow of materials for use in production;
(iii) It also facilitates preparation of accurate monthly or periodical statement
required for management information;
(iv) Reduces, to the minimum the working capital locked up in various
inventories;
(v) Reduces the risk of fraud and theft; and
(vi) Provides for accountability on the part of those who are involved in the
process of material management.

Procedure of Material Control:

In brief, the materials controls procedures include:
(i) Purchasing, Receipt, Storage and issue, Inventory control and associated
costing procedures.
(ii) The purchasing function is of paramount importance which aims at buying
proper type o materials at competitive price. It aims for an appropriate balance
of price, quality and delivery.
(iii) The purchase requisition giving precise details of quantity required,
specification, delivery etc. initiates the main purchasing procedures.
(iv) The purchasing procedures consist of search for Supplier, Selection of
Supplier, placing of order to the selected supplier and expediting the
deliveries.
(v) Goods supplied must be properly received. Before taking delivery of goods
they should be verified with reference to Purchase Order, inspected and to be
entered in Goods Received Note (GRN).
(vi) The G.R.N. is an acknowledgement of goods received and is used for
making payment to supplier.
(vii) Store keeping involves receipt and issue of materials, preservation of
materials and storage space organization.
(viii) Materials should be issued to production departments on the basis of
Materials Requisition to be issued by a responsible authority of the production
department concerned.

(ix) Ideal stock level should be maintained by the stores so that replenishment
of stock can take place at an appropriate time. It should see that the
production departments do not suffer from dearth of materials.
(x) Stock taking is carried out on a periodic or continuous basis. Continuous
stock taking is essential for perpetual inventory systems.

6. Notes on Departments Involved in Controlling

Labour Cost:
A. Personnel Department:
Most firms of any size have a Personnel Department which has
responsibility for numerous tasks involving labour. The tasks include:
(i) Advertising, recruiting and engaging labour.
(ii) Discharge, transfer and administration of and appraisal of schemes.
(iii) Industrial relations and negotiations with unions to settle industrial
disputes.
(iv) Staff development, training and educational schemes including day
release, apprenticeships and courses.
(v) Execute the policies, regarding appointment, promotion, wage and
incentive systems etc.
(vi) Communication of information to the management on such matters as
absenteeism, lateness, labour turnover, normal and overtime worked.

(vii) Welfare, sports and social facilities, safety and medical facilities.
(viii) Manpower planning and forecasting.
In brief, the personnel department has the responsibility to provide an efficient
labour-force which is cost effective and to keep labour turnover to a minimum.
B. Engineering Department:
This department helps to maintain control over working conditions, production
methods, job performance. It is also responsible for maintaining safety and
efficient working conditions. It has to initiate and supervise research and
development (R & D) and to make method study, motion study and time study.
Making job evaluation, merit rating and job analysis are the important
functions of the Engineering Department.
This department should aim at improving labour efficiency or productivity,
thereby cutting down the effective labour cost. The Engineering Department
maintains control over working conditions and production methods for each
job or process by performing the above functions.
C. Time-Keeping Department:
The function of this department is to maintain the exact time for which each
worker has worked.
Proper time-keeping in labour costing and control is very important
because of the following reasons:
(a) It accumulates the total number of hours worked by each worker so that
his total periodical earnings can be computed.

(b) Absence of proper time-keeping arrangement is sure to create frustration

among sincere and punctual employees. This situation will adversely affect
the morale of employees resulting in low productivity and production and
increased costs.
(c) Certain retirement benefits like pension, gratuity, leave with pay,, provident
fund and salary are linked with continuity of service of employees. Attendance
records can be immensely helpful and useful in the determination of various
retirement benefits and other fringe benefits.
(d) Time-keeping is of paramount importance in the task of apportionment of
overhead costs on the basis of labour hours.
(e) Time-keeping records are also useful for analysis purposes.
Time Recording for Piece Worker:
Time recording for workers who are paid on piece rate basis is essential
for the following reasons:
(i) Time recording is necessary to ensure discipline in the factory.
(ii) When the workers are guaranteed minimum wages, time recording
becomes necessary to ascertain the time spent by the workers irrespective of
their individual output.
(iii) Time recording is important because it facilitates the preparation of pay roll
as a whole and calculation of dearness allowance.
(iv) In fixing up differential wage rates, time recording becomes essential.

(v) Time recording also facilitates the apportionment of overheads on the

basis of labour hours.
Objects of Time-keeping:
The main objectives of time keeping function are:
(i) To maintain workers activity records to meet statutory requirements;
(ii) To maintain basic data required for the preparation of payroll;
(iii) To generate statistical data to ascertain productivity of labour and to
control labour cost;
(iv) To find out the labour cost and to control labour cost;
(iv) To find out the labour cost of a job or product or service;
(v) To maintain discipline in attendance; provide;
(vi) To nationalize basis of overhead distribution in various situations;
(vii) To calculate overhead cost of a job.
D. Payroll Department:
The tasks of preparing pay rolls are complicated as some specified amounts
like income tax, professional tax, cooperative loan, contribution to P.F.,
employees contribution to E.S.I, etc. are withheld from the earnings of
employees.
There are three major problems that involve the preparation of payrolls:
(a) Allocating labour costs to products, departments;

(b) Accurate computation of earnings and prompt payment to individual

employees; and
(c)Computing and remitting withholdings to proper authorities like government,
local authority etc. From the view-point of employees, promptness of
payments and pinpoint accuracy are the foremost criteria for judging the
merits of any payroll system.
The functions of a payroll department is an intermediary function between the
timekeeping and the cost accounting departments.
The main functions of pay roll department are:
(i) To compute employees wages accurately;
(ii) To make prompt payment to employees;
(iii) To compute the deductions to be made from employees earnings under
different heads and to remit them to the appropriate authority in time, for
example, income tax, professional tax, E.S.I, etc. ;
(iv) To compile labour statistics for management to formulate labour policy;
(v) To maintain a permanent pay roll record for each employee;
(vi) To maintain a record of job classification, department and wage rate for
each employee;
(vii) To verify and summarise the time of each worker as shown on the daily
time cards.
Payment of Wages:

Due care should be taken for payment of wages to employees to ensure

proper payment i.e. right amount to the right persons. In order to maintain acontrol to safeguard the payroll against the inclusion of ghost workers or the
names of those employees who have already left their jobs, the paymaster
should require the identity of each employee at the time of payment of wages
by one of the following:
(i) Personal identification by foreman or authority of the department;
(ii) Identification card or badge;
(iii) Signed receipt for comparison with a personal signature on file in the
personnel department.
Preparation of Pay Roll:
The preparation of pay roll is the responsibility of the pay roll accounting
department. Wages for each worker is calculated in wage sheet or pay roll.
The following documents are used to prepare the pay roll of the
workers:
(i) Time cards
(ii) Piece-work cards, and
(iii) Job cards.
Care should be taken at the time of preparing pay roll to avoid errors and
frauds. It is to be seen that no wage bill has been drawn in the names of
dummy workers.

E. Cost Accounting Department:

This department is responsible for the accumulation and classification of all
the cost data of which labour cost is one of the most important elements.
There must be a proper coordination and close relationship between cost
department and time keeping and pay roll departments.
In the determination of labour cost time keeping and pay roll departments feed
the costing department with necessary data in respect of time taken (labour
hours) by each worker and his remuneration. Time-keeping is the first function
in the labour accounting process.
The pay roll department computes the earnings of each employee after
making necessary deductions. The cost accounting department is responsible
for the accumulation and classification of all cost information of which labour is
one element.
Direct and Indirect Labour:
Direct labour:
The Institute of Cost and Management Accountants (U.K.) defines direct
labour cost as the cost which can be identified with, and allocated to, cost
centre or cost units. In the words of Horngren All labour that is
physically traceable to the finished goods in an economically feasible
manner.
So, direct labour costs are identifiable with individual units of product or job
orders as far as practicable.
Examples:

Wages paid to machine operators and assemblers are treated as direct labour
costs.
Indirect Labour:
According to the Institute of Cost and Management Accountants (U.K.) indirect
labour costs mean wage costs other than direct wage costs. According to
Horngren indirect labour refers to that activity of employees which is not
possible and economically feasible to trace to any specific products via
physical observation.
Otherwise, the indirect labour cost is the cost which cannot be allocated to
any specific job but can be apportioned or absorbed by cost centres or cost
units.
Examples:
Factory Supervisors salary, Storekeepers salaries, Foremens salaries etc.
are examples of indirect labour costs.
Distinction between Direct and Indirect labour cost:
The distinction between direct labour cost and indirect labour cost is very
important for the following reasons:
(i) To provide a more accurate product cost;
(ii) To provide a strict control over labour costs because direct labour efficiency
can be measured by the number of units completed by direct labour;
(iii) If this distinction is not made, proper allocation of overheads will be
erroneous.

Direct labour cost is the cost for employees efforts and skills used directly for
a product or saleable service. The nature of the work of an employee is to be
considered for making a distinction between direct labour and indirect labour.
A machine mans work is treated as direct labour but while he spends time to
repair a machine or to clean it up, his labour for doing so is to be treated as
indirect labour because it is not directly connected with production process.
From this view-point, labour activities can be classified into the
following categories to draw a line of distinction between direct and
indirect labour:
(i) Contribution Activities:
They refer to those activities which are directly connected with the production
of goods or services which generate the firms income. The costs of these
activities are treated as direct labour cost.
(ii) Service Activities:
These activities are those which support contribution activities but do not
generate income. All such labour is treated as indirect labour.
(iii) Control Activities:
These are the activities which are necessary to control the employees. They
relate to the control or supervision or managerial aspect of the whole show.
These activities do not create income for the firm but help to generate income
in a better way. All such labour is treated as indirect labour.
Need for distinguishing between direct and indirect labour:
The distinction between direct and indirect labour is essential from costing
point of view for the following reasons:

(a) The distinction between direct and indirect labour is important for
calculating labour cost accurately which provides a basis for labour control;
(b) It facilitates the measurement of labour efficiency;
(c) Such distinction helps allocation of overheads;
(d) Introduction of incentive schemes for payment of wages becomes feasible
and easy; and
(e) It also helps to estimate total labour cost.

7. Notes on Classification of Overhead Costs:

i. Function-Wise Classification:
Classification of overhead expenses on a functional basis is done with
reference to the various activities of a concern. The main groups consist
of:
(a) Manufacturing overhead costs
(b) Office and Administration overhead costs
(c) Selling overhead costs
(d) Distribution overhead costs
(a) Manufacturing Overhead Costs:

Manufacturing Overhead Costs = Indirect Materials used in factory +

Indirect or unproductive wages paid for the factory + Indirect expenses
incurred in the factory:
In the words of W. M. Harper: Overheads incurred in production i.e. overhead
incurred within the four walls of the factory proper are known as Production
Overheads.
Students are to note that production overhead is also known as factory
overhead or works overhead or production overhead.
Production overhead includes the following indirect expenses:
Factory rent, rates and taxes;
Lighting, heating, power and fuel; depreciation, repairs and insurance for
factory assets;
State Insurance, retirement pension premiums, wages of indirect workers;
salaries and related costs of production management;
Indirect materials and materials of little individual value used in production
screws, nails, bolts, nuts etc.;
Carriage inwards on materials purchased;
Normal wastage of materials;
Canteen and Welfare expenses;
Tool room expenses, production control and progress department expenses;
Oil, rags and other factory supplies.

(b) Office and Administration Overhead Costs:

Cost of Indirect materials used, indirect remuneration paid to the office and
administrative staff and indirect expenses incurred in office management are
the constituent factors of office and administration overhead costs.
It is the sum total of those costs of general management, and of secretarial,
accounting and administrative services, which cannot be directly related to the
production, marketing, research and development functions of the enterprise.
Office and .administration overhead costs include the following:
Office rent, rates and taxes and insurance.
Office lighting, heating and cleaning.
Repairs to office buildings, furniture and fittings and equipment.
Salaries, overtime, bonus of office staff, printing and stationery used in the
office.
Salaries of administrative directors and other managerial personnel.
Audit fees, legal charges and bank charges.
(c) Marketing, Selling and Distribution Overhead Costs:
Marketing Cost has been defined by the I.C.M.A., London, as the Cost
incurred in publicizing and presenting to customers the products of the
undertaking in suitably attractive forms and at acceptable prices,
together with the costs of all relevant research work, the securing of
orders and, usually, delivery of the goods to customers. In certain cases,
after-sales service and/or order processing may also be included.

Sometimes it becomes useful in most businesses to subdivide the marketing

cost into selling, publicity and distribution costs. Marketing overhead costs
include the following indirect materials, labour costs and indirect expenses
incurred in connection with marketing the products:
Selling:
Salaries, commissions and travelling expenses of technical representatives
and sales engineers and salesmen.
Bad debts written-off.
Maintenance and administration costs of Sales Offices.
Publicity:
Cost of advertisement, Cost of printing catalogues, price lists, Cost of
maintenance of showrooms, Salaries of showroom personnel, Stationery used
in showrooms, Cost of participation in industrial exhibitions.
(d) Distribution Overhead Cost:
Carriage outwards,
Cost of packing materials,
Packing charges,
Costs of running and maintaining of delivery vehicles,
Costs of maintenance of warehouse.
Research and Development Costs:
They include the following expenses:

Salaries of Laboratory technicians, Work-study engineers, Research

Associates etc.
Cost of raw materials used in research.
Depreciation of Laboratory Equipment.
Cost of technical journals.
Patent fees.
Subscriptions for Research Association etc.
ii. Element-Wise Classification:
Under this method total indirect expenses are classified as:
(a) Indirect materials;
(b) Indirect labour and
(c) Indirect expenses.
These have been discuss and earlier.
iii. Behaviour-Wise classification:
Overhead costs can be classified into:
(a) Fixed;
(b) Variable; and
(c) Semi-variable costs.
(a) Fixed Costs:

Definition:
Fixed Costs are those which remain fixed and do not vary with the increase or
decrease in volume of output for a given period of time.
Examples:
Rent of building, Property taxes, Management salaries, Building depreciation,
Salaries of Works Managers, Supervisors, Accountants, Stationery, Printing
etc.
(b) Variable Costs:
Definition:
Variable Costs refer to those costs which do vary with the change in the level
of production. This type of cost tends to vary in direct proportion to changes in
the volume of output.
Examples:
Indirect labour; Indirect material; Power and Fuel; Lighting ; Power ; Repairs
and Maintenance ; Tools and Spares ; Overtime pay etc.
(c) Semi-variable Costs:
Definition:
Costs that contain both fixed and variable elements, which are, therefore,
partly affected by fluctuations in the volume of output or turnover are known
as semi-variable costs. These costs remain fixed in total amount over a
relatively short range of variation in output and then are abruptly changed to a
new level of production.
Examples:

Normal maintenance of buildings, salaries and wages of administration,

stationery and postage, wages of service department, wages of supervisors
etc.
iv. Control-Wise classification:
Costs may also be classified as:
(a) Controllable and
(b) Uncontrollable costs.
Controllable costs refer to those costs which can be controlled effectively if
proper managerial control is exercised. Uncontrollable costs are those which
are beyond the control of the management. They are bound to occur.

8. Notes on Contract Costing:

Features of Contract Costing:
The following features are common to most contract costing system:
(a) Higher proportion of direct costs:
Because of the self contained nature of most site operations, many items of
indirect expenses can be identified specifically with a contract and, thus, can
be charged directly. For example, telephones installed on site, site power
usage, site vehicles, transportation design and planning salaries are charged
directly to contract account.
(b) Low indirect costs:
For most contracts, the only item of indirect cost would be a charge for Head
Office expenses. This forms a very small portion of the total cost of contract

and is absorbed on some overall basis, such as a percentage of total contract

cost.
(c) Surplus Materials:
All materials bought for a contract would be charged directly to the contract. At
the end of the contract, the contract account would be credited with the cost of
materials not used. If the materials are transferred to any other contract the
new contract account is to be debited.
(d) Difficulties of Cost Control:
There exists frequently major problems of cost control concerning materials
usage and losses, pilferage, labour supervision and utilisation, damage to and
loss of plant and tools etc. because of the scale of some contracts and the
size of the site.
(e) Materials:
Materials purchased or supplied from the stores shall be debited to contract
account. Materials returned to stores and amount received from sale of
materials will appear on the credit side. The accruing profit or loss being the
difference between cost and sale price is transferred to Profit & Loss Account.
When the materials are transferred from one contract to another or from one
site to another to avoid transportation, expenses in returning them to central
stores and issuing them again, contract receiving the materials is debited with
the cost of such materials and contract transferring the materials is credited.
Normal wastage of materials and store should be charged to the contract at a
price at which they are priced out.
(f) Wages:

All workers employed at the contract site shall be treated as direct labour and,
as such, wages paid to them should be debited to Contract Account.
(g) Contract Plant:
Plant includes cranes, trucks, excavators, mixers and lorries. The usual
ways in which cost of plant is dealt with are as follows:
A. When plant is purchased:
The following two methods are in common use:
(i) Charge new plant at cost to the contract. When the plant is no longer
required and is transferred to another contract, the original contract is credited
with the depreciated value of the plant. In this way the contract bears the
charge of depreciation.
(ii) Where plant is moved frequently from contract to contract, each contract is
charged a daily or weekly rental.
B. When Plant is leased:
The leasing charges are charged directly to the contract.
Note:
Whatever method is followed, the ordinary running costs like fuel, repairs and
insurance, would be charged direct to the Contract Account.
Profit on Incomplete Contracts:
A contract may take more than one financial year for its completion. In such a
case problem arises as to how much profit shall be credited to P & L A/c. It
becomes necessary to compute profit on partly completed contract and take
credit for a part of it in the accounts at the year end.

The amount of profit that is to be credited to Profit & Loss A/c depends upon
the fact that how far the contract has advanced i.e. the stage of completion it
has reached.
The computation of profit is done in the following ways:
(i) Profit should be considered in respect of work certified only. Work
uncertified should always be valued at cost.
(ii) For contract which has been taken just in hand or which has not advanced
far or 1/4th has been completed, no profit should be taken to the credit of
Profit and Loss A/c. This is because it would be too early to forecast or
estimate profit with a reasonable degree of accuracy.
(iii) In case of a contract which is covered by Architects certificate, profit is
computed by deducting the cost of contract from work certified. A portion of
this notional profit is taken to new Profit & Loss Account and the balance of
notional profit is carried forward as profit in suspense. Conventionally, 1/3 or
2/3rds of profit is credited to Profit and Loss Account.
If less than 50% but more than 25% of contract is completed then the
portion of profit to be taken to the credit of profit and loss account is
computed as follows:
1/3 x Notional profit x (Cash received Work certified)
But, where more than 50% but less than 75% of contract is completed
then Profit is computed for taking to Profit and Loss Account:
2/3 x Notional Profit x (Cash received Work certified).
(iv) Where the contract is almost complete, an estimated total profit is
ascertained by deducting the total cost and additional expenditure to be

incurred to complete the contract from the contract price. The Profit and Loss
Account should be credited with that proportion of total estimated profit on a
cash basis, which the work certified bears to the total contract price.
The formula is as follows:
Estimated total profit x (Value of work certified Contract price):
(v) If there is any loss, the total loss should be transferred to Profit and Loss
Account by crediting the Contract Account.
Profit & Loss Account Dr.
To Contract Account
The Costing Entries:
A separate account will be maintained for each contract with the object of
finding out the overall Profit or Loss of the contract.
To do this, a proforma of a contract account is shown on the next page:

9. Notes on Process Cost:

The Elements of Process Cost:
The elements of Cost of a Process consist of:
(i) Material Cost;
(ii) Cost of Labour;
(iii) Direct Expenses; and
(iv) Production Overhead.
An account is maintained for each process to which all costs of material,
labour, direct expenses and overhead are debited.
(i) Materials:
Materials required for production are issued to the first process. The finished
goods of first process are passed to the next process, each process merely
performs some operation on the material passed from the earlier process. The
finished goods of Process I become the raw materials of Process II and so on.
There are some systems where extra or new materials may be needed and
added to the finished goods passed from earlier process and this may
continue until completion. The method to be followed depends upon the
nature of the product.
Whatever method is followed, sufficient supply of raw materials should be
assured to meet production needs. It is to be seen that production does not
come to a halt due to paucity of raw materials.
(ii) Labour:

Both direct and indirect wages paid to direct workers and indirect workers like
supervisory staff are debited to the Process Account. However, where workers
are engaged in more than one process, the gross wages are distributed to
each process on the basis of time spent on each process. Generally, the cost
of direct labour forms a very small part of the cost of production in industries
that adopt process costing.
(iii) Direct Expenses:
Direct expenses which can easily be directly allocated to a particular process
are known as direct expenses. Examples of such expenses are cost of
design, cost of electricity, depreciation and hire charges of equipment. These
expenses are debited to Process Account.
(iv) Production Overhead:
In process costing the overhead element forms a major part of total cost. So,
great care should be taken to ensure that each process is charged with a
reasonable share of overhead. Overheads are to be apportioned where they
cannot be directly allotted and actual overhead in respect of a particular
process should be charged or debited to the Process concerned.
Overhead may be recovered at a predetermined rates and charged to the
Process. Having discussed the elements of cost we now proceed towards the
preparation of Process Account where there is no process loss.
The following steps are involved in costing procedure:
(i) Debit the cost of basic raw materials to the first process account showing
both quantity and amount.

(ii) Debit costs of other materials, direct labour and direct expenses pertaining
to each process.
(iii) Debit each process account with production overheads as given or on
some equitable basis.
(iv) Credit the process account with realisable value of scrap.
(v) Ascertain the total cost of the process and calculate average cost per unit.
(vi) If the whole output of a process has been transferred to the next process,
the total cost may be shown on the credit side as transfer to next process and
the same shall be shown on the debit side of the next process account.
(vii) If a portion of the output has been earmarked for sale or has been sold
show its cost as transfer to stores and the balance as transfer to the next
process. It should be noted that when a portion of output has been sold, the
process account should credited only with its cost and not the sale value.
(viii) The cost of containers used for packaging the finished goods should be
debited to the last process account.
(ix) The total cost of the last process shall be transferred to Finished Stock
Account
Treatment of Process Losses, Scrap and Wastage:
In the course of production through different processes, some losses are
bound to occur. The quantity and weight of the process output will be-less
than the quantity, weight or volume of the materials input.

This may happen due to various reasons:

(i) Evaporation, residuals,
(ii) Unavoidable handling, breakage and spoilage losses.
So, it is imperative that accurate records are to be maintained to have control
over materials. The cost department must be kept informed of the losses
through the medium of scrap tickets, materials credit notes and loss reports.
This information is essential for ascertainment of actual cost of the final
product.
Materials which have been processed and later on are found to be defective
and scrapped have surely incurred their share of labour cost and overhead
cost up to the point of rejection. More defective and scrapped materials mean
financial loss to the concern.
Classification of Process Loss:
Process losses may be classified as:
(i) Normal Process Loss and
(ii) Abnormal Process Loss.
(i) Normal Process Loss:
This type of loss is caused by the factors like evaporation, pilferage and which
is inherent in large scale production. This loss cannot be avoided but sure to
occur. This loss may not be a total loss but may often include scrap and
waste. The amount of normal process loss is reduced by selling the scrap and
waste.

(ii) Abnormal Process Loss:

Abnormal Process Loss is caused by unexpected or abnormal conditions. The
causes are substandard materials, accidents, carelessness. Moreover, it may
happen sometimes that the percentage of wastage or loss may exceed the
predetermined percentage of normal wastage or loss.
So, any wastage exceeding the normal wastage is termed abnormal wastage
or loss. All abnormal losses must be thoroughly investigated, and, where
necessary, all possible steps should be taken to prevent its occurrence in
future.
Treatment of Normal and Abnormal Loss in Process Costing:
(i) Normal Process Losses:
Normal Loss is normally expressed as a percentage of the quantity of output.
Loss arising out of normal wastage is absorbed in the cost of good units i.e. it
becomes the part of total cost and surely, increases the total cost of output.
If any value can be recouped from the sale of imperfect articles or materials
then the amount so realised shall be credited to relevant Process Account
which will reduce the cost of output of that process.
(ii) Abnormal Process Losses:
Abnormal loss or wastage is not treated as a part of production cost or total
cost. Its value is credited to the concerned Process A/c and debited to Costing
Profit & Loss Account.
The value of abnormal loss is calculated with the help of the following
formula:

A separate account is opened for abnormal losses to which is debited the cost
of materials, labour and proportionate overhead incurred by the wastage.
Since the value of abnormal loss is not treated as a part of cost of production
it is written off to the Costing Profit and Loss Account.
Treatment of Abnormal Gain in Process Costing:
Abnormal Gain arises when the actual loss is smaller than estimated loss.
According to Wheldon, sometimes the actual loss in a process is smaller
than was expected, in which case an abnormal gain results. The value of
abnormal gain is calculated at the rate at which the effective output would
have been valued if normal wastage had taken place according to
expectation.
Relevant Process Account is debited with the value of Abnormal Gain and
Abnormal gain A/c is credited by Process A/c. The Abnormal Gain A/c is
debited with the Scrap Sales A/c and the balance is written off to Profit and
Loss A/c.
Abnormal Gain = Normal Loss Actual Loss
Value of Abnormal Gain

10. Notes on Motor Transport Costing:

In motor transport undertaking most of the data required for computation of
cost and cost control purpose are obtained from Daily Log Book. The Log

Book should be filled up by the driver of the vehicle furnishing necessary

details of trips made by vehicle during a specified period of timeusually on
daily basis.
A specimen of Log Book is given below:

The above log sheet helps the management to avoid unnecessary or

duplicate trips, to avoid under-utilization of capacity by low burdening or overutilization of extra loading and to avoid waste or idle running capacity.
Selection of Unit:
In transport costing, a composite cost unit such as passenger kilo-meter or ton
kilo-metre is usually adopted. The main advantage of selecting of a composite
unit cost is that it takes into account both the number of passengers or weight
of goods carried and distance covered.

At present many organisations provide facilities for canteen to workers. The

workers are provided with food at subsidized prices. It may be considered a
service by the company.
The following are the main items of costs relating to canteen costing:
(a) Provisions:
Provisions will include items like meat, fish poultry egg, tea, coffee, milk, flour,
rice, soft drinks etc.
(b) Labour:
Labour will include:
Wages and salaries of canteen staff such as cooks, waiters, kitchen
assistants, supervisors etc.
(c) Services:
It will include steam, gas, electricity, power, light and water.
(d) Consumable Stores:
They will include items like linen, cutlery, crockery, glass wares, mops,
washing up clothes, dustpans, cleaning materials and brushes
(e) Overheads:
Overhead charges will include rent, rates, insurance, depreciation.
Receipts:
The receipts will consist of:
(i) Subsidy received from company,
(ii) Sale of coupons.

11. Notes on Integrated Accounting System:

Meaning of Integral Accounts:
A single book-keeping system which contains both financial and cost accounts
is termed an integral accounting system.
This system contains two types of account:
(i) Simple accounts and
(ii) Control accounts.
The former represent assets, liabilities etc.; while each of the latter forms a
connecting link with a subsidiary ledger in which the detailed composition of
the control account balance is recorded.
In fact, this system tends to merge cost and financial accounting to form one
inseparable accounting function and precisely, integrated accounting is a
system of recording both financial and costing transactions in one integrated
set of books.
Features of Integrated Accounting System:
The essential features of integrated system are as follows:
(i) The integrated system records financial items not required for cost
accounting. For examples Accounts for capital expenditure, Sundry Debtors
and Creditors, share capital, cash and bank balances, prepaid expenses and
accruals are opened.

(ii) Store transactions are recorded in the Stores Control Account. For store
purchased Store Control Account is debited and credited to
Cash/Bank/Creditors Account.
(iii) Payment of wages is debited to Wage Control Account. Similarly, for
overhead expenses incurred Overhead Control Account is debited and Sundry
Creditors/ Cash/Bank Account is credited.
(iv) At the end of the accounting period, the total of Wages Control A/c, Stores
Control A/c and Overhead Control A/c is transferred to Work-in-Progress
Account. The entry is:
Work-in-Progress Control A/c Dr.
To Stores Control A/c
To Wages Control A/c
To Overhead Control A/c
(v) All accruals are debited and advance payments are credited. While capital
expenditure is separated in the process of Cost analysis and debited to
Capital Assets Account.
Advantages of Integrated Accounting System:
The following are the advantages of integral accounting system:
(a) Duplication in accounting and analysis can easily be avoided.

(b) Since the need for maintaining of separate sets of financial and Cost
accounts ledgers is absent, preparation of reconciliation statement is not
required.
(c) There is an automatic check on the correctness of the cost data, which
creates confidence in the management.
(d) Centralisation of accounting function leads to economy.
(e) As Cost accounts are posted immediately from the original entries, there is
no delay in obtaining cost data.

12. Notes on Reconciliation of Cost and Financial

Accounts:
Introduction to Reconciliation of Cost and Financial Accounts:
Cost accounts are maintained independent of financial accounts. The two
accounts have a different order of recording revenue and expenses. In cost
accounting expanses are analysed and recorded in objective form while in
financial accounting expenses are recorded in the books of accounts in
subjective form.
As a result, there occurs a difference between profit shown by Cost
accounting and that of financial accounting. Therefore, it becomes imperative
to reconcile two accounts which enables to test the reliability of cost accounts.

Need for Reconciliation of Cost and Financial Accounts:

In a manufacturing concern both financial and cost accounting are maintained.
Naturally, two sets of accounts disclose profit which will not agree with each
other. Profit disclosed by the financial accounting does not agree with the
profit disclosed by the cost accounting. But this does not happen when a
manufacturing company uses an integrated accounting system i.e. no
separate cost and financial accounts are maintained.
So, when cost and financial accounts are maintained separately and
independently of each other, profit disclosed by one system tends to differ
from that of the other accounting systems. This difference in profit creates
problems and the need of reconciling the accounting systems arises to arrive
at one profit figure.
Reasons for Disagreement between Reconciliation of Cost and Financial
Accounts:
Disagreement between Cost and Financial accounts generally arises due
to the following factors:
i. Items that are included only in financial accounts:
The following items of purely financial nature are included in financial
accounts but not in cost accounts:
(a) Interest received on bank deposits
(b) Profit on sale of assets
(c) Rents receivable
(d) Interest and dividend on investments

(e) Loss on sale of Assets

(f) Loss on sale of investment
(g) Interest paid on Bank Loan, Debentures
(h) Damages payable
(i) Payment of income-tax
(j) Payment of dividend
(k) Transfer to Reserves
(l) Creation of provisions
(m) Donations
(n) Writing off fictitious Assets like Preliminary expense, Discount on issue of
shares, debentures
(o) Writing of intangible fixed assets like Goodwill, Patent Rights etc.
ii. Under or over-absorption of overhead expenses:
In cost accounts overheads are absorbed at predetermined rates which are
based on past data. On the other hand, in financial accounts the actual
amount of expense incurred is only considered. Hence difference arises.
iii. Adoption of different bases for stock valuation:
In financial accounts stocks are valued either at cost or at market value
whichever is less. But in cost accounts stock of materials are issued to

production departments at cost by using FIFO, LIFO, Simple Average,

Weighted Average method. This leads to a difference.
iv. Bases of Depreciation:
The methods of charging depreciation and the rates may be different
which surely leads to difference:

13. Notes on Cost Volume Profit Analysis:

Definition of Cost Volume Profit Analysis:
Profit of an undertaking depends upon a large number of factors, the most
important of which are cost of manufacture, volume of sales and selling prices
of products sold. The three factors of cost volume and profit are interlinked
and interdependent.
As we know, profit depends upon sales; selling price; to a great extent;
depends upon cost; volume of sales depends upon volume of production
which, in turn, is related to cost. In cost-volume-profit analysis an attempt is
made to measure variation in cost with variation in volume.
Cost-Volume-Profit analysis is the analysis of three variables, viz., cost,
volume and profit, that seek to explore the relationship existing amongst
costs, revenues, activity levels and the resulting profit. Profit, as a variable, is
a reflection of a number of internal and external conditions which exert their
influence on sales, revenue and costs.
Revenue depends upon selling prices, costs, volume of sales, demand,
competition etc. Although none of these can be singled out as the most

important, the volume is considered to be a dominant factor. This is probably

because changes in volume are more frequent, take place rapidly and are
outside the purview of management control.
Further, Costs rarely vary in direct proportion to the volume and hence, a
small change in the volume may have a more than proportionate effect on
profits than the other factors. It is thus, the volume which is perhaps the
largest single factor that influences cost. Therefore, there exists an intimate
relationship amongst costs, volume and profit.
The cost-volume-profit analysis is an extension of marginal costing and makes
use of the principles of marginal costing. It is important tool of short-term
planning and is more relevant where the proposed changes in the level of
activity are relatively small. Therefore, it is very much useful in making shortrun decisions.
Importance of Cost Volume Profit Analysis:
The relationship between cost, volume and profit makes up the profit structure
of an undertaking. This analysis may be useful for profit planning, cost control
and decision making.
The main objectives of cost-volume-profit analysis are discussed below:
(i) Profit Planning:
In Profit planning it becomes essential to know the relationship between cost,
volume and profit. The most important feature of cost-volume-profit analysis is
the manner in which it relates cost, selling price and volume and enables
calculation to be made to show the effect of change in these on profit.

Accordingly, the management can plan profit with reference to cost volume
profit analysis.
(ii) Preparation of Flexible Budget:
Cost volume profit analysis is of special help in the preparation of flexible
budget that indicates cost and profit at various levels of activity.
(iii) Decision Making:
Cost volume profit analysis is very much useful in making decisions like
make or buy, pricing, selection of a product mix, selection of the best channel
of distribution, and selection of best method of production.
(iv) Cost Control:
In the area of cost control, cost volume profit analysis is of great
assistance to the management. The effect on cost of changes in volume can
be evaluated for the purpose of reviewing profits achieved and cost incurred.

14. Notes on Standard Costing:

Introduction to Standard Costing:
The concept of Control a third and final link of managerial processmeans
the process of ensuring accomplishment of plan. This involves not only action
to implement the plan but also the measurement of performance in
comparison with the specified plan or some other standards, the

communication of results to the appropriate authorities for taking corrective

measures in time.
Standard costs are predetermined costs and are used as a measure with
which the actual cost as ascertained are compared. Standard costing seeks to
measure the efficiency of performance and identify weakness in performance,
if any, at an early stage so that appropriate managerial measures can be
taken to remove the weakness for effective cost control.
In standard costing, cost of a product or service is known in advance and
deviations from actual are used for effective cost control purpose.
Meaning of Standard Cost:
Standard cost may simply be defined as predetermined cost. More formally, a
standard cost may be defined as a predetermined calculation of how much
costs should be under specified working conditions.
The I.C.M.A. summaries the concept and purpose of standard dost as:
A predetermined calculation of how much costs should be under specified
working condition.
It is built up from an assessment of the value of cost elements and correlates
technical specifications and the quantification of materials, labour and other
costs to the prices and / or wage rates expected to apply during the period in
which the standard cost is expected to be used.
Its main purposes are to provide bases for control through variance
accounting, for the valuation of stocks and work in progress, and, in some
cases, for fixing selling prices.

The price and quantity are the two constituents of cost elements for which
standards are specified. The production engineer specifies the quantity of
materials to be required and the purchasing manager sets a standard price for
the materials on the basis of current prices.
Time department will set the labour times and wage rates will be set according
to the type of labour required and anticipated average rates. Direct expenses
will be assessed and overhead absorption rates will be calculated as
appropriate. Standards are set before the commencement of a period and
should cover all aspects of production.
Advantages of Standard Costing:
The introduction of a system of standard costing may offer the following
advantages:
(i) The setting of standards leads to economics by determining best materials
and methods.
(ii) Actual performance may easily be compared with the predetermined
standards. Showing separately the favourable or unfavorable variance.
(iii) A detailed analysis of variance enables the management to investigate the
causes of inefficiencies of labour, of the use of materials and of the operation
of plant and machineries.
(iv) A target of efficiency can be set for the employees to reach and the sense
of cost consciousness is thereby stimulated.
(v) Since variances can be calculated, the operation of the principle
management by exception becomes possible.

(vi) Gains and losses arising out of market fluctuations in prices of raw
materials, as distinct from variations due to manufacturing conversion are
revealed.
(vii) Standard costs provide a valuable aid to the management in fixing up
prices and formulating policies.
(viii) The effects of variations in the price and use of materials, the ratio of
labour wages to other expenses and the volume of production are
demonstrated at short intervals.
(ix) It is a management tool for having effective cost control.
(x) Costing procedures can be made simple.
(xi) It facilitates the evaluation of stock and optimizes the use of plant facilities,
current assets and working capital.
(xii) Since attention is focused on the variances, weak areas can be identified,
as a result, management can take corrective and prompt actions on right
spots.
(xiii) Better allocations and utilization of resources are possible due to critical
study of all the operations, methods in respect of production, sales and
administration.
(xiv) A properly developed standards costing system with full participation and
involvement creates a positive and cost effective attitude through all levels of
management.

(xv) Standard costing facilitates the integration of accounts so that

reconciliation between cost accounts and financial accounts may be avoided.
Limitations of Standard Costing:
The standard costing suffers from the following limitations:
(i) It does not become effective without Budgetary Control.
(ii) Cost of its installation is very high.
(iii) Its effectiveness depends upon the efficiency of historical costing. It
becomes effective only when historical costing periodically supplements it.
(iv) In volatile conditions with rapidly changing methods, rates and prices,
standards become quickly out of date and, thus, lose their control and
motivational effects. This may cause resentment and loss of goodwill.
(v) It may not be appropriate to the business to which it is applied.
(vi) A badly conceived standards costs may yield inaccurate and misleading
results and, therefore, may not enjoy the confidence of the users of this
system.
Applicability of Standard Costing:
Standard costing in practice is a detailed process and requires considerable
development work before it becomes a useful management tool for taking
managerial and economic decisions. It can gainfully be used in a variety of
costing situations like batch and mass production, process manufacture,
transport.

However, the greatest benefit can be gained when the manufacturing method
involves a substantial degree of repetition. Its major application in practice is
in organisation involved in mass production and/or repetitive assembly work.
Types of Standard:
There are different types of standard which are discussed below:
(i) Ideal Standard:
This is the standard which can be attained under the most favourable
conditions possible. In other words, ideal standards are based on perfect
performance. It is assumed that there is no wastage, no idle time, no
inefficiencies or other imperfections in the manufacturing process. But it is
very difficult to attain such standards in practice.
(ii) Expected Standard:
This is the standard which may be anticipated to be attained during a future
specified budget period. Expected standards are based on expected
performance. In setting these standards, a reasonable allowance is made for
wastages and other inevitable lapses. It is more realistic than ideal standard.
This type of standard is best suited from cost control point of view.
(iii) Basic Standard:
This is a standard which is established for use unaltered over a long period of
time. Basic standards are set up for some base year and is not changed as
material prices and labour rates change. It is suited for those items of
expenses which are fixed in nature. But basic standard is of no practical
importance from cost control point of view.
(iv) Normal-Standard:

This standard is based on average performances of the past. They are

attainable under normal conditions. If there is stability in the past
performances, such standards may be useful from cost ascertainment point of
view. But, for cost control, it is not so much effective.
Introduction of Standard Costing System in a Factory:
Standard costing is a system of cost accounting which makes use of
predetermined standard costs relating to each element of costmaterial,
labour and overhead. It is basically a technique of accounting which compares
the standard cost of each product or service with the actual cost to determine
the efficiency of the operations.
So, that any remedial measure may be taken quickly. It is the most effective
method for controlling performance and cost.
While introducing a standard costing system in a factory, the following
preliminary steps are required:
(i) Review of Existing System of Costing:
Before introduction of standard costing system, it is important to review the
existing system of costing with special reference to existing forms and
records.
(ii) Study of Technical Aspect:
It is essential to study the technical aspects because standard costing must
be based on actual conditions in the factory. Technical aspects involve
methods of production, different processes or stages of production, normal
and abnormal losses and gains and input-output relations etc.
(iii) Organisation Chart:

Lines of authority and responsibility should clearly be defined so that

responsibility may be assigned as and when required.
(iv) Allocation and Apportionment of Overhead:
The existing methods and policies in respect of allocation and apportionment
should be reviewed in the background of standard costing principles.
(v) Staff Training:
The staff concerned with the working of standard costing system should be
properly trained up.
(vi) Existing Controls:
The existing control techniques like internal control, budgetary control should
also be reviewed to avoid overlapping.
(vii) Type of Standard:
Setting up Standard costs for material, labour and overheads is a complicated
task. So, an in-depth study should be made to determine the type of standard
to be established.
(viii) Standard Cost Manual:
Standard cost manual should be prepared that should clearly define various
terms and procedures to be used. This may provide a good guide to the staff.