SUPER 25 - COST THEORY QUESTIONS

1. OBJECTIVES OF COST ACCOUNTING

(a) Ascertainment of cost: The main objec ve of cost accoun ng is accumula on and
ascertainment of cost.

(b) Determina on of selling price: The cost accoun ng system helps in determina on of
selling price and thus profitability of a cost object.

(c) Cost control and cost reduc on: To exercise cost control, the following steps should
be observed:
(i) Determina on of pre-determined standard or results
(ii) Measurement of actual performance
(iii) Comparison of actual performance with set standard or target
(iv) Analysis of variance and ac on

Cost Reduc on may be defined “as the achievement of real and permanent reduc on in the
unit cost of goods manufactured or services rendered without impairing their suitability for
the use intended or diminu on in the quality of the product.”

(d) Ascertaining the profit of each ac vity: The profit of any ac vity can be ascertained
by matching cost with the revenue of that ac vity.

(e) Assis ng management in decision making: Cost and Management accoun ng by

providing relevant informa on, assist management in planning, implemen ng, measuring,
controlling and evalua on of various ac vi es.

2. COST UNITS
Industry Cost unit
Bricks Per 1,000 bricks
Power Per kilowatt hours
Coal / Mining / Steel / Sugar / Paper / Fertilizer / Cement Per tone
Gas Per Cubic feet
Road construction Per kilometer or per mile
Advertising / Interior decoration Each job
Made to order / Readymade garments / Automobile / Furniture / Number
Bicycle manufacturing
Tyres & tubes Batch / Toy making / Printing press Each batch
Pharmaceuticals 1,000 nos., tablets, strips
Water Supply Per 1,000 litre
Bus service Per passenger-kilometer
Education Per student hour
Electricity Per kilowatt-hour
Goods transport Per ton-mile or per ton-km
Taxi Per km
Road transport Per km/ per passenger km
Airline Per passenger per one way
Hospital Per patient day/ per bed day
Hotel Per room per day / per meal
Cinema Per seat
Bridge construction / Civil construction Each contract
Ship building Each ship
Petro chemicals / Oil refinery Per tons, gallons litres
Textiles Per meter
Chemical Per kg / litre / tonne

3. DISTINGUISH BETWEEN COST CONTROL & COST REDUCTION

Cost Reduc on is defined by C.I.M.A London as “the achievement of real & permanent
reduc on in the unit cost of goods manufactured or services rendered without impairing
their suitability for use intended”. This defini on reveals the following characteris cs of cost
reduc on:
i. Cost reduc on must be real; say, through increase in produc vity.
ii. There is a saving in unit cost.
iii. Such saving is of permanent nature.
iv. The u lity & quality of goods & services remain unaffected, if not improved.

Cost Control: The cost control is the func on of keeping cost within prescribed limits.
According to C.I.M.A, London, cost control “is the regula on by execu ve ac on of the cost
of opera ng an undertaking, par cularly where such ac on is guided by cost accoun ng.”
Cost control is based on the principle of pre- determined costs & achieving these cost levels
so that inefficiencies & wastages may be reduced.

The main points of dis nc on between Cost Reduc on & Cost Control are as follows:
1. Cost control aims at maintaining the costs in accordance with the established
standards. While cost reduc on is concerned with reducing costs. It challenges all standards
and endeavors to be er them con nuously
2. Cost control seeks to a ain lowest possible cost under exis ng condi ons. While
cost reduc on recognises no condi on as permanent, since a change will result in lower
cost.
3. In case of Cost Control, emphasis is on past and present while in case of cost
reduc on it is on present and future.
4. Cost Control is a preven ve func on, while cost reduc on is a correc ve func on. It
operates even when an efficient cost control system exists.
5. Cost control ends when targets are achieved while cost reduc on has no visible end.
 4. METHODS OF COSTING

f output Method Description Example

A. Based on Customer’s specification:
- Single Unit Job Costing To ascertain the cost Automobile
of each job / order / Workshops, Interior
assignment. Decoration etc.
- No of similar units Batch Costing To ascertain the cost of Pharmaceuticals,
each batch / lot of units Printing press
produced. i.e. visiting cards,
invitation etc.
- Execution of works Contract Costing To ascertain the cost for Roads, bridge
each contract projects, Civil
Construction, Ship
Building.
B. Similar units of single product, from:

- Single process Unit or Output For the entire activity, but Quarries, Brickworks,
or Single Costing averaged for the output. Paint Manufacturing
etc.
- Series of processes Process or For each process or Oil Refinery, Breweries,
Operation operation. Sugar etc.
Costing
C. Multiple varieties of Multiple Costing Combination of any of the Production of TVs,
activities and processes methods listed above. computer etc,
automobile assembly.
D. Rendering of services Operating For each type of service. Transport, Hotels,
Costing Cinema, Hospitals etc.

5. DIGITAL COSTING SYSTEM

Digital cos ng system links different business func ons such as produc on, procurement,
inventory management with the digital cos ng system of its suppliers, customers and the
market through data sharing and network interac on.

Digital Cos ng System provides data to get the following informa on:
(i) Cost incurred on a cost object.
(ii) Data on me spent.
(iii) Data on resource consump on.
(iv) Data on current market price of final product and raw materials.
 Benefits of Digital Cos ng System
(i) Ascertainment of cost with certainty on a cost object
(ii) Analysis of data on me spent on each ac vity to study and formulate incen ve
plans.
(iii) Helps in material requirement planning and scheduling the material procurement.
(iv) Helps to iden fy and eliminate the non-value-added ac vi es.
(v) Data on resource consump on is helpful in se ng the standards and measurement
of variances on real me basis.
(vi) Extrapola on of data on customer behaviour towards the products to predict the
market demand. It is helpful is prepara on of budgets and planning of produc on.
(vii) A be er analysis of cost behaviour improves the cost benefit analysis and equipping
the management in informed decision making.

6. DIFFERENCE BETWEEN BILL OF MATERIAL & MATERIAL REQUISITION

Bill of material Material requisition note
1. It is a document prepared by the drawing 1. It is prepared by the foreman of the consuming
office (part of production, planning & control. department.
2. It is a complete schedule of component parts 2. It is a document authorising store keeper to
& raw material required for a particular job per issue materials to the consuming department.
work order along with the necessary blueprint
of drawings.
3. It often serves the purpose of a Store 3. It cannot replace a bill of material.
Requisition as it shows the complete schedule
of materials required for a particular job i.e. it
can replace stores requisition.
4. It can be used for the purpose of quotation. 4. It is useful in arriving historical cost only.
5. It helps in keeping a quantitative control on 5. It shows the material actually drawn from
materials draw through Stores Requisition. stores.

7. BIN CARDS AND STORES LEDGER

(i) Bin cards are maintained by the store keeper, while the stores ledger is maintained
by the cost accoun ng department.
(ii) Bin card is the stores recording document whereas the stores ledger is an
accoun ng record.
(iii) Bin card contains informa on with regard to quan es i.e. their receipt, issue and
balance while the stores ledger contains both quan ta ve and value informa on in respect
of their receipts, issue and balance.
(iv) In the bin card entries are made at the me when transac on takes place. But in the
stores ledger entries are made only a er the transac on has taken place.
(v) Bin cards record each transac on but stores ledger records the same informa on in
a summarized form.
8. JUST IN TIME (JIT) PURCHASES

JIT mean the purchases of goods materials such that delivery immediately precedes their
use. This will ensure that stocks are as low as possible. JIT purchasing is implemented by
developing closer rela onship with supplier so that the company & supplier work together
coopera vely. In JIT purchasing arrangement is made with supplier for more frequent
deliveries of smaller quan es of materials so that each delivery is just sufficient to meet
immediate produc on requirement.

JIT is based on two principles

(i) Produce goods only when it is required and
(ii) the products should be delivered to customers at the me only when they want.

It is also known as ‘Demand pull’ or ‘Pull through’ system of produc on. In this system,
produc on process actually starts a er the order for the products is received. Based on the
demand, produc on process starts and the requirement for raw materials is sent to the
purchase department for purchase.

1. The supplier of materials cooperates with the company & supply request quan ty of
materials for which order is placed before the start of produc on reducing the cost of stock
outs.
2. Investment in raw materials & WIP is substan ally reduced thereby saving
opportunity/ interest cost.
3. It result in saving is factory space & thus storage costs.
4. JIT purchases results in saving in materials handling & breakage costs.

9. TREATMENT OF NORMAL AND ABNORMAL LOSS OF MATERIALS

Waste - The por on of raw material which is lost during storage or produc on and discarded.
The waste may or may not have any value.

Scrap - The materials which are discarded and disposed-off without further treatment.
Generally, scrap has either no value of insignificant value. Some me it may reintroduced
into the process as raw material.

Spoilage - It is the term used for materials which are badly damaged in manufacturing
opera ons, and they cannot be rec fied economically and hence taken out of process to be
disposed of in some manner without further processing.

Defec ves - It signifies those units or por ons of produc on which do not meet the
quality standards. Defec ves arise due to sub-standard materials, bad-supervision, bad-
planning, poor workmanship, inadequate-equipment and careless inspec on.

10. ABC AND VED ANALYSIS - – REFER CLASS NOTES

11. TREATMENT OF IDLE TIME, OVERTIME AND LABOUR TURNOVER – REFER CLASS
NOTES
12. UNDER OR OVER RECOVERY & ITS TREATMENT

1. Supplementary overhead rate : If the under-absorp on is significant, supplementary

overhead rate is computed and applied to the jobs

2. Transfer to current year’s cos ng PL A/C : If the under-absorp on is minor and

insignificant, it may be transferred to the current year’s cos ng P and L a/c., without re-
opening the various job accounts involved.

3. Transfer to next year : Alterna vely, the under-absorp on can be transferred to the
next year’s Factory overhead control account with the hope that the same can be adjusted in
the next year. But this method is not recommended as most of the overhead are period costs
and related to me.

13. ADVANTAGES OF INTEGRATED ACCOUNTING :

 No need for Reconcilia on-Since there is one set of accounts, thus there is one
figure of profit. Hence the ques on of reconcilia on of cos ng and financial profit
does not arise.
 Less efforts-There is no duplica on of recording of entries to maintain separate
books.
 Less Time consuming-Cos ng data are available from books of original entry and
hence no delay is caused in obtaining informa on.
 Economical process-Centraliza on of accoun ng func on results in economy.

Essen al pre-requisites for integrated accounts:

 The management’s decision about the extent of integra on of the two sets of
books.
 Some concerns find it useful to integrate up to the stage of primary cost or factory
cost while other prefer full integra on of the en re accoun ng records.
 A suitable coding system must be made available so as to serve the accoun ng
purposes of financial and cost accounts.
 Perfect coordina on should exist between the staff responsible for the financial and
cost aspects of the accounts and an efficient processing of accoun ng documents
should be ensured.

14. REASONS FOR DIFFERENCE BETWEEN PROFITS SHOWN IN COST ACCOUNTS AND
THOSE SHOWN IN FINANCIAL ACCOUNTS
1. Items included in financial accounts only
2. Items included in cost accounts only – Usually no onal charges / imputed costs /
opportunity costs.
3. Under or over absorp on of overheads, if transferred to next year’s accounts-
4. Different bases of stock valua on
5. Different methods of charging deprecia on –
15. DIFFERENCE BETWEEN JOB AND BATCH COSTING

Job Costing Batch Costing

Method of costing used for non- standard and Homogeneous products produced in a continuous
non- repetitive products produced as per customer production flow in lots.
specifications and against specific orders.
Cost determined for each Job Cost determined in aggregate for the entire Batch
and then arrived at on per unit basis.
Jobs are different from each other and independent Products produced in a batch are homogeneous
of each other. Each Job is unique. and lack of individuality

16. INTER-PROCESS PROFITS

Generally processes are regarded as cost centres i.e. the focus is only on ascertainment of
cost. Some mes, they can also be treated as profit centres i.e. responsibility for earning
profits. However, since output of intermediate processes is not directly saleable, the output
of one process is transferred to the next process not at cost but at market value or cost plus
a percentage of profit. This is called as transfer price. The difference between cost incurred &
the transfer price is known as inter-process profits.

Advantages:
(a) It is a possible to compare cost of output & market value at each stage of
comple on.
(b) It is easier to fix responsibility of process managers for cost control through indirect
means of achieving profits.
(c) Each process is made to stand by itself as to profitability.

Disadvantages:
(a) It is a complicated method involving transfer-pricing considera ons. The
determina on of appropriate transfer price is not a simple affair.
(b) It might promote conflicts & misunderstandings among mangers as regards
compara ve profitability.
(c) It requires reconcilia on between profits books at each stage & actual realised
profits since it shows profits locked up in unsold stock.

17. TREATMENT OF BY PRODUCT – REFER CLASS NOTES

18. BUILD-OPERATE-TRANSFER (BOT) APPROACH

In recent years a growing trend emerged among Governments in many countries to solicit
investments for public projects from the private sector under BOT scheme. BOT is an op on
for the Government to outsource public projects to the private sector.
With BOT, the private sector designs, finances, constructs and operate the facility and
eventually, a er specified concession period, the ownership is transferred to the
 Government. Therefore, BOT can be seen as a developing technique for infrastructure
projects by making them amenable to private sector par cipa on.
The fundamental principle in determining user levy is, ‘if the price for a transport facility is
set at a level that reflects the benefit, each user gains from improvements in the facility, it
will result in traffic flow levels that equate social costs with user benefits.’

19. FIXED VS FLEXIBLE BUDGETS:

Basis Fixed Budget Flexible Budget

Assumption Based on assumption that business Based on assumption that business
conditions will remain constant. conditions are changing.
Nature It has a fixed nature. Change is not
It has a dynamic / variable nature.
possible once prepared. Adjustment is possible.
Classification Cost is not classified according to their
Cost is classified into fixed, variable and
nature. semi-variable.
Forecast Pure forecast is not possible on the
Pure forecast about various costs of
basis of fixed budget. production is possible on the basis of
flexible budget.
Business decisions Fixed budget is not suitable and Flexible budget is more suitable and
appropriate for business decisions. appropriate for business decisions.

20. BUDGETARY CONTROL

It is the system of management control and accoun ng in which all the opera ons are
forecasted and planned in advance to the extent possible and the actual results compared
with the forecasted and planned results.

Budgetary Control Involves

1. Establishment of budgets
2. Con nuous comparison of actuals with budgets for achievement of targets.
3. Revision of budgets a er considering the changes in the circumstances.
4. Fixa on of the responsibility for failure to achieve the budget targets.

Objec ves of Budgetary Control System

1. Portraying with precision the overall aims of the business and determining targets of
performance for each sec on or department of the business.

2. Laying down the responsibili es of each of the execu ves and other personnel so
that everyone knows what is expected of him and how he will be judged. Budgetary control
is one of the few ways in which an objec ve assessment of execu ves or department is
possible.

3. Providing a basis for the comparison of actual performance with the predetermined
targets and inves ga on of devia on, if any, of actual performance and expenses from the
budgeted figures. This naturally helps in adop ng correc ve measures.
 4. Ensuring op mum use of available resources to maximise profit or produc on,
subject to the limi ng factors. Since budgets cannot be properly drawn up without
considering all aspects, usually there is good co-ordina on when a system of budgetary
control operates.

5. Co-ordina ng various ac vi es of the business, and centralising control and yet

enabling management to decentralise responsibility and delegate authority in the overall
interest of the business.

6. Providing a basis for revision of current and future policies.

7. Drawing up long range plans with a fair measure of accuracy.

8. Providing a yards ck against which actual results can be compared.

21. ZERO – BASED BUDGETING (ZBB)

Zero based budge ng differs from the conven onal system of budge ng because it mainly
starts from scratch or zero and not on the basis of trends or historical levels of expenditure.
ZBB is suitable for both corporate and non-corporate en es. In case of non- corporate
en es like Government department, local bodies, not for profit organisa ons, where these
en es need to jus fy the benefits of expenditures on social programmes like mid-day meal,
installa on of street lights, provision of drinking water etc.

In case of corporate en es, ZBB is best suited for discre onary costs like research and
development cost, training programmes, adver sement etc.

ZBB involves the following stages:

(i) Iden fica on and descrip on of Decision packages
(ii) Evalua on of Decision packages
(iii) Ranking (Priori sa on) of the Decision packages
(iv) Alloca on of resources

Advantages of Zero-based Budge ng

• It provides a systema c approach for the evalua on of different ac vi es and rank

them in order of preference for the alloca on of scarce resources.
• It ensures that the various func ons undertaken by the organiza on are cri cal for
the achievement of its objec ves and are being performed in the best possible way.
• It provides an opportunity to the management to allocate resources for various
ac vi es only a er having a thorough cost-benefit-analysis. The chances of arbitrary cuts and
enhancement are thus avoided.
• The areas of wasteful expenditure can be easily iden fied and eliminated.
• Departmental budgets are closely linked with corpora on objec ves.
• The technique can also be used for the introduc on and implementa on of the
system of ‘management by objec ve.’ Thus, it cannot only be used for fulfillment of the
objec ves of tradi onal budge ng but it can also be used for a variety of other purposes.
 Limita ons of Zero-based Budge ng

• The work involves in the crea on of decision-making and their subsequent ranking
has to be made on the basis of new data. This process is very tedious to management.
• The ac vi es selected for the purpose of ZBB are on the basis of the tradi onal
func onal departments. So, the considera on scheme may not be implemented properly.

Difference between Tradi onal Budge ng and Zero- based budge ng

• Tradi onal budge ng is accoun ng oriented. Main stress happens to be on previous

level of expenditure. Zero-based budge ng makes a decision- oriented approach. It is very
ra onal in nature and requires all programmes, old and new, to compete for scarce
resources.
• In tradi onal budge ng, first reference is made to past level of spending and then
demand for infla on and new programmes. In zero- based budge ng, management focuses
a en on to only on decision packages, which enjoy priority to others.
• In tradi on budge ng, some managers deliberately inflate their budget request so
that a er the cuts they s ll get what they want. In zero-based budge ng, a ra onale analysis
of budget proposals is a empted. The managers, who unnecessarily try to inflate the budget
request, are likely to be caught and exposed. Management accords its approval only to a
carefully devised result-oriented package.
• Tradi onal budge ng is not as clear and as responsive as zero-base budge ng.
• Tradi onal budge ng makes a rou ne approach. Zero-based budge ng makes a very
straigh orward approach and immediately spotlights the decision packages enjoying priority
over others.

22. DISTINCTION BETWEEN MARGINAL COSTING AND ABSORPTION COSTING

Basis Marginal costing Absorption costing

Fixed costs Fixed costs are ignored & not included Fixed overheads are added to cost of
in costs of production or costs of production. The stocks are also valued at
finished stock or work-in-progress. a cost which includes fixed expenses as
well.
Cost per unit Cost per unit remains the same Cost / unit reduces the production
irrespective of the production as it is increase as it is fixed cost which reduces,
valued at variable costs. whereas, the variable cost / unit remains
the same.
Decision Making It is suitable for decision making. Not suitable for decision making.
Cost comparison & Cost comparison & cost control is Costs are found to be different due to
cost control easy. inclusion of FC & thus making cost
comparison & control difficult.
23. TREATMENT OF VARIANCES IN COST ACCOUNTS:
1. Transfer to Cos ng P&L: In this method, WIP A/C, Finished Stock A/C & cost of Sales
A/c are maintained at standard costs. Hence, all the cost variances are transferred to cos ng
P& L A/C. All adverse variances are debited & favourable variances are credited to Cos ng
P&L A/C.
2. Appor onment of variances to Work –in-progress, Finished Stock & cost of Sales:
Under this method, the variances are distributed to WIP A/C, Finished Stock A/C and Cost of
Sales A/C in propor on to the closing balances of each account & it has the effect of
recording actual costs in the Financial Statements .The arguments in favour of this method
are as follows:-
(a) Adding back the variance to the standard costs will reflect the actual costs.
(b) Showing the inventory at actual costs for balance sheet purposes.
(c) Standard costs are tools of control & hence only actual costs should be
reflected in P & L A/C & Balance Sheet.
(d) Variances are not actual losses and hence they should not be allowed to
distort profits.
3. Carry Over of Variances: Under this method net favourable or net adverse variances
are carried forward to the next year. Net favourable variances are shown as deferred credit
or reserve, & net adverse variances are shown as deferred charge.

24. BUDGETARY CONTROL VS STANDARD COSTING

Basis Standard cost Budgetary control

Meaning A control technique which compares It requires setting up budgets which are
standard costs & revenues with actual related to the responsibilities of the
results to obtain variances which are executives for the implementation of the
used to stimulate improved policy
performance.
Based on Based on technical assessments Based on past actual adjusted to future
trends.
Scope Used mainly for production expenses Compiled for sales, production, purchase,
i.e. elements of cost. expenses, profit, capital expenditure & cash.
Accounting Is a projection of Cost Accounts. A projection of Financial Accounts.
Uses Standards are pointers to further Budgets are indices, adherence to which
improvements. keeps a business out of problems.
Expressed as Expressed per unit of production. Expressed in totals of amounts.
Detailed Detailed analysis is needed in case of No further analysis is required if costs are
analysis variances. within the budget.
25. LEVEL OF ACTIVITIES UNDER ABC METHODOLOGY

Unit level activities - The use of indirect materials / consumables tends to increase in
proportion to the number of units produced.
- The inspection or testing of every item produced, if this was deemed
necessary or, perhaps more likely, every 100th item produced.
Batch level activities - Material ordering–where an order is placed for every batch of
production
- Machine set-up costs–where machines need resetting between each
different batch of production.
- Inspection of products where the first item in every batch is
inspected rather than every 100th item quoted above.
Product level activities - Designing the product,
- Producing parts specifications
- Keeping technical drawings of products up to date.
Facilities level activities - Maintenance of buildings
- Plant security

26. ACTIVITY BASED MANAGEMENT

The use of ABC as a cos ng tool to manage costs at ac vity level is known as Ac vity Based
Cost Management (ABM).
ABM is a discipline that focuses on the efficient and effec ve management of ac vi es as the
route to con nuously improving the value received by customers. ABM u lizes cost
informa on gathered through ABC.

Analysis involved in ABM:

(1) Cost Driver Analysis: The factors that cause ac vi es to be performed need to be
iden fied in order to manage ac vity costs. Cost driver analysis iden fies these causal
factors.
(2) Ac vity Analysis.
(a) Value-Added Ac vi es (VA): The value-added ac vi es are those ac vi es which
are indispensable in order to complete the process. The customers are usually willing to pay
(in some way) for these services. For example, polishing furniture by a manufacturer dealing
in furniture is a value added ac vity.
(b) Non-Value-Added Ac vi es (NVA): The NVA ac vity represents work that is not
valued by the external or internal customer. NVA ac vi es do not improve the quality or
func on of a product or service, but they can adversely affect costs and prices. Moving
materials and machine set up for a produc on run are examples of NVA ac vi es.
(3) Performance Analysis: Performance analysis involves the iden fica on of
appropriate measures to report the performance of ac vity centres or other organisa onal
units, consistent with each unit’s goals and objec ves.
Ac vity Based Management in Business
(i) Cost Reduc on: ABM helps the organisa on to iden fy costs against ac vi es and to
find opportuni es to streamline or reduce the costs or eliminate the en re ac vity,
especially if there is no value added.
(ii) Business Process Re-engineering: Business process re-engineering involves
examining business processes and making substan al changes to how organisa on currently
operates. ABM is a powerful tool for measuring business performance, determining the cost
of business output and is used as a means of iden fying opportuni es to improve process
efficiency and effec veness.
(iii) Benchmarking: Benchmarking is a process of comparing of ABC-derived ac vity costs of
one segment of company with those of other segments. It requires uniformity in the
defini on of ac vi es and measurement of their costs.