COST ACCOUNTING

Unit – I
LESSON 1
INTRODUCTION TO COST ACCOUNTANCY
CONTEXT OF THE LESSON
This lesson will familiarize with the different terms and their meaning which are used in the area
of cost accountancy. This lesson signifies the objectives and advantages of applying cost
accounting techniques and methods within the industry.
OBJECTIVES OF THE LESSON
The objective of this lesson is to know:
1. Meaning and definition of various terms used in cost accounting.
2. Objective of cost accounting.
3. Significance of cost accounting.

INTRODUCTION:
Cost is the amount of resources given up or sacrificed in exchange for some goods/article/product
or services. The resources given up are expressed in cash or cash equivalent expressed in
monetary units. The Chartered Institute of Management Accountants,(CIMA) London, has defined
cost as “the amount of expenditure (actual or notional) incurred on or attributable to a specified
thing or activity”. Thus, cost includes the amount which has been actually incurred and for decision
making, notional or imputed costs which do not involve cash outlay and hence do not find place
in accounting records are also considered (for example rent of the owned building, or salary of
the owner working as manager).
DEFINITIONS:
COSTING
“Costing can be defined as “the techniques and process of ascertaining costs” - I.C.M.A
Costing relates to the determination of cost of a product manufactured or services rendered. In
order to ascertain cost, it involves system, methods and techniques of costing and a certain
process in followed for accumulation, classification and analysis of cost.
The technique refers to application of principles and rules for ascertaining costs. These
techniques can be applied for specific purpose. These techniques are- Historical costing
technique; Absorption costing technique; Marginal costing technique; Standard costing technique;
Direct costing technique; Uniform costing technique etc.
The methods of costing differ from the techniques and the methods of costing are applied as per
the nature of the organization. The methods of costing can be classified as-
a) Specific Order Costing Method

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b) Continuous Operation costing method

The word “process of ascertaining cost” includes the day to day routine of determining cost
through the process related to Allocation, Apportionment and Absorption of costs, besides the
presentation of statement of cost, showing how the cost have been arrived at.
Cost Allocation: - Allocation is the process whereby cost items are charged directly to a cost unit
or cost centres i.e. a cost can be specifically and exclusively be identified and allocated entirely
to a specific department or cost centre.
Cost Apportionment: - Apportionment is the process of division or apportionment of cost among
two or more cost centre on some appropriate basis. Those cost which are associated or related
with two or more than two cost centres are to be apportioned among these cost centres that have
been benefited by these expenditures.
Cost Absorption: - It is a process of ascertaining the charge of indirect cost on per unit of
production of goods or services. In other word, the overhead is absorbed by the physical units
manufactured or units of services rendered during a period or for specific job.
COST ACCOUNTING
“Cost Accounting is the process of accounting for cost from the point at which expenditure is
incurred or committed to the establishment of its ultimate relationship with cost centres and cost
units. In its widest usage it embraces the preparation of statistical data, the application of cost
control methods and the ascertainment of the profitability of activities carried out or planned.”
-ICMA
Cost Accounting is the method of accounting for total cost and per unit cost of product, service,
order, process or job. Cost comprises three elements, viz., material, labour and expense. The
recording and accounting for all these elements of cost find their treatment in cost accounting. All
the cost incurred from the very beginning of manufacturing operation till the final stage of disposal
of goods find their recording in cost accounting.
Cost accounting as a tool of management process and evaluates monetary and non-monetary
data in order to provide necessary, adequate and reasonable information for effective and efficient
planning and control of business operations, managerial decisions and special analysis.
COST CENTRE AND COST UNIT
A cost accountant has to ascertain cost by cost centre or cost unit or by both.
COST CENTRE:
According to the Chartered Institute of Management Accountants London, cost centre means a
production or service location, function, activity or items of equipment whose cost may be
attributed to cost unit. Cost centre is the smallest organizational sub-unit for which separate cost
collection is attempted. Thus, cost centre refers to one of the convenient unit into which the whole
factory organization has been appropriately divided for costing purposes. Each such unit consists
of a department or a sub-department or item of equipment or, machinery or a person or a group

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of persons. For example, although an assembly lines. Sometimes each assembly line is regarded
as a separated cost centre with its own assistant foreman. Washing of clothes are performed.
Each activity may be considered as a separate cost centre and all costs relating to a particular
cost centre might be found out separately.
COST UNIT:
Chartered Institute of Management Accountants London, defines a unit of cost as “a unit of
product or service in relation to which costs are ascertained” A cost unit is a device for the purpose
of breaking up or separating costs into smaller sub-divisions. These smaller sub-divisions are
attributed to products or services to determine product cost or service cost or cost of time spent
for a particular job etc.
For instance, cost per ton of steel, per ton kilometer of a transport service or cost per machine
hour. The forms of measurement used as cost units are usually the unit of physical measurement
like number, weight, area, length, value, time etc. unit selected should be unambiguous, simple
and commonly used. Following are some examples of cost unit:
COST ACCOUNTANCY:

INDUSTRY/ PRODUCT COST UNIT

Automobile Number
Brick work 1000 brick
Cement Tonne
Transport Tonne – kilometer
Passenger – kilometer
Chemical Liter, gallon, kilogram, tonne
Steel Tonne
Sugar Tonne
“Cost
accountancy is the application of costing and cost accounting principles, methods and techniques
to the science, art, and practices of cost and the ascertainment of profitability. It includes the
presentation of information derived therefore for the purpose of managerial decision-making.”
-ICMA
The term cost accountancy includes (i) costing and (ii) cost accounting. Its purpose is (i) cost-
control, and (ii) profitability- ascertainment. It serves as an essential tool of the management for
decision-making.

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Cost control is the objective of cost accountancy but the application of cost control methods lies
in the domain of accounting. The cost control methods are: (i) Budgetary Control, (ii) Standard
Costing and (iii) Responsibility Accounting.

The cost control does not necessarily mean cost reduction. If the price of material and labour go
up and consequently the operation cost goes up, the cost can be said to be within control even
with the increased cost provided there is no abnormal wastage or greater idle capacity or any
marked inefficiency, however the cost reduced as a result of application of cost control methods
are very much welcome.
Profitability is different from profit making. Profitability is the potentiality to make profit, inherent in
the business, or in an enterprise. An enterprise may be capable to yield a profit, but due to non-
applicability of cost accounting techniques; it may be earning only a low amount of profit. The
ascertainment of profitability is the function or the objective of cost accountancy but the application
of methods for its ascertainment is the task of cost accounting.
Self Check Questions
1. Define Costing.
2. Explain the term process in costing.
3. What do you mean by Cost Account?
4. What is Cost Centre & Cost Unit?

OBJECTIVES OF COST ACCOUNTING:

The main objectives of cost accounting can be identified as:
(a) Ascertainment of Cost: The main objective of cost accounting is considered as to
determine the cost of the product or article or service. For the purpose of ascertainment
of cost of the product or service, various methods of costing and techniques are used
under various conditions. Through cost accounting, ascertainment of cost is possible for
each unit of production, job, process or department and every stages of production. These
costs can be determined on the basis of actual cost but cost is also predetermined for
various purposes.
(b) Cost Control and Cost Reduction: One of the primary objectives of cost accounting is
to improve profitability by exercising control and reducing cost. Cost control is done by
comparing the actual cost of production by the pre-determined cost or standard cost so
that the difference between these two can be measured and then analysed according to
the reasons for taking corrective action. For this purpose various specialized techniques
of control are applied. These are standard costing technique, budgetary control, inventory
control etc. Cost reduction on the other hand means permanent reduction of cost through
continuous research for improvement in products, methods, procedures and

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organizational practices. Cost reduction should be real and permanent – through increase
in productivity, change in product design, and improvement in technology.
(c) Managerial Decision Making: Cost accounting is of immense help to the management
as it aims at serving the need of the management in conducting the business with utmost
efficiency. The cost data accumulated and analysed provides meaningful information to
the management to formulate various policy and guidelines for various decisions like make
or buy, accept or reject an offer, shut down or continue the business, pricing decisions etc.
(d) Determination of Selling Price: Cost accounting provides the information as regards to
cost on the basis of which selling prices of products or services may be fixed. In period of
recession, cost accounting helps the management in deciding to what extent the selling
price may be reduced to meet the changing situation.
In order to attain these above objectives, it is necessary that there should be an effective system
of cost accounting prevailing in the organization which should be re-classified, re-organized and
updated according to the need of the management.
SIGNIFICANCE/ IMPORTANCE OF COST ACCOUNTING
The limitations of financial accounting led the management to realize the importance of cost
accounting. Any sort of manufacturing business involves expenditure on material, labour, and
other items for manufacturing and disposing of product. The management has to avoid the
possibility of wastage at each stage. It has to ensure that no machine remains idle, efficient labour
gets due incentives, by-product are properly utilized and costs are properly ascertained. Besides
the management, the creditors and employees are also benefited in numerous ways by
installation of a good costing system. Cost accounting increases the overall productivity of an
organization and serves as an important tool for growth and development of business &ultimately
bringing prosperity in the counry. Importance of cost accounting can be discussed as follows:
(a) Costing as an Aid to Management: Cost accounting provides detailed costing information
to the management to enable them to maintain effective control over stores and inventory, to
increase efficiency of the organization and to check wastage and losses. It facilitates
delegation of responsibility for important tasks and rating of employees. The management
should be capable enough of using the information provided by cost accounts in proper way.
The various advantages derived by the management from a good system of costing are as
follows:
1. Cost accounting helps in period of trade depression and trade competition- In period of
trade depression, the organization cannot afford to have losses hence the management
must know the areas where economies may be brought out, wastages can be eliminated
and efficiency can be increased. The management should know the actual cost of their
products before applying on any scheme of price reduction.
2. Cost accounting aids price fixation- The price of a product to a large extent is affected by
the law of supply and demand but to a great extent the cost of article to the producer does
play an important role. The producer can take necessary measures and guidance from his
costing record while fixing the price of his product or service.

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3. Cost accounting helps in making estimates- Proper costing records provide a reliable
basis for making estimates and quoting tenders.
4. Cost accounting helps in channelizing production on right lines- Adequate costing
information helps the management to distinguish between profitable and non profitable
activities. Profit can be maximized by selecting profitable activities and eliminating non-
profitable activities.

5. Cost accounting helps in eliminating wastages- As cost accounting provides a detailed

break-up of costs at various stages and as direct and indirect cost, it thus facilitate to check
various forms of wastages and help the management in formulation of future course of
action so that the wastages can be eliminated and production can be improved by
application of improved technology, quality material, efficiency of labour etc.
6. Cost accounting facilitates comparisons - Maintenance of past years costing records,
records of various products etc. helps the management in comparison which in turn helps
the management in formulation of future policies.
7. Cost accounting provides data for periodical profit and loss account- Adequate costing
records provide the management with such data as may be necessary for preparation of
profit and loss account and balance sheet at such intervals as may be desired by the
management.
8. Cost accounting helps in determining and enhancement efficiency-Llosses due to
wastages of material, idle time of workers, poor supervision, etc., will be disclosed if the
various operations involved in the production are studied carefully. Efficiency can be
measured, costs controlled and various steps can be taken to increase the efficiency.
9. Cost accounting helps in inventory control- cost accounting furnishes control which
management requires in respect of stock of material, work in progress and finished goods.
(b) Costing as an Aid to Creditors- Investors, bank and other financial institutions have a
stake in the success of the business concern and are, therefore benefited immensely by
the installation of an efficient system of costing. They can base their judgment about the
profitability and future prospects of the enterprise on the costing records.
(c) Costing as an Aid to Employees- Employees has a vital interest in their employer’s
enterprise in which they are employed. They are benefited by a number of ways by the
installation of an efficient system of costing. They are benefited, through continuous
employment and higher remuneration by the way of incentives bonus plans, etc.
(d) Costing as an Aid to National Economy- An efficient system of costing brings prosperity
to the business enterprise in turn result in stepping up of the government revenue. The
overall economies development of a country takes place as a consequence increase in
efficiency of production. Control of costs, elimination of wastages and inefficiencies led to
the progress of the industry and, in consequences of the nation as a whole.

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(e) Costing as an Aid to Consumer: - Cost accounting system provides cost control which
leeds to reduction in cost of product and services. These help the organization to offer
product and services to the consumer at lower price and of good quality.
(f) Costing as an Aid to Government: - This system is useful for government for deciding
the state subsidy to industry and also for economic planning and development by the state.
The government requires various details of cost in formulating various economic policies
such as tax policy, business policy, export policy, etc.
(g) Costing as an Aid to Investors: - The banks and other investors also find it useful to
make investment in the companies which employ costing methods because it helps in
determining worthiness of credit being granted to them.
SELF CHECK QUESTION: -
1. Define costing and explain the terms process and techniques used in the definition?
2. Differentiate between cost and costing?
3. What is meant by cost accounting, explain its objectives?
4. What is the significance of cost accounting to various stake holders?
5. Define cost accounting and discuss its significance?
6. Explain the term costing, cost accounting and cost accountancy?
7. What do you mean by cost centre and cost unit?
8. What is cost accounting? Discuss briefly its objectives and advantages.
9. “Costing system has become an essential tool in the hands of management.” Discuss.
10. Describe briefly the role of cost accounting in a manufacturing organization?

LESSON 2
METHODS AND TECHNIQUES OF COSTING

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CONTEXT OF THE LESSON

This lesson will familiarize with the various methods of costing which are used in the various
industries for determination of cost and techniques of costing which is applied for specific
purposes. It will also bring out the difference between cost accounting and financial accounting.
OBJECTIVES OF THIS LESSON
The objective of this lesson is to understand:
1. Various methods of costing,
2. Techniques of costing, and
3. Difference between financial accounting and cost accounting.

METHOD OF COSTING
As per latest CIMA terminology, there are two methods of costing i.e., (i) specific order costing
and (ii) continuous operating costing. Specific order costing method is a method which is applied
in those industries where the production activities are taken on the order or request of the
customer. The customer provides the size, specification and quantity to be produced. Hence, in
the industry where these methods are applied, production is not done for stock. Continuous
operating costing method is applied in those industries where production in carried out on a large
scale, on a continuous basis and goods produced are either sold off or kept in stock. The various
costing methods are as follows:
(a) JOB COSTING: It refers to a method of costing, in which costs are ascertained in terms
of specific jobs or order, which are not comparable with each other. The cost is accumulated
for specific job. The job is generally for a short duration and are carried out within the factory
premises. Industries where this method of costing is generally applied are printing press,
automobile garage, repair shop, ship building, house building, engine and machine
construction, etc.
(b) CONTRACT COSTING: Contract costing does not differ in principle from job costing.
This method is applied where production or work is taken on the request of the customer.
For each contract, a separate contract account is prepared. The contracts undertaken may
involve more than one year for its completion, hence profits on incomplete contracts are
determined. As contracts can be carried over for a longer period of time, hence, this method
is also termed as terminal costing. Works on contracts are generally carried out at different
sites, outside the business premises.
(c) BATCH COSTING: This method is also a type of job costing. A batch of similar products
is regarded as one job and the cost of this complete batch is ascertained. It is used to
determine the unit cost of the articles produced. It should, however, be noted that the article
produced should not lose their identity in manufacturing operations.

(d) OPERATION COSTING: This method is adopted when it is desired to ascertain the cost
of carrying out an operation in a department, for example, welding. For large undertaking, it
is frequently necessary to ascertain the cost of various operations.

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(e) PROCESS COSTING: This method of costing is applied in those industries where a
product passes through distinct stages or processes and the output of one process becomes
the input of the subsequent process, till it reaches the final process. The output of the last
process is thereafter transferred to warehouse for sale or is kept as stock. The cost of each
stage or process of production is determined by preparing separate process accounts.
Process costing is generally adopted in textile industries, chemical industries, etc.
(f) UNIT OR SINGLE OR OUTPUT OR SINGLE-OUTPUT COSTING: This method is used
where a single article is produced or services are rendered by continuous manufacturing
activity. The cost of whole production-cycle is ascertained as a process and the cost per unit
is arrived at by dividing the total cost by the number of units produced. The unit of costing
is chosen according to the nature of product. Cost statement or cost sheets are prepared,
under which, various items of expenses are classified and total expenditure is divided by
total quantity produced in order to arrive at unit cost of production.
(g) OPERATING COSTING: This method is applicable where services are rendered rather
than goods produced. The procedure is same as in the case of single output costing. The
total expenses of the operation are divided by the units and cost per unit of services is
arrived at. This method is employed in railways, road transport, water supply undertaking,
telephone services, etc.
(h) MULTIPLE OR COMPOSITE COSTING: Some products are so complex that no single
system of costing is applicable. It is used where there are a variety of components separately
produced and subsequently assembled in a complex production. Total cost is ascertained
by computing component costs, which are collected by job or process costing and then,
aggregating the cost through use of the single or output costing system. This method is
applicable to manufacturing concern producing motor cars, aeroplanes, machine tools, etc.
(i) UNIFORM COSTING: It is not distinct method of costing by itself. It is the name given
to a common system of costing, followed by a number of firms in the same industry. This
helps in comparing performance of one firm, with that of another.
(j) DEPARTMENTAL COSTING: When costs are ascertained, department by
department, the method is called “Departmental costing.” Usually, for ascertaining the cost
of various goods or services produced by a department, the total costs will have to be
analyzed, say, by the use of job costing or unit costing.
Self Check Questions
1. What are the various methods of costing?
2. Explain Process costing.
3. How does job costing differ from contract costing?

TECHNIQUES OF COSTING
HISTORICAL (OR CONVENTIONAL) COSTING: It refers to the determination of costs after they
have been actually incurred. It means that cost of a product can be calculated only after its
production. In this case, only past cost data’s are taken into consideration, as such, it is termed
as historical costing. This system is useful only for determining costs, but not useful in exercising

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any control over costs. It can serve as guidance for future production, only when condition
continues to be the same in future.
STANDARD COSTING: It refers to the preparation of standard cost and applying them to actual
cost to measure the variation from standard cost and analyzing the variation with a view to
maintain maximum efficiency in production. The actual cost is compared with the pre-determined
costs and deviations known as variances are identified. Thereafter, the reasons for the variances
are ascertained, so that corrective actions may be taken.
MARGINAL COSTING: It refers to the ascertainment of marginal costs by differentiating between
fixed costs and variable costs. Marginal costing regards only variable cost as the cost of the
product and is charged to product or operations while fixed costs are charged to profit and loss
account in which they arise. This technique is used to study the effects on profit of the changes
in volume or type of output.
ABSORPTION COSTING: In this method, the cost is not classified into fixed and variable cost
and the total costs are charged to the products. It is a contrast to marginal costing technique, and
now days it is considered to have a limited scope of use.
UNIFORM COSTING: When a large number of firms under an industry, adopts the same system
of costing terminology for various items and processes, then it is said to have followed a system
of uniform costing. The costing technique helps to compare the performance of one firm with that
of other firms.
DIRECT COSTING: In this method, all direct costs are charged to operations, processes or
products leaving all indirect costs to be written off against profits in which they arise.
Cost accounting may be regarded as: a specialized branch of accounting which involves
classification, accumulation, assignment and control of costs. The costing terminology of C.I.M.A.,
London, defines cost accounting as “the establishment of budgets, standard cost and actual costs
of operations, processes, activities or products, and the analysis of variances, profitability or the
social use of funds.” Wheldon defines cost accounting as “classifying, recording and appropriate
allocation of expenditure for determination of cost of products or services and for the presentation
of suitably arranged data for the purpose of control and guidance of management.” It is thus, a
formal mechanism by means of which cost of products or services are ascertained and controlled.
DIFFERENCE BETWEEN COST ACCOUNTING & FINANCIAL ACCOUNTING
Financial Accounting and Cost Accounting are the constituent part of accounting. They serve
different purposes altogether. Both have merits and demerits. Both follow accounting principles.
Both pass the entries from the same source of documents. For example, a purchase invoice forms
a basis for an entry in purchase account in Financial Accounts and an entry in stores control
account in CA. However, there are dissimilarities also. The differences are summarized as below:

Financial Accounting Cost Accounting

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(1)To record the actual or accrued expenses (1) To record the normal revenue
and income and capital. expenses for ascertaining the cost.

(2) To know the profit or loss for the (2) To analyse, control and reduce the
accounting period. cost.

(3)To know the financial position of the firm. (3)To help management in decision-
making activities.
(4) Profit and Loss account
(4) Cost statement and cost sheet.
(5) Balance Sheet
(5)Variance Analysis.
(6) Stock and Assets Register
(6) Report and Wastage, etc.
(7) Annual Report
(7) Quotations and Estimations.

(8) Essentially record expenses after they are (8) Essentially records expenses before
incurred or due, therefore reports are “post they are incurred at pre-determined
mortem” in nature. They are “retrospective”. rates. Therefore reports are “Intelligence
report: in nature. They are “ prospective”.
(9) Estimations and quotations are not
prepared. Deals with past expenses only. So, (9) Estimations and quotations are
it is “curative” prepared. Deals with sciencetifically
expected expenses and so it is
“preventive”

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Self Check Questions

(10) P and L Account is prepared for an (10) Cost statement is prepared as and
accounting year and balance sheet is on the when required by the management. It is
last date prepared product wise and so it can be
prepared weekly, monthly, fortnightly,
monthly, etc.
(11) Financial statement is for shareholders, (11) Cost Statement is for management
creditors, government etc. so, it is more for decision making activities. So, it is more for
external purpose. internal purpose.

(12)Financial Accounts have to be (12) Cost Accounts are not compulsory for
maintained by companies, firms, and all. They are required to me maintained by
concern compulsorily as required by the acts. those companies for which Cost Accounting
record rules apply. It is based on the
products for which government order
applies.
(13) Accounts have to be audit every year.
(13) Only those accounts which are
subjected to cost audit are to be audited
every year.

(14) Auditor is appointed by the shareholders

(14) Auditor is appointed by the directors
in the general body meeting.
approved by central government.

(15) Auditor must be a charted Accountant.

(15) Auditor must be a cost Accountant
(16) Audit report is open to public and is a not
secret document. (16) Audit report is not open to public and is
a secret document.

1. Discuss the various methods of costing?

2. Discuss the various techniques of costing and their significance?
3. List out the various methods of costing and explain their practical applications?
4. State and explain the major difference between cost accounting and financial
accounting?
5. What are the methods of costing? Explain their adaptability in different industries?
6. Name at least three industries in which each of the following methods would be suitable:
(a) Process costing (b) Unit costing
(c) Operation costing (d) Job costing
7. What method of costing would you recommend for the following industries? Give five
reasons.
(a) Shipbuilding (b) Toy making (c) Oil refinery
(d) Sugar (e) Radio receivers
LESSON 3
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ELEMENT OF COST AND ITS CLASSIFICATION

CONTEXT OF THE LESSON
This lesson deals with the understanding of various elements of cost which form the part of the
cost of the product/article or service. It also deals with various classification of cost which are
helpful in taking short term and long term decision making.
OBJECTIVES OF THE LESSON
• To understand the elements / components of cost
• To familiarize with different types of cost.
ELEMENT OF COST
The cost of a product or service is generally composed of three elements, i.e., material, labour,
and expenses. The elements of cost can be broadly studied under the classification of direct and
indirect cost. This is shown ahead:-
ELEMENTS OF COST

Total cost

Direct cost Indirect cost

Direct Direct Direct Indirect Indirect Indirect

Material Labour Expenses Material Labour Expenses

Prime Cost Overheads

Factory Administrative Selling &

Overheads Overheads distribution
Overhead

MATERIAL COST
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As per CIMA, London, Material cost is “the cost of commodities supplied to an undertaking.”
Material cost comprises of cost of procurement of raw material, freight, taxes, insurance, etc.,
which are directly attributable to the procurement or acquisition of material. Any trade discount,
rebate, duty drawback, refund etc. are deducted in determining the cost of material. Material cost
may be further classified as direct material or indirect material cost.
DIRECT MATERIAL COST: Direct material cost can be termed as the cost of
that material which can be easily identified and allocated to cost units. Direct Direct Material
material generally becomes a major part of the finished product. For example, • Clay in brick
timber used in making furniture is a direct material. In certain cases the primary • Leather in shoe
• Steel in machine
packing materials also becomes a part of the finished product, and hence is • Cloth in garments
treated as direct material. For example match box for keeping match sticks.
INDIRECT MATERIAL: Indirect materials are those materials which cannot
be easily and conveniently identified with individual cost units. These are less
Indirect Material
• Lubricating
significant and play a minor role in making of the product. These materials may • Sand powder
be (i) Small and relatively inexpensive items, which may become a part of the • Nuts and Bolts
finished product. For example, nuts, bolts, screw, threads, etc and (ii) those • Small tools
items which do not physically become a part of the finished products, e.g., coal,
lubricant oil and grease, etc.
LABOUR COST: This is “the cost of remuneration (wages, salaries, commission, bonuses, etc.)
of the employees of an undertaking” (CIMA). It includes all fringe benefits like P.F. contribution,
gratuity, ESI, overtime, incentive bonus, wages for holidays, idle time.
DIRECT LABOUR: - Direct labour cost consists of wages incurred on Direct Labour
employees, who are directly engaged in the process of converting raw material • Machine operator
into finished product. These wages can be clearly and conveniently identified • Shoe-maker
with a particular product, job or process. Wages paid to a machine operator is • Carpenter
• Tailor
a case of direct wages.
INDIRECT LABOUR: - The indirect labour cost is the cost which is incurred
on indirect employees, who are not directly engaged in the process of Indirect Labour
conversion of shape of raw material into finished product but they assist in the • Supervisor
• Inspector
process of supervision, maintenance, transportation, handling, etc. In other
• Cleaner
words, indirect labour cost should be treated as overhead and should be • Peon
apportioned to various cost centres or production departments.
EXPENSES
All cost other than material and labour are termed as expenses. It is defined as “the cost of
services provided to an undertaking and the notional cost of the use of owned assets.” (CIMA)
DIRECT EXPENSES: - According to CIMA, London “direct expenses are those expenses which
can be identified with and allocated to cost centres or units.” These are those expenses which
are specially incurred and charged for a specific or a particular job or cost unit. These are also
called as chargeable expenses. For example, cost of drawings, design and layout, hiring charges
of a specific plant, fees of a technical expert required on a specific job.

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INDIRECT EXPENSES: All indirect costs other than indirect materials and
Indirect
indirect labour costs are termed as indirect expenses. Expenses
These cannot be directly identified with a particular job, • Rent and rates
• Advertising
process or work order and are common to cost units or cost centres. • Insurance
• Repairs
• Depreciation
PRIME COST •

This is the aggregate of direct material cost, direct labour cost and direct expenses. Thus,
DIRECT MATERIAL + DIRECT LABOUR + DIRECT EXPENSES = PRIME COST.
OVERHEAD
This is the aggregate of indirect material cost, indirect labour cost and indirect expenses. Thus,
INDIRECT MATERIAL+ INDIRECT LABOUR+ INDIRECT EXPENSES = OVERHEAD
Overhead can be classified as follows:
1. FACTORY/PRODUCTION OVERHEAD: Also known as manufacturing or works
overhead. Factory or works overhead or manufacturing overhead includes cost of indirect
material, indirect wages and indirect expenses incurred on production of goods or
services.
(a) Indirect material- Examples: Coal, oil, grease, etc, Stationery in factory office,
cotton waste, brush, sweeping broom, etc.
(b) Indirect labour- Examples: works manager’s salary, salary of factory office staff,
wages of sweeper, watchmen, etc.
(c) Indirect expenses- Examples: Factory rent, lighting, heating, insurance,
depreciation of plant, repairs of plant, etc.
2. OFFICE AND ADMINISTRATIVE OVERHEAD: The administration overhead is the
indirect expenditure incurred in general administrative function of the organization, i.e., in
formulating policies, planning and controlling the function, directing and motivating the
personnel of the organization in the attainment of its objectives.
This category of overhead can also be, classified into indirect material, indirect labour, and
indirect expenses.
(a) Indirect material- Examples: Stationery and postages used in administrative work.
(b) Indirect labour- Examples: salary of office staff, salary of managing director,
remuneration of director of the company, etc.
(c) Indirect expenses- Examples: Rent of office building, legal expenses, audit fees,
insurance of office, office lighting and power expenses, etc.
3. SELLING AND DISTRIBUTION OVERHEAD: Selling overhead refers to the cost of
creating, promoting and stimulating sales demand and retaining customers of the
organization. It is defined as “the cost of seeking to create and stimulate demand & of securing
15
 COST ACCOUNTING

orders. Distribution cost includes all expenditure incurred on delivery of goods after the
production of product is completed till if reaches its distribution. It is defined as the cost of
sequence of operation which begins with making the packed product available to dispatch
and ends with making the reconditioned returned empty packages, if any, available for reuse.”
Examples are carriage outwards, insurance of goods in transit, upkeep of delivery vans, etc.
Selling and distribution overhead are also grouped into indirect material, indirect labour and
indirect expenses.
(a) Indirect material- Examples: Packing material, stationary used in sales office,
cost of samples, price list, etc.
(b) Indirect labour- Examples: Salary of sales manager, salary of sales office staff,
salary of warehouse staff, wages of packers, salary of delivery van drivers etc.
(c) Indirect expenses- Examples: Advertising, travelling expenses, showroom
expenses, carriage expenses, running expenses of delivery vehicles etc.
CLASSIFICATION OF COSTS: -
The different bases of costs classification are:
(1) As per time (historical, pre-determined).
(2) As per nature of element (material, labour and overhead).
(3) As per degree of traceability to the product (direct, indirect).
(4) As per association with product (product, period).
(5) Changes in activity or volume(fixed, variable, semi variable)
(6) As per function (manufacturing, administration, selling, research and development, pre-
production).
(7) As per relationship with accounting period (capital, revenue).
(8) As per controllability (controllable, non-controllable).
(9) Cost for analytical and decision-making purpose (opportunity, sunk differential, joint,
common, imputed, etc).
(10) Others (conversion, traceable, normal, etc.)
CLASSIFICATION ON THE BASIS OF TIME:
(a) Historical Costs: - It is the cost which is ascertained after they are incurred. Such costs
are available only when the production of a particular thing has already been done.
(b) Pre- determined Costs: - These costs are calculated or determined even before they are
incurred on the basis of a specification of all factors affecting cost. These may be:
(i) Estimated costs: These costs are estimated before goods are produced and
are naturally less accurate than standards.

16
 COST ACCOUNTING

(ii) Standard cost: This is a particular concept and technique of costing. This
method involves:-
(a) Setting of predetermined standards for each element of cost and each
product;
(b) Comparison of actual cost with standard cost.
(c) Determining the causes or reasons of variance and taking remedial
action.

BY NATURE OR ELEMENT:
Already discussed earlier in the chapter.
BY DEGREE OF TRACEABILITY TO THE PRODUCTS:
This cost can be distinguished as direct and indirect cost.
Costs which can be easily traceable to a product or some specific activity are called direct cost
and can be directly charged to the cost centres. Indirect cost is difficult to trace to a single product
and cannot be allocated to a specific job or product but can be apportioned to cost centres or cost
units, e.g. salary of a factory manager.
ASSOCIATION WITH THE PRODUCT:
Cost can be classified as product and period costs:
Product cost: Product costs are those which are traceable to the product and included in
inventory values. In a manufacturing concern, it includes the cost of direct material, direct labor
and factory overheads.
Period cost: Period costs are those cost which tends to be unaffected by changes in the level
of production or activity, during a given period of time. These costs are associated with time, such
as rent, salaries, etc. This cost includes various administrative cost and selling and distribution
cost which are essential for running the business.
BY CHANGES IN ACTIVITY OR VOLUME:Cost can be classified as fixed, variable and semi-
variable cost.
Fixed costs: - CIMA, London, defines fixed cost as “the cost which is incurred for a period, and
which, within certain output and turnover tends to be unaffected by fluctuation in the levels of
activity (output or turnover). Thus, fixed cost remains constant in total regardless of changes in
volume up to a certain level of output. However, the fixed cost per unit is variable.
Variable costs:Variable costs are those cost that vary directly and proportionately with the
change in level of output e.g. direct material, direct labour. It should be kept in mind that the
variable cost per unit is constant but the total cost changes corresponding to the levels of output.
Semi-fixed/ variable costs: - This cost contains an element of fixed and variable costs. As it
includes the variable elements, hence, it fluctuates with change in volume and because of the

17
 COST ACCOUNTING

fixed element; they do not change in direct proportion to output. Semi-variable costs change in
the same direction as that of the output, but not in the same proportion.
Functional classification of costs: - A manufacturing firm performs a number of functions. As
per function the cost may be classified as follows:
(a) Manufacturing/ production costs: - It is the cost of operating the manufacturing
department of the business. It includes the cost of direct materials, direct labour, direct
expenses and factory expenses.
(b) Administration costs: - they are indirect and cover all expenditure incurred in formulating
the policy, directing the organization and controlling the operation of a concern.
(c) Selling and distribution cost: - selling cost is the cost of seeking to create and stimulate
demand. E.g. advertisement, market research, etc. Distribution cost is the expenditure
incurred, which begins with making the package produced available for dispatch and ends
with making the reconditioned packages available for re-use e.g. warehousing, cartage
etc.
(d) Research and development costs: - they include the cost of discovering new ideas,
processes, and products by examination and experimentations and implementing such
results on a commercial basis.
RELATIONSHIP WITH ACCOUNTING PERIOD:On the basis of accounting period, cost can be
classified as capital and revenue expenditure. Capital expenditure are those expenditure which
involves huge capital outlays and provides benefits in future for a longer period of time. These
expenditures are generally incurred on acquiring fixed assets for the business. On the other hand,
revenue expenditure are those expenditures which are incurred on a regular basis and benefits
only for a short period of time.
CONTROLLABILITY:
On the basis of controllability, cost can be classified as controllable and non- controllable.
Controllable cost: According to CIMA, London, controllable costs are “cost which can be
influenced by its budget holders.” Controllable costs are those costs which can be influenced by
managerial persons as per his action. All variable costs are generally considered as controllable.
Non controllable cost: -It is the cost which is not subject to control at any level of managerial
supervision. The cost which cannot be influenced by a person as per his action is treated as non
controllable cost.
COST FOR ANALYTICAL AND DECISION MAKING PROCESS:
(a) Opportunity cost: Opportunity cost is the sacrifice involved in accepting an alternative under
consideration. In other words, it is a cost that measures the benefit that is lost or sacrificed
when the choice of one course of action requires that other alternative course of action be
given up.
(b) Sunk cost: - A sunk cost is the cost which has already been incurred in past and cannot be
changed or avoided by decision taken in the future and over which the management has no
controls.

18
 COST ACCOUNTING

(c) Differential cost: - It is the difference in the total cost between alternatives, which is
ascertained for the purpose of assisting decision making. Differential cost is the increase or
decrease in total costs resulting out of: -
(i) Producing and distributing a few more or few less of products;
(ii) A change in the method of production/distribution.
(iii) An addition or deletion of a product or a territory; and
(iv) The selection of an additional sales channel.
(d) Joint costs: - The joint cost relates to a situation in which the factor of production by
their basic nature, results in two or more products.
(e) Common cost: - Common costs are those costs which are incurred for more than one
product, job, or any specific costing object; they are not easily related with individual
product and hence are generally apportioned.
(f) Uniform costs: These are not distinct cost. Uniform costing signifies common costing
principles and procedure adopted by a number of firms.
(g) Imputed cost: - This is the cost which is not actually incurred but is only considered
while taking decision pertaining to a particular situation. These costs are known as
imputed cost.
Others:
(a) Conversion cost: Conversion cost is the cost of a finished product or work in progress
which mainly comprises of direct labour and manufacturing overhead,
(b) Normal cost: - This is the cost which is normally incurred at a given level of output in
the condition in which that level of output is achieved.
(c) Traceable cost: - This is the cost which can be easily associated with a product, process
or department.
(d) Avoidable cost: - Avoidable costs are those costs which under the present condition
need not have been incurred.
(e) Unavoidable cost: - Unavoidable costs are those costs which under the present
condition must be incurred.
(f) Total cost: - This is the sum of all costs associated to a practically unit, or process, or
department or batch or the entire concern.

Self Check Question: -

1- Distinguish between variable, semi variable and fixed cost.

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 COST ACCOUNTING

2- State the important ways of classification of cost and discuss each of them in detail.
3- “The classification of costs as controllable and non-controllable depends upon a point of
reference” Explain.
4- Enumerate the characteristic of fixed and variable cost.
5- Tabulate the “Element of Cost” showing the usual items of expenditure appertaining to
each?
6- What do you mean by element of cost? Give main classes of cost and explain them with
the help of diagram?
7- What do you understand by element of cost, explain in detail?
8- Explain the following: - (1) Shut down cost (2) Replacement cost (3) Sunk cost
(4) Opportunity cost (5) Imputed costs

UNIT II
LESSON 4

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 COST ACCOUNTING

PURCHASE OF MATERIAL

CONTEXT OF THE LESSON

The lesson deals to familiarize with the procedure of purchase of material in the organizations
and the various methods for pricing of material issue along with maintenance of stock register
which highlights the receipt, issue and carrying inventories.
OBJECTIVES OF THE LESSON
• To discuss the procedure of purchase of material
• To understand the methods of pricing of issued material
Purchasing is the process of acquiring the required raw material, general supplies, spares and
tools, office stationary and other items for the production of the product and maintain the business.
The key to success lies in efficient purchasing of the material of right quantity, right quality, right
time, right place, right source and delivery at the right place. Hence, it is very much essential that
there should prevail an efficient system of purchase within the organization.
PURCHASE PROCEDURE
Purchase procedure may differ from organization to organization. The important steps in
purchasing and receiving of materials may be as follows, assuming that purchases are
centralized:
1. Purchase Requisition:
Purchases of material are initiated through purchase requisitions. A purchase requisition is a
formal request by the head of a department or an authorized person to the purchase manager to
purchase the specific materials. Purchase requisitions may be prepared by the following persons
as per the requirements:
(i) Storekeeper: When materials reach ordering level, the storekeeper should
purchase procedure initiate.
(ii) Production Manager: For some specific material which will be required for the
manufacture of a new product.
(iii) Plant engineer : Material for repair and maintenance
(iv) Department heads: For any material required for his department.
Generally two copies of purchase requisition are prepared. The original copy is sent to the
purchasing department and duplicate copy is retained and filed by the requisitioner for his own
reference.
2. Selection of the supplier: The purchasing department on receipt of the duly authorized
purchase requisition has to select the source of supply. The purchase department generally
maintains a list of supplier for each type of materials and selects a particulars supplier after inviting
quotations. Emphasis is made to buy the best quality of materials at the lowest possible price
after giving due to consideration to delivery dates and other terms and conditions of purchase.
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 COST ACCOUNTING

3. Purchase order and follow- up

After the selection of the supplier the next step in the purchase procedure is the preparation of a
purchase order. The purchase order is the form used by the purchasing department authorizing
the suppliers to supply the specified materials at the price and terms mentioned therein. A
purchase order should be carefully prepared as it forms a basis of legal contract between the
purchaser and the vendor concerned. Authority to sign purchase orders should also be restricted
to selected responsible officials.
4. Receipt of Materials
All the materials supplied by the supplier should be received by the Receiving Department. This
department receives the goods or material and verifies their quantities and physical conditions.
The quantity is checked against the purchase order copy and their supplier’s advice note which
is normally received along with the goods.
5. Inspection and Testing of Materials’
Goods received from the supplier should be inspected for quality to ensure that they comply with
size and other specifications stated on the purchase order. If any goods need laboratory
inspection it is necessary that the goods are passed to a laboratory which will provide a report on
the quality of goods.
6. Return of Rejected Materials
Where materials received are damaged or are not in accordance with specifications, these are
usually returned to the supplier along with a Debit note, informing the supplier that his account
has been debited with the value of material being returned. The supplier signifies his acceptance
by the issue of a credit note. The rejected materials may be returned to the supplier immediately
or they may be held pending his instruction.
7. Passing invoice for payment
When the invoice is received by the purchasing department the invoices are numbered serially
and entered in the invoice Register. The following documents are assembled in support of the
invoice: (a) Purchase Order (b) Goods Received Note (c) inspection Report, if not incorporated in
the goods, Received Note, (d) Debit or Credit Note. After all documentation work is over and
payments are fully authorized by the concerned departments, payments are made to the supplier
and receipt is received in this regard.
Pricing of material of Issue
The price at which material issued are to be charged when they are issued to the various
production department or cost centre for the purpose of production of the product is one of a
difficult problem. There may be certain circumstances when a particular or same type of material
may have been purchased in different lots at different dates at several different prices. At the time
of issue it may even be possible that a same type of material is being issued to the production
department may be priced at different prices on the same day due to the method being adopted
for pricing of issued material. This means that actual cost of material issued to the production
department may include different prices under the same method of pricing the issue of material.

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 COST ACCOUNTING

There are various methods of pricing of issued material which are being used in the various
industrial world. These methods can be broadly classified as follows:

1. Cost Price Method 2. Average Price Method 3. Notional Price Methods

(a) Specified Price (a) Simple Average (a) Simple Average

(b) First-in First-Out (b) Weighted Average (b) Weighted Average
(FIFO)
(c) Last-in First-Out
(c) Periodic Simple Average (c) Periodic Simple Average
(LIFO)
(d) Moving Simple Average
(d) Highest- in- First-Out
(HIFO) (d) Moving Simple Average
(e) Base Stock (e) Moving weighted Average
(e) Moving Weighted Average
(I) Cost Price Methods
(a) Specified Price (identifiable) Method
There are certain occasions when the materials are purchased to be utilized particularly for a
specific job or issues can be identified with a particular receipt. In these cases, the actual purchase
price can be charged. This method can be adopted when prices are stable or when the materials
are covered by price control orders. This method has very limited application.
(b) First-in First-Out(FIFO)
This method is based on the assumption that materials which are purchased first are issued first.
It uses the price of the first lot of materials purchased until all units from this lot have been issued.
In other words the, materials are issued at the oldest cost price listed in the stores ledger account
and thus, the materials in stock are valued at the price latest purchased. It should be noted that
this assumption of FIFO is only used for accounting purpose i.e., the physical flow of materials
need not necessarily be in the order of the flow of cost; though normally materials would be
expected to move out of stock on approximately a FIFO basis because oldest stocks are usually
consumed up first.

Advantages:
(I) It is good inventory management system since the oldest units are used first and inventory
consists of the stock.
(II) It is logical and easy to understand and operate.
(III) It facilitates inter-firm and intra-firm comparisons.
23
 COST ACCOUNTING

(IV) This method provides a realistic cost of finished goods.

Disadvantage:
(I) The cost of production is not related to the current prices.
(II) If prices are increasing, production cost is understated.
(III) It does not present the true picture when many lots are purchased at different prices. The
calculation becomes complicated.
(IV) The pricing of material returns is difficult.
(V) High inflation creates problems in replacing used materials, this aspects is not dealt with in
FIFO.
(VI) Usually more that one price has to be adopted for a particular issue.
(VII) Cost comparisons between two batches of production become difficult when issues are priced
differently.

Illustration: 1 Following data is available with respect to material M1 for the month of July 2008.
Opening stock 300 units @ 26 per unit.

Purchase: Issues:

Date Units Rate Date Units

04/07/2008 700 24 05/07/2008 600

Prepare a stores ledger
09/07/2008 800 22 08/07/2008 200
Account under FIFO
16/07/2008 600 20 15/07/2008 500 method

27/07/2008 800 19 26/07/2008 800

31/07/2008 700
Solution: -
Stores Ledger Accounts
FIFO Method

24
 COST ACCOUNTING

Date Receipts Issue Balance

Qnty Rate Amt. Qnty Rate Amt. Qnty Rate Amt.
1/7/08 - - - - - - 300 26 7,800
4/7/08 700 24 16,800 - - - 300 26 7,800
700 24 16,800

5/7/08 - - - 300 26 7,800

300 24 7,200 400 24 9,600

8/7/08 - - - 200 24 4,800 200 24 4,800

9/7/08 800 22 17,600 - - - 200 24 4,800

800 22 17,600

15/7/08 - - - 200 24 4,800

300 22 6,600 500 22 11,000

16/7/08 600 20 12,000 - - - 500 22 11,000

600 20 12,000

26/7/08 - - - 500 22 11,000

300 20 6,000 300 20 6,000

27/7/08 800 19 15,200 - - - 300 20 6,000

800 19 15,200

31/7/08 - - - 300 20 6,000

400 19 7,600 400 19 7,600
TOTAL 2,900 61,600 2,800 61,800 400 7,600

Illustration: 2 Following particulars are available with respect to the material M4 for the month of
June 2008.Opening stock balance 800 Kgs at Rs. 12 per Kg Stock verifier reported a shortage of
10 kg on 29th June 2008 and surplus of 20 kgs on 25th June 2008.

25
 COST ACCOUNTING

2008 Particular
June

2 Purchase 1000 kgs at Rs. 14

8 Issued 700 kgs to production.
14 Purchase 900 kgs at Rs. 12.
17 Returned 50 kg to vendor purchased on 14/6/2008
21 Issued 1000 kgs to production.
23 Returned from production dept.40 kgs
28 Purchase 500 kgs at Rs. 13.
30 Issued 800 kgs to production.

Prepare a stores ledger accounts under FIFO method and ascertain (i) cost of material issued
during the month & (ii) closing stock on 30/06/2008

Solution: Stores Ledger Accounts

FIFO Method

26
 COST ACCOUNTING

Date Receipts Issue Balance

June08 Qnty Rate Amt. Qnty Rate Amt. Qnty Rate Amt.
1 - - - - - - 800 12 9,600
2 1000 14 14,000 - - - 800 12 9,600
1000 14 14,000
8 - - - 700 12 8,400 100 12 1,200
1000 14 14,000

900 12 10,800 - - - 100 12 1,200

14 1000 14 14,000
900 12 10,800

- - - Return 100 12 1,200

50 1000 14 14,000
17 12 600
850 12 10,200

100 14 1,400
100 12 1,200
850 12 10,200
21 900 14 12,600

140 14 1,960
Return
850 12 10,200
23 40 14 560 - - -

140 14 1,960
Surplus
850 12 10,200
25 20 14 280 - - -
20 14 280

140 14 1,960
- - -
850 12 10,200
28 500 13 6,500 20 14 280
500 13 6,500

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 COST ACCOUNTING

Shortage 14 140 130 14 1,820

29 - - - 10 850 12 10,200
20 14 280
500 13 6,500

130 14 1,820 180 12 2,160

30 - - - 670 12 8,040 20 14 280

500 13 6,500

TOTAL 2,560 32,800 700 8,940

(c)Last-in-First-out (LIFO) Method

The principle adopted in this method is that the material used in production is from the latest
purchase. The inventory is priced at the oldest costs. As the method applies the current cost of
material to the cost of units. It is also known as the replacement cost method. It is the most
significance method in matching cost with revenue in the income determination procedure.

Advantages:
(I) It is simple and commonly used by the industry in practice for reaping the tax benefits.
(II) It is a systematic method. It matches current costs with current revenues in a better ways.
(III) It reveals real income in times of rising prices.\
Disadvantages
(I) In case of high fluctuation in the rates of material, the method becomes complicated
(II) More than one price may have to be taken into consideration for an issue.
(III) Due to variation in cost inter-firm and intra-firm comparison becomes difficult.
(IV) The stocks require to be adjusted during falling prices.

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 COST ACCOUNTING

Illustration: 3 Popline Company uses a raw material called pop for its production purpose. The
details are as below:

July 2008 Particular

1 Opening balance 300 liters @ Rs. 25.00 per liter
3 Purchase 500 liters @ Rs. 26.60 per liter.
4 Issued 220 liters.
10 Issued 440 liters
20 Purchase 490 liters @ Rs. 23.00 per liter.
25 Issued 300 liters
26 Surplus of 20 liters returned to stores out of issue on July
4th

Prepare a stores ledger Accounts under LIFO method

Solution: Stores Ledger Accounts (LIFO Method)
Date Receipts Issue Balance
July08 Qnty Rate Amt. Qnty Rate Amt. Qnty Rate Amt.
1 - - - - - - 300 25 7,500
3 500 26.6 13,300 - - - 300 25 7,500
500 26.6 13,300
4 - - - 220 26.6 5,852 300 25 7,500
280 26.6 7,448

10 - - - 280 26.6 7,448

160 25 4,000 140 25 3,500

20 490 23 11,270 - - - 140 25 3,500

490 23 11,270

25 - - - 300 23 6,900 140 25 3,500

190 23 4,370

26 20 26.6 532 - - - 140 25 3,500

190 23 4,370
20 26.6 532

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 COST ACCOUNTING

(d) Highest-in-first-out
In this method the costliest material is issued first, inventory is valued at the lowest possible price.
It is mainly used for monopoly products or cost plus contacts.

(f) Base stock method

March 2008 Particular

1 Opening balance 1100 units @ Rs. 60.00 per unit
3 Issued 140 units
4 Issued 250 units
8 Issued 210 units
13 Received from vendor 400 units at Rs.59 per unit
14 Refund of surplus from a work order 30 units at Rs. 58 per unit.
16 Issued 350 units
20 Received from vendor 480 units at Rs.62 per unit
24 Issued 608 units
25 Received from vendor 640 units at Rs.60 per unit

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 COST ACCOUNTING

26 Issued 524 units

28 Refund of surplus from a work order 24 units issued on 3rd March 2008
31 Received from vendor 150 units at Rs.64 per unit
In base stock method a certain level of minimum stock of a material is always carried and it is
priced at the original cost (usually at the lowest purchase price). The portion of the stock above
this level is issued and priced under any one of the methods. The disadvantage of this method is
that the stock may be under valued and hence the computation of return on capital will not be
reliable.

II Average Price Methods

(a)Simple Average Method
The simple average is the average of prices ignoring the quantities involved. This
method is used when the prices are normally stable and the stock purchased are in equal
quantities or the value of stock is very small. It is ascertained by dividing the total rates of material
by the number of rates of material. A new average is worked out after every receipt.

Illustration: 4 The following were the receipts and issue of material ‘Zed’ during March 2008

From the above, write the store ledger account on Simple Average Method.

Solution: -
Stores Ledger Accounts

Date Receipts Issue Balance

March Qnty Rate Amt. Qnty Rate Amt. Qnty Rate Amt.

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 COST ACCOUNTING

1 - - - - - - 1100 - 66,000
3 - - - 140 60 8,400 960 - 57,600
4 - - - 250 60 15,000 710 - 42,600
8 - - - 210* 60 12,600 500 - 30,000
13 400 59 23,600 - - - 900 - 53,600
14 30 58 1,740 - - - 930 - 55,340
16 - - - 350** 59 20,650 580 - 34,690
20 480 62 29,760 - - - 1,060 - 64,450
24 - - - 608*** 59.75 36,328 452 - 28,122
25 640 60 38,400 - - - 1092 - 66,522
26 - - - 524**** 61 31,964 568 - 34,558
28 24 60 1,440 - - - 592 - 35,998
31 150 64 9,600 - - - 742 - 45,598
(Simple Average Method)

* = All issue on 3rd, 4th, and 8th are on Rs. 60 ** 60+59+58/4 = 59

*** = 60+59+58+62/ 4 = 59.75 **** = 62+60/ 2 = 61

(B)Weighted Average Method

For determining the weighted average price the total quantities and total costs are taken into
account. After every purchase weighted average price is calculated by adding the quantity
received to the stock in hand and the cost is divided by the quantity to arrive at the value. This
method avoids price fluctuations and reduces the number of calculation and gives an acceptable
figure for stock.
Advantages
(I) It is logical and consistent.
(II) Changes in prices do not affect issues and inventory.
(III) The values reflect actual costs.
Disadvantage
(I) It involves considerable amount of clerical work.
(II) When prices change frequently, it is Unconventional and complex.
(III) As it is not the actual price, it is not realistic.
Illustration: 5 The following purchase has been extended in respect of material “Exe”. Prepare
store ledger account under “Weighted average method” of pricing material issue:
Receipts - Issues:

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 COST ACCOUNTING

Oct. Particular Oct. Particular

3 Purchased 500 units at Rs. 4 5 Issued 400 units
4 Purchased 100 units at Rs. 4.20 10 Issued 50 units
10 Purchased 50 units at Rs. 4.25
15 Issued 900 units
13 Purchased 800 units at Rs. 4.30 Solution:
25 Issued 450 units
23 Purchased 850 units at Rs. 3.80 Stores
Ledger
Accounts
(Weighted Average Method)
Date Receipts Issue Balance
Oct. Qnty Rate Amt. Qnty Rate Amt. Qnty Rate Amt.
3 500 4 2,000 - - - 500 4 2,000
4 100 4.20 420 - - - 600 4.033 2,420
5 - - - 400 4.033 1,613 200 4.035 807
10 50 4.25 212.5 - - - 250 4.078 1,019.5
10 - - - 50 4.078 203.9 200 4.078 815.6
13 800 4.30 3,440 - - - 1,000 4.256 4,255.6
15 - - - 900 4.256 3,830 100 4.256 425.6
23 850 3.80 3.230 - - - 950 3.848 3,655.6
25 - - - 450 3.848 1731.6 500 3.848 1,924

Closing inventory 450 units @ 3.815, Rs. 1,732.80

Cost of material consumed, 1800 units valued a Rs. 7,379.70

III Notional Price Methods

(a) Standard Price Method
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 COST ACCOUNTING

The price of issue for each item is pre-determined for a stated period taking into accounts all the
factors affecting price, e.g., market trends, transportation cost, etc. Standard prices are
determined for each material. All issues and inventory are kept at the standard price. This price
should be revised from period to period. Standard can be basic or current standard. The basic
standard is fixed for long periods and gives the ideal price, it assists forward planning. Current
standard keeps costs of the product adjusted to prevailing trends in markets. Basic standard on
the other hand to study trends in production cost over a period.
Advantages:
(I) It simplifies accounting as only quantities are recorded.
(II) As only one rate is adopted, inconsistency is avoided.
(III) It helps to determine purchase efficiency If actual cost is more than the standard than there
is unfavorable purchasing efficiency and vice-versa.
(IV) It is simple to operate.
(V) It provides stability to the costing system.
Disadvantage
(I) It does not reflect the actual or expected cost but only a target.
(b)Inflated Price Method.
In this method the cost of the material to be issued is inflated by the cost of lost of material. Inflated
price includes carrying costs, losses due to evaporation etc. it aims to recover full costs of material
purchase.
(c) Replacement Price Method: Material may be issued at the replacement price. The
replacement price is the cost of the same type of materials in the market at any given time.
SELF CHECK QUESTIONS
THEORETICAL QUESTIONS
1. Discuss the different methods of pricing the materials issued from stores for production.
2. Discuss the merits & demerits of the following methods of valuation of inventories of issued
material.
o FIFO method
o Weighted Average
o Replacement price
3. Explain with examples the following methods of pricing of issue material:
o FIFO method
o LIFO method
Under condition of rising prices which of these methods of pricing issues of material is suitable.

Question 1
Prepare a store ledger account from the following transaction adopting the FIFO.

34
 COST ACCOUNTING

Receipts Issues
Date Qty. Rate Date Issue
Dec. Dec. 4 100
3 200 20.00 10 50
18 300 18.00 20 300
28 50 15.00 30 100

Question 2
From the following particulars prepare “Stores Ledger Account” showing issue of material for the
month of December under FIFO method

Receipts Issues
Date Qty. Rate Date Issue

Aug. Aug.
3 750 2.00 19 850
18 350 2.10 26 450
25 600 2.20 29 510
28 500 2.30 30 150

Question 3
With the help of the following particulars, prepare stores Account showing issue of materials on
the basis of LIFO:

March 2008 Particular

1 Opening balance 200 units @ Rs. 2.00 per unit
2 Purchased 600 units @ Rs. 3.00 per unit
6 Issued to production 600 units
12 Purchased 400 units @ Rs. 3.40 per unit
22 Issued 300 units
26 Purchased 500 units @ Rs. 3.50 per unit
30 Issued 200 units
Question 4

35
 COST ACCOUNTING

From the following information, write the stores ledger account based on Simple Average method
of pricing issue:

Receipts Issues
Date Particular Qty Rate per unit Date Issue
May May
12 Purchase material 400 59.00 3 140
14 Refund of surplus 30 58.00 4 250
20 Purchased 480 62.00 8 210
25 Purchased 640 60.00 16 350
28 Refund of surplus(issue 24 608
on 3rd may) 26
24 524
Received from supplier
31 150

Opening stock on 1stMay 2008, 1,100 units @ Rs. 60 per unit.

Question 5
From the following particulars, prepare stores ledger for the month of Jan. 2008, showing material
issue process on the Weighted Average Price Method:

Receipts Issues
Date Qty. Rate Date Issue
Jan. Jan.
1 500 2.00 1 400
10 200 3.00 15 100
18 400 4.00 22 200
27 300 5.00 31 300
29 Return 10 unit issue on 15th Jan.

2 ton loss was revealed on Jan.28 during stock verification.

Question 6
From the following information prepare Store ledger Account showing issue of material on LIFO
method:
36
 COST ACCOUNTING

October 1 Balance 500 units @ Re, 1.00 per unit.

October 10 Ordered 250 units.
October 18 Issued 125 units.
October 21 Received 150 units @ Rs. 1.10 per unit.
October 25 Ordered 200 units.
November 1 Issued 175 units.
November 10 Received 200 units @1.20 each.
November 20 5 units defective, returned: they were purchased on 21st Oct.
December 1 Received 100 units @ Rs.1.10 each.
December 15 Issued 100 units
December 20 Returned to store 25 units, issued on 15th December.
December 30 Issued 125 units.

Lesson 5
METHODS OF REMUNERATION OF LABOUR
CONTEXT OF THE LESSON

37
 COST ACCOUNTING

This lesson deals with various types of labour cost and various method adopted for payment of
remuneration.
OBJECTIVES OF THE LESSON-
• Classification of labour cost
• Methods of remuneration on various bases.
INTRODUCTION
Labour is considered as one of the important factor of production in an industrial organization. It
is the employment of labour which help to convert the raw material into finished products and
services. Labour is the only factor which can give almost unlimited productivity-its output can be
increased whereas the output from other factors is limited by their physical limitations. However,
labour is complex and delicate hence it should be handled very carefully and efficiently and should
be remunerated properly.
LABOUR COST
In the narrow sense, the term labour cost encompasses only wages paid to the workers but it
represents the various payment made to a worker arising out of his employment in the orgnisation.
The total labour cost can be classified as follows:
(a) Direct labour costs;
(b) Indirect labour cost.

DIRECT LABOUR COST

It refers to all expenses which are incurred on labour in altering the construction composition,
confirmation or condition of the product. The wages paid to skilled and unskilled workers for his
labour can be allocated specifically to the particular product or the process as the case may be.
In any manufacturing process or department, the workers employed may be of the following two
categories.
(i) Those who are directly engaged on the production or in the carrying out of an
operation or process.
(ii) Those who are assisting in the process by way of supervision, maintenance,
transportation of material, etc.
The workers who are directly engaged in the production or carrying out the operation process
constitute as direct labour and the wages paid to them are termed as direct wages. Direct labour
cost is that part of wages and salaries which can be identified with and charged to a single costing
unit. It is the cost which can be easily identified and has a direct relationship with the product or
process of operation.
INDIRECT LABOUR COST: - It refers to all expenses that are incurred on labour but that does
not alter the construction, confirmation, composition or condition of the product, but which
contributes or assist generally to such work and help in the completion of the product and handling
38
 COST ACCOUNTING

up to the point of dispatch. In other words, Labour employed for the purpose of carrying out tasks
incidental or ancillary to goods produced or services provided is regarded as indirect labour.
Wages or salaries paid to foreman, supervisors, inspectors, clerks, etc, are the example of indirect
labour.
Need for distinguishing between direct and indirect labour cost: The distinction has to be made:
(a) For calculating appropriate labour cost and thus provide a basis for strict control;
(b) For facilitating calculation of labour efficiency.;
(c) For proper allocation of overheads;
(d) For introduction of incentive schemes;
(e) For inter-unit comparison; and
(f) For estimating total labour cost.
METHODS OF REMUNERATION
Time rate system:
Time rate or day rate is related to the hours of wage and is commonly used. The wage rate can
be fixed on hourly, daily, weekly, monthly basis depending on the nature of his skill. In this method
the worker is remunerated for the time which he has devoted or spent within the factory premises
irrespective of the work he has done.
This method can be applied where:
(a) Quality of work is of greater significance;
(b) Output of a worker cannot be measured;
(c) Output of a worker is beyond his control;
(d) The work can be closely supervised;
ADVANTAGES
The advantages of this system are:
(a) Easy to understand and simple to calculate;
(b) Widely accepted by trade unions as all workers are paid alike;
(c) Less clerical expenditure is involved;
(d) A steady income is guaranteed
(e) Employees are in no hurry in completing the job as a result, tools and material are handled
carefully and wastages are minimized.
DISADVATAGES
(a) It does not motivate or encourage workers to take initiative;
(b) Labour cost may increase thereby decreasing profit. This may be caused by decrease in
productivity;
39
 COST ACCOUNTING

(c) Standard for labour are difficult to set;

(d) Productivity may decrease thereby disturbing the production schedules, creates
production bottlenecks and increase cost per units;
(e) Idle time may increase and even lead to inefficiency;
This system can be further classified as:
(a) High Wage Plan: - A higher wage rate can be fixed as compared to the wage rate
prevailing in the area. This is generally applied to attract efficient workers in order to increase
the production. In order to enable the workers to achieve the standard, suitable working
environment and conditions are provided. This method is also beneficial to employer as it lead
to reduction in overheads.
The advantages of this methods are:
(a) It is simple and economical
(b) Encourages and attract skilled workers for the job
(c) Leads to increase in production
(d) Decrease wages and overhead cost per unit.
(b) Different time rates: - This method is applied were workers have various levels of
efficiency and as such different rates are fixed. For the workers whose efficiency is up to
the standard level, to them normal wages are paid and for workers having efficiency
beyond the standard level, the rate is gradually increased.
(c) Measured day work (Graduated):- In this method the hourly rates are divided into two
parts. A certain part of the hourly rate is fixed which generally depends upon the nature of
the job and the other part is variable depending on the merit rating and cost of living.
From the above discussion it is clear that this system is very complicated and the
calculation involved in this process also increases when the workers change jobs on
frequently basis. Merit rating may be arbitrary. There is multiplicity of rates. It is difficult for
the workers to easily understand the system.
(d) Payment by results
It is a method of remunerating the workers which in payment mainly depends on the output
or units produced by the workers. The workers have an opportunity to earn and increase
his income by producing more units.
Piece Rate Method
In this method, the workers are paid on the basis of the quantity produced or output achieved by
each worker. It is a very simple and commonly used method of wage payment. The worker is paid
on the basis of output produced irrespective of the time taken for production.
The total wages to be paid to the worker is determined on the basis of the following formula:
Wage = Number of units produced during the period X Rate per unit.

40
 COST ACCOUNTING

The piece rate method is more suitable in the following cases:-

(a) The work is of repetitive nature and is standardised;
(b) Piece rate can easily be determined;
(c) There is uninterrupted flow of work;
The piece rate can be fixed by determining the time required to complete the piece of work on the
basis past experience or estimation or time and motion study. In case the job is carried out for the
first time or it is a new job then few trial runs can be taken into consideration for fixation of piece
rates.

Merits: -
(a) A worker expertise himself by continuously doing the same work on a regular basis.
(b) It leads to increase the efficiency of the worker which leads to earn more income;
(c) It reduces costs;
(d) Idle time is automatically controlled;
(e) The reward is related to effort. Efficiency is recognized;
(f) Less supervision is required.
(g) Workers discover new techniques of producing goods which leads to increase in
production.
Demerits: -
(a) Quality is effected in order to increase production.
(b) Wastages of material may increase if not properly supervised.
(c) More supervision and inspection is required so that units produced achieve the standard
quality.
(d) Improper use as machine and tools in order to maximize output by the workers.
(e) If work stops due to machine break down, power failure etc. the workers may feel insecure.
(f) In order to earn more the workers may highly stress themselves which may affect their
health adversely.
(g) This method is not preferred by inefficient and less efficient workers as there is no
guaranteed wages for the period.
(h) It is not easy to determine the piece rate.
Piece Rate with Guaranteed Time Rate: -
A certain standard level of output is determined. Workers are paid on the basis of output. If the
output is less than the standard, the worker is paid on time rate basis.

41
 COST ACCOUNTING

Thus, this system incorporates the merits of the time rate and piece rate system and eliminates
any misunderstanding may arise.
Incentive scheme: -
Both time rate and piece rate system have their certain merits and demerits. Incentives system
attempts to combine the good aspects of both systems. The main objective of incentive plan is to
induce a worker to produce more and to earn a higher wage. Producing more in the same period
of time should result in higher pay.
Classification of Incentive Scheme
Incentive scheme can be classified as follows:
(a) Differential piece rate
(b) Premium bonus rate
(c) Group bonus rate
(d) Bonus schemes for indirect workers.
(a) Differential Piece Rate
Efficient and inefficient workers are distinguished. More than one piece rate is determined.
Standard are set for each operation or job. Efficient workers, i.e.; those who attain or better the
standard set are given a higher rate and inefficient one are given a lower rate. Hence, there is
encouragement to improve the performance. As the level of output increases the piece rate also
increases. This ratio may be proportionate or proportionately less or more than the increase in
output, hence output is maximized.
This system is suitable where:
(a) The method of working are standardized;
(b) The workers do the same job over a long period;
(c) The nature of work is repetitive;
(d) Output of each person can be measured;
(e) The standard time for each job can be determined with precision.
Taylor’s Differential Piece Rate System
This system was introduced by· F.W. Taylor, the father of Scientific Management. The main
features of this incentive plan are as follows:
(a) Day wages are not guaranteed, i.e. it does not assure any minimum amount of wages to
workers.
(b) A standard time for each job is set very carefully after time and motion studies.
(c) Two piece rates are set for each job-the lower rate and the higher rate. The lower piece rate
is payable where a worker takes a longer time than the standard time to complete the work. Higher
rate is payable when a worker completes the work within the standard time. In other-words, lower

42
 COST ACCOUNTING

piece rate is payable to inefficient workers and higher piece rate is payable to efficient workers.
Usually these rates are 83% of the piece work rate for inefficient workers and 175%, of the piece
work rate for efficient workers.
Illustration:1
Standard production = 8 units per hours
Working hours per day = 8 hours
Lower rate = Rs. 5 per unit
Higher rate = Rs. 8.75 per unit
Worker X produces = 7 units.
Worker Y produces = 9 units
Wages of worker X and Y under Taylor’s plan will be as follows.
Worker X — He has produced 7 units which is below standard. He will, therefore, be paid at the
lower rate of Rs. 5 per unit. His wages will be·7 units @ Rs. 5 = Rs. 35 .
Worker Y - He has produced 9 units which is above standard. He will, therefore, be paid at the
higher rate. His: wages will be 9 unit Rs. 8.75 = Rs. 78.75. It will be seen that there is a great
difference between the wages of an efficient and an inefficient worker.
Merrick’s Differential Piece RateSystem(Multiple Piece Rate System)
This is a modification of Taylor’s plan. While Taylor prescribed two rates, Merrick’s plan lays down
three rates. The lowest rate is for the beginners, the middle rate is for the developing workers and
the highest rate is for the highly efficient workers. Efficiency of the workers is determined in terms
of percentages. Thus, the rates of remuneration are:
Level of efficiency Piece rate Piece rate
Upto 83% Ordinary piece rate
83% to 100% 110% of ordinary piece rate
Above 100% 120% of ordinary piece rate

Like Taylor’s plan, this method also does not guarantee minimum wages. The general criticism
leveled against Tay1or’s plan also applies to it except that it lessens the punitive character of
Taylor’s plan.
Illustration:2
Standard output = 150 units per day of 8 hours.
Piece rate = Re. 0.20 per unit.
Output of A 100 units, B 135 units and C 180 units.
Calculate the earnings of A, B and C workers under Merrick’s Differential Piece Rate System.

43
 COST ACCOUNTING

Solution-
Actual output
Efficiency in % = × 100
Standard output

100 2
Rates applicable:𝐴 = 150 × 100 = 66 3 %

135
𝐵= × 100 = 90%
150
180
𝐶= × 100 = 120%
150
A = Re. 0.20 per unit. (normal rate)
B = Re. 0.20 × 110% = Re. 0.22
C = Re. 0.20 ×120% = 0.24
Earnings:
A = 100 units × Re. 0.20 = Rs. 20.00
B = 135 units × Re. 0.22 = Rs. 29.70
C = 180 units × Re. 0.24 = Rs. 43.20
Illustration:3
Three workers-X ,Y and Z-work in a factory. The following particulars apply to them-
Normal rate per hour Rs. 0.40
Piece rate Rs. 0.30 per unit
Standard 2 units per hour
In a 40 hour week, the production of the worker is as follows:
X 50 units
Y 80 units
Z 120 units
Calculate the earnings of the workers under (a) Taylor differential piece rate system,(b) Merrick
differential piece rate system, Also show cost per unit under these methods.
Notes:
(a) The two rates under Taylor’s system have been found as follows:
Low piece rate = 83% of 30 paise = 25 P.(approx.)
High piece rate = 175% of 30 paise = Rs. 0.525
Solution:

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 COST ACCOUNTING

Workers Output Efficiency Taylor system Taylor system Merrick system Merrick system
Earnings Cost per unit Earnings Cost per unit
X 50 62.5 12.5 0.25 15 0.3
Y 80 100 42 0.525 26.4 0.33
Z 120 150 63 0.525 43.2 0.36

(c) PREMIUM BONUS PLANS

All the gains of efficient workers and all the losses of inefficient workers benefit the employer
under the time rate system. Under the piece rate system, it is the workers who gain or lose.
Under the premium bonus system, the gains are shared by the employer and employees in agreed
proportions. Apart from the minimum guaranteed wages, the efficient workers get bonus which
depends on the time saved. The standard is determined scientifically. The various incentive
schemes should be chosen keeping in mind the nature of the work, with the consent of trade
unions in order to make it successful.
These plans regulate the speed of work so that the pace of work is not slow and at the same time
it is not fast.
Basically, there are two types of plans. Under the constant sharing plans, the proportion of sharing
is constant at all levels of efficiency, but under variable sharing plans, it varies with the time saved.
Emerson’s Efficiency Plan
Though minimum daily wages is guaranteed, efficiency is also rewarded. Standard is set based
on the time and motion study.
Bonus is payable when efficiency reaches 66-2\3% and increases as the output increases.
Levels of Efficiency Piece Rate
66-2\3 Guaranteed time rate
90% Time rate +10% as bonus
100% Time rate +20% as bonus
Above 100% Time rate+20% as bonus +
additional bonus of 1% for
every increase of % beyond 100% efficiency
The bonus is usually calculated on the efficiency achieved for all the jobs in a wage period taken
together.

Efficiency % =Standard time for all jobs done in a period×100

Time taken for doing all jobs in a period

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 COST ACCOUNTING

Slow work is avoided and work is done at a uniform rate.

But under this scheme, the incentive for efficiency beyond the standard is not appreciable.

Illustration:4
Standard output in 8 hours = 60 units
Actual output in 8 hours. = 72 units
Time rate = Rs. 2 per hour
Calculate earnings under Emerson`s plan.
Solution
Efficiency in % = 72/60* 100 = 120%
Bonus % = 20% + 20%
= 40%
Time wages 8 hours @ Re. 2 = Rs. l6.00
Add; Bonus 40% of Rs. l6 = Rs. 6.40
Total earnings Rs. 22.40
In this Illustration, if the actual output of worker is up to 40 units, i.e. 662/3% efficiency, he will
not get any bonus and his wages will be simply time wages i.e., 8 hours X Rs. 2 = Rs. 16. The
worker will start earning bonus if his output in 8 hours is above 40 units. lf he produces 60 units
i.e. when his efficiency is 100%, his total earnings will be:
Total earnings = Time wages + Bonus
= (8 hrs. >< Rs. 2) + 20%
= 16 + 3.20 = Rs. 19.20
Advantages
1. It guarantees minimum time wages.
2. It is easy to understand and simple to operate.
3. It provides an incentive to beginners and even to those who are less proficient.

Disadvantages
The incentive offered is considered to be inadequate to motivate efficient and ambitious orkers.
1.Halsey Premium Plan
This plan was introduced by F A Halsey in 1891. It is a simple combination of time and piece rate
systems. The main features of this plan are as follows:

46
 COST ACCOUNTING

(a) Workers are paid at a rate per hour for the actual time taken by them.
(b) A standard time is set for each piece of work, job or operation.
(c) If a worker takes standard time or more than the standard time to complete his work, he is
paid wages for the actual time taken by him at the time rate. In other words, time wages are
guaranteed.
(d) If a worker takes less than the standard time, he is paid a bonus equal to 50% of the time
saved at the time rate fixed. Thus, under this system, total earnings of a worker are equal to
wages for the actual time taken by him plus a bonus.

The formula for calculating bonus and total earnings is as follows:

Bonus = 50% of [Time saved ×Time rate]
Total earnings = Time rate × Time taken + 50% of [Time saved × Time rate]

Illustration:5
Standard time (or Allowed time) = 50 hours. ,
Wage rate per hour = Rs. 3
Actual time taken = 42 hours ·
Thus time saved = 50 hours - 42 hrs. = 8 hrs.
Earnings = Rs. 3 × 42 hours + 50% of (8 hrs. × Rs. 3)
= Rs. 126 +12 = Rs. 138
Advantages of Halsey Plan
l. It is easy to understand.
2. lt guarantees a minimum time wages to all the workers. Thus, slow and relatively inefficient
workers have nothing to fear from it.
3. The benefit resulting from saving in time is equally divided between worker and employer.
4. Bonus is separately calculated for each job. Time saved by a worker on one job is not
adjusted against excess time taken by him on another job.
Disadvantages of Halsey Plan
l. Workers do not like the employer to share the benefit of time saved by them.
2. It does not provide the employer with full protection against high rate setting.
3. Extra efficiency of a worker is not fully rewarded.
Halsey Weir Plan
The bonus under this plan is 33.1\3% of the standard time saved.

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 COST ACCOUNTING

Total wages =Time taken * Hourly rate + 33.1\3%(Time saved)*Hourly rate

Rowan Plan
This plan is also similar to Halsey Plan except in the calculation of bonus. The main features of
Rowan Plan are as follows:
(a) Wages are paid on time basis for the actual time worked by the workers.
(b) A standard time is determined for each piece of work or job.
(c) If a worker completes his work in standard time or in more than standard time, he is paid
wages for the time actually taken by him
(d) If a worker completes his work in less than the standard time he is entitled to a bonus.
(e) Bonus is that proportion of wages of actual time taken which the time saved bears to the
standard time. Its formula is:
Bonus = Time saved / Time allowed × Time taken × Time rate
Earnings = (Time taken × Time rate) + Bonus.

Illustration: 6
Standard time = 50 hours
Wage rate per hour = Rs. 3
Actual time taken = 42 hours.
Calculate earnings and bonus under Rowan Plan.
Time Saved = 50 hours - 42 hours = 8 hrs.
Bonus = 8÷50 × 42 hours × Rs, 3 = Rs. 20.l6
Earnings = (Time taken × Time rate) + Bonusi
= (42 hrs. × Rs. 3)+ Rs. 20.l6
= Rs. 146.16

Advantages of Rowan Plan

l. Like Halsey plan, it provides guaranteed minimum wages to workers.
2. It protects the employers against loose rate setting
3. lt pays a higher bonus than that under the Halsey plan up to 50% of the standard time saved.
4. The worker is not induced to rush through the work because if the time saved is more than 50%
of the standard time, the bonus increases at a decreasing rate.

48
 COST ACCOUNTING

5. lt provides good incentive for comparatively slow workers and beginners.

Comparison of Halsey and Rowan Plan
If the worker finishes the work in half the time fixed for it, the result under Rowen and Halsey plan
will be same. If the time saved is less than 50% of the standard time, the Rowan plan is better. If
time saved is greater than 50% of the standard time, the Halsey plan is better.
Bedauxe Point System
Under the scheme originated by C.E.Bedauxe, time wages is guaranteed. Earnings increase after
the worker attains 100% efficiency level. Standard time and standard work is measured in terms
of Bedauxe points, which are also known as B’s.
‘B’ means a standard work performance in a standard minute. In other words, one ‘B’ unit
represents the amount of work which an average worker can do under normal conditions in one
minute allowing for the relaxation needed. Workers get a bonus which is equal to 75% of B’s
saved.
Bonus = B’s saved ×Hourly rate ×75÷60×100
Thus, if a person gets 90 B’s and hourly rate is Rs.1.20, then his bonus will be:
B’s saved =90-60 =30 B’s
Bonus =30 ×1.20 × 75÷60×100 = 45 paise
If bonus is given to the extent of the value of the entire time saved, then the scheme
will be called the 100% Bedauxe Scheme. But if nothing is mentioned, it is assured that it is 75%
Bedauxe Scheme.
Under 75% Bedauxe Scheme, the labour cost increases till 100% efficiency and then starts
declining.
Hayne’s Scheme
Time wages are guaranteed. The standard time is set in terms of standard man minutes called
‘manits’. A manit means a standard work performed in a standard minute. Bonus is given for the
time saved. The value of the time saved is shared by the worker and foreman in the ratio of 5:1 if
the worker is standardized and repetitive in nature, otherwise, the ratio of sharing between worker,
employer and supervisor will be 5:4:1.
The labour cost falls until 100% efficiency is reached. Thereafter, it falls at a decreasing rate if
work is non-standardised or remains constant if the work is standardised.
Misc. Illustrations
Illustration: 7
From the following information, calculate the bonus and earnings under Emerson Efficiency
Bonus Plan:
Standard output in 12 hours 48
Actual output in 12 hours 42

49
 COST ACCOUNTING

Time rate Rs.0.75 per hour

If the actual output is 60 units, what will be amount of bonus earnings.

Solution:
Under Emerson Efficiency Bonus Plan earnings will be calculated as follows:
E =T X R + P (T×R)
P (bonus percentage) will vary as follows:
Efficiency Bonus
(i)Below 66 - ⅔% efficiency Time wages. No bonus
(ii)66 - ⅔% to 100% efficiency A bonus increasing 0.01%to20%
above basic wages on 100% efficiency
(iii) Over 100% A bonus of 20% above basic wages
plus 1% for each 1% increase in efficiency
Efficiency in terms of output
𝑎𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
× 100
𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑜𝑢𝑡𝑝𝑢𝑡
42
× 100 = 87.5%
48

Bonus percentage of 87% efficiency is 7.56 and at 88% efficiency is 8.32,given in Emerson
Bonus Percentage Table. Thus at 87.5% efficiency we can take bonus percentage as
7.94(average of 7.56 and 8.32%).Bonus will, therefore, be

7.94
× 12 × 0.75 = 𝑅𝑠. 0.71
100

Earnings
7.94
12 × 0.75 + ( × 12 × 0.75)
100

= 9+0.71 = Rs.9.71

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 COST ACCOUNTING

(c) If the actual output in 12 hours is 60 units, efficiency will be:

60
× 100 = 125%
48

Bonus percentage = 20% + (125 − 100) × 1%

= 20 +25 = 45%
Bonus
45
( × 12 × 0.75)
100

45
Earnings 12 × 0.75 + (100 × 12 × 0.75)

=9 + 4.05 =Rs.13.05
Illustration : 8
In a factory guaranteed wages at the rate of Rs.1.80per hour are paid in a 48 –hour week. By
time and motion study it is estimated that to manufacture one unit of a particular product 20
minutes are taken. The time allowed is increased by 25%.During one week Abraham produced
180 units of the product. Calculate his wages under each of the following methods (a) Time
rate,(b) Piece rate with a guaranteed weekly wage,(c)Halsey Premium bonus and (d) Rowan
Premium Plan
Solution:
(a) Time rate:
E = T×R
= 48 ×1.80 =Rs.86.40

(b) Piece rate:

E = N ×R, where N means number of units produced
and R means rate per unit
= 180 × 0.75= Rs.135
Rate per unit will be found as follows:
Time taken 20 minutes

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 COST ACCOUNTING

Incentive allowance 25% 5 minutes

Standard time to manufacture one unit 25 minutes
Rate per minute =Rs. 1.80/60 =Rs.0.03
Rate per unit = Rs.0.03 × 25 = Rs.0.75

(c) Halsey Premium Bonus Plan:

E = T×R +1\2 (S-T) ×R
= 48 ×1.80 + 1\2 (75-48) ×1.80
= 86.40 + 24.30 =Rs.110.70
Standard Time:
One unit takes 25 minutes
180 units should take 180 × 25 = 4,500 minutes
Or 4500/60 =75 hours
(d) Rowen Premium Bonus Plan:
E =T ×R + (S-T)S×T × R

=48 × Rs.1.80 + 27 75×48×Rs.1.80

=Rs.86.40 + Rs.31.10 =Rs.117.50

SELF CHECK QUESTIONS

1. What is meant by an ‘incentive plan’ in the remuneration of labour? Also explain their
plans in brief.
2. Discuss the principles methods of wage payments.
3. What are the main incentives wage payment system methods? Explain three in brief.

Practical Questions
Q.1 From the following particulars calculate the earnings of a worker under Rowen Premium
Bonus System and Halsey Premium Bonus System:
Hourly rate of wages(guaranteed) Rs.0.75
Standard time for producing one dozen articles 3 Hours
Actual time taken by the worker to produce 20 dozen articles 48 Hours
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 COST ACCOUNTING

Ans. Rowen Rs.43.20;Halsey Rs.40.50.

Q.2 What earnings will workmen receive under Halsey Plan and Rowen Plan if he executes a
piece of work in 60 hours as against 75 hours allowed? His hourly rate is Rs.2 and he is paid
50% of the time saved under Halsey Plan. He gets a dearness allowance of Rs.8 per day of 8
hours worked in addition to his wages.
Ans. Under Halsey Plan Rs.195; Under Rowen Plan Rs.204

Q.3 Calculate the earnings under (a) Time rate (b)Piece rate (c)Halsey and (d)Rowen methods,
from the following information:
Standard time 40 hours Time taken 30 hours
Wages are paid at Rs.1 per hour and a dearness allowance is paid at 50 paise per hour worked.
Ans.(a)Rs.45;(b)Rs.55;(c)Rs.50;(d)Rs.52.50

Q.4 A workmen takes 9 hours to complete a job on daily wages and 6 hours on a scheme of
payment by result. His day rate is Rs.1.50 per hour. The material cost of the product is Rs.24
and the work overhead is recovered @ 150% of the total direct wage. Calculate the factory cost
of the product (a) the piece -work plan, (b) the Halsey plan and (c) the Rowen plan.
Ans. Factory cost-(a) Rs.46.50; (b) Rs.52.125 and (c) Rs.54.00

LESSON 6
ALLOCATION, APPORTIONMENT AND ABSORPTION OF OVERHEADS

CONTEXT OF THE LESSON

This lesson deals with the treatment of indirect costs also known as overheads. In order to
determine the total cost of the product the overheads are to be allocated to the various

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 COST ACCOUNTING

departments on some suitable basis. The process and various methods for distribution of
overheads to the various products have been explained in this lesson.
OBJECTIVES OF THE LESSON
• To understand the various types of overheads
• To deal with various methods of distribution of overheads
• To deal with various methods of Absorption of overheads

INTRODUCTION

In Cost Accounting, for the purpose of determination of cost and its control, the analysis and
collection of overheads, their allocation and apportionment to different cost centres and
absorption to products or services plays an important role. An effective system of distribution of
overheads can lead for accuracy in determination of cost of products and services. It is therefore,
necessary to ensure that a standard practices for allocation, apportionment and absorption of
overheads should be followed within the organization for preparation of cost statements.
DEFINITION:
OVERHEADS
Overheads comprise of cost of indirect materials, indirect labour and indirect expenses which are
not directly identifiable or traceable and allocable to a cost object in an economically feasible way
CLASSIFICATION OF OVERHEADS
Overheads can be classified on the basis of functions to which the overheads are related viz.
- Production overheads
- Administrative overheads
- Selling overheads
- Distribution overheads
Overhead can also be classified on the basis of behavior. On the basis of behavior overhead can
be classified as variable overheads, semi-variable overheads and fixed overheads.
Variable overheads are those expenses which vary in same proportion to the change of volume
of production. For example, cost of utilities etc.
Fixed overheads are those expenseswhose values do not change with the change in the
volume of production. For example salaries, rent etc.
Semi-variable overheads are those expenses which are partly affected by change in the
production volume. A part of the overhead is variable and a part of the overhead is fixed.
COLLECTION OF OVERHEADS
Collection of overheads refers to the pooling of various indirect items of expenses from books of
account and other records into certain logical groups having regards to their nature and purpose.
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 COST ACCOUNTING

Overheads are collected on the basis of predetermined groups which are termed as cost pools.
Homogeneity of the cost components in respect of their behavior and character is to be
considered while developing the cost pool. Variable and fixed overheads should be collected in
separate cost pools under a cost centre. A greater degree of homogeneity in the cost pools are
to be maintained to make the apportionment of overheads more rationale and scientific.
ALLOCATION OF OVERHEADS
Allocation of overheads is a process of assigning a particular item of cost directly to a cost centre.
An item of expense which can be directly, wholly and exclusively related to a cost centre is to be
allocated to the cost centre. For example, depreciation of a particular machine should be allocated
to a particular cost centre if the machine is directly attached to the cost centre.
APPORTIONMENT OF OVERHEAD
Apportionment of overhead is the process of distribution of overheads to more than one cost
centre on some equitable basis. Thus, a particular item of expense which is not directly related to
one cost centre but is related to more than one cost centre is required to be distributed on various
cost centre is known as apportionment of overhead.
When an item of indirect expense is common to various cost centers, then it has to be apportioned
to the cost centers on an equitable basis. For example, the expenditure on general repair and
maintenance pertaining to a department can be allocated to that department but has to be
apportioned to various machines (Cost Centers) in the department. If the department is involved
in the production of a single product, the whole repair & maintenance of the department may be
allocated to the product.
SELF CHECK QUESTIONS
1. What do you mean by overhead?
2. Classify the various types of overheads.
3. What do you mean by allocation and apportionment of overheads?
4. What do you mean by fixed and variable expenses?
5. What is a semi variable expense? Give two examples of it.

PRIMARY AND SECONDARY DISTRIBUTION OF OVERHEADS:

An organization which deals in various products may have single service department which may
be rendering services to the various production departments and other service departments. The
costs of services are required to be apportioned to the relevant departments Initially it will be
required to apportion the overheads to different departments and later on to apportion the costs
of service department to production department on an equitable and justified basis. The first
process is termed as primary distribution and the second process is termed as secondary
distribution of overheads.

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 COST ACCOUNTING

Absorption of overheads - Absorption of overheads is a process of charging of overheads from

cost centers to products or services by means of absorption rates for each cost center which is
calculated as follows:

𝐓𝐨𝐭𝐚𝐥𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝𝐬𝐨𝐟𝐭𝐡𝐞𝐜𝐨𝐬𝐭𝐜𝐞𝐧𝐭𝐫𝐞
𝑶𝒗𝒆𝒓𝒉𝒆𝒂𝒅𝑨𝒃𝒔𝒐𝒓𝒑𝒕𝒊𝒐𝒏𝑹𝒂𝒕𝒆 = 𝐓𝐨𝐭𝐚𝐥𝐪𝐮𝐚𝐧𝐭𝐮𝐦𝐨𝐟𝐛𝐚𝐬𝐞

The base (denominator) is selected on the basis of type of the cost centre and its contribution to
the products or services, for example, machine hours, labour hours, quantity produced etc.

Overhead absorbed = Overhead absorption rate × units of base in product or service

APPORTIONMENT AND ABSORPTION OF PRODUCTION OVERHEADS

Overheads can be apportioned to different cost centers on the basis of following two principles:
i) Cause and Effect - Cause is the process or operation or activity and effect is the
incurrence of cost. Apportionment of overheads based on this basis ensures better
rationality as it is guided by the relationship between cost object and cost.

ii) Benefits received – Overheads can also be apportioned to the various cost centers in
proportion to the benefits received by them.

PRIMARY DISTRIBUTION OF OVERHEADS:

Basis of primary apportionment of items of production overheads is to be selected to distribute
them among the cost centres following the above two principles as given above.
Once the base is selected, the same is to be followed consistently and uniformly. However,
change in basis for apportionment can be adopted only when it is considered necessary due to
change in circumstances like change in technology, degree of mechanization, product mix, etc.

Basis of primary distribution of some items of production overheads

Item of Cost Basis of Apportionment

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 COST ACCOUNTING

Power H.P. rating of Machines x hours x LF*

Fuel Consumption rate x hour
Jigs, tools & fixtures Machine hours or Man hours
Crane hire charges Crane hours or weight of materials handled
Supervisors’ salary & fringe benefits Number of employees
Labour welfare cost Number of employees
Rent & rates Floor or Space area
Insurance Value of fixed asset
Depreciation Value of fixed asset

* LF = Motor Load Factor

SECONDARY DISTRIBUTION OF OVERHEADS:
Secondary distribution of overheads may be apportioned by following either Reciprocal basis or
Non-Reciprocal Basis. While reciprocal basis considers the exchange of service among the
service departments, non-reciprocal basis considers only one directional service flow from a
service department to other production department.
SECONDARY APPORTIONMENT OF OVERHEADS ON RECIPROCAL BASIS
The services provided by certain service department are also utilized by other service
departments. In reciprocal secondary distribution, the cost of service department is apportioned
to production department as well as other service department. In such case, any one of the
following three methods may be followed:
I. Repeated Distribution Method
II. Trial & Error Method
III. Simultaneous Equation Method
REPEATED DISTRIBUTION METHOD
Following steps are required to be followed under this method:
i) The proportion at which the costs of a service department are to be distributed to
production department and other service department is determined.
ii) Costs of first service department are to be apportioned to production department and
service department in the proportion as determined in step (i).
iii) Similarly, the cost of other service department is to be apportioned.
iv) This process as stated in (ii) and (iii) are to be continued till the amount remaining
undistributed in the service amount are negligibly small. The negligible small amount left
with service department may be distributed to production department.

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 COST ACCOUNTING

Reciprocal Overheads Apportionment:Repeated Method

Production Department Service
Department
Machine Assembl Finishin Store Repair
y g s
Ratio of apportionment from 50% 20% 15% 15%
Stores
Ratio apportionment from 40% 35% 15% 10%
Repair
Primary Distribution 35500.00 31900.00 14800.00 5000. 6000.00
0
Stores Dept. 2500.00 1000.00 750.00 5000. 750.00
0
Total 38000.00 32900.00 15550.00 10000. 6750.00
0
Repairs & Maintenance Dept 2700.00 2362.50 1012.5 675.0 -6750.00
0
Total 40700.00 35262.50 16562.5 675.0 0.00
0
Stores Dept. 337.50 135.00 101.25 - 101.25
675.0
0
Total 41037.50 35397.50 16663.75 0.00 101.25
Repairs & Maintenance Dept 40.50 35.44 15.19 10.13 -101.25
Total 41078.00 35432.94 16678.94 10.13 0.00
Stores Dept. 5.06 2.03 1.52 -10.13 1.52
Total 41083.06 35434.96 16680.46 0.00 1.52
Repairs & Maintenance Dept 0.61 0.53 0.23 0.15 -1.52
Total 41083.67 35435.49 16680.68 0.15 0.00
Stores Dept. 0.10 0.03 0.02 -0.15 0.00
Total 41083.77 35435.52 16680.71 0.00 0.00

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 COST ACCOUNTING

Reciprocal Overhead Apportionment : Trial & Error Method

Production Department Service
Department
Machin Assem Finishi Store Repair
e bly ng s
Ratio of apportionment from 50% 20% 15% 15%
Stores
Ratio of apportionment from 40% 35% 15% 10%
Repair
Distribution from
Primary Distribution 35500.0 31900. 14800. 5000. 6000.00
0 00 00 00
Distribution between service
centres
Stores Dept. 0.00 750.00
Total 5000. 6750.00
00
Repairs & Maintenance To 675.0 0
stores 0
Stores Dept. to Repair & 0.00 101.25
Maintenance
Repairs & Maintenance To 10.13 0.00
stores
Stores Dept. to Repair & 0.00 1.52
Maintenance
Repairs & Maintenance To 0.15 0.00
stores
Stores Dept. to Repair & 0.00 0.02
Maintenance
Gross cost of service cost 5685. 6852.79
centres 28
Stores to Production cost 2842.63 1137.0 -
centres 6 852.79 5685.
28
Repairs & Maintenance to 2741.14 2398.4 1027.9 -6852.79
Production centres 6 2

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 COST ACCOUNTING

Total 41083.7 35435. 16680. 0 0

7 52 71

Trial and Error Method

This method is to be followed when the question of distribution of costs of service department
which are interlocked among themselves arises. In the first step, gross costs of services of service
department are determined and then in the second step, costs of service department are
apportioned to production department. The following process can be followed in this regard:
i) The proportion at which the costs of a service department are to be distributed
to production department and other service department is determined.
i) Cost of first service department is distributed to the other service department in
the proportion of service they received from the first as assessed in step (i).
ii) In the next step, total cost of second service department so arrived has to be
distributed to the other service department in the proportion of service they
received from the second as assessed in step (i).
iii) Similarly, the cost of other service department to be apportioned to the service
department.
v) This process as described in (iii) and (iv) is to be continued till the figures
remaining undistributed in the service department is negligibly small.
i) At the last, total cost of service department is to be distributed to production department.
Example:
Simultaneous Equation Method
The simultaneous equation method is to be adopted to take care of secondary distribution of cost
of service department to production department with the help of mathematical formula. Steps to
be followed:
i) Proportion of service benefits received by different cost centres from a cost centre are
assessed on the basis of records
ii) The same ratios are used as coefficients in the equations framed for apportionment of
cost of service department to production department.
iii) Solution of the equations gives the cost of service department.
iv) Cost of service department to be distributed to production department.

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 COST ACCOUNTING

Example,
Reciprocal Overhead Apportionment : Simultaneous Equation Method
Production Service
Departments Departments
Machi Assem Finishi Stores Repair
ne bly ng
Ratio of apportionment from 50% 20% 15% 15%
Stores
Ratio of apportionment from 40% 35% 15% 10%
Repair
Distribution from
Primary Distribution 35500. 31900.0 14800. 5000.0 6000.0
00 0 00 0 0
Let x, ybe Store Dept and Repair & Maintenance Dept expenses respectively.
𝒙− 𝟎. 𝟏𝟎𝒚 = 𝟓𝟎𝟎𝟎
−𝟎. 𝟏𝟓𝒙 + 𝒚 = 𝟔𝟎𝟎𝟎

𝐒𝐨𝐥𝐯𝐢𝐧𝐠 𝐱 = 𝟓𝟔𝟖𝟓. 𝟐𝟖 , 𝐲 = 𝟔𝟖𝟓𝟐. 𝟕𝟗

Now, distribution of expenses will be as follows:
Production Departments Service
Departments
Machine Assembly Finishin Stores Repair
g
Ratio of apportionment from 50% 20% 15% 15%
Stores
Ratio of apportionment from 40% 35% 15% 10%
Repair
Amounts from Primary 35500.0 31900.00 14800.0 5685.28 6852.7
Distribution 0 0 9

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 COST ACCOUNTING

Stores to Production cost 2842.63 1137.06 852.79 -

centres 5685.28
Repairs & Maint to Production 2741.14 2398.46 1027.92 6852.7
centres 9
Total 41083.7 35435.52 16680.7 0 0
7 1

Secondary Apportionment of Overheads on Non-Reciprocal basis

In non-reciprocal secondary distribution, the costs of service cost centres are apportioned
to the production cost centres. Steps involved are :
i) The cost of first service cost centre is apportioned on a suitable basis to production
cost centres.
ii) The next step is to apportion the cost of second service centre to the production
cost centres as indicated in stage (i).
iii) The process is to be continued till the costs of all service cost centres are
apportioned.

Example,
Non-Reciprocal Overheads Apportionment
Primary Distribution
Production Departments Service
Departments
Expenses Basis of Total Machin Assemb Finishin Stores Repair
allocation / e Shop ly Shop g s &
(Rs.)
apportionment Maint.
Dept
Consumabl Direct 15,400 5,200 6,000 2,000 600 1,600
e stores Materials
22,800 7,900 5,100 6,100 2,200 1,500
Supervision Direct Wages
10,000 3,000 2,000 2,500 1,000 1,500
Rent & Area
2,000 800 900 200 50 50
Rates
Asset Value
30,000 12,000 13,500 3,000 750 750
Insurance
Asset Value
9,000 5,400 3,600 - - -

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 COST ACCOUNTING

Depreciatio H.P x Hours x

n LF
4,000 1,200 800 1,000 400 600
Power
Light & Heat Area
Total 93,200 35,500 31,900 14,800 5,000 6,000

Secondary Distribution
Production Departments Service
Departments
Expenses Basis of Total Machin Assem Finishi Stores Repairs
allocation / e Shop bly ng & Maint.
(Rs.)
apportionme Shop
Dept
nt
Primary dist. 93,200 35,500 31,900 14,800 5,000 6,000
( earlier
Table)
Direct 2,250 1,500 1,250 - 5,000
Stores Material
( 9 : 6 :5)
2,000 3,000 1,000 - 6,000
Repairs & Direct
Maint
( 2: 3: 1)
Total 93,200 39, 750 36.400 17,050 0 0

Self Check Questions

1. What do you mean by primary and secondary distribution of overheads?
2. What are the various methods of secondary distribution of overheads?
Absorption of Production overheads:
Production Overheads absorption rate for each cost centre is to be determined with the help of
quantum base as indicated in 5.6 above and the formula as indicated below :
𝑭𝒊𝒙𝒆𝒅𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅𝒔
𝑭𝒊𝒙𝒆𝒅𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅𝒔𝒂𝒃𝒔𝒐𝒓𝒑𝒕𝒊𝒐𝒏𝒓𝒂𝒕𝒆 =
𝐍𝐨𝐫𝐦𝐚𝐥 𝐨𝐫 𝐚𝐜𝐭𝐮𝐚𝐥 𝐪𝐮𝐚𝐧𝐭𝐮𝐦 𝐨𝐟 𝐛𝐚𝐬𝐞,
𝐰𝐡𝐢𝐜𝐡𝐞𝐯𝐞𝐫 𝐢𝐬 𝐡𝐢𝐠𝐡𝐞𝐫
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 COST ACCOUNTING

𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝𝐬
𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝𝐬𝐚𝐛𝐬𝐨𝐫𝐩𝐭𝐢𝐨𝐧𝐫𝐚𝐭𝐞 =
𝐀𝐜𝐭𝐮𝐚𝐥𝐪𝐮𝐚𝐧𝐭𝐮𝐦𝐨𝐟𝐛𝐚𝐬𝐞
A pre-determined rate may be used on a provisional basis for internal management decision
making such as cost estimates for quotation, fixation of selling price etc. These rates are to be
calculated for each cost centre for a particular period. Budgeted overheads for the respective cost
centres for the period concerned are to be taken as numerator and budgeted normal base for the
period as denominator for determining the rate.

𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝐎𝐯𝐞𝐫𝐡𝐞𝐚𝐝𝐬𝐟𝐨𝐫𝐭𝐡𝐞𝐩𝐞𝐫𝐢𝐨𝐝
𝐏𝐫𝐞 − 𝐝𝐞𝐭𝐞𝐫𝐦𝐢𝐧𝐞𝐝𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝𝐑𝐚𝐭𝐞 =
𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝐧𝐨𝐫𝐦𝐚𝐥𝐛𝐚𝐬𝐞𝐟𝐨𝐫𝐭𝐡𝐞𝐩𝐞𝐫𝐢𝐨𝐝

The amount of total overheads absorbed by a product, service or activity will be the sum total of
the overheads absorbed from individual cost centres on pre-determined basis. The difference
between overheads absorbed on pre-determined basis and the actual overheads incurred is the
under- or over-absorption of overheads.
The under- or over- absorption of overheads is mainly due to variation between the estimation
and actual.
Method of absorption of overheads
Production overheads
There are many ways to absorb overheads which are as follows:
DIRECT MATERIAL COST PERCENTAGE
Suitable in situations where:
• the material value has some relationship with the overheads;
• quality and prices of materials do not vary drastically;
• quantity and cost of materials in each product is almost the same and
• where processing is uniform

Unsuitable when:
• Overheads are time-based where there is little relationship with the cost of material used
hence products with high material content absorb more overheads.
Example
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅
𝑫𝒊𝒓𝒆𝒄𝒕𝒎𝒂𝒕𝒆𝒓𝒊𝒂𝒍𝒄𝒐𝒔𝒕𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆𝒓𝒂𝒕𝒆 × 100
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏𝒎𝒂𝒕𝒆𝒓𝒊𝒂𝒍𝒄𝒐𝒔𝒕

70.00
= × 100
10,000

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 COST ACCOUNTING

= 700%
Overhead absorbed by the job= 10 x700
DIRECT LABOUR COST PERCENTAGE
Suitable in situations where:
• wages have some relationship with the overheads
• one type of labour rate and one type of pay rate in the cost centre.
Need to be careful to charge overheads with higher labour costs in the event of different level of
skill.

Example
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅
𝐃𝐢𝐫𝐞𝐜𝐭𝐋𝐚𝐛𝐨𝐮𝐫𝐂𝐨𝐬𝐭𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞𝐑𝐚𝐭𝐞 = × 𝟏𝟎𝟎
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒅𝒊𝒓𝒆𝒄𝒕𝒎𝒂𝒕𝒆𝒓𝒊𝒂𝒍𝒄𝒐𝒔𝒕
70.000
= × 100
40,000

=175%
Overhead absorbed by the job= 30 x 175% =52.50
PRIME COST PERCENTAGE
Prime cost consists of direct material and direct labour. Not a good absorption method as it has
little relationship with overheads.
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅
𝐏𝐫𝐢𝐦𝐞𝐂𝐨𝐬𝐭𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞𝐑𝐚𝐭𝐞 = × 𝟏𝟎𝟎
𝐏𝐫𝐢𝐦𝐞𝒄𝒐𝒔𝒕

70.000
= × 100
50,000(10,000 + 40,000)
=140%
Overhead absorbed by the job= 40(10+30) x140% =56
DIRECT LABOUR HOUR RATE
Suitable in labour intensive industry or where certain departments are still using manual means.
Uses time as a basis.

Disadvantages:
• It assumes that operations that take the same time are costed with the same overheads
irrespective of the operators different pay rates.
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 COST ACCOUNTING

also, more businesses are deploying machines, hence this absorption method is getting more
unpopular.
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅
𝐃𝐢𝐫𝐞𝐜𝐭𝐋𝐚𝐛𝐨𝐮𝐫𝐡𝐨𝐮𝐫𝐑𝐚𝐭𝐞 = × 𝟏𝟎𝟎
𝑩𝒖𝒅𝒈𝒆𝒕𝒆𝒅𝒍𝒂𝒃𝒐𝒖𝒓𝒉𝒐𝒖𝒓
70.000
= × 100
30,000
=2.34 %
Overhead absorbed by the job= 20 hours x2.34 =46.80

MACHINE HOUR RATE

Is suitable when the business is of capital intensive in nature or production being carried out by
machines.

Disadvantage:
If a cost centre uses different type of machines, then we cannot use a single machine rate. A
separate machine rate must be computed for each machine or group of machines. Also, there is
a need to keep records of the machine time for each operation. This method therefore can be
very tedious and increases clerical work
𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝
𝑴𝒂𝒄𝒉𝒊𝒏𝒆𝐡𝐨𝐮𝐫𝐑𝐚𝐭𝐞 = × 𝟏𝟎𝟎
𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝑴𝒂𝒄𝒉𝒊𝒏𝒆𝐡𝐨𝐮𝐫

70.000
= × 100
20,000
=3.5 per machine hour
Overhead Absorbed by the job= 10 hours x 3.5 =35

COST UNIT RATE

Suitable where cost units passing through a cost centre are homogenous.
Applies in standard costing or budgetary control systems. Cost Unit Rate method is very simple
and a more direct mean.
𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝
𝑼𝒏𝒊𝒕𝐑𝐚𝐭𝐞 = × 𝟏𝟎𝟎
𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝𝒐𝒖𝒕𝒑𝒖𝒕

70.000
= × 100
5,000

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 COST ACCOUNTING

=14 per unit

Overhead absorbed by the job= 14 x 1unit =14
Apportionment and Absorption of Administrative Overheads
Administrative overheads include the following items of cost:
Printing and stationery, other office supplies
Employees cost – Salaries of administrative staff
Establishment expenses – Office rent & rates, insurance, depreciation of office building
and other assets, legal expenses, audit fees, bank charges etc.
Administrative overheads are to be collected in different cost pools such as :
- General Office
- Personnel department
- Accounts department
- Legal department
- Secretarial department etc
Administrative overheads can be further analysed into two – one for production activities and
other for sales and distribution activities. Costs collected under the cost pools indicated above are
to be distributed to administrative overheads relating to production activities and administrative
overheads relating to selling and distribution activities on rational basis for each cost pool.
Administrative overheads relating to production activities are to be apportioned to different
production cost centres on the basis conversion costs of production cost centres. The apportioned
overheads are absorbed to products on the basis of the normal capacity or actual capacity,
whichever is higher.
In case of under-absorption or over-absorption of administrative overheads relating to production,
the same shall also be adjusted with Costing Profit & Loss Account.

Apportionment and Absorption of Selling overheads and Distribution overheads

The selling overheads and distribution overheads are collected under different cost pools such
as :
Selling Overheads:
(i) Sales Employees cost
(ii) Rent
(iii) Traveling expenses
(iv) Warranty claim
(v) Brokerage & Commission
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(vi) Advertisement relating to sales and sales promotion

(vii) Sales incentive
(viii) Bad debt etc
Distribution Overheads:
(i) Secondary Packaging
(ii) Freight & forwarding
(iii) Warehousing & storage
(iv) Insurance etc.
Some items of selling overheads and distribution overheads are directly identified and
absorbed to products or services and remaining part of selling and distribution overhead along
with the with share of administration overheads relating to selling and distribution activities
are to be apportioned to various products or jobs or services on the basis of net actual sales
value (i.e. Gross sales value less excise duty, sales tax and other government levies).
SELF CHECK QUESTIONS
1.What are the various methods of absoption of factory overheads.
2. Discuss the method of apportionment and absorption of administrative overhead.

MACHINE HOUR RATE

Machine hour rate is a method of absorbing factory overhead. This method is applied in those
industries where production activity heavily depends on machines. The machine hour rate is an
actual or predetermined rate of cost apportionment for overhead absorption, which is calculated
by dividing the cost to be apportioned or absorbed by the number of hours for which a machine
or machines are operated or expected to be operated.

PROCESS OF MACHINE HOUR RATE METHOD

The following process is generally adopted to determine the machine hour rate:
(i) All the factory overhead are apportioned to the various machines or group of
machines on some suitable basis.
(ii) Working hours of a machine are calculated for the period for which the machine
is to run.
(iii) The overheads of a machine cost centre are divided by the effective machine
hours, the machine hour rate pertaining to the machine or group of machines is
determined.
BASES OF APPORTIONMENT OF FACTORY OVERHEAD TO THE MACHINES
The following basis is generally adopted for apportionment of expenses which are common to
more than one machine:
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(i) Rent, Rates and Taxes etc: Floor area occupied by the machine
(ii) Depreciation : Actual depreciation as per plant register
(iii) Lighting: Number of bulbs or wattage used for lighting by the machines
(iv) Heating: Floor area occupied by the machine or technical estimates
(v) Power: Horse power of the machine or technical estimate by meter reading
(vi) Repairs and Maintenance: Allocation as per actual repairs or according to hours worked
by the machines
(vii) Supervisory Expenses: Number of hours devoted by the supervisor on each machine
(viii) Labour Welfare Expenses: In the ratio of number of employee engaged on machines
(ix) Insurance: In the ratio of machine value keeping into consideration the insurance period
(x) Lubricating oil, cotton waste and consumable stores: On the basis of machine hour
worked in the certain period or on the basis of size of machine
(xi) Interest included in hire purchase : Interest is treated as an overhead and actual interest
of the machine is charged as overhead for the particular machine
COMPUTATION OF MACHINE HOUR RATE
In order to calculate the machine hour rate, the factory overhead is divided into (a) Standing
charges and (b) Machine or Variable expenses
(A) Standing Charges: Standing charges are those expenses which are not related to the
running of the machine and these expenses are bound to incur even if the machine
remains idle. The following expenses are generally included in this category:
(i) Rent of the Factory,
(ii) Rates and Taxes,
(iii) Insurance premium of Factory building,
(iv) Insurance premium of Machines,
(v) Salary of Manager,Supervisor, Foreman etc.,
(vi) General Lighting,
(vii) Cotton Waste, Lubricants oil,
(viii) Consumable stores,
(ix) Sundry Supplies
(x) Operators Wages: Generally Operators wages is treated as direct labour cost
and is shown in Prime cost. However, if an operator works on several machine
then the wages should be shown as standing charges
All the standing charges are totaled together and divided by the working hours
of the machine of the specified period thus obtaining hourly rate of standing
charges.
(B) Machine Expenses: Machine expenses are those expenses which are incurred on
running of the machines. These expenses are calculated for hourly rate on individual
basis. Generally following expenses are treated as machine expenses:
(i) Depreciation of machine
(ii) Power Expenses
(iii) Repair and Maintenance charges
Treatment of Idle time and setting time:

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The idle time in respect of a machine is generally deducted from the budgeted working hours of
a machine in order to calculate the effective machine hour. Similarly, if a machine requires some
setting time before it is ready for operation, the setting time should be added in calculating
effective hours of the machine.
ILLUSTRATION
1. Calculate Machine Hour Rate for recovery of overhead for a machine from the following data.
There is a group of 4 similar machines in the department.
Original cost of 4 Machines Rs. 76,800; Depreciation at 10% per annum on straight line method;
Maintenance cost average Rs. 8 per day of 8 hours for the group machines.
Power 25 Paisa per running hour (per machine), Supervision for the machine group Rs. 640 per
month. Allocation of building depreciation for 4 Machines on a floor area basis Rs. 80 per month.
Share of manufacturing overheads Rs. 240 per month for the group.
Normal working days in the year 300; Normal running : One shift of 8 hours, Each machine
remained idle for 20% of its normal running hours.
Solution ·
Computation of Machine Hour Rate
Base Period : 1 year Working Hours : 300 ×8 = 2,400 — 480 = 1,920
Particular Per year Per hour
(A).Standing Expenses : Rs. Rs.
(i) Supervision Exp. (Rs. 640 × 12 months / 4) 1,920
(ii) Depreciation of Building (Rs. 80 × 12 months / 4) 240
(iii) Manufacturing Overhead (Rs. 240 × 12 months / 4) 720
2880
Standing Expenses per hour (Rs. 2,880 / 1,920 hrs.)
1.50
(B) Machine Expenses
(i) Depreciation (Rs. 76,800 / 4 = Rs. 19,200 × 10%
=Rs. 1,920 / 1,920 hrs.) 1.00
(ii) Power 0.25
(iii) Maintenance cost (Re. 1 per hour for 4 machines) 0.25
Machine Expenses 3.00

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2. A Machine costing Rs. 28,700, excluding installation cost of Rs. 300, has an anticipated life of
10 years with residual value of Rs. 500. It is depreciated on straight line method. From the
following particulars, compute machine hour rate on the basis of anticipated working hours:
(i) Rent and Rates for the factory is Rs. 6,000 per annum and 10% of the effective area is
occupied by this machine.
(ii) Insurance for this machine is Rs. 450 per annum.
(iii) Repairs and Maintenance for the whole factory for the year is Rs. 2,000; 25% of this amount
relates to this machine.
(iv) Consumable Stores etc. attributable to this machine for the whole year is Rs. 110.
(v) Total of production services is Rs. 5,000; 20% of this amount is applicable to this machine.
(vi) Power cost is Re. 0.50 per Working Hour.
(vii) The year contains 250 working days of 8 hours each but it is anticipated that the machine
will remain idle 20% of this time.

Solution
Total hours = 250 working days x 8 hours each day = 2000 hours
Less idle time being 20% of 2,000 hours = 400 hours
Effective working hours = 1600 hours

Particular Per year Per hour

(A).Standing Charges : Rs. Rs.
(i) Rent and Rates (Rs. 6,000 × 10%) 600.00
(ii) Insurance 450.00 450.00
(iii) Consumable Stores 110.00
(iv) Production service overheads (Rs. 5,000 × 20%) 1,000.00
Total Standing Charges Rs. 2,160.00
Standing Expenses per hour (Rs. 2, 160 / 1,600 hrs.) 1.35

(B) Machine Expenses

28,700 +300−500 1.78
(i) Depreciation 10 ×1,600
0.31
(ii) Repairs and Maintenance (Rs. 2,000 × 25% = Rs. 500
/ 1,600 hrs.) 0.50

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(iii) Power
Machine Hour Rate 3.94

3. In a factory department, a machine costs Rs. 1,15,000. It is expected that it will work for about
20,000 hours and its scrap value is estimated at Rs. 15,000. The rent of the factory department
is Rs. 4,000 p.m. of the 25% of the area of the department is utilised for conducting the operation
of the machine. One foreman and an attendant are employed on a salary of Rs. 2,000 and Rs.
1,000 p.m. respectively, to work on one more machine of a similar type. The expenses of the
month incurred in the department are as follows:
Light charges for the department Rs. 800, having 16 points in all out of which only 4 points are
used at the machine. Total power used for two machines of equal horse-power Rs. 3,200; Indirect
Labour for the machine Rs. 500 and Repairs and Renewals Rs. 400.
You are required to find out the Machine Hour Rate for one month when it is expected to work for
40 hours a week. ‘
Solution: Computation of Machine Hour Rate
Machine No............

Standing Charges Rs. Rs.

Rent (Departmental Rent Rs. 4,000; 1/4 for the machine) 1,000
Foreman’s salary (for one machine) 1,000
Attendant’s salary (for one machine) 500
800 ×4 200
Lighting charges 16
500
Indirect Labour

3,200
Total Standing Charges

20.00
Hourly rate for standing charges (3,200 ÷160)
Machine Expenses
5.00
Hourly rate for depreciation (1,15,000 — 15,000 ÷ 20,000)
Repairs and Renewals (400 ÷ 160) 2.50
Power (for one machine) (1,600÷ 160) 10.00

Machine Hour Rate 37.50

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4. The following annual charges are incurred in respect of a machine where manual labour is
almost nil and where the work is done by means of five machines of exactly similar type and
specifications:
1. Rent and Rates (proportional to the floor space occupied) for the shop Rs. 48,000
2. Depreciation on each machine Rs. 5,000
3. Repairs and maintenance for five machines Rs.10, 000
4. Power (as per metre) @ Rs. 10 per 16 units consumed for the shop) Rs. 37,500
5. Electric charges for light in the shop Rs. 5,400
6. Attendants: There are two attendants for the five machines and they are each paid Rs. 600 per
month.
7. Supervision: For the five machines in the shop there is one supervisor whose emoluments are
Rs. 2,500 per month.
8. Sundry supplies, such as Lubricants, Jute and Cotton waste, etc. for the shop Rs. 4950
9. Hire-purchase instalment payable for the machines
(including Rs. 3,000 as interest) A
The machine uses 10 units of power per hour.
Calculate the Machine Hour Rate for the year.
Solution : Computation of Machine Hour Rate
Machine No............
Standing Charges Rs. Rs.
Rent & Rates per Machine (Rs. 48,000 ÷5 Machines) 9,600 9,600
light in Workshop per Machine (Rs. 5,400 ÷ 5 Machines) 1,080
Salary of attendants per Machine (Rs.600 × 2 × 12 ÷ 5) 2,880
Supervision per Machine (Rs. 2,500 × 12 ÷ 5) 6,000
Sundry Supplied per Machine (Rs. 4,950÷5) 990
Eve-purchase Charges per Machine (Rs. 3,000 ÷ 5) 600
Total Fixed Expenses 21,150
Hourly rate for standing charges (Rs. 21,150 ÷ 1,200 hrs.) 17.625
Machine Expenses :
Depreciation (Rs. 5,000 ÷ 1,200 hrs.) 4.166
Repairs & Maint. (Rs. 2,000 ÷ 1,200 hrs.) 1.667
Power (10 Units per hour, @ Rs. 10 per 16 Units) 6.250
Machine Hour Rate 29.708
Working hours of Machine have been computed as follows:
Power Units @ Rs. 1.00 per 1.6 Units = Rs. 37,500 × 1.6 = 60,000 which is for all 5 Machines.
Hence, per Machine Consumption is 12,000 Units. Machine consumes 10 Units per hour and
hence a Machine, Runs for 1,200 Hrs in a year
SELF CHECK QUESTION

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1. What do you mean by machine hour rate? How is it determined?

2. What is the process of determining machine hour rate? What factors do you keep in view
while ascertaining the rate.
3. What is meant by overhead expenses? Give various methods of absorbing overhead and
discuss any two of these method in detail?
4. What do you understand by overheads? Discuss the different methods of allocating the
factory overheads.
5. What is the difference between apportionment of overheads and absorption of
overheads? State with the help of imaginary figures.
PRACTICAL QUESTIONS
1. The following annual charges are incurred in respect of a machine where manual labour is
almost nil and where the work is done by means of five machines of exactly similar type and
specifications:
1. Rent and Rates (proportional to the floor space occupied) for the shop 48,000
2. Depreciation on each machine 5,000
3. Repairs and maintenance for five machines 10,000
4. Power (as per metre) @ Rs. l0 per 16 units consumed for the shop 37,500
5. Electric charges for light in the shop 5,400
6. Attendants: There are two attendants for the five machines and they are each paid Rs.
600 per month.
7. Supervision: For the five machines in the shop there is one supervisor whose
emollients are Rs. 2.500 per month.
8. Sundry supplies, such as Lubricants, Jute and Cotton waste.Etc. for the shop 4,950
9. Hire-purchase installment payable for the machines (including Rs. 3.000 as
interest) 12,000
10. The machine uses l0 units of power per hour.
Calculate the Machine Hour Rate for the year.
2. The expenditure pertaining to a department having four identical machines is given below:
Rent and Taxes 6,000 perannum,
Power consumed (at 10 paisa per unit) . 4,800 per annum
Repair 1,000 per annum
Lighting expenses 800 per annum
Consumable stores 100 per annum
Depreciation on each machine 600 per annum
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Hire-purchase installment payable for the machines

(Including Rs. 300 interest) 1,200 per annum
Supervisor`s Salaries 600 per annum
Attendants: There are two attendants in the department. Each is paid Rs. 60 per month.
The machine uses 10 units of power per hour.
Calculate the machine hour rate of the machine.
Ans. Machine Hours: 1,200; Machine Hour Rate: Rs. 5.008.

3. Prepare a Machine Hour Rate computation for the month of January, 2005 to recover the
overhead expenses from the information indicated below:
Per Annum (Rs.)
Rent of the Department (Space occupied by the machine 1/4) 1,200
Lighting (12 men in the department; 2 men are engaged on this machine) 576
Insurance 96
Cotton Waste, Oil, etc. 60
Salary of Foreman (one-third of foreman’s time is spent on this machine and the remaining on
other two machines) 9,000
Cost of machine is Rs. 27,500 and scrap value of machine is Rs. 500. It is assumed from the
past experience that:
(a) The machine will work 1,200 hours per annum.
(b) It will incur expenditure of Rs. 4,500 in respect of repairs and maintenance for whole working
life of machine. , .
(c) It will consume 5 units of power per hour at the rate of 10 Paisa per unit.
(d) The working life-time of the machine will be 15,000 hours.
Ans. Rs. 5.56 per hour.

4. The following annual expenses have been incurred in respect of a shop having 5 identical
machines: Rs.
(i) Rent and Rates 4000
(ii) Power consumed by the shop @ 61/4 Paisa per unit 3,750
(iii) Repair and maintenance for the machines 1,000
(iv) Lighting charges for the lighting of the shop 500
(v) Attendant’s salary (There are two attendants and each is paid Rs. 50 per month)
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(vi) Supervisor’s salary (There is one supervisor for the 5 machines, his monthly salary is Rs.
300)
(vii) Lubricants and cotton waste for the shop. 100
(viii) Hire-purchase installment for the machines (including Rs. 300 for interest) 2,300
(ix) Each machine consumes 10 units of power per hour.
(x) Depreciation on each machine Rs. 600 p.a.
Ans. Rs. 2.91 including Hire-purchase interest.

UNIT III
Lesson – 7
Single/Output/Unit Costing
Context of the lesson
This lesson deals with preparation of cost sheet and statement of cost. Cost sheet is used to
ascertain the total cost and per unit of each item of expense and statement of cost is used to
determine the total cost and cost per unit of the products manufactured. Output costing method
is applied in industries where goods are produced on mass scale and goods are uniform.
Objective of the lesson
• To understand the concept of output costing.
• To know the meaning of meaning of cost sheet and statement of cost.
• Preparation of cost sheet and statement of cost.
Single/ Output costing method is a costing procedure, which is applied in those concerns which
generally produce a single article or product or two or more grades of one product on mass scale
by a common continuous process of manufacturing. The cost units are similar and identical. The
products whose cost is to be ascertained are homogenous and are similar to each other.
DEFINITIONS OF UNIT OR OUTPUT COSTING
Herold J. Wheldon—"Production cost accounting or unit cost accounting is such a method of cost
ascertainment which is based on production unit. It is applicable where the production work is
done continuously and the units are of same types or manufactured identical."
Walter W. Bigg-—"Unit costing method is a method of costing applied to ascertain the cost unit
or production where standard and identical products are manufactured."
J. R. Batliboi— “Single or output cost system is used in business where a standard product is
turned out and it is desired to find out the cost of a basic unit of production.
The above definitions bring out the fact that single or output method of costing is used in those
industries, where following characteristics are found:
(i) Production is uniform or homogeneous and a continuous affair;
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(ii) The units of production is identical or similar;

(iii) The cost units are physical and natural;
(iv) Per unit cost has to be determined, for example per ton, per metre, per kg., etc.
Generally these characteristics are found in following industries—Coal mines, Sugar mills, Cloth
mills, Flour mills, Cement factory, Brick kilns, breweries etc.

OBJECTIVES OF UNIT OR OUTPUT COSTING

The following are the main objectives of output costing method:
(i) To determine the total cost of production within specific period.
(ii) To classify cost under related categories
(iii) To have detailed analysis in order to determine per unit cost.
(iv) To determine the effect of each element of cost on total cost and to exercise control over cost.
(v) To determine tender price, estimated price or selling price of the product.
ELEMENTS OF COST UNDER UNIT OR OUTPUT COSTING
The various elements of cost under output costing for determination of cost of the products are:
Materials : The quantity and value of material consumed in manufacturing of the product is to be
determined.
Labour : Direct labour has to be determined from the wage analysis sheet.
Direct Expenses: Other than material and labour various other expenses are also incurred on
production which are directly related to production. These expenses are termed as direct
expenses.
Overheads: The overheads are debited to production for the period for which the cost is being
determined. These overheads expenses are taken from the financial records. There are certain
expenses which cannot be determined before the end of the accounting period. For those
expenses, an estimate is made in beginning of the year and are apportioned on appropriate basis.
These overheads are the total of indirect material, indirect labour and indirect expense. In output
costing, for in depth analysis of overheads, these are classified as Factory Overheads, Office or
Administrative Overheads and Selling and Distribution Overheads.

SELF CHECK QUESTIONS

1. What is output costing method. In which industries is it applied
2. What are the objectives of application of Output costing method.
Determination of costing under output costing method

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In order to determine cost of the product in industries where production is carried out on a
continuous basis and on mass scale and where standard products are manufactured, generally
the orgnaisation prepares:
• Cost sheet
• Statement of Cost
• Production account

Cost Sheet
In order to determine cost of the product under single or output costing method a cost sheet is
prepared. Cost sheet is a document which provides for the assembly of the detailed cost centre
or cost unit. It is a periodical statement of cost designed to show in detail the various elements of
cost of goods produced, like prime cost, factory cost, cost of production and total cost.
DEFINITION OF COST SHEET
ICMA LONDON: “A Cost Sheet or Cost Statement is "a document which provides for the assembly
of the detailed Cost of a Cost Centre or Cost Unit".
WHELDON: “Cost Sheet are prepared for the use of management and consequently they must
include all the essential details which may assist the manager in judging the efficiency of
production”.
W W Bigg, “The expenditure which has been incurred upon production for a period is extracted
from the financial books and the store records set out in a memorandum statement. If this
statement is confined to the disclosure of the cost of units produced during the period, it is termed
as Cost Sheet." `
ADVANTAGES OF COST SHEET
The main advantages of a Cost Sheet are as follows:
1. It provides the information of total cost as well as cost per unit of production.
2. It helps in comparison of cost of different periods and products.
3. It helps in cost estimation required for submitting tenders.
4. It help in determination of selling price.
5. It facilitates cost control by disclosing operational efficiency.
6. lt acts as a guide to manufacture in formulation of suitable and definite policies.

STATEMENT OF COST
It is a statement which shows the total cost and the profit or loss. It is prepared when it is not
desired to find out cost per item of expense. If from this statement the cost per unit has to be
determined then it can be had by dividing the total cost by the number of units produced. In cost

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sheet, per unit cost of each item of expenses is calculated whereas in statement of cost it is not
done.
EXPLANATION OF VARIOUS TYPES OF COST APPEARING IN COST SHEET OR
STATEMENT OF COST
(1) Prime Cost
Prime cost is the aggregate cost of direct material, direct labour and direct expenses.It is also
known as ‘Direct Cost, ‘First Cost’ or ‘Flat Cost’.
Prime Cost = Direct Material + Direct Wages + Direct Expenses
(i) Direct Material : Direct material is that material which forms the major part of the
product., e.g., timber in furniture making. Direct material refers to the amount of of
direct material consumed which is worked out as under:

Opening Stock of Raw Material .....

If
+ Purchase of Raw Material .....
any
part + Carriage Inward or Freight .....
of — Closing Stock of Raw Material ..... ·
raw
Raw Material Consumed XXX
material is returned to the supplier or sold then its value is deducted in the above calculation.
(ii) Direct Wages or Labour : The wages paid to workers who are directly engaged in
converting the shape of the raw material to finished product and whose time can be
conveniently and economically be traceable to units of product or service is known as
direct wages. It is also known as ‘Productive wages’
(iii) Direct Expenses : These expenses are also called as ‘Chargeable Expenses’, or
‘Productive Expenses’. These are expenses which are directly identified and incurred
on a particular job or process.
(2) Factory Cost or Works Cost
The next stage after prime cost is factory cost. This cost is the sum of prime cost and factory
overhead and can be expressed as:
Factory/Works Cost = Prime Cost + Factory Overheads
Factory overheads are of indirect nature and are incurred within factory premises or production
process or in operating and controlling production activity. These expenses are also known as
‘Manufacturing Overheads’. Some of the important items of factory overheads are as follows :
(i) Factory rent, rates and tax, (ii) Factory light, power, fuel etc., (iii) Loose tools and
spares, (iv) Wages and salaries of factory employees, (v) Salary of Factory Manager,
(vi) Remuneration of Technical Director, (vii) Depreciation, insurance and repairs of
factory building, (viii) Depreciation, insurance and repairs of plant and machinery of
factory, (ix) Store expenses, (x) Cotton waste, oil, lubricants, nut and bolts, (xi)
Expenses on training of factory employees, (xii) Factory stationery and telephones,
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(xiii) Employees welfare expenses, (xiv) Bonus to factory employees, (xv) Cost of idle
time, (xvi) Research and development expenses, (xvii) Drawing office salary, (viii)
Haulage, (xix) Cost of rectification of defective work, (xx) Removal of overburden, etc.

The presentation of factory cost in cost sheet can be shown as:

Prime Cost .....
Add : Factory Expenses .....
Add : Opening Stock of Work-in-Progress ......
Less : Closing Stock of Work-in-Progress .......
Less : Sale of Scrap .......
Works/Factory Cost XXXX

(3) Office and Administration Cost

The sum of office and administrative expenses and factory cost, is known as office and
administration cost. This cost is also known as Cost of Production. The expenses which are
incurred in operating and controlling the business and on effective functioning and maintenance
of business, policy creation and implementation are termed as office and administrative expenses.
It includes :
(i) Rent, rates and tax of office building, (ii) Expenses on light and cleaning of office premises,
(iii) Salaries & wages to office employees, (iv) Depreciation on office furniture, (v) Repair of office
furniture, (vi) Repair of office building, (vii) Depreciation of office building, (viii) Insurance of office
building and furniture, (ix) Salary of office manager and executives, (x) Expenses on printing and
stationery, (xi) Postage, Telegram & Telephone, (xii) Expenses on business magazine, (xiii) Audit
fee, (xiv) Bank charges, (xv) Legal expenses, (xvi) Counting office salaries, (xvii) Director’s fees,
(xviii) Other office and administration expenses.
(4) Total Cost
When selling and distribution expenses are added in cost of production, then the cost arrived is
known as total cost. Selling expenses are those expenses which are incurred on creating or
stimulating the demand of the product. Distribution expenses includes those expenses which are
incurred in keeping the finished stock in godown and on delivering the goods to the customers
godown. The following are some of the examples of selling and distribution overheads :
(i)Expenses of sales office, (ii) Salary, commission allowed to sales manager & sales
representative, (iii) Travelling expenses of sales representative, (iv) Advertisement, (v) Bad
debts, (vi) Price-list, samples & gifts, (vii) Discount allowed to customers, (viii) Legal expenses
regarding sales, (ix) Stationery regarding sales, (x) Expenses on tender & estimates, (xi) Market
research, (xii) Warehouse expenses, (xiii) Salary of wharehouse staff (xiv) Transit insurance of
goods, (xv) Depreciation and maintenance expenses of delivery vans, (xvi) Carriage or freight of

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sale of goods, (xvii) Theft or loss of goods in transit, (xviii) Reconditioning, repair and packing
expenses of containers, etc.

SELF CHECK QUESTION

(1) What is a cost sheet.
(2) Explain cost sheet. How does it differ from statement of cost
(3) Discus the various stages of cost depicted in cost sheet
(4) What are the advantages of cost sheet.

Items excluded from cost sheet

The following items are of financial nature and thus not included with preparing a cost sheet.
(i) Cash discount ,(ii) Interest paid ,(iii) Preliminary expenses written off,(iv)Goodwill written
off,(v)Provision for taxation,(vi)Provision for bad debts,(vii)Transfer to
reserves,(viii)Donations,(ix)Income tax paid,(x)Dividend paid,(xi)Profit\loss on sale of
assets,(xii)Damages payable at law etc.

TREATMENT OF ITEMS OF STOCK IN COST SHEET

Stock includes stock of raw materials, work-in-progress and finished goods. These item of stock
are dealt in a specific manner while preparing a cost sheet.
Stock of Raw Materials:
Opening stock of raw material and closing stock of raw material are used to determine the cost of
raw material consumed.

Opening stock of raw materials ——

Add: Purchase of raw materials ——
Less: Closing stock of raw materials ____
Value of raw materials consumed XXX
Stock of Work-in-Progress:
Work-in-progress is valued at prime cost or works cost basis, but latter is preferred. lf it is valued
at works or factory cost then opening and closing stock will be adjusted as follows :

Prime cost ——
Add: Factory overheads ____
Work-in-progress (beginning) ——
Less: Work-in-progress (closing) ____

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Works cost XXX

Stock of Finished Goods

Opening and closing stock of finished goods are adjusted before calculating cost of goods sold:

Cost of production —
Add: Opening stock of finished goods —
Less: Closing stock of finished goods —
Cost of goods sold XXX

NUMERICAL ILLUSTRATIONS
Illustration 1
From the following particulars of a colliery mine for the month of April 2009 prepare a cost sheet.
Rs.

Wages: Underground
15,000
Surface 2,500
Working Expenses:
Repairs and Renewals 600
Timber 350
Royalties and Way-leaves 500
Stable Expenses 150
Stores 200
Rent, Rates and Taxes 175
Depreciation 300
Administrative Expenses:
General Administration, Selling and Distribution Charges 700
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Saleable Ton raised, 500 ton

Solution Colliery Cost Sheet

(for the month of April, 2009)

Particulars Total Cost Cost per ton

Rs. Rs.
Wages
• Wages underground Surface 15,000 30.00
Prime cost 2,500 5.00
Working Expenses 17,500 35.00
• 600
• Repairs and Renewals
350 1.20
• Timber
500
• Royalties and Way-leaves 0.70
• Stable Expenses 150
1.00
• Stores 200
0.30
• Rent, Rates and Taxes 175
• Depreciation 0.40
300
• 0.35
0.60

Works Cost 19.775 39.55

Administrative Expenses :
General Administration, Selling and Distribution
700 1.40
Charges

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Total cost 20,475 40.95

Illustration 2
Below is enumerated expenditure for a year in the manufacture of a product :
Raw Material 56,000 Rent (Factory) 4,000
Fuel 14,000 Tax & Insurance (Factory) 800
Electric Power 2,800 Depreciation on Machine 4,800
Process and General Wages 1, 26,000 Advertisement 1,000
Repairs 4,800 Salaries to Sales Agent 1,600
Carriage Inward 4,000 Carriages on Sales 400
Light & Water 800
Office Salary 14,000
Administrative Expenses (office) 10,000
Units manufactured 40,000
Prepare a cost sheet for the year showing cost per unit for each item of expenses and also the
total cost of the production.
Solution
Cost sheet
(Output: 40,000 Units)

Particulars Total Cost Cost per unit

Raw Materials 56,000
Add : Carriage Inward 4,000
Cost of Material Consumed 60,000 1.50
Process & General Wages 1,26,000 3.15
Prime Cost 1,86,000 4.65
Works Overheads
Fuel 14,000 0.35
Electric Power 2,800 0.07
Repairs 4,800 0.12
Light & Water 800 0.02
Tax & Insurance 800 0.02

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Depreciation on machine 4,800 0.12

Rent 4,000 0.10
Works Cost 2,18,000 5.45
Office Overheads:
Office salary 14,000 0.35
Adm. Expenses 10,000 0.25
Office/Cost of Production 2,42,000 6.05

Selling & Distribution Overheads

Advertisement 1,000 0.03
Salaries to Sales Agent 1,600 0.04
Carriage on Sales 400 0.01
Cost of Sales / Total Cost 2,45,000 6.13

Illustration 3
The following expenses are related to the production of 1,000 units during the month of August
2009:
Direct Material 12,000
Wages 10,000
Factory Rent & Taxes 1,000
Depreciation on Machinery 1,000
Supervisor’s Salary 2,000
Indirect Material 500
Indirect Labour 300
Office Expenses 1,500
Other Factory Exp. 500
Office Salaries 1,800
Printing & Stationery 400
Selling Expenses 2,500
Prepare a cost sheet.
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Solution:
Cost Sheet
(For the month of August 2009)
(Output: 1,000 units)
Particulars Total Per Unit
Rs. Rs.
Direct Material 12 000 12.00
Wages 10,000 10.00
Prime Cost 22,000 22.00

Factory Overheads :
Factory Rent & Taxes 1,000 1.00
Depreciation on Machinery 1,000 1.00
Supervisor’s Salary 2,000 2.00
Indirect Material 500 .50
Indirect Labour 300 0.30
Other Factory Expenses 500 0.50
Factory Cost 27,300 27.30

Office Overheads :
Office Expenses 1,500 1.50

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Office Salaries 1,800 1.80

Printing & Stationary 400 0.40
Office Cost or Cost of Production
Selling overheads:
Selling Expenses

Total cost and cost of sales

31,000 31.00

2,500 2.50

33,500 33.50

Illustration 4
During march 2009, Thakkar Ltd had produced 5,000 units of motor parts . The following cost
were incurred on its production:
Direct material 1,20,000 Office saleries 40,000
Direct labour 1,80,000 Sales salaries 60,000
Factory rent 30,000 Carriage outward 10,000
Office rent 20,000 Delivery van Exp. 15,000
Showroom rent 40,000 Depericiation on plant 25,000
Power 15,000 Crane expenses 20,000
Light 6,000 Depreciation on office 5,000
exp.
Factory exp. 8,000 Direct factory exp. 40,000
Non productive wages 50,000 Counting house salary 6,000

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Advertisement 50,000 Drawing office salary 8,000

Sales commission 20,000 Gas & water 3,000
Bad debts 9,000 Cash discount allowed 500
Manager’s salary 15,000 Loose tools 400
(2/3 factory,1/3 office)
Interest on capital 5,000 Sales 8,50,000
Estimating expenses 500 Haulage 1,000

Prepare a statement of cost sheet giving all details regarding various components of cost.

Solution
Statement of cost
(For the month of March)

Particular Cost Total Cost

Direct material 1,20,000
Direct labour 1,80,000
Direct factory expenses 40,000
PRIME COST 3,40,000
FACTORY OVERHEADS OR WORK IN
PRODUCTION
30,000

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Factory rent 15,000

Power 8,000
Factory expenses 50,000
Non- productive wages 10,000
Managers salary(2/3) 25,000
Depreciation on plant 20,000
Crane expenses 3,000
Gas &water 400
Losse tools 1,000
8,000
Haulage 1,70,4000
Drawing office salaries 5,10,400
FACTORY COST
20,000
OFFICE OVERHEADS
6,000
Office rent
5,000
Light
40,000
Managers salary(1/3)
5,000
Office salaries
6,000
Depreciation on office equipment
82,000
Counting house salaries
5,92,400

COST OF PRODUCTION OR OFFICE COST

SELLING &DISTRIBUTION OVERHEADS

500
Estimating expenses
40,000
Showroom rent
50,000
Advertisement
20,000
Sales commission
9,000
Bad debts
60,000

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Sales salary 10,000

Carriage outward 15,000
Delivery van expenses

COST OF SALES
PROFIT
2,04,500
SALES
7,96,900
53,100
8,50,000

ILLUSTRATION 5
From the following information relating to the production of commodity ‘X’ you are required to
ascertain:
(a) Value of material used, (b) cost of production (c) cost of sales (d) net profit and (e) profit per ton
of commodity
Rs.
Purchase of raw material 1,32,000
Carriage inward 1,580
Rent, rates &insurance of factory 44,000
Opening stock of raw materials 22,000
Opening stock of finished goods (800 tons) 17,600
Closing stock of raw materials 24,460
Closing stock of finished goods (1,600 tons) 35,200
Work in progress opening 5,280
Work in progress closing 17,600
Sale of finished products 3,30,000
Cost of factory supervision 8,800
Direct wages 1,10,000

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Discount allowed advertisement and selling expenses amount to 75 paise per ton sold, 12,800
tons of commodity were produced during the period.
Solution Statement of cost
Particular Rs. Rs.
Opening stock of raw materials 22,000
+ Purchase 1,32,000
+ carriage inward 1,580
1,55,580
- Closing stock of raw materials 24,460
Value of material used 1,31,120
Direct wages 1,10,000
PRIME COST
2,41,120

Work Overhead:
44,000
Rent, rates, insurance, etc.
8,800
Cost of factory supervision
52,800
5,280
+ Opening stock on work In progress
2,99,200
17,600
-Closing stock of work in progress
2,81,600
WORKS COST
-----
Office Overhead:
2,81,600
Cost of production 12,800
17,600
Add opening stockof finished goods 800
2,99,200
35,200
13,600
2,64,000
Less closing stock of finished goods 1,600
Cost of goods sold Tons
12,000
9,000
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Selling Overhead 2,73,000

Selling exp., advertising and discount etc. 57,000
@75 paisa per ton on 12,000 tons 3,30,000
Cost of Turnover or Sales
Net Profit
Sales of Finished Goods
57,000
(a) Net profit per ton = Rs. 4.75
12,000

Illustration 6
A company manufactures two types of pens namely ‘Hero” & ‘Raja’. Following are the details of
cost for the year ended as on 31st march 2009:
Direct material 1, 30,000
Direct labour 1, 10,000
Production overheads 75,000
Following additional information is given:
I. The direct material in Raja pen was 40% of that in hero pen
II. The direct labour cost in Hero pen was twice as much as that in Raja pen.
III. Production overhead per pen was in the ratio of 5:3 (Hero: Raja)
IV. Administration overheads for each type of pen was 100% of direct labors cost.
V. Selling & distribution overheads were Re. 1 per pen.
Following was the production & sales of pen during year.
Particular Production Sales Rates
Hero pens 20,000 18,000 @Rs.22.00
Raja pens 15,000 14,000 @Rs.14.00

Prepare a statement showing the cost details & profit per pen of each type.
Solution:
Particular Hero pens ( 20,000) Raja Pens (15,000)
Total Per pen Total Per pen
Direct material 1,00,000.00 5.00 30,000.00 2.00
Direct labour 80,000.00 4.00 30,000.00 2.00
Prime cost 1,80,000.00 9.00 60,000.00 4.00

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Production overheads 46,875.00 2.34375 28,125.00 1.875

Work cost 2,26,875.00 11.34375 88,125.00 7.875
Administration overhead 80,000.00 4.00 30,000.00 2.000
Cost of production 3,06,875.50 15.34375 1,10,250.00 7.875
Less ; closing stock 30.687.50 - 7,875.00 -
Cost of goods sold 2,76,187.50 15.34375 1,10,250.00 7.875
Selling &distribution
overheads 18,000.00 1.00 14,000.00 1.00
Cost of sales 2,94,187.50 16.34375 1,24,250.00 8.875
Profit 1,01,812.50 5.65625 71,750.00 5.125
Sales 3,96,000.00 22.00 1,96,00.00 14.00

Illustration 7
The following figures are collected from the books of Iron Foundry after the close of the year:
Raw Material
7,000
• Opening stock in the beginning of the year
50,000
• Purchase during the year
5,000
• Closing stock at the end of the year
10,000
• Direct wages

▪ Works overhead -50% of direct wages

▪ Store overhead on cost of material consumed 10%
▪ 10% of the casting were rejected being not upto specification and a sun of Rs. 400 was
realised on sale as scrap.
▪ 10% of the finished casting were found to be defective in manufacture and were rectified
by expenditure of additional work to overhead charged to the extent of 20% on the
proportionate direct wages.
▪ The total gross output of casting during the year 1000 ton
Find out the manufacturing cost of the saleable per ton.

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Solution
Particular Quantity in ton Amount
Opening stock of raw material 7,000
Add: Purchases during the year 50,000
57,000
Less : closing stock of raw materials 5,000
Raw material consumed 52,000
Direct wages 10,000
Prime cost 62,000
Work overhead ( 50% of direct wages) 5,000
Stores overhead (10% on the cost materials 5,200
consumed) 1,000 72,200
Total cost of gross output 100 400
Less: sale of rejected casting
900 71,800
Cost of finished casting
Additional work overhead
Cost of rectifying 10% of the finished casting found
defective to the extent of 20% of the proportionate direct
wages 180*

Manufacturing cost a saleable casting :

(per ton Rs. 79.98 of 80 per ton appox.) 900 71,980
* 10% of finished casting in 90 ton. These 90 ton have been rectified by increasing works overhead
to the tune of 20% of the proportionate direct wages i.e,
90
𝑅𝑠. 10,000 × 20% × = 𝑅𝑠. 180
1,000
SELF CHECK QUESTION
1. What are the characteristics features of Unit Costing?
2. What is Output Costing? To what types of concerns is this method suitable?
3. What are Cost Sheets? What are their advantages? How do they differ from Cost
Accounts?
4. What is a Cost Sheet and why is it prepared? Prepare a cost sheet with imaginary
figures.
5. Define Cost Sheet? How does Cost Sheet differ from Cost Statements?

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PRACTICAL QUESTIONS
1. Following data has been drawn from the records of Centre Corporation for the period from
Jan. 1 to Jan. 31,2005.
2005 2005
1st Jan. 31st Jan.

Cost of raw materials 60,000 50,000

Cost of work-in progress 24,000 30,000
Cost of finished goods 1,20,000 1,10,000
Transaction during the month
Purchase of raw materials 90,000
Wages paid 4,60,000
Factory Overheads 1,84,000
Administration Overheads 60,000
Selling overheads 40,000
Sales 18,00,000
Draft the cost sheet.
ANS. PRIME COST RS. 13,70,000, WORKS COST RS.15,48,000,COST OF PRODUCTION RS.
16,08,000, COST OF GOODS SOLD RS. 16,18,000; COST OF SALES RS.16,58,000
2. From the following information extracted from the records of the M/s Sundaram &Co. The
stock position of the firm is:
Particulars Rs. 1-4-1994 Rs. 31-3-1995
Stock of raw materials 80,000 1,00,000
Stock of fininshed goods 2,00,000 3,00,000
Stock of work-in-progress 20,000 28,000

Particulars Rs. Particulars Rs.

Indirect labour 1,00,000 Administartive expenses 2,00,000
Oil 20,000 Electricity 60,000

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Insurance on fixtures 6,000 Direct labour 6,00,000

Purchase of raw materials 8,00,000 Depreciation on 1,00,000
Machinery
Sale of Commission 1,20,000 Factory rent 1,20,000
Salaries of Salesmen 2,00,000 Property tax on building 22,000
Carriage outward 40,000 Sales 24,00,000
Prepare cost statement of M\s Sundaram & Co.

3. Mr.Anand provides the following information which is related to the product of his
enterprise for the month of December 1995.
Particular Rs.
Raw materials consumed 30,000
Direct labour charges 18,000
Machine hours worked 1,800
Machine hour rate 10
Administrative overheads 20% on works cost
Selling overheads Re.1 per unit
Units produced 26,400 units
Units sold 25,000 units Rs.8 per unit

Draft the cost statement and determine the cost per unit, profit per unit sold and profit during
the period.
4. Prepare the cost sheet to show the total cost of production and cost per unit of goods
manufactured by a company for the month of january,2005.Also find the cost of sale and
profit.
Particulars Rs. Particulars Rs.
Stock of raw materials Factory rent and rates 6,000
1.1.2005 6,000
Raw materials procured 56,000 Office rent 1,000
Stock of raw materials General expenses 800
31.1.2005 9,000

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Direct wages 14,000 Discount on sales 600

Plant depreciation 3,000 Advertisement expenses 1,200
Loss on the sale of plant 600 Income tax paid 2,000
Sale RS. 1,00,000

5. From the following information,prepare the balance sheet from the cost records of Aditya
Chemicals Ltd. For 2009
Particulars Rs.
Finished goods on 1-1-2009 50,000
Raw material on 1-1-2009 10,000
Work in progress 14,000
Direct labour 1,60,000
Purchase of raw material 98,000
Indirect labour 40,000
Heat,light and power 20,000
Factory,insurance and Taxes 5,000
Repairs to plant 3,000
Factory Supplies 5,000
Depreciation-factory building 6,000
Depreciation-plant 10,000
Factory cost of goods produced in 2009 2,80,000
Raw materials consumed in 2009 95,000
Cost of goods sold in 2009 1,60,000
No office and administration expenses were incurred during the year 2009.Prepare a statement
of cost for the year ending 2009 giving maximum possible information and its break up.
6. The pen manufacturing company is producing two types of pen – Deluxe and popular. The
manufacturing costs of the year ended 31st march 2008 were:

Particular Amount
Direct material 2,00,000
Direct wages 1,12,000

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Production overhead 48,000

It is ascertained that:
(i) Direct materials in Deluxe type cost twice as much as that of Popular type.
(ii) Direct wages of Popular type were 60 percent of those for Deluxe type.
(iii) Production was 30 paise per pen for both types.
(iv) Administration overhead for each type was 200 per cent of direct labour.
(v) Selling cost was 25 paise per pen for both the types.
(vi) Production during the year was:
Deluxe type – 40,000 pens of which 36,000 were sold.
Popular type – 1,20,000 pens of which 1,00,000 were sold.
(vii) Selling prices were Rs. 7 per pen of Deluxe type and Rs. 5 per pen of Popular
type.Prepare a statement showing the total cost per pen of each type and the profit made on each
type.
Ans: cost per pen deluxe: Rs. 5.55; Popular Rs. 3.35; Profit per pen Rs. 1.45 and Rs.1.65
respectively
7. A manufactures Stools, chairs and tables. The material and wages costs are separated
as follows:
Particular Stool Chair Table

Material of each 3.6 6.00 44.00

Wages of each 4.8 4.00 12.00
Productions(units) 6,000 3,000 600

Total factory overhead Rs. 60,000

You are requested to determine the works cost of each type of furniture after assuming that one
table is equivalent to four stool and two chair are equivalent to one table for the purpose of factory
overhead allocation.
Ans. Stool Chair Table
Works cost 75,400 55,000 43,600
Ratio of factory overhead 5: 5: 2

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LESSON 8
TENDER PRICE
CONTEXT OF THE LESSON
This lesson deals with preparation of tender price where price is to be quoted for producing certain
article or product. The tender price is quoted considering the cost of the work to be done in future
and by adding a certain margin of profit to the cost. In order to determine the total estimated cost,
a manufacturer considers his past experience and past cost and also in addition, pays significant
attention and consideration to the possible changes in past cost (increase or decrease) in future
OBJECTIVE OF THE LESSON
To understand the meaning of tender, estimate and quotation
To deal with preparation of tender price
INTRODUCTION
Cost accounting helps in estimating the cost of job or order or service in advance. A producer or
a manufacturer may be required to supply in advance the tender price of a particular job or order
to a customer. This tender price is generally quoted by considering the estimated cost of the work
to be performed in future and by adding a certain margin of profit to the cost. To ascertain the
total estimated cost, a manufacturer not only considers his past experience and cost but also
pays significant consideration to the possible changes or fluctuation in the various elements of
cost (increase or decrease) which may likely take place in future. In order to quote an accurate
tender price, each element of cost of production should be carefully analyzed individually and all
indirect expenses or overheads should be classified into fixed, variable and semi-variable
expenses for the purpose of detail analysis. Tender price, estimated price or quotation price
should be determined carefully so as to be competitive. In brief the above three prices can be
explained as follows:
(1) Tender Price: A formal statement of price, at which the goods are agreed to be supplied or
work order is to be executed, which is sent in reply to an invitation is called tender. This term is
generally used in governmental transactions.
(2) Quotation Price: A statement of price that is quoted for a work order to be executed or service
to be rendered or goods to be supplied is called a “Quotation”. This term is generally used in other
than government transactions.

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(3) Estimation Price: An approximate price of` a work order or goods or service, calculated on
the basis of general opinion and judgment is called ‘Estimation’. While preparing estimation price,
the general work, views, opinions and personal judgments plays significant role. As a result, the
price so stated, would only be an approximate price.
In order to calculate Tender price or estimated price the following costs are taken into
consideration:
(a) Cost of Direct Material
(b) Cost of Direct Labour.
(c) Cost of Direct Expenses.
(d) Share of Factory Overhead.
(e) Share of Office & Administrative Overhead.
(f) Share of Selling and Distribution Overhead.
(g) Desired percentage of Profit.
In this way, tender price can be expressed as under:
Tender Price = Cost + Profit
DETERMINATION OF TENDER PRICE
Following points should be taken into consideration while determining a tender price:
(1) The quantity or units to be produced for which the tender price is to be quoted. In this regard
it should also be observed as to what change will be there in overheads which can be further
classified as fixed, variable and semi-variable. These changes should also be analyzed
considering whether there will be any change in size and type of product or units required.
(2) Past accounting records should be taken into consideration to know the previous cost. If there
is a change in the price of material, labour and expenses, it should accordingly be adjusted in the
tender price.
(3) Where per unit tender price has to be quoted, cost sheet is very helpful in this job as whatever
change has been there in any element of cost can be easily adjusted.
(4) Where a quotation is to be given for a job, then after determining the cost of direct material
and direct labour, overheads can be determined by charging it on a certain percentage to a
relevant basis and thus total cost can be determined whereby a certain percentage of profit can
be added.
(5) In order to determine tender price, a statement of cost is prepared where adjustment are made
in material, labour and overheads for prospect changes in price.
(6) For determining the tender price care should be taken whether the profit percentage to be
included in the tender is to be calculated on the basis of cost price or the selling price.

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Illustration 1
The following figures relate to the costing of a Tarpaulin manufactured in respect of a certain type of a
sheet for a period of three months:
Particular Amount
Stock of Materials 1st January 5,500
Stock of Materials 31st March 3,500
Factory Wages 83,000
Materials Purchased 61,500
Sales 1,41,500
Indirect expenses 13,000
Finished stock,1st January Nil
Finished stock ,31st March 29,000
The number of sheets manufactured during three months was 2,200 and the price is to be quoted for 648
sheets in order to realize the same percentage of profit as for the period under review, assuming no alteration
in rates of wages and cost of materials. Prepare a statement of cost for the manufacture of 2,200 sheets and
quotation for 648 sheets.
Solution: Statement of Cost
(For the period ending 31st March, 20…)
Total Cost of Cost per
2,200 Tarpaulin
Tarpaulin sheet
Particulars sheets Rs.
Rs.
Materials Consumed:
Opening of Materials 5,500
Purchase of Materials 61,500
67,000
Less: Closing stock of materials 3,500
Materials Consumed 63,500 28.86
Factory wages 83,000 37.73

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 COST ACCOUNTING

Particular Amount
Opening stock of Raw Materials 10,000
Closing stock of Raw Materials 5,000
Purchase of Raw Materials 15,000
Factory Expenses 10,000
Opening stock of Finished Goods 5,000
Sales 72,500
Factory wages 30,000
Office expenses 10,000
Closing stock of Finished goods 12,000
Prime cost 1,46,500 66.59
Indirect expenses 13,000 5.91
Cost of production
Less: Closing stock of Finished Goods 1,59,500 72.50
Cost of goods sold 29,000
Profit 1,30,500
11,000
Sales
1,41,500

11,000 × 100
Percentage of profit on Cost = = 8.429 = 8.43%
1,30,500
Quotation for 648 Sheets
Illustration 2
From the following data, prepare a cost and profit statement of Popular Stove Manufacturing
Company for the year 2008:

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500 stoves were manufactured during the year 2008.Company has to quote for the supply of
2,000 stoves in 2009.The proposed stoves are of uniform quality and make and similar to those
manufactured in the previous year, but the cost of materials has increased by 15% and the cost
of factory labour has increased by 10%.The same percentage of profit on cost as realized during
2008 has to be earned. Assuming that the cost per unit of overheads remains the same as in
previous year, prepare a statement showing quotation price.
Solution:Statement of Cost and Profit
(For the year 2008)
(500 stoves)
Particulars Total Per
stove
Opening stock of Raw Materials 10,000
Add: Purchase of Raw Materials 15,000
25,000
Less: Closing of Raw Materials 5,000
Materials Consumed 20,000
Factory wages 30,000
Prime cost 50,000
Factory expenses 10,000
Factory cost 60,000
Office expenses 10,000
Cost of production 70,000
Add: Opening stock of finished goods 5,000
75,000
Less: Closing stock of finished goods 12,000

Cost of goods sold

Profit 63,000
Sales 9,450
72,450
9,450×100
Percentage of profit on cost = 63,000
= 15%

Statement showing Quotation price for 2,000 Stoves

Materials @ Rs. 40 per stove 80,000

Add: Increase 15% 12,000
92,000
Factory wages @ Rs. 60 per stove 1,20,000
Add: Increase 10% 12,000 1,32,000

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Prime cost 2,24,000

Factory expenses@ Rs.20 per stov 40,000
Factory cost 2,64,000
Office expenses @ Rs.20 per stove 40,000
Cost of production 3,04,000
Profit 15% on Cost =3,04,000 X 15
100 45,600

Quotation Price
3,49,600

3,49,600
Quotation price per unit = = Rs. 174.80
2,000

Illustration 3
The following is the summarized Profit & Loss Account of Rajasthan Electric Company for the
half-year ending 30th June,2007.1,600 electric fans were manufactured and sold by the
company during the half-year:
Profit & Loss Account
(For the half-year ending 30th June, 2007)

Rs. Rs.
To Materials Consumed 64,000 By Sales 3,20,000
To Wages 96,000
To Manufacturing Expenses 40,000
To Gross Profit c\d 1,20,000
3,20,000 3,20,000

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Office Salaries 48,000 By Gross Profit 1,20,000

Rent & Taxes 8,000
Selling Expenses 16,000
General Expenses 24,000
Net profit 24,000
1,20,000 1,20,000
The following estimates were made by the costing department of the company for the next half-
year ending 31st, Dec, 2007.
(a) The output and sales will be 2,000 electric fans.
(b) The price of materials will rise by 25% on the previous half-year’s level.
(c) Wages during this period will rise by 12 1\2 %.
(d) Manufacturing expenses will rise in proportion to the combined cost of materials and
wages.
(e) Selling expenses per unit will remain unchanged.
(f) Other expenses will remain unaffected by the rise in output.
Prepare a statement showing the price at which each electric fan would be sold so as to ensure
a net profit of 10% on the cost price.

Solution: Cost Sheet

(For the half-year ending 30th June, 2007)
(1,600 Electric Fans)
Particulars Total Cost Per Fan
Rs. Rs.
Cost of Materials used 64,000 40.00
Wages 96,000 60.00

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Prime cost 1,60,000 100.00

Manufacturing Expenses 40,000 25.00
Works cost 2,00,000 125.00
Office & General Expenses:
• Office Salaries 48,000 30.00
• Rent & Rates 8,000 5.00
• General Expenses
24,000 15.00

2,80,000 175.00
Cost of Production
16,000 10.00
Selling Expenses
2,96,000 185.00
Cost of Sales
24,000 15.00
Profit
Sales 3,20,000 200.00

Statement of Estimate
(For the next half-year ending 31st Dec., 2007)
(Output 2,000 fans)
Particulars Total Cost Per fan
Rs. Rs.
Materials (2,000 X Rs.40) 80,000
Add:25% rise 1,00,000 50.00
20,000
Wages (2000 X Rs.60) 1,35,000 67.50
1,20,000
2,35,000 117.50
Add:12 1\2 % rise
15,000
Prime cost 58,750 29.375

Manufacturing Expenses
( 40,000 X 2,35,000) 2,93,750 146.875

1,60,000
Works cost
80,000 40.00

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Office & General Expenses 3,73,750 186.875

(Same in total as in previous 20,000 10.00
period(48,000+8,000+24,000)
3,93,750 196.875
39,375 19.687
Cost of production
Selling Expenses Rs.10 per unit
Cost of Sales
Profit(10% on cost)
Sales Price 4,33,125 216.562

Note: It has been stated in the question that manufacturing expenses will rise in proportion
to the combined cost of materials and wages, which means in the proportion of Prime cost.
That is why it has been calculated directly on Prime cost. Alternatively it can be calculated
as follows:
40,000
% of Manufactuirng Expenses on Prime Cost = = 25%
1,60,000

2,35,000 × 25
Hence, Manufacturing Expenses = = Rs. 58,750
100
Illustration 4:
A manufacturer of Scooter finds that in the year 2006 it costs him Rs.6,16,000 to manufacture
200 scooters which he solds at Rs.4,000 each. The cost was made up:
Materials 2,00,000
Direct Labour 3,00,000
Factory Overheads 60,000
Office Overheads 56,000

For the year 2007 his estimates are:

(i)That each scooter will require materials to the value of Rs.1,000 and an expenditure on
wages Rs.1,500.
(ii) That factory overheads expenses will bear the same relation to direct wages as in the
previous year.

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(iii) That the percentage of factory overheads on factory cost will be the same as in the
previous year.
Prepare a statement showing the profit he should make if he increases the price of the
scooter by Rs.80.
Solution:Statement of Cost (for 2006)
Rs.
Materials 2,00,000
Direct Wages 3,00,000
Prime Cost 5,00,000
Factory Overheads 60,000
Factory Cost 5,60,000
Office Overheads 56,000
Total Cost 6,16,000

(i)Percentage of Factory Overheads on Wages:

60,000 × 100
= 20%
3,00,000
(ii) Percentage of Office Overheads on Factory Cost:

56,000 × 100
= 10%
56,000

Statement of profit (for 2007)

Rs
Materials 1,000
Direct Wages 1,500
Prime Cost 2,500
Factory Overheads (20% of Wages) 300
Factory Cost 2,800
Office Overheads (10% of Factory Cost)
280

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3,080
Total Cost 1,000
Profit (Bal. Fig.)

Increase Selling Price(4,000+80) 4,080

SELF CHECK QUESTION

1. Define a cost sheet and explain how a cost sheet helps in finding out tender price. Elucidate with the
help of an example.
PRACTICAL QUESTION
1. The following figures relate to the costing of a manufacturer of electric fans for a period of 3 months
ending 31st Dec., 2006.

Completed stock on 1st Oct., 2006 Nil

Competed stock on 31st Dec., 2006 20,250
Stock of raw materials 1st Oct., 2006 5,000
Stock of raw materials 31st Dec.,2006 3,500
Factory wages 75,000
Indirect charges 12,500
Materials purchased 32,500
Sales 1,12,500

The number of fans manufactured during the 3 months was 3,000.Prepare a statement showing the cost per
fan and the price to be quoted for 750 fans to realise the same percentage of profit as was realized during
the three months.
Ans. Cost per fan Rs.40.50; Quotation for 750 fans Rs.33, 750.
2. The following in formations are extracted from the books of a Blanket manufacturer who intends to
quote for the supply of 5,000 Blankets. Prepare a statement showing what price he should quote so that
he may get the same percentage of net profit on turnover which he got during the last year for which
the particulars are given:

Stock of materials on 1st April, 2006 1,00,000

Material purchased during the year 1,50,000

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Factory Wages 3,00,000

Indirect Expenses 50,000
Sales 5,40,000
Stock of Materials,31st March,2007 14,000
Completed stock in hand on 1st April, 2006 Nil
Completed stock in hand on (2,047 Nos. of Blankets) 1,00,000
Output during the year (Blankets) 12,000
Provision has to be made in the estimate for the expected increase of 10% in the cost of factory labour and
5% in the material cost.
Ans. Tender price Rs.2,92,963. (if it is assumed that indirect expenses are based on factory wages, i.e.
16.67%),Rs.2,90,672(if it is assumed that indirect expenses are fixed per unit.
3 .Crystal Cold Private Limited manufactured and sold 200 Fan coolers in the year ending 31st March,
2007.The summarized Trading and Profit and Loss Account is given below.
Rs. Rs.
Cost of Materials 16,000 Sales 80,000
Direct Wages 24,000
Factory Expenses 10,000
Gross Profit 30,000
80,000 80,000
Management and staff salaries Gross Profit 30,000
Rent, Rates and Insurance 12,000
Selling Expenses 2,000
General Expenses 8,000
Net Profit 6,000
2,000
30,000 30,000
For the year ending 31st March, 2008 it is estimated that:
(a) Output and sales will be 300 Fan coolers.
(b) Price of Raw Materials will rise by 25% on the previous level.
(c) Wages will rise by 10%
(d) Factory on cost will rise in proportion to the combined cost of materials and wages.
(e) Selling on cost per unit will remain unchanged.
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(f) Rent, Rates and Insurance will be reduced by 25% per unit.
(g) Other expenses will remain unaffected by rise in output.
You are required to submit a statement for the board of Directors showing the price at which the Fan
coolers should be quoted so as to show a profit of 20% on the selling price.
Ans. Year Prime cost Work cost Cost of production Total cost
31.3.07(Rs.) 40,000 50,000 70,000 78,000
31.3.08(Rs.) 69 ,600 87,000 1,07,250 1,19,250
Total Selling Price (31.3.08) =Rs.1,49,062.50
Selling Price per fan =Rs.496.87.
4. The accounts of Saraf Co.Ltd. show the following information for the year 31st March, 2007:
Materials used 70,000
Direct Wages 54,000
Works Overheads 16,200
Establishment and General Expenses 11,216

Calculate:
(1)Works cost;
(2)Total cost of manufacture:
(3)The percentage that works overheads bear to direct wages:
(4) Establishment and General Expenses as percentage work cost.
What price should the company quote to manufacture a machine which, it is estimated, will require an
expenditure of Rs.720 on materials and Rs.600 on wages so that it will yield a profit of 15% on the
total cost.
Ans.(1)Rs.1,40,200 (2)Rs.1,51,416,(3) 30%,(4)8%,Quotation price for a machine Rs.1,863.
5. The under-mentioned figures have been collected from the books of a company.
Cost of materialRs.4,00,000, Cost of labour Rs.3,00,000, Factory Charges Rs.1,50,000,
Administration Charges Rs.1,70,000, Selling Charges Rs.42,500, Distribution Charges
Rs.42,500.
On the basis of the above figures, a work-order has been executed and the following expenses have
been incurred thereon:
Materials Rs.10,000, Labour Rs. 6,000
Factory overheads are based on Direct Wages, Administration, Selling and Distribution charges are
based on factory cost. Assuming that the factory overheads have gone up by 10% and other overheads

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expenses maintaining the same percentages and the profit charged is 20% 0n total cost, find the total
price of the work-order .
Ans .Prime cost Rs,7,00,000;Factory cost Rs.8,50,000;Cost of production Rs.10,20,000;Total cost
Rs.11,05,000;Percentage of factory overheads on Direct wages 50%;Percentage of Administration
Expenses 20%, Selling Expenses 5%,Distribution Expenses 5% on works cost; Quotation price
Rs.30,108.
6. The Managing Director of a Company consults you as to the minimum price at which he can sell the
output of one of the department of the company which is intended to go for mass production in future.
The company’s records show the following particulars for this department for last year:
Particular Amount
Production & Sales 100 units
Materials 7,500
Direct Wages 5,000
Direct Expenses 5,000
Factory Overheads 2,500
Office Overheads 1,200
Selling Expenses 8,00
Profit 2,500
20,000
It is ascertained from the records that 70% of factory overheads fluctuate directly with production and
50% of selling expenses fluctuate with sales. Direct wages per unit will be reduced by 30% while fixed
factory overheads will increase by 1,000.Office overheads and fixed selling expenses are expected to
show an increase of 25%.Besides there, no other changes are anticipated.
It is expected that the department would produce and sell 1,500 units per annum. Prepare a statement
for submission to your client.
Ans. Total Sales Value Rs.2,38,285;Selling price per unit 158.86 after charging the same rate of profit
as last year. Material per unit Rs. 75; Direct wages per unit Rs.35;Factory overheads-Fixed Rs.
1,750(750+1,000),Variable factory overheads per unit Rs.17.50;Office overheads total
Rs.1200+300=Rs. 1,500,Selling expenses Fixed Rs.400+100=Rs 500,Variable selling expenses per
unit Rs 4.

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LESSON 9
RECONCILIATION STATEMENTS
CONTEXT OF THE LESSON:

Through this lesson we will understand why there is difference in the profit disclosed by the
financial books of accounts and cost accounts. Further the lesson will focus upon the procedure
of reconciliation of profits of the two sets of books of accounts.

OBJECTIVES OF THE LESSON

1. Meaning of reconciliation statement.

2. Necessity of reconciliation
3. Reason for disagreement among the profits of cost account and financial accounts.
4. To deal with practical problem.

INTRODUCTION

The objective of financial accounts is to ascertain the profit or loss of the concern as whole for the
accounting period under review and also to determine the financial position of the concern at the
end of the financial year. The financial accounts deals with the recording, classification and
summarization of business transaction of the concern and ends up with preparation of final
statements viz. profit and loss accounts and balance sheet for the accounting period.
Cost accounting on the other hand deals with the ascertainment of cost of product, absorption of
overheads into product cost and determination of profitability on either segment wise or division
wise or product wise etc,.
Different sets of books of accounts are maintained under both the branch of accounting i.e.
financial accounting and cost accounting. Furthermore, both the accounting system follows to
some extent different sets of accounting principles, methods and approaches and practices. The
maintenance of different sets of books of accounts with different objects results in depicting
different results as regards to profit or loss in cost accounts and financial accounts. Therefore, it
highly necessitates for the reconciliation of the two set of accounts periodically and preparation
of a statement of reconciliation to show the reasons or causes for difference in profit or loss as
shown by cost and financial accounts.

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NECESSITY FOR RECONCILIATION:

The various reasons which necessiates for carrying out the process of reconciliation of cost and
financial accounts are as follows: -
• The major reasons for difference in profit or loss in cost accounts and financial accounts
is traced and analysed. These reasons for deviations can be further used for controlling
and managing efficiently the various operations.
• The accuracy of cost accounting methods, techniques and approaches adopted by the
concern can be verified with the financial accounts. For e.g. methods of absorption of
overheads, basis of providing depreciation allowance, inventory valuation etc.
• The reliability of cost accounting data and financial accounting data is verified by
reconciling both the accounts.
• The process of reconciliation helps in standardization of various accounting policies.
• It helps to establish co- ordination and co-operation between financial and costing
department in generating accurate and reliable accounting data to fulfill the statutory
requirement and for taking various managerial decisions.
• It helps the management in identification of reasons for deviation in profit between costs
accounts and financial accounts for internal control and efficient management of
operations.
REASONS FOR DISAGREEMENT
The difference in profit or loss ascertained in cost accounts and financial accounts is due to the
following reasons
(I) Items only shown in financial account and which does not appear in cost accounts: There are
certain items of expenses and income which are of purely financial in nature. These items are not
shown in the books of cost accounts as a result the profit and loss as shown by financial sets of
books of account varies. These items are:
(a) Profit or loss on sale of fixed assets
(b) Discounts on issue of redemption of shares and debenture.
(c) Capital issue expenses
(d) Preliminary expenses written off
(e) Receipts of interest and dividend on investment
(f) Cash discount and bad debts.
(g) Miscellaneous income or expenditure not relating to business.
(h) Distribution of dividends

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(i) Payment of income tax

(j) Donations
(k) Transfer of profits to reserves
(l) Goodwill written off
(m) Expenses relating to previous year
(n) Profit or loss relating to transactions of abnormal or non- recurring nature
(o) Lay off wages and retrenchment compensation.

(II) Items only shown in cost accounts which do not appear in financial accounts: There are certain
items which do not appear in the financial sets of books of account but are taken into consideration
in cost books for taking any managerial decisions. These are:
(a) Notional rent on premises owned
(b) Notional rent on capital.

(III) Disagreement due to under or over absorption of overhead items: In financial accounts the
overheads are recorded on actual basis. However, in cost accounts for ascertainment of cost of
the product or cost unit estimated overheads are taken into consideration. These overheads are
predetermined overheads absorption rates like machine hour rate, direct labour hour rate,
percentage of direct material, direct material, direct labour, prime cost, factory overhead, etc. are
used for over absorption of overheads. Hence, the absorption of overheads in cost accounts may
be under or over recovered than the actual overheads incurred.
(IV) Change in the method of stock valuation:
(a) In financial accounts, the stocks of raw material are valued at cost or market price
whichever is lower. However in cost accounts stock may be valued under FIFO, LIFO,
simple average methods, etc.
(b) The finished goods are valued under absorption costing method in financial accounts. In
preparation of cost account, the stocks may be valued under absorption costing, marginal
costing, and standard costing.

(V) Difference due to use of different rates of depreciation:

In financial accounts the amount of depreciation is charged as par the rates given in the
Companies Act, 1956, but in cost accounts, appreciation and suitable method is used for
calculation of the amount of depreciation.
SELF CHECK QUESTION
1. What do you understand by reconciliation statement

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2. What is the necessity for reconciliation of profit as shown by financial accounts and cost
accounts?
3. Explain the causes of difference among the profits as shown by financial and cost books.
METHOD OF PREPARING RECONCILATION STATEMENT
In order to prepare a reconciliation statement, profit shown by any one set of accounts can be
taken as base and items of difference are either added to it or deducted from it to arrive at the
figure shown by other set of accounts:
PARTICULARS AMOUNT AMOUNT
Profit/Loss as per Cost Accounts XXX
Add: Income Not Considered In Cost Accounts
• Trading profit XXX
• Profit from other activities XXX
• Income from investment XXX
• Income relating to previous years XXX
• Profit on sale of investment XXX
• Profit on sale of raw material XXX
• Abnormal/Non-recurring income XXX
XXX
Less: Expenses not considered/short considered in cost
account
XXX
• Abnormal losses
XXX
• Expenses relating to previous years
XXX
• Lay off wages
XXX
• Retrenchment compensation
XXX
• Difference in depreciation, if any
XXX
• Delayed payment charges for power bill
Add/less: Difference in opening and closing stocks as XXX
per financial accounts and cost accounts
Finished goods stock
XXX
Work in progress
XXX
XXX

Profit (loss) as per Financial Accounts

XXX

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 COST ACCOUNTING

Memorandum Reconciliation Account: It is an account not being a part of double entry system
of book keeping. It is simply a method by which a record can be difference in cost account and
financial accounts, in order to show by their respective profit figures are different. The debit and
credit of normal account will not apply in preparation of memorandum reconciliation accounts. In
this statement profit under one set of accounts is taken as opening balance and all items of
difference required to be deducted are debited and those to be added are credited to this account.
The balancing figure of this account is the profit shown by other set of accounts.
PERFORMA MEMORANDUM RECONCILIATION A/c
Particulars Amount Particulars Amount
To Under absorption of By profit as per cost accounts XXX
overheads in cost accounts
XXX By over absorption of overheads XXX
To under valuation of opening in cost accounts
stock in cost accounts
By items only charged in cost
To over valuation of closing accounts
stock in cost accounts XXX XXX
• Interest on own capital
To items only charged in
• Rent on own building XXX
financial accounts
• Brokerage
XXX By over valuation of opening
• Underwriting
XXX stock in cost accounts XXX
commission
XXX By under valuation of closing XXX
• Donation
stock in cost accounts
• Income tax XXX
By incomes received only
• Goodwill written off XXX XXX
credited in financial accounts
• Preliminary expenses XXX

• Written off XXX XXX

Interest, rent , dividend received
• Discount on issue of XXX
redemption of share
By profit on sale of assets
To net profit as per financial XXX credited in financial accounts XXX
accounts

XXX

Illustration 1
The net profit of the Bharat Company Pvt. Ltd was Rs. 1, 28,755 as per financial record for the
year ended 31st December 2008. The cost books however showed a net profit of Rs. 1, 72,400
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for the same period. A scrutiny of the figure from both the sets of accounts revealed the following
facts:-

• Works overheads under-recovered in cost 3,120

• Administration overheads recovered in excess 1,700
• Depreciation recovered in cost 12,500
• Depreciation charged in financial accounts 11,200
• Interest on investment not included in cost 8,000
• Loss due to obsolescence in financial accounts 5,700
• Income tax provided in financial accounts 40,300
• Bank interest and transfer fees( in financial books) 750
• Stores adjustments ( credited in financial books) 475
• Loss due to depreciation in stock values (charged in financial account) 6,750
You are required to prepare a Reconciliation statement to reconcile both the figure of the net
profits. Also show the memorandum Reconciliation Account
Reconciliation Account
Particular Rs. Rs.

Profit as per Cost Account 1,72,400

Add:-
Administration overheads recovered in excess 1,700
Depreciation recovered in cost 12,500
Depreciation charged in financial accounts 11,200 1,300
Interest on investment not charged in cost accounts 8,000
Bank interest and transfer fees not charged in cost accounts 750
Stores adjustments ( credit in financial books) 475 12,225
1,84,625
Less:
Works overheads under-recovered in cost 3,120
Loss due to obsolescence 5,700
Income tax 40,300
Loss due to depreciation in stock values 6,750
55,870

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 COST ACCOUNTING

Net profit as per Financial Accounts 1,28,755

MEMORANDUM RECONCILIATION ACCOUNT

(As at 31-12-2008)
Rs. Rs.
To Works overheads under- 3,120 By Net profit as per cost a/c 1,72,400
recovered in cost
By Administration overheads
To Loss due to obsolescence recovered in excess
5,700 1,700
To Income tax By Depreciation recovered in
40,300
Cost a/c 12,500
To Loss due to depreciation in
6,750
stock values Fin. a/c 11,200
1,300
To net Profit as per Financial By Interest on investment
Accounts 1,28,755 8,000
By Bank interest and transfer
fees
1,84,625 By Stores adjustments 750
475

1,84,625

Illustration 2
The cost book of Mr. Ravi Sen for the year 2006 shows a profit of Rs. 50,255. The profit
disclosed by his financial book is Rs. 31,200. The following information is gathered through
the observation of accounts: -
• Payment for income tax was Rs. 15,000 in financial accounts.
• Bad debts amounted of Rs. 2,000 in financial books
• Factory overheads in cost accounts were Rs. 15,000 while the actual overhead was Rs.
12,255.
• Transfer fees received was Rs. 1,200.
• Rs. 1000 was paid for directors fees
• Plant costing Rs. 50,000 was installed but not yet used. Depreciation @10% was charged.

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 COST ACCOUNTING

You are required to prepare a statement reconciling cost accounts profit with profit of financial
accounts

Reconciliation Account
Particular Rs. Rs.
Profit as per cost book 50,255
Add:-
Factory overheads 2,745
Transfer fees 1,200 3,945
Less: 54,200
Income tax not charged to cost accounts 15,000
Director’s fees 1,000
Bad Debts 2,000
Depreciation on plants 5,000 23,000

Net profit as per Financial Accounts

31,200

Illustration 3
From the following particulars, prepares (a) profit & loss accounts (b) a statement of cost of
manufactures calculating overhead at 25% of prime cost and office overhead at 75% of factory
overhead, (c) a statement reconciling the profit shown by the cost accounts with that shown by
the financial accounts. The selling price is fixed at cost + 25%.
Stock on 1st January 2008
Raw material 4,000
Finished goods 8,000
Stock on 31st December 2008
Raw material 6,000
Finished goods 2,000
Purchase of raw material 24,000
Wages 10,000
Sales 65,000
Factory overhead 7,750

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Office expenses 6,100

Profit And Loss Account

Rs. Rs.
To opening stock By sales 65,000
Raw material 4,000 By Closing Stock
Finished goods 8,000 Raw material 6,000
To Purchase of raw material 24,000 Finished goods 2,000
To Wages 10,000
To Factory Expenses 7,750
To Office Expenses 6,100
To Net Profit 13,150
73,000

73,000
Statement of Cost and Profit

Opening stock of raw material 4,000

+ Purchase of raw material 24,000
28,000
- Closing stock of raw material 6,000
Raw material Used 22,000
Wages 10,000
Prime Cost 32,000
Factory overheads(25% of prime cost) 8,000

Factory Cost 40,000

Office overheads (75% of factory overheads) 6,000
Cost of Production Add: Opening stock of finished goods 46,000
8,000
Less: Closing stock of Finished goods 54,000
2,000
Profit 52,000
Sales 13,000
65,000

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Reconciliation Statement
Particular Rs. Rs.
Profit as per cost accounts 13,000
Add:
Factory overheads over charged in Cost Accounts (Rs.8,000-7,750) 250
13,250
Less:

Office overheads under charged in cost accounts ( Rs. 6,000- 6,100)

100
Profit as per P/L A/c

13,150

Illustration 4
For the year 2008, the profit as per cost accounts of ABC Company has been estimated to be Rs.
23,063 but the profit and loss account as prepared by the auditors shows Rs.16,624 from the
following information, prepare a Reconciliation statement showing the causes of differences:
Rs. Rs.
Material Sales 3,46,000
Opening Stock 2,47,179 Sundry Incomes 316
+ Purchase 82,154
3,29,333
-Closing stock 75,121

2,54,212
Direct Wages 23,133
Office Expenses 20,826
Factory Expenses 9,845
Selling expenses 22,176

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Profit 16,624

3,46,814
3,46,814

Cost records shows (i) closing balance of stock ledger Rs. 78,197; (ii) summary of wages shows
wage payment Rs. 24,867; (iii) factory overhead Rs. 19,714; (iv) Office overhead are charged at
3% of sales value; (v) selling expenses charged at 5% of sales value; (vi) Sundry incomes not
shown in cost accounts.
Solution Reconciliation Statement
Particular Rs. Rs.
Profit as per cost book 23,063
Add:-
i. Wages over charged (24,867-23,133) 1,734
ii. Office overhead over recovered (10,395- 9,845) 550
iii. Sundry income not shown in cost accounts 316 2,600
Less:
i. Over valuation of stock (75,197- 75,121) 3,076
ii. Factory overhead under recovered (20,826-19,714) 1,112

iii. Selling expenses under recovered (22,176-17,325) 4,851 9039

Net profit as per Financial Account 16,624

SELF CHECK QUESTION
1. There is a difference between the profit shown by cost accounts and the profit shown by
financial accounts of a business concern. Explain the reasons for the difference by giving
examples?

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2. State the reasons for disagreement between the costing and financial result. Prepare an
imaginary reconciliation statement?

PRACTICAL QUESTION:
1. The net profit disclosed by a company’s cost accounts for the year was Rs, 30,114 while
the net profit as shown by the financial accounts amounted to Rs. 19,670 due to the following
reasons:
(a) Overheads in the cost accounts amounted were estimated at Rs. 7,500 however the
charges for the year shown by the financial accounts was Rs. 6,932.
(b) Directors fees not charged in the cost accounts amounted to Rs. 750.
(c) General provision for bad debts, Rs. 600
(d) A new factory of Rs.12, 000 was installed this year, on which depreciation of 5% was
provided for in the financial accounts.
(e) Transfer fees received amounted to Rs 28.
(f) Income tax charged Rs. 9,000.
2 The net profit of Kamal manufacturing Co. Ltd. appeared at Rs. 64,377 as per the financial
records for the year ended 31st December 2008. The cost book however showed a net profit of
Rs. 86,200 for the same period. A scrutiny of the figures from both the sets of accounts revealed
the following facts:
(a) Works overhead under recovered in excess (in cost) 1,560
(b) Administrative overhead recovered in excess 850
(c) Depreciation recovered in costs 6,250
(d) Depreciation recovered in financial accounts 5,600
(e) Interest on investment not included in costs 4,000
(f) Loss due to obsolescence charged in financial accounts 2,850
(g) Income tax provided in financial accounts 20,150
(h) Bank interest and transfer fees ( in financial books) 375
(i) Stores adjustment (credit in financial books) 237
(j) Loss due to depreciation in stock values (in financial account) 3,375

Prepare a statement showing the reconciliation between the figure of net profit as per cost
accounts and the figure of the net profit as shown in the financial books. Also prepare a
memorandum reconciliation account.

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3. From the following particulars prepare (a) a statement of cost of manufacture for the year
2007 showing the percentage which each individual items of cost bears to the cost; (b) a
statement of profit as per cost accounts and (c) profit and loss accounts in the financial books,
and show to what you would attribute the difference in the profit as shown by (b) and (c).
• Opening stock of raw materials 60,000
• Opening stock of finished articles 1,20,000
• Purchase of raw materials 3,60,000
• Stock of raw materials at the end 90,000
• Stock of finished articles at the ends 30,000
• Wages 1,50,000
Calculate factory overhead at 25% on prime cost and office overhead at 75% on factory overhead.
Actual works expenses amounted to Rs. 1,16,250 and actual office expenses amounted to Rs
91,500. The selling price was fixed at a profit of 20% of the selling price.

4. Mittal industry Ltd. financial accounts shows the following profit & loss A/c for the year
ending 31st Dec. 2008
Rs. Rs.
To Opening stock 2,47,179 By Sales 3,46,500
To Purchase 87,420 By closing stock 75,121
To Direct wages 24,867
To Factory Expenses 20,826
To Gross Profit c/d 48,329
4,21,621 4,21,621
To Administrative Expenses 9,845 48,329
By Gross Profit b/d
To Selling expenses 22,176 316
By Sundry Income
To Net Profit 16,224
48,645 48,645

The profit as per company cost accounts was Rs. 24,797; the following additional information is
available from costing record:
(a) Closing stock Rs. 78,197
(b) Factory overhead absorption Rs. 19,714
(c) Administration overhead absorption @ 3%of sales
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(d) Selling overheads @5% of sales

(e) No credit for sundry income was given
Prepare Reconciliation statement.

LESSON 10
CONTRACT COSTING - I
CONTEXT OF THE LESSON
Contract costing is a specialised system of job costing which is applied in long term contracts.
This chapter deals with the various items of cost and the procedure of recording cost incurred on
contracts and method to determine profit in case of incomplete contracts.
OBJECTIVES OF THE LESSON
To know the meaning of contract costing
To understand elements of cost in contract account
To deal with the methods for calculating profit or loss on contract accounts.
Meaning of Contract Costing:
Contract or terminal costing, as it is termed is one form of application of the principles of job
costing. Contract costing is that form of specific order costing which applies where work is
undertaken on the special requirements of customer and each order is of a long term period.
Contract costing is usually adopted in civil construction, engineering projects, ship building, road
and railways line construction, bridges etc.
Contract costing being a part of specific order costing method is applied where substantial time
is taken for completion of the work and which may even take several years to get itself completed.
However, some contract may even be finished within a short duration and may not involve more
than one accounting period. If the profit on contracts is recorded only after their completion, then
wide fluctuations in the profit may be noticed in different accounting periods. It may be possible
that in some financial year only few contracts may be completed and in any other financial year a
large number of contracts may be completed. To avoid the fluctuations in the reported profits and

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to reflect the revenue in the same accounting period during which the activity is undertaken the
profit in respect of each contract in progress is transferred to the profit and loss account of the
year by calculating the notional profit. The portion of notional profit to be transferred to the profit
and loss account depends on the stage of completion of a contract.
SELF CHECK QUESTION
1. What is the contract costing? Explain
2. Mention the type of job where contract costing is applied.
Procedure of contract costing:
Each contract is identified with a distinguished number for the purpose of accounting of cost and
administration. For each contract a separate account is prepared and all costs related to the
specific contract is charged to the respective contract. Contract cost generally includes a major
part of expenses of direct nature in the form of cost of material, wages, plants and stores and
direct expenses and some portion of indirect expense are apportioned as overheads. The items
of cost which is generally dealt in contract costing is discussed as below:
Material Cost :
All materials supplied for the contract from the stores or purchased directly for the contract are
debited to the concerned contract account.
The cost of material transferred from one contract to other contract, material returned to stores or
material lying at site is credited to the contract account.
If any material is sold then the concerned contract account is credited with the sale price. Any
profit or loss arising there from is transferred to the Profit and Loss Account.
Any theft or destruction of material by fire represent a loss and as such, the same is transferred
to the Profit and Loss Account.
lf any stores items are used for manufacturing tools, the cost of such stores items are charged to
the work expenses account.
If the contractee has supplied some materials without affecting the contract price, no accounting
entries will be made in the contract account, only a note may be given about it.
Labour Cost:
The labour actually employed or worked at the site of the contract is regarded as direct labour
(irrespective of the nature of the task performed) and the wages paid to them are charged to the
concerned contract directly or on the basis of a wage analysis sheet. The salaries and incentives
of the administrative and supervisory staff of a specific contract is also charged to that specific
contract.
Direct Expenses:
Direct expenses (if any) which are exclusively incurred for a specific contract are directly charged
to the concerned contract.

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Indirect Expenses:
Indirect expenses (such as expenses of engineers, surveyors, supervisors etc.) may be
distributed over several contracts as a percentage of cost of materials, or wages paid or of the
prime cost. lf however, the contracts are big, the labour hour method may be used for the
distribution of expenses.
Plant and Machinery:
If the plant is taken on hire then hire charges paid will be debited to the contract account.
In case if the plant is purchased specifically for the contract or plant was sent to a specific contract
then the value of the plant is debited to contract account and the written down value thereof at
the end of the year is entered on the credit side for closing the contract account. The difference
in the value debited and credited shows the value of plant used at site.
If in between the accounting period of the contract, any part of the plant is sold then the value of
plant sold is credited to the contract account and profit and loss arising due to sale is transferred
to the profit and loss account.
If any plant is damaged or returned to store, then the contract account is credited by its cost.
If a plant is to be used in the contract for a shorter period of time then the contract account is
debited by the amount of depreciation for the time the plant was used in the contract account.
Sub-Contract Cost:
When any job to be performed on a contract or a part of the contract is given to a other contractor
on sub contract basis then the payment made to the sub contractor is termed as Sub-contract
costs and such costs are also debited to the Contract Account.
Cost of Extra work:
When any extra work is requested by the contractee to be performed on the contract which was
earlier not included in the original contract then the cost of the extra work amount payable by the
contractee should be added to the contract price. If extra work is substantial, it is better to treat it
as a separate contract. lf it is not substantial, expenses incurred should be debited to the contract
account as "Cost of Extra work".
Cost of work certified:
Contractor receives payments on the contract periodically known as "running payment" on the
basis of the architect’s or surveyor’s certificates. These payments are not equal to the value of
the work certified which has been certified by the surveyor. A certain amount or a percentage of
the amount due is retained as security for any defective work which may be discovered later within
the guarantee period or to safeguard himself from the risks that may arise in future from the
contractor.
Mathematically:
Cost of work certified = Cost of work to date — (Cost of work uncertified + Material in hand +
Plant at site) The amount retained is called retention money. The full value of the work certified
should be credited to the Contract Account and debited to the account of the contract. Since the
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cash received from him will be less, the balance in his account will be shown as an asset in the
balance sheet.
Cost of Work uncertified: It represents the cost of the work which has been carried out by the
contractor but has not been certified by the contractee’s architect. It is always shown at cost price.
The cost of uncertified work may be ascertained as follows:
Particular Rs.
Total cost to date -----
Less:Cost of work certified -----
Material in hand -----
Plant at site -----
Cost of work certified -----
Retention money: A contractor does not receive full payment of the work certified by the
surveyor. Generally the contractee retains some amount (say 10% to 20%) to be paid, after
sometime, when it is ensured that there is no fault in the work carried out by contractor. If any
deficiency or defect is noticed in the work, it is to be rectified by the contractor before the release
of the retention money. Retention money provides a safeguard against the risk of loss due to
faulty workmanship.
Cash received: It is ascertained by deducting the retention money from the value of work certified
i.e.
Cash received = Value of work certified — Retention money.
Work-in-progress: In Contract Accounts, the value of the work-in-progress consists of (i) the
cost of work completed, both certified and uncertified; (ii) the cost of work not yet completed; and
(iii) the amount of profit taken as credit. In the Balance Sheet, the work-in-progress is shown under
two heads, viz., certified and uncertified. The cost of work completed and certified and the profit
credited will appear under the head ‘certified’ work-in progress, while the completed work not yet
certified and the cost of labour, material and expenses of work which has not yet reached the
stage of completion are shown under the head “uncertified" work-in-progress.

SELF CHECK QUESTIONS

1. What are the various types of cost which are debited in contract account.
2. What are the various items which are shown in credit side of contract account.
3. What do you mean by work certified and work uncertified.
4. What is retention money. What is the use of retention of money in contract accounts.
5. How is cost of plant shown in contract account. Discuss.

Calculation of Profit and Loss Account

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Notional profit: It represents the difference between the value of work certified and cost of work
certified. It is determined:
Notional profit = Value of work certified - (Cost of work to date — Cost of work not yet certified)
Estimated profit: It is the excess of the contract price over the estimated total cost of the contract.
Profit/loss on incomplete contracts: To determine the profit to be taken to Profit and loss
account the following conditions are taken into consideration:
(i) If completion of contract is less than 25% or less than one-fourth of the value of contract price:
In this case no profit should be taken into profit and loss account.
(ii) If completion of contract is up to 25% or more than 25% but less than 50% of the value of
contract: ln this case one-third of the notional profit, reduced in the ratio of cash received to work
certified, should be transferred to the Profit and Loss Account.
Mathematically:
1 Cash received
× Notional Profit ×
3 Work Certified
(iii) If the work completed on contract is up to 50% or more than 50% but less than 90%: In this
case, two-third of the notional profit, reduced by proportion of cash received to work certified, is
transferred to the Profit and Loss Account.

Mathematically:
2 Cash received
× Notional Profit ×
3 Work Certified
(iv) If completion of the work on contract is up to 90% or more than 90% i.e. it is nearing completion
- In this case the profit to be taken to Profit and Loss Account is determined by determining the
estimated profit. In order to calculate the estimated profit any one of the following formula can be
used which are as follows:
Work received
(a) Estimated Profit ×
Contract price

Work received Cash received

(b) Estimated Profit × ×
Contract price Work Certified
OR
Cash received
(c) Estimated Profit ×
Contract price

Cost of work to date Cash received

(d) Estimated Profit × ×
Estimated total cost Work Certified

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Work certified
(e) Notinal Profit ×
Contract price

(This formula may be preferably used in the absence of estimated profit figure.)
It is preferable to use formula (b) in the absence of specific instructions.

SELF CHECK QUESTIONS

1. Discuss the procedure of determining profit or loss in contract account.
2. What are the rules of calculating profit in case of incomplete contract.

Cost plus Contract: Under Cost plus Contract, the contract price is ascertained by adding a
percentage of profit to the total cost of the work. Such type of contracts are entered into when it
is not possible to estimate the contract cost with reasonable accuracy due to unstable condition
of material, labour services, etc.
Escalation Clause - If during the period of execution of a contract, the prices of materials, or
labour etc., rise beyond a certain limit, the contract price will be increased by an agreed amount.
Inclusion of such a clause in a contract deed is called an "Escalation Clause".
HOME ASSIGNMENTS
1. What is contract costing? What important points should be kept in mind in its preparation?
2. What is a contract account? What are the various items debited and credited in contract
accounts.
3. How is profit calculated in case of incomplete contracts? Discuss
4. Explain the following
a. Work Certified
b. Work Uncertified
c. Retention Money
d. Cost plus contract
e. Escalation Clause

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LESSON 11
CONTRACT COSTING - II
CONTEXT OF THE LESSON
This lesson deals with preparation of contract account in case of complete and incomplete
contracts. It also specifies procedure of calculation of profits in case of long term contracts.
OBJECTIVES OF THE LESSON
• To deal with numerical aspects of preparation of contact account.
• To calculate profits in case of incomplete contracts.

Illustration: 1
The following expenses were incurred on a contract:
Material purchased 6,00,000
Material drawn from stores 1,00,000
Wages 2,25,000
Plant issued 75,000
Chargeable expenses 75,000
Apportioned indirect expenses 25,000

The contract was for `20,00,000 and it commenced on January 1, 1998. The value of the work

completed and certified up to 30th November, 1998 was `13,00,000 of which `10,40,000 was

received in cash, the balance being held back as retention money by the contractee. The value

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of work completed subsequent to the architect’s certificate but before 31st December, 1998 was

`60,000. There were also lying on the site materials of the value `40,000. It was estimated that the

value of plant as at 31st December, 1998 was `30,000.

Solution :
Contract Account
Particular Amount Particular Amount
To Material purchased 6,00,000 By Work-in-progress:
Stores issued 1,00,000 Work certified 13,00,000
Wages 2,25,000 Work uncertified 60,000
Plant 75,000 Plant less depreciation 40,000
Chargeable expenses 75,000 Material unused 30,000
Indirect expenses 25,000
Profit and Loss
Account2/3rds of profit 1,76,000*
on cash basis
Work—in-progress
1,54,000
balance of profit c/d

14,30,000 14,30,000

13,00,000
Balance b/d Work
certified 60,000

Uncertified 40,000
30,000

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Material at site 14,30,000

Plant at site 1,54,000
12,76,000

Less: Reserves

*Computation of Profit : Rs.

Apparent profit 3.30,000
2/3rd of that since 65% of the work is complete 2, 20,000
80% of that on cash basis 1, 76,000

An alternative method of presentation can be to deduct the balance of profit to be carried down
(Rs. 1,54.000 in the above case) from the work certified before it is entered in the contract
account. It will be Rs. 1 1,46,000 in the illustration given above. Of course, the reserve to be so
deducted from the work certified will have to be first ascertained by considering the value of the
work certified.
Illustration: 2
A contractor prepares his accounts for the year ending 31st December each year. He commenced
a contract on 1st April, 2007.
The following information relates to the contract as on 31st December, 2007:

Material used 2,51,000

Labour charges 5,65,600
Salary to foreman 81,300

A machine costing Rs. 2, 60,000 has been on the site for 146 days, its working life is estimated
at 7 years and its final scrap value at Rs. 15,000. A supervisor, who is paid Rs. 8,000 p.m., has
devoted one-half of his time to this contract.All other expenses and administration charges
amount to Rs 1,36,500Material in hand at site costs Rs. 35,400 on 31st December, 2007.
The contract price is Rs. 20,00,000, On 31st December, two third of the contract was completed.
The architect issued certificates covering.50% at the contract price, and the contractor had been
paid Rs. 7,50,000 on account. Prepare Contract A/c and show how much profit or loss should be
included in financial accounts to 3lst December, 2007.
Solution:
Contract Account
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Particular Amount Particular Amount

To Material issued 2,51,000 By Machine (see note-1) 2,46,000
Labour charges 5,65,600 Material (in hand) 35,400
Foreman salary 81,300 Works cost 10,49,000
Machine 2,60,000
Supervisor’s salary
(Rs. 8,000 X 9) / 2 36,000
Adm. Charges 1,36,500
13,30,400 13,30,400
To Work cost 10,49,000 By Work certified 10,00,000
Notional Profit 2,13,250 Work uncertified(see
note-2) 2,62,250
12,62,250 12,62,250
To, Profit & Loss A/c 1,06,625 By Notional Profit 2,13,250
Work- in -progress 1,06,625
2,13,250 2,13,250

Notes :

1. Machine:
146
[( 𝑅𝑠. 2,60,000 − 𝑅𝑠. 15,000)] × = 𝑅𝑠. 14,000
365
Hence the value of machine after the period of 146 days is

Rs. 2,60,000 – Rs14,000 = Rs. 2,46,000

2. The cost of 66.67% of the contract is Rs. 10,49,000

𝑹𝒔.𝟏𝟎,𝟒𝟗,𝟎𝟎𝟎
Cost of 100% of the contract is Rs.
𝟔𝟔.𝟔𝟕
× 100 = Rs. 15, 73,500
Cost of 50% of the contract which has been certified by the architect is Rs. 7, 86,750. Also the cost of 16.67% of the contract. Which

has been completed but not certified by the architect is Rs. 2, 62,250

Illustrations: 3
Bansals Constuction Company Ltd. took a contract for Rs.6,00,000 expected to be completed in
three years. The following particulars relating to the contract are available:
2006 2007 2008
Rs. Rs. Rs.
Materials 6,75,000 10,50,000 9,00,000
Wages 6,20,000 9,00,000 7,50,000
Cartage 30,000 90,000 75,000
Other expenses 30,000 75,000 24,000

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Cumulative work certified 13,50,000 45,00,000 60,00,000

Cumulative work uncertified 15,000 75,000 -

Plant costing Rs.3,00,000 was bought at the commencement of the contract. Depreciation was to
be charged at 25% per annum, on the written down value method. The contractee pays 75% of
the value of work certified as and when certified, and makes the final payment on completion of
the contract.
You are required to make contract account and contractee account as they would appear in each
of the three years. Also show the work-in-progress and other they items should appear in the
balance sheet:

Solution
Contract Account
Particular Rs Particular Rs.
To Materials 6,75,000 By Plant c\d 2,25,000
To Wages 6,20,000 By work-in-progress
To Cartage 30,000 Work certified 13,50,000
To Other expenses 30,000 Work uncertified 15,000 13,65,000
To Plant 3,00,000 By Profit & Loss a\c 65,000
16,55,000 16,55,000

2007 Rs 2007 Rs.

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To Work in progress By Work in Progress c/d

Work certified 13,50,000 Work certified 45,00,000
Work uncertified 15,000 13,65,000 Work uncertified 75,000 45,75,000
To Plant b\d 2,25,000 Plant at site c\d 1,68,750
To Materials 10,50,000
To Wages 9,00,000
To Cartage 90,000
To Other expenses 75,000
To Notional profit c\d 10,38,750

47,43,750 47,43,750
Profit &Loss A\c 5,19,375 By Notional profit b\d 10,38,750
Work-in-progress c\d 5,19,375
10,38,750 10,38,750
2008 2008
To Work-in-progress b\d By Work-in-progress b\d
Work certified 45,00,000 Plant at site 5,19,375
Work uncertified 75,000 45,75,000 Contractee’s A\c 1,26,375
To Plant b\d 1,68,750 60,00,000
To Materials 9,00,000
To Wages 7,50,000
To Cartage 75,000
To Other expenses 24,000
To Profit & Loss\c 1,53,187
66,45,937 66,45,937

Working Notes:
1. In 2006, there is a loss, and so the whole of it will be transferred to the profit and loss account.

2. In 2007,the contract is 3\4th complete. Hence the profit to be transferred to the profit and loss account will be determined as under:
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2 Cash received
= × Notional profit ×
3 Work certified
2 33,75,000
= × 10,38,750 × = Rs. 5,19,375
3 45,00,000
Contractee’s Account

Rs. Rs.
To Balance c\d2007 10,12,500 By Bank2007 10,12,500
By Balance b\d
To Balance c\d2008 33,75,000 By Bank2008 10,12,500
By Balance b\d 23,62,500*
To Contract A\c 60,00,000 By Bank
33,75,000
26,25,000
60,00,000 60,00,000

*The total value of work certified at the end of 2007 was Rs.45,00,000 of that worth Rs.13,50,000 was certified in 2006.Hence,the cash to be received
in 2007 is 75% of Rs.31,50,000(Rs.45,00,000-Rs.13,50,000)i.e.Rs.23,62,500.

Balance sheet (Extract 2006)

Liabilities Rs. Assets Rs.
Capital - Plant at site 2,25,000
Less: Loss during 65,000
the year Work-in-progress: Rs.
Work certified 13,50,000
Work uncertified 15,000
13,65,000
Less: Cash received 10,12,500 3,52,500

Balance sheet (Extract 2007)

Liabilities Rs. Assets Rs.

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Capital - Plant at site 1,68,750

Add: profit during the year Work-in-progress:Rs.
5,19,375 Work certified 45,00,000
Work uncertified 75,000
45,75,000
Less: Profit in reserve 5,19,375
40,55,625
Less: Cash received 33,75,000 6,80,625

Balance sheet (Extract 2008)

Liabilities Rs. Assets Rs.

Capital - Plant at site 1,26,562
Add: Profit during the year 1,53,157

Illustration:4
Compute a conservative estimate of profit on a contract (which has been 90% complete) from the
following particulars. Calculate the proportion of profit to be taken.

Total expenditure to date 4,50,000

Estimated further expenditure to complete the contract(including
contingencies) 25,000
Contract price 6,12,000
Work certified 5,50,800
Work uncertified 34,000
Cash received 4,40,640
Solution:
Computation of notional profit Rs.
Value of work certified 5,50,800

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Less: Cost of work certified

(Rs.4,50,000-Rs.34,000) 4,16,000

Notional Profit 1,34,800

Computation of notional profit 6,12,000
Contract price 4,50,000
Less: cost of work done 25,000
Estimated further expenditure to complete the contract
Estimated total cost 4,75,000
Estimated Profit 1,37,000

Profit &loss Account under various methods and give your recommendations
Profit to be transferred under various methods
Work certified
(i) = Notional profit × Contract price
Rs.5,50,800
= Rs. 1, 34,800 × =Rs.1, 21,320
Rs.6,12,000
Work certified
(ii) = Estimated profit × Contract price

Rs. 5,50,800
= Rs. 1, 37,000 ×
Rs. 6,12,000
=Rs.1,23,300
Work Certified Cash Recevied
(iii) = Estimated profit × ×
Contract Price Work Certified

Rs. 5,50,800 Rs. 4,40,640

= Rs. 1, 37,000 × ×
Rs. 6, 12,000 Rs. 5, 50,000
= Rs.98, 640
Cost of Work date
(iv) Estimated Profit × Estimated total cost

Rs. 4, 50,000
= Rs. 1, 37,000 ×
Rs. 4, 75,000
=Rs.1, 29,790
Cost of Work date Cash Recevied
(v) Estimated Profit × Estimated total cost
× Work Certified

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Rs. 4,50,000 Rs. 4,40,640

= Rs. 1,37,000 × ×
Rs. 4,75,000 Rs. 5,50,800

=Rs.1, 03,832
Recommendations:
It is recommended that a sum of Rs.98,640 may be transferred to the profit and loss
account. This amount is the least and has been arrived by using the formula (iii) above.
According to this formula, profit transferred to the profit and loss account is generally kept
the minimum and allows withholding in reserve a larger portion of notional profit to meet
future unforeseen expenses and contingencies.
5 M.P. Construction company took a contract of Rs. 50,00,000 for the construction of new
buildings in a college. Following expenditure was incurred during the year.
Material directly purchased 4,50,000
Material issued from stores 5,00,000
Plant installed (cost) 3,50,000
Wages paid 10,00,000
Other expenses 1,65,000
Accrued Wages & Other Expenses 4,25,000
Of the plant and materials charged to contract account. Plant costing Rs. 20,000 and
material costing Rs. 1,50,000 were destroyed. Material costing Rs. 20,000 were sold for
Rs.25, 000. Plant costing Rs. 5,000 was transferred to stores at the last day of the year
and a part of plant whose cost was Rs. 2,000 became useless due to damage. Work
costing Rs. 24,00,000 was certified 80% of which was received in cash. Work done but
not certified was Rs. 10,000. Depreciate plant @ 10 per annum. Prepare contract account
for the year and show the items related contract in the balance sheet.
Solution: Contract Account
Rs. Rs.
To Materials Purchased 4,50,000 By Work-in-progress:
To Materials issued from stores 5,00,000 Work certified 24,00,000
To Wages Paid 10,00,000 Work uncertified 10,000 24,10,000
To Plant issued 3,50,000
To Other expenses 1,65,000 By P/L A/c:
To Accrued Wages & other 4,25,000 Plant destroyed 20,000
expenses
To P/L A/c (Profit on Mat. Sold) 5,000 Materials destroyed 1,50,000

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To Balance c/d(National Profit) 7,200 Plant damaged 2,000

By Materials sold 25,000

By Plant transferred to stores 4,500
By Plant at site 2,90,700

29,02,200 29,02,200

To P/L A/c 1,920 By Balance b/d(Notional Profit) 7,200

To Work-in-progress

(Profit Reserved) 5,280

7,200 7,200

Profit to P/L A/c = 7,200 *1\3 *80\100 = Rs.1,920.

Work-in-Progress Account

Rs. Rs.
To Contract A/c: By Contract A/c (Profit 5,280
reserved)
Work certified 24,00,000
Work uncertified 10,000 By Balance c/d 24,04,720

Balance Sheet (Asset side only)

Rs. Rs.
Work-in-Progress 24,04,720
Less: Cash received from Contractee 19,20,000 4,84,720
Plant at site 2,90,700

Note: Plant at site:

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Rs.
(1) Total Cost of Plant issued 3,50,000
Less: Cost of Plant destroyed 20,000
Cost of Plant returned 5,000
Cost of Plant damaged 2,000 27,000
3,23,000
Less: Depreciation @ 10% p.a. 32,300
Plant at site 2,90,700
(2)Plant transferred to stores
Cost of Plant returned 5,000
Less: Dep: for whole year @10% p.a. 500
4,500
6 The following particulars relate to a contract undertaken by a firm of Engineers :
Materials sent to site 85,349
Labour engaged on site 74,375
Plant installed at cost 15,000
Direct expenditure 3,169
Establishment charges 4,126
Materials retuned to Stores 549
Work certified 1,95,000
Cost of work not certified 4,500
Materials in hand on 31st December 1,883
Wages accrued due at 3lst December 2,400
Direct expenditure accrued due at 3lst Dec. 240
Value of plant at 31st December 11,000

The contract price has been agreed at Rs. 2,50,000. Cash received from the contractee
was Rs. 1, 80,000
You are required (a) to prepare Contract Account showing profit, (b) to prepare
Contractee’s Account, (c) suitable entries in the Balance Sheet of the Contractors.
Solution:(a) Contract Account

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(for the year ended 31st December)

Rs. Rs.
To Materials 85,349 By Materials returned to stores
To Labour 74,375 By Work-in-progress: 549

Add: Wages due 2,400 76,775 Work certified

Work uncertified 1,95,000
To Plant installed 15,000 By Materials in hand 4,500
To Direct expenditure 3,169 By Plant at site 1,883
Add: Direct exp.due 2,40 3,409 11,000

To Establishment charges 4,126

To Balance c/d 28,273
Rs.
Rs. 2,12,932 2,12,932
By Balance b/d

To Profit & Loss A/c 17,399 28,273

To Work-in-progress 10,874

Rs. 28,273 Rs. 28,273

(b) Contractee’s Account

Rs. Rs.
To Balance c/d 1,80,000 By Bank A/c 1,80,000

(c)Balance Sheet(As at 31st December)

Liabilities Amount Assets Amount

Rs. Rs.
Outstanding Liabilities: Materials in hand 1,883
Wages accrued due 2,400 Plant at site 11,000
Direct expenditure due 2,40 Work-in-progress
Profit & Loss Account 17,399 (Rs.199,500-10,874)

1,88,626

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Less: Cash received from

contractee 1,80,000 8,626

(Methods of Determination of W.I.P)

Value of Work certified 1,95,000
Add: Cost of Work uncertified 4,500
1,99,500
Less: Profit reserved (or Profit not taken credit of) 10,874
W.I.P. Rs. 1,88,626

Cost of Work certified 1,66,727*

Add: Cost of Work uncertified 4,500
Profit taken credit for 17,399
W.I.P. Rs. 1,88,626
*[{85,349+76,775+15,000+3,409+4,126-(549+4500+1,883+11,000}]

7 Surbhi & Co. closes its accounts annually on 31st December. Contract No 265
commenced on 1st April. The costing records show the following information on 31st
December, 2006

Materials issued 24,000

Wages 45,000
Outstanding wages 2,000
Office expenses 4,000
Foreman’s salary 5,000
Direct expenses 10,000
Sub-Contract costs 3,000

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A machine costing Rs. 16,000 had been on the site for 146 days. Its working life is
estimated at five year and its scrap value at Rs. 1,000. A supervisor who is paid Rs.
1,000 pm. has spent one-half of his time on this contract.
Materials at site on 3 l st Dec., 2006 were Rs. 3,000. The contract price is Rs. 2,00,000
and 2/3 of contract was completed by 31st Dec., 2006. Architect had issued certificate
covering 60% of contract price. 80% has so far been received by the contractor. Prepare
Contract Account, Works-in-Progress Account and Contractee‘s Account,

Solution: Contract No.265 Account

Rs. Rs.
To Materials issued 24,000 By Materials at site 3,000
To Wages 45,000 By Cost of work 95,700
Add: Outstanding 2,000 47,000
To Office expenses 4,000
To Foreman’s salary 5,000
To Direct expenses 10,000
To Sub-contract cost 3,000
To Depreciation on machine 1,200
To Supervision charges 4,500
98,700 98,700

To Balance c/d 33,870 By Work-in-progress A/c:

Work certified 1,20,000
Work uncertified 9,570

1,29,570 1,29,570
18,064 33,870
To Profit & Loss A/c 15,806 By Balance b/d
To Work-in-progress 33,870 33,870

Work- in-Progress Account

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Rs. Rs.
To Contract A/c: By Contract A/c(Profit
Works certified 1,20,000 reserved) 15,806
Works uncertified 9,570 By Balance c/d 1,13,764

1,29,570 1,29,570

Contractee’s Account
Rs. Rs.
To Balance c/d 96,000 By Bank A/c 96,000

Cost of Work Uncertified:

Cost of 2\3 work completed =Rs.95,700
Cost of full contract = 95,700 * 3\2 = Rs.1,43,550
Cost of Work certified =1,43,550 * 60%=Rs.86,130
Value of uncertified Work=95,700-86,130=Rs.9,570
(4) Profit taken to P/L A/c:
33,870 *2\3*80\100=Rs.18,064

NUMERICALS
1. Prepare Contract Account from the following particulars:
Materials Rs.40,000;Wages Rs.27,000;Plant Rs.18,000;Stores issued Rs.2,000;Loose
tools Rs.3,500;Other indirect expenses Rs.2,700;Running materials of tractor and wages of
drivers Rs.6,000;.The contract was completed in 73 days. At the end of this period plant was
returned after charging 15% depreciation on original cost. The values of loose tools and
stores returned were Rs.2,400 and Rs.900 respectively. The value of the tractor was
Rs.18,000 and depreciation was to be charged to this contract at the rate of 15% per annum.
You are required to provide for Administration expenses at the rate of 10% on total works
cost. The contract price was Rs.1, 15,000.
Ans: Works cost Rs.81, 140, Total Profit Rs.25, 746.
2. A contractor undertook a contract of Rs.5, 00,000 on 1st January, 2007.The work was
completed on 30th June, 2007.Following are the details of this contract.

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Particular Rs.
Materials sent to site from stores 30,200
Materials purchased directly from vendor 45,500
Materials received from other contracts 20,300
Labour engaged 1,35,000
Direct charges 42,000
Plant installed at site 40,000
General expenses 32,000
Establishment charges 18,000
Wages accrued 12,000
Direct charges accrued 3,000
General charges accrued 5,000
Materials returned to stores 15,000
Materials at site 13,000
Materials transferred to other contracts 11,000
Materials sold(costing Rs.8,000) 9,000
Plant sold (costing Rs.15,000) 10,000
Materials destroyed by fire 8,000

Prepare a contract account charging depreciation on plant@10% per annum from the
above particulars.
Ans: Profit to Profit & Loss A\c,Rs.2,10,750.
Hints: It is assumed that plant has been sold in the beginning.
3. The following particulars relate to a contract undertaken by a firm of engineers:
(Year 1.1.2006 to 31.12.2006)
Particular Rs.

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Materials sent to site 85,349

Labour engaged 74,375
Plant installed 15,000
Direct expenses 3,169
Establishment charges 4,126
Materials returned to stores 549
Work certified 1,95,000
Work not certified 4,500
Materials in hand on 31.12.06 1,883
Wages due on 31.12.06 2,400
Direct expenses accrued 31.12.06 240
Value of Plant 31.12.06 11,000

The contract price was Rs.5, 00,000.Cash received from contractee was Rs.1, and
80,000.You are required to (a) Prepare the Contract Account, (b) Prepare the
contracture’s Account.
Ans: Total Profit Rs.28, 273, Profit to P &L-Rs.8, 699, Profit to WIP-Rs.19, 574.
4. The Gujarat Engineering Company Limited undertakes large contracts. On 31st Dec.,2006
when annual accounts were prepared, the position of a bridge contract which was
commenced on 1st April,2006 was as follows:
Materials purchased RS. 6,00,000; Wages paid Rs.7,00,000;Sundary expenses
Rs.30,000;Plant dispatched to site (cost) Rs.1,00,000;Wages accrued Rs.10,000;Materials
in hand Rs 24,000.The value of work certified was Rs.14,40,000 of which Rs.10,80,000 has
been received. The work finished but uncertified was valued at Rs.40, 000.The plant on the
site on 31st Dec., 2006 was valued at Rs.80,000.The contract price was Rs.24,00,000 ant
the cost of the work to date was within the estimates.
You are required to prepare Contract Account show in the profit which should reasonably
be transferred to the Profit & Loss Account, to calculate Work-in-progress and to show how
the particulars relating to the contract should appear in the Balance Sheet of the company
as at 31st December,2006.
Ans. Total profit Rs.1,44,000;Profit transferred to P&L A\c Rs.72,000;Balance of
W.I.P.Rs.14,08,000.
5. A Firm of Builders, carrying out large contracts kept in a contract ledger separate account
for each contract. The following particulars relate to a certain contract carried out during the
year ended 31st december,2006.
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Particular Rs.
Works certified by architects 4,29,000
Cash received from the contractee 3,90,000
Materials sent to site 1,93,500
Labour engaged on site 1,64,400
Plant installed on site 33,900
Value of plant at 31.12.06 24,600
Cost of work not certified 10,200
Establishment charges 9,750
Direct expenditure 7,200
Wages accrued at 31.12.2006 5,400
Materials in hand at 31.12.2006 4,200
Materials returned to store 1,200
Direct expenditure accrued due at 31.12.2006 600
Contract price 6,00,000
You are required to prepare an account showing the profit on the contract to 31st dec.,2006.
Ans. Total Profit Rs.54,450;Profit taken to Profit & Loss Account Rs.33,000.

5. From the following information, prepare a Contract Account for the year 2006.
Particular Rs.

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Contract price 5,00,000

Materials purchased 80,000
Materials issued from the store 70,000
Payment to labour 30,000
Direct expenses 40,000
Indirect expenses 5,000
Cost received being 80% of work certified 2,00,000
Work uncertified 40,000
Materials returned to store 4,000
Materials at site 3,000
Outstanding wages 5,000
Materials destroyed by fire 4,000
The construction of building was started on 1st January,2006.Plant costing Rs 40,000 was
issued to contract on 1st March,06.On 31.8.06,plant costing Rs 2,000 was transferred to
other contract. Plant costing Rs.1,000 was lost by theft and of Rs.500 was destroyed by
fire. Plant costing Rs.2,000 was sold for Rs.2,200.Depreciation of plant is charged each
year @ 10% p.a.
Ans. Total Profit Rs.68,025;Profit P\L A\c Rs.36,280;Total of Contract Account
Rs.3,38,025.

LESSON 12
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JOB COSTING
CONTEXT OF THE LESSON
Job costing is the process of identifying the expenses incurred on a job against the revenue
generated by that job. Job costing is an important tool for determining the cost of job which is to
be undertaken on request of customer which varies according to the customer’s specific
requirement and hence individual cost for each job has to be calculated. For example, building
contractors, subcontractors, architects and consultants often use job costing.
OBJECTIVES OF THE LESSON
• Develop a job order cost sheet for a manufacturer.
• Record the costs for each job in the job order cost sheet.
INTRODUCTION
A job is a specific order for work which is generally performed within the factory premises or
workshop and the work moves through various activities and operations as a continuously
identifiable unit. Job costing is that form of specific order costing which is applied in those
industries where work is undertaken on the special request of the customer on its specific
requirement and each job is comparatively of a small duration.
In this method, accumulation and collection of cost are made in reference to specific jobs,
products or work orders. Each job or work of production is treated as a separate unit for the
purpose of costing. Job costing is carried out for the purpose of ascertaining cost of each job and
takes into account the cost of materials, labour and overheads etc. The job costing method is also
applicable to industries in which production are in batches. The method can also be described as
“Batch Costing”.
The job costing method of costing may be regarded as the principal method of costing since the
basic object is to analyses and ascertain cost of each unit of production so that it may be possible
to control and regulate cost and to determine the profitability or otherwise of each work order or
product line. The basic principles enunciated for the job costing method are, therefore valid
essentially for all types of industry. For example printing: furniture: hardware; ship-building; heavy
machinery; interior decoration, repairs and other similar work.
In this method of costing the cost is ascertained through preparation of a separate cost sheet for
each job, disclosing cost of material issued for the job, labour charges incurred for completion of
the job and overhead charges are added for ascertaining total expenditure.
JOB COSTING MAY BE EMPLOYED IN THE FOLLOWING CASES:
• When jobs are to be performed for different customers according to their specific requirements
and specifications.
• When two orders are not alike and each order/job needs special treatment.
• Where the work-in—progress differs from period to period on the basis of the number of jobs
in hand.

PROCEDURE OF JOB COST ACCOUNTING:

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ACCOUNTING FOR MATERIALS:

The cost of direct material must be traced to and identified with specific job or work order. The
identification of materials cost by jobs or work orders mainly brought about by the use of separate
stores requisitions for each job or work order.
The materials cost of each job is posted to individual job cost sheets or cards in the Work-in-
Progress ledger, the postings are usually made weekly or monthly. Similarly, at periodical
intervals, from the material abstract books, summary cost of indirect material is posted to different
standing orders or expense code numbers in the Overhead Expenses ledger. If any special
material has been purchased for a particular job, it is directly charged to the job concerned.
If any surplus material is left over in the case of any job, unless it can be immediately and
economically used on some other job, the same is returned to the store, and the relevant job
account is credited with the value of excess material returned to the store.
If the surplus material is transferred to some other job or utilized on some other job, instead of
being returned to the store, the cost thereof can be adjusted in the Work-in-Progress Ledger.
ACCOUNTING FOR LABOUR:
All direct labour cost must be analysed according to individual jobs or work orders. Similarly
indirect labour cost also must be collected and accumulated under appropriate standing order or
expenses code number.
The analysis of labour according to jobs or work orders is, usually, made by means of job time
cards or sheets. All direct labour is charged to the specific jobs. All the idle time also is charged
against appropriate standing order expense code number either in the job time card for each job
or on a separate idle time card for each worker (where the job time card is issued job-wise). The
time booked or recorded in the job time and idle time cards is valued at appropriate rates and
entered in the labour abstract or analysis book.
The abstraction of idle time costs under suitable standing order or expenses code numbers is
likewise done and the amounts are posted to the relevant departmental standing order or expense
code number in the Overhead Expenses Ledger at periodical intervals. As regards other items of
indirect labour cost these are collected from the payrolls books for the purpose of posting against
standing order or expenses code numbers in the Overhead Expenses ledger.
ACCOUNTING FOR OVERHEAD
Manufacturing overheads are collected under suitable standing order numbers and selling and
distribution overheads against cost accounts numbers. Total overhead expenses so collected are
apportioned to service and production departments on some suitable basis. The expenses of
service departments are finally transferred to production departments. The total overhead of
production departments is then applied to products on some realistic basis. e.g. machine hour;
labour hour; percentage of direct wages; percentage of direct materials; etc.
Price of the job: Price of a job may be arrived by adding the desired percentage of profit to the
total cost of the job.

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Treatment of spoiled and defective work: Spoiled work is the quantity of production that has
been totally rejected and cannot be rectified. Defective work on the other hand refers to production
that is not as perfect as the saleable product but is capable of being rectified and brought to the
required degree of perfection provided some additional expenditure is incurred.
DEFECTS ARISE IN THE FOLLOWING CIRCUMSTANCES:
(1) Where a percentage of defective work is allowed in a particular batch as it cannot be avoided:
ln this case when a normal rate of defectives has already been established, if the actual
number of detectives is within the normal limit or is near thereto the cost of rectification will
be charged to the whole job and spread over the entire output of the batch. lf on the other
hand, the number of defective units substantially exceeds the normal ,the cost of rectification
of the number which exceeds the normal will be written off as a loss in the Costing Profit and
Loss Account.
(2) Where defect is due to bad workmanship: When the defective work is due to bad workmanship
the cost of rectification will be treated as abnormal cost. The cost of rectification shall be
written off as a loss. Unless by an arrangement it is to be recovered as a penalty from the
workman concerned. However, it may be possible that the management practices a policy to
provide for a certain proportion of defectives on account of bad workmanship as an
unavoidable feature of production. lf that be the case, the cost of rectifying to the extent
provided for by the management will be treated as a normal cost and charged to the batch.
(3) Where defect is due to the Inspection department wrongly accepting incoming material of poor
quality: If the defect is due to negligence of the inspection department, the cost of rectification
will be charged to the department and will not be considered as cost of manufacture of the
batch. Being an abnormal cost, it will be written off to the Costing Profit and Loss Account.
ILLUSTRATION
The information given below has been taken from the costing records of an
Engineering works in respect of job No. 123
Material – Rs. 4,010
Wages Deptt. A 60 Hours @ Rs. 3 p.hr
Deptt. B 40 Hours @ Rs. 2 p.hr
Deptt. C 20 Hours @ Rs. 5 p.hr
Overhead expenses
for these departments were estimated as follows:
Variable overheads:
Deptt. A Rs. 5,000 for 5,000 labour hours.
Deptt. B Rs. 3,000 for 1,500 labour hours.
Deptt. C Rs. 2,000 for 500 labour hours.

Fixed overheads
Estimated at Rs. 20,000 for 10,000 normal working hours.
You are required to calculate the cost of job 123 and calculate the price to give profit of 25%
on selling price.
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Solution:
COST SHEET OF JOB No. 123
Particular Amount

Materials 4,010
Wages
Deptt. A( 60 hrs X Rs. 3) 180
B ( 40 hrs X Rs. 2) 80
C( 20 hrs X Rs. 5) 100 360

Overheads:
Variables Overhead
Deptt. A ( 60 hrs X Rs. 1) 180
B ( 40 hrs X Rs. 2) 80
C ( 20 hrs X Rs. 5) 100 220
Fixed Overheads

( 120 hrs X Rs. 2) 240

TOTAL COST 4,830

Profit (25% of selling price or 33% on cost) 1,610
Sales 6,440

Working Notes:

1. Calculation of variable overheads rate labour hour

Department

A = Rs. 5,000/ 5,000 L.H. = Re. 1

B = Rs. 3,000/1,500 L.H. = Rs. 2

B = Rs. 2,000/ 500 L.H. = Rs. 4

2. Calculation of fixed overheads per hour

Rs. 20,000 / 10,000 = Rs. 2

LESSON 13
PROCESS COSTING
CONTEXT OF THE LESSON

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This lesson deals with process costing method which is a part of contionus operating method and
applied in those industries where production is carried on regular bases and production is done
on mass scale. The output is received after a sequence of process where by the output of one
process becomes the input of the next process.
OBJECTIVES OF THE LESSON
• Meaning of process costing.
• Features of process costing.
• Component of cost in case of process costing method.
• Terminologies used in process costing and their treatment in process account
DEFINITION
Process costing is a method for ascertaining the total unit cost of the output of a continuous
production run (such as in foodprocessing, petroleum, and textileindustries) in which a product
passes through various processes. It is a method that aggregates manufacturing costs by
departments or by production processes. Total manufacturing costs are accumulated in form of -
direct materials, direct labor, and factory overhead incurred. Unit cost is determined by dividing
the total costs charged to a process by the output of that process. Process costing is applied in
those industries that produce a continuous mass of similar units through a series of operations
or processes-generally used in such industries as petroleum, chemicals, oil refinery, textiles, and
food processing.
CIMA’s definition: The costing method applicable where goods or services result from a
sequence of continuous or repetitive operations or processes. Costs are average over the units
produced during the period, being initially charged to the operation or process.
FEATURES/CHARACTERISTICS OF PROCESS COSTING
Process Costing Method is applicable where the output results from a sequence of continuous
or repetitive operations or processes and products are identical and cannot be segregated.
Process Costing enables the ascertainment of cost of the product at each process or stage of
manufacture.
The following features may be identified with process costing:
1. The output consists of products which are homogenous.
2. Production is carried on in different stages (each of which is called a process) having a
continuous flow.
3. Production takes place continuously except in cases where the plant and machinery are
shut down for maintenance etc. Output is uniform and all units are identical during each
process. It would not be possible to trace the identity of any particular lot of output to any
lot of input.
4. The input will pass through two or more processes before it takes the shape of the
output. The output of each process becomes the input for the next process until the final
product is obtained, with the last process giving the final product.

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5. The output of a process (except the last) may also be saleable in which case the
process may generate some profit.
6. The input of a process (except the first) may be capable of being acquired from the
outside sources.
7. The output of a process is transferred to the next process generally at cost to the
process. It may also be transferred at market price to enable checking efficiency of
operations in comparison to the market conditions.
8. Normal and abnormal losses may arise in the processes
9. An account called a process account is maintained for each process.
Elements of Cost
For the purpose of cost accounting, the process industry is divided into separate divison or
departments with each division or department representing a specific process. The Direct
Material and Direct Labour costs are collected for each division or department individually and
the total overheads collected are apportioned over the various departments/processes on some
suitable basis.
The following are the main elements of costs involved in the manufacturing organisation where
process costing method is adopted.
1. Direct Materials
In industries where process costing method is used the direct material can be classified
into two parts:
o Primary Material
Primary materials are those materials which are introduced in the initial process
and passed on to the next process as a part of output after completion of
processing.
o Secondary Material
Secondary materials are those materials which are introduced in the first or
subsequent processes in addition to the main material introduced in the initial
process. The secondary material gets mixed up with the main material and is
passed on to the subsequent processes as a part of the output.
2. Direct Labour Cost
The direct labour cost is generally incurred in every process for the purpose of conversion
of the shape of raw material. Identification of direct labour cost is also relatively easy in
process costing industry
3. Direct Expenses
All those expenses which are relevant to a specific process and are expenses which are
incurred in addition to direct material and labor and which can be directly attributable to a
particular process are termed as direct expenses.
Production Overheads

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The overhead expenses are generally expended over all the processes involved in
production. These are to be apportioned over the various processes in an suitable manner.
▪ Preparation of Process Accounts
A nominal account for each process is prepared to record all the costs related to the
process.
Each process account is Debited with the cost of:
▪ Primary Direct Material
▪ Secondary Direct Material
▪ Direct Labor
▪ Direct Expenses and
▪ Production Overheads allocated and/or apportioned to the process.
Each process account is Credited with:
The value of output transferred to the subsequent process or finished stocks.
▪ Process Stock Accounts
Stocks relevant to a process that are maintained in a separate stock account. Stock
accounts for input may be maintained where all the input acquired/received for a process
during a period is not used up. Stock accounts for output may be maintained where all the
output produced/completed in a process during a period is not disposed off either by
transfer to the next process or by sale.Where the output relevant to a process is sold apart
from being transferred to the next process, it generates revenue. These revenues relevant
to a process, are generally recorded using the process account or the stock account.
FORMAT OF PROCESS ACCOUNT
Process I A/c
Particulars Quantity Amount Particulars Quantity Amount
(in (in Rs) (in (in Rs)
Units) Units)
To Direct Material 10,000 4,00,000 By Process II 10,000 6,24,000
To Other Material 50,000 a/c
To Direct 1,20,000
Labour/Labor 54,000
To Production
Overheads
6,24,000 6,24,000

SELF CHECK QUESTIONS

1. What is process costing?

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2. In which industries process costing is apply?

3. What are the characterstics of process costing?

TREATMENT OF NORMAL /ABNORMAL LOSS AND ABNORMAL GAIN

Losses can be classified based on the basis of their nature as well as of their physical form.
On the basis of nature the loss can be classified as:
▪ Normal Loss
The loss of input/output where the occurrence is inevitable i.e. which occur on account of
normal reasons are normal losses. The magnitude of the loss is dependent on the
production process in consideration. Normal losses may be expressed in absolute terms
as 100 units or in proportionate terms as 1/10th or in percentage terms as 2% of the inputs.
Whether the calculation of loss should be based on the input or output is dependent on
the method used to express the loss and to some extent on the process in consideration.
In problem solving, where no specific mention is made, the loss is calculated (where it is
given as a proportion or percentage) based on gross input.
In process account normal loss is credited in the respective process account to which it
belongs. In the unit column of the process account the normal loss units are shown and if
the normal loss can be sold and some value can be realized then the value is also credited
in the process account. If due to any reason the normal loss does not fetch any value then
process account will be credited by the normal loss unit and no value will be credited in
the amount column. If the loss is due to loss in weight of the material then loss of weight
unit will be credited in the respective process account as loss in weight will fetch nothing.
▪ Abnormal Loss
The loss of input/output whose occurrence can be avoided i.e. which occur on account of
abnormal reasons are abnormal losses. This can also be interpreted as the magnitude of
actual loss that is incurred in excess of the normal loss.
It is given by the relation "Abnormal Loss Units" = "Normal Output Units" − "Actual Output
Units"
Abnormal loss is not expected to arise, when operations are carried on efficiently
according to norms relating to manufacturing operations. Cost of normal loss is shared by
good units of production in the process, but the same treatment cannot be given to
abnormal loss.
Abnormal loss units are valued like good units produced and the value of units
representing abnormal loss is debited to a separate account, which is known as abnormal
loss account. The value of abnormal loss is calculated with the help of the following
formula:

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𝑪𝒐𝒔𝒕 𝒐𝒇 𝑨𝒃𝒏𝒐𝒓𝒎𝒂𝒍 𝑳𝒐𝒔𝒔

𝑺𝒄𝒓𝒂𝒑 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇
𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 − ( )
𝒏𝒐𝒓𝒎𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒍𝒐𝒔𝒔
=
𝑻𝒐𝒕𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝑵𝒐𝒓𝒎𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚
( )− ( )
𝑰𝒏𝒑𝒖𝒕 𝑳𝒐𝒔𝒔
× 𝑨𝒃𝒏𝒐𝒓𝒎𝒂𝒍𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒍𝒐𝒔𝒔
If the abnormal loss has got any scrap value, it should be credited to the abnormal loss
account and the balance is ultimately written off to costing profit and loss account.
Abnormal loss represent good units, which could have been produced if the operations
had been carried out according to accepted norms of manufacturing operations.Hence,
units reperesnting abnormal loss are treated at par with good units for the purpose of
valuation. All cost relating to abnormal loss is debited to abnormal loss account and
credited to process account.
ABNORMAL GAIN
If the quantum of loss is less than the determined percentage of normal loss, the
difference is called as abnormal gain or effectiveness. Abnormal gain units should not
effect the cost of good units in the normal circumstances. The value of abnormal gain is
debited to the concerned process account and credited to abnormal gain account. This
value is calculated at the rate at which the effective output would have been valued if
normal wastage had taken place according to expectation. The value of abnormal gain is
calculated by the help of the following formula:
FORMULA
𝑪𝒐𝒔𝒕 𝒐𝒇 𝑨𝒃𝒏𝒐𝒓𝒎𝒂𝒍 𝑮𝒂𝒊𝒏
𝑺𝒄𝒓𝒂𝒑 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇
𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 − ( )
𝒏𝒐𝒓𝒎𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒍𝒐𝒔𝒔
=
𝑻𝒐𝒕𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝑵𝒐𝒓𝒎𝒂𝒍 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚
( )− ( )
𝑰𝒏𝒑𝒖𝒕 𝑳𝒐𝒔𝒔
× 𝑨𝒃𝒏𝒐𝒓𝒎𝒂𝒍𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝑮𝒂𝒊𝒏
A Problem (illustration)
A product is finally obtained after it passes through three distinct processes. The following
information is available from the cost records.

Process I Process II Process III Total

Rs. Rs. Rs. Rs.

Materials 5,200 3,960 5,924 15,084

Direct Wages 4,000 6,000 8,000 18,000
Production Overheads 18,000

1,000 units @ Rs. 6 per unit were introduced in process I. Production overheads are absorbed
as a percentage of direct wages. The actual output and normal loss of the respective processes
are giben below:
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Normal loss
Output Value of scrap
as a percentage
(Units) (per unit)
of input

Process I 950 5% Rs. 4

Process II 840 10% Rs. 8
Process III 750 15% Rs. 10

Prepare the process accounts and the other relevant accounts.

SOLUTION:
Ledger Accounts
Process I a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Material (Primary) 1,000 6,000 By Normal Loss a/c 50 200

To Material (Secondary) 5,200 By Process II a/c 950 19,000
To Direct Labour 4,000 [Output Transferred]
To Production Overheads 4,000

1,000 19,200 1,000 19,200

Normal Loss a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Process I a/c 50 200

Process II a/c

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Quantity Amount Quantity Amount

Particulars (in Units) (in Rs) Particulars (in Units) (in Rs)
To Process I a/c 950 19,000 By Normal Loss a/c 95 760
(Primary)

To Material 3,960 By Abnormal Loss 15 600

(Secondary) a/c

To Direct 6,000 By Process III a/c 840 33,600

Labour/Labor [Output Transferred]
To Production 6,000
Overheads

950 34,960 950 34,960

Normal Loss a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Process I a/c 50 200

To Process II a/c 95 760

Abnormal Loss a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Process II a/c 15 600

Process III a/c

Quantity Amount Quantity Amount

(in (in
Particulars Units) (in Rs) Particulars Units) (in Rs)
To Process II a/c (Pr) 840 33,600 By Normal Loss a/c 126 1,260

To Material 5,924 By Finished Stock a/c 750 57,000

(Secondary)
To Direct Labour 8,000 [Output Transferred]
To Production 8,000
Overheads
To Abnormal Gain a/c 36 2,736
876 58,260 876 58,260
Normal Loss a/c

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Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Process I a/c 50 200 By Ab Gain a/c 36 360

To Process II a/c 95 760
To Process III a/c 126 1,260 By Bal c/d 235 1,860

271 2,220 271 2,220

To Bal b/d 235 1,860

Abnormal Loss a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Process II a/c 15 600

Abnormal Gain a/c

Quantity Amount Quantity Amount

Particulars Particulars
(in Units) (in Rs) (in Units) (in Rs)

To Normal Loss a/c 36 360 By Process III a/c 36 2,736

To Costing P&L a/c – 2,376

36 2,736 36 2,736

SELF CHECK QUESTIONS:

1. What do you mean by process costing? Explain it’s features and industry to which it
applies?
2. Discuss the components of cost and their treatment in process accounts?
3. Discuss the type of losses nad gains in process accounts? What accounting treatment id
done for them in process accounts?

LESSON 14

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PROCESS COSTING-II
(1) The product of a manufacturing concern passes through two processes A and B and then to
finished stock. It is ascertained on the basis of past experience that in each process 2% of the
total weight put in is lost and 10% is scrap which from process A and B realizes Rs. 100 per kg
and Rs. 150 per kg respectively.

Particular Process 1 Process 2

Rs. Rs.
Material consumed in kg 1,000 70
Cost of material per kg 120 200
Wages 17,500 10,000
Manufacturing expenses 5,380 5,342

Prepare process Accounts, showing the cost of the output of each process and the cost per kg.
Solution
Process A Account

Particular Kg Rs. Particular Kg Rs.

To Material @Rs. 120 per By Loss in weight(2%
kg of 1000 kg)
1000 1,20,000 20 __
To Wages By Sale of Scrap
17,500
(10% of 1,000 kg)
To Manufacturing
100 10,000
expenses By Process B A/c
5,380 @Rs. 151 Per Kg
880 1,32,000
1000 1,42,880 1000 1,42,880

Process B account
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 COST ACCOUNTING

Particular Kg Rs. Particular Kg Rs.

To, Process A A/c By Loss in weight(2%
(transfer) of 950 kg)
880 1,32,880 19 __
To Material consumed By Sale of Scrap
70 14,000 95 14,250
(10% of 950 kg)
To Wages
10,000
By Finished Stock A/c
To Manufacturing
5,342 @Rs. 177Per Kg 836 1,47,972
expenses
950 1,62,222 950 1,62,222

(2) On the basis of the following information prepare process Account and a statement of profit:
Particular Process 1 Process 2 Process 3
Raw material used 1000 ton - -
Cost per ton Rs. 200 - -
Manufacturing wages & expenses Rs. 87,500 Rs. 34,500 Rs. 10,710
Weight lost 5% 10% 20%
Scarp (sales price Rs. 50 per ton) 50 ton 30 ton 51 ton
Sale price of output per ton Rs. 350 Rs. 500 Rs. 800
Management expenses were Rs. 17,500 and selling expenses Rs. 10,000. Two-third of the output
of process I and on half of the process II are transferred to next process and the balance are sold.
The entire output of process III is sold.
Solution Process I Account
Particular ton Rs. Particular ton Rs.
To Raw material used By Loss in weight(5% __
(1000 X Rs. 200) of 1000 ton)
1000 2,00,000 50
To Manufacturing By Sale of Scrap (50
50 2,500
expenses & Wages ton X Rs. 50)
87,500
By Transfer to
warehouse 1/3 300 95,000
By Process II (2/3)
@Rs. 316.67 per ton
600 1,90,000
1000 2,87,500 1000 2,87,500

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Process II Account

Particular ton Rs. Particular ton Rs.

To Process I A/c 600 1,90,000 By Loss in
weight(5% of 1000
To Manufacturing 34,500 60 __
ton)
expenses & Wages
By Sale of Scrap (30
ton X Rs. 50) 30 1,500
By Transfer to 255 1,11,500
warehouse 1/2
255 1,11,500
By Process III (1/2)
@Rs. 497.25 per ton

600 2,24,500 600 2,24,500

Process III Account

Particular ton Rs. Particular ton Rs.

To Process II A/c 255 1,11,500 By Loss in weight _

(20% of 255 ton)
To Manufacturing 51
expenses & Wages By Sale of Scrap (51
10,710 51 2,550
ton X Rs. 50)
By Transfer to
warehouse @Rs. 153 1,19,660
782.09 per ton

255 1,22,210 255 1,22,210

Statement of Profit
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Particular Rs.
Sales Price of output
Process I = 300 ton X Rs. 350 1,05,000
Process II = 255 ton X Rs. 500 1,27,500
Process III = 153 ton X Rs. 800 1,22,400 3,54,900

Less : Cost of production in each process

Process I = 300 95,000

Process II = 255 1,11,500
Process III= 153 1,19,660
3,26,160

Gross Profit
28,740
Less
Management Expenses 17,500
Selling Expenses 10,000

27,500
Net Profit
1,240

(3) The imperial manufacturing company’s product passes through two distinct processes A and
B and then to finished stock. It is known past experience that wastages in the processes are as
under:
In process A 5% of the units entering the process.
In process B 10 % of the units entering in process.
The scrap value of the wastages in process A is Rs. 8 per 100 units and in process B is Rs. 10
per 100 units.

The process figures are:

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 COST ACCOUNTING

Particular Process A Process B

Material consumed 3,000 1,500
Wages 3,500 2,000
Manufacturing expenses 1,000 1,000
5,000 units were brought into A costing Rs. 2,500

The outputs were:

Process A 4,700 units
Process B 4,150 units
Prepare process cost accounts showing the cost of the output. Also show abnormal wastage.
Solution
Process A account
Particular units Rs Particular units Rs.
.
To Units introduced 5000 2,500 By Normal wastage
(5% of 5000 units
To Materials 3,000 250 20
@ Rs. 8 per 100
To Wages 3,500 units)
To Manufacturing 1,000 By Abnormal 50 105
expenses wastages A/c
By Process B A/c
4700 9,875
@Rs. 2.10 Per unit

5000 10,000 5000 10,000

Abnormal Wastage Account ( Process A)

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 COST ACCOUNTING

Particular units Rs Particular units Rs.

.
To, Process A A/c 50 105 By Cash A/c sale of
(transfer) Scrap (Rs. 8 per
50 4
100)
101
By P/L A/c Loss
transferred

50 105 50 105

Process B account
Particular units Rs. Particular units Rs.
To, Process A A/c By Normal weight
(transfer) (10% of 4700 units
4,700 9,875 470 47
@ Rs. 10 per 100
To Material 1,500
units)
To Wages 2,000
By Abnormal 80 271
To Manufacturing 1,000 wastages A/c
expenses
By Finished Stock
A/c @Rs. 3.39Per
unit 4150 14,057

4,700 14,375 4,700 14,375

Abnormal Wastage Account (Process B)

Particular units Rs Particular units Rs.
.
To, Process B A/c 80 271 By Cash A/c sale of 80 8
(transfer) Scrap (Rs. 10 per
100)
263
By P/L A/c Loss
transferred

80 271 80 271

(4)The product of a manufacturing concern passes through two processes A and B and then to
finished stock. It is ascertained that in each process 5% of the total weight is lost an 10% is
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scarp which from processes A and B realize Rs. 80 per tonne and Rs. 200 per tonne,
respectively.
The following are the figures relating to both the processes:

Process A Process B
Material(tonne) 1,000 70
Cost of material (Rs. Per tonne) 125 200
Wages (Rs.) 28,000 10,000
Manufacturing expenses (Rs.) 8,000 5,250
Output (tonne) 830 780

Prepare process cost accounts showing cost per tonne of each process there was no stock in
any process.
Solution:
Process A Account
Particular ton Rs. Particular ton Rs.
To Material 1000 1,25,000 By Loss in weight(5% 50
of 1000 tonne)
To Wages 28,000 __
By Normal loss(5% of
To Manufacturing 8 ,000 100 8,000
1000 tonne Rs. 80 per
expenses
tonne)
By Abnormal 20 3,600
Wastage
By Transfer to
process B @ Rs. 180
per tonne 830 1,49,400
1000 1,61,000 1000 1,61,000
Cost of abnormal wastage = Rs. 1, 61,000 – Rs. 8,000 X 15 = Rs. 3,600
900 – (45+90)

Process A Account

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 COST ACCOUNTING

Particular ton Rs. Particular ton Rs.

To Transfer from Process By Loss in weight(5% 45 __
A A/c of 900 tonne)
830 1,48,400
To Material By Normal loss(10%
70 14,000 90 8,000
of 1000 tonne Rs. 200
To Wages
10,000 per tonne)
To Manufacturing
5,250 By Transfer finished 780
expenses
stock @ Rs. 210 per
To Abnormal Effectives 1,63,800
tonne
A/c 3,150

15
915 1,81,800 915 1,81,800

Cost of Abnormal Wastage = Rs. 1, 78,650 – Rs. 18,000 X 15 = Rs. 3,150

900 – (45+90)

(5) A limited company manufactures and sells three chemicals produced by consecutive
process known as A, Band C. in each process 2% of the total weight put in is lost and 10% is
residue which is from process A and B realized Rs. 100 a ton and from C process Rs. 20 per
ton. The products of the three processes are dealt with as follows: -
Particular A B C
Sent to warehouse 25% 50% 100%
Passed on to the next process 75% 50% ---
The following particulars are for the month of march: -
Material used 1,000 140 1,348
Cost per tons of material used 120 200 80
Manufacturing Expenses 30,800 25,760 18,100

Prepare an account for each process, showing the cost per ton of each product

Process A Account

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 COST ACCOUNTING

Particular ton Rs. Particular ton Rs.

To Raw material used By Loss in weight(2% 20 __
(1000 X Rs. 200) of 1000 tons)
1000 1,20,000
To Manufacturing By Sale of Scrap (100
30,800 100 10,000
expenses & Wages ton X Rs. 100)
By Transfer to
warehouse cost 220 35,200
Rs.160
By Transfer to
660 1,05,600
process B @ Rs. 160
1000 1,50,800 per ton 1000 1,50,800

COST PER TON: - 1, 50,800-10,000 = Rs. 160 per ton

880 tons

Process B Account

Particular ton Rs. Particular ton Rs.

To Process A A/c 660 1,05,600 By Loss in weight(2% 16 --
of 800 tons)
To, Material 140 28,000
By Sale of Scrap
To Manufacturing 100 8,000
(10% of 800 tons)
expenses & Wages
25,760 352
By Transfer to
warehouse @ Rs. 75,680
215
352
By Transfer to
Process C @Rs. 215
per ton 75,680

800 1,59,360 800 1,59,360

COST PER TON: - 1, 59,360-8,000 = Rs. 215 per ton

704 tons

Process C account

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 COST ACCOUNTING

Particular ton Rs. Particular ton Rs.

To Process B A/c 352 75,680 By Loss in
weight(2% of
To, Material 1,348 1,07,840 34 --
1700 tons)
To Manufacturing 18,100
By Sale of Scrap
expenses & Wages
(10% of 1,000 170 3,400
tons)
By Transfer to
1,496 1,98,220
warehouse @
Rs. 132.50

1,700 2,01,620 1,700 2,01,620

COST PER TON: - 2, 01,620-3,400 = Rs. 132.50 per ton

1,496 tons
(6) The process of a company passes though two processes A and B respectively . From past
experience the percentage of loss, which is computed on the computer on the number of units
entering the process concerned, is ascertained as under:
Process A 2% Process B 5%
The loss of each process has a scrap value. The wastages of process A is sold at Rs. 10 per
100 units and that of process B at Rs.20 per 100 units. The following information is available for
the year ended 31st March 2007.
Process A Process B

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 COST ACCOUNTING

8,000 2,800
Materials consumed 12,200 14,000
Direct Wages 3,080 1,000
Manufacturing Expenses Units Units
39,000 38,500

Finished Product
Stock: 4,000 6,000
1st April 2004 3,000 8,000
31st March 2005

40,000 units of crude materials were introduced in Process A at a cost Rs. 16,000. Stock
valuation on April 1(per unit): Process A : Re 0.90; Process B : Re 1.47
Stock at 31st March is to be valued at the cost shown by the year’s process accounts.
Prepare the necessary accounts

Solution:
Process A Account

Particular unit Rs. Particular unit Rs.

To Unit Introduced 40,000 16,000 By Normal Wastage
(2% of 40,000 units @
To Material 8,000 800 80
Rs.10 per 100 unit
To Wages 12,200 200 200
By Abnormal Wastage
To Manufacturing
By Process A Stock @
expenses 39,000
3,080 Rs. 1 per unit 39,000

40,000 39,280 40,000 39,280

Process A Stock

Particular units Rs. Particular units Rs.

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 COST ACCOUNTING

To, Balance b/d @ Rs. By Process B

0.90 A/c (Unit
4000 3,600 40,000 39,600
Transfer)
To, Process A A/c
39,000 39,000
(transfer) By Balance c/d
@ Re. 1 per unit 3,000 3,000

43,000 42,600 43,000 42,600

Process B account
Particular unit Rs. Particular unit Rs.
To Unit Introduced 40,000 39,600 By Normal Wastage
(5% of 40,000 units
To Material 2,800 2000 400
@ Rs.20 per 100 unit
To Wages 14,000 38,500
By Process B Stock
To Manufacturing 1,000 @ Rs. 1.50 per unit 57,750
expenses
750
To Abnormal Effectives
500
40,500 58,150 40,500 58,150

Process B Stock
Particular units Rs Particular units Rs.
.
To, Balance b/d @ Rs. 6000 8,820 By Finished stock 36,500 54,570
1.47 38,500 57,500 A/c
To, Process A A/c By Balance c/d @ 8,000 12,000
(transfer) Re. 1.50 per unit

44,500 66,570 44,500 66,570

Calculation of cost of Abnormal Wastages and Abnormal Effectiveness: -
Process A: - Abnormal Wastages: - 39,200 X 200/ 39,200 = Rs.200
Process B: - Abnormal Effectiveness: - 57,000 X 500 / 38,000 = Rs.750
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 COST ACCOUNTING

(7). The product of a manufacturing concern passes through two processes A and B and then to
Finished Stock. It is ascertained on the basis of past experience that in each process 2% of the
total weight put in is lost and 10% is scrap which from process A and B realises. Rs.100 per Kg
and Rs.150 per Kg respectively.
The process figures are as follows:
Process Process
A B
Materials consumed in Kg Rs. Rs.
Cost of material per Kg 1000 70
Wages 120 200
Manufacturing Expenses 17,500 10,000
5,380 5,342
Prepare Process Accounts, showing the cost of the output of each process and the cost per Kg.

Solution:
Process A Account
Particulars kg Rs. Particulars Kg Rs.
To Materials @Rs.120 1,000 1,20,000 By Loss in Weight 20 -
per Kg
(2% of 1000Kg) 100 10,000
To Wages
17,500 By Sale of Scrap
To Manufacturing
5,380 (10% of 1,000Kg 880 1,32,880
Expenses
By Process B A/c
@ Rs.151 per kg

1,000 1,42,880 1,000 1,42,880

Process B Account
Particulars Kg Rs. Particulars Kg Rs.
To Process A A/c 880 1,32,880 By Loss in Weight 19
(Transfer)
(2% of 950 kg) -
To Materials
70 14,000 By Sale of Scrap 95 14,250
Consumed
10,000 (10% of 950 kg)
To Wages
5,342 836 1,47,972
To Manufacturing
Expenses

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 COST ACCOUNTING

By Finished Stock
A/c @ Rs.177 per
kg

950 1,62,222 950 1,62,222

(8)On the basis of the following information prepare Process Accounts and a statement of Profit:

Particular Process I Process II Process III

Raw Materials used 1,000 Ton

Cost per ton Rs.200
Manufacturing Wages Rs87,500 Rs.34,500 Rs,10,710
& Expenses
Weight lost 5% 10% 20%

Scrap(Sales price Rs.50 per ton) 50 ton 30 ton 51 ton

Sale price output per ton Rs.350 Rs.500 Rs.800

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 COST ACCOUNTING

Management Expenses were Rs.17,500 and selling expenses Rs.10,000.Two third of the
output of process I and one-half of the output of process II are transferred to next process
and the balance are sold. The entire output of Process III is sold.
Solution:
Process I Account
Particulars Ton Rs. Particulars Ton Rs.
To Raw materials By Loss of Weight
used 1,000 2,00,000 (5% of 1,000 Ton) 50 _
(1000 * Rs.200) By Sale of Scrap
To Manufacturing _ 87,500 (50 ton *Rs.50) 50 2,500
Wages & Exp. By Transfer to
Warehouse(1/3) 300 95,000
By Process II A/c
(2/3)
@ Rs.316.67 per ton 600 1,90,000

1,000 2,87,500 1,000 2,87,500

Process II Account
Particulars Ton Rs. Particulars Ton Rs.
To Process I A/c 600 1,90,000 By Loss of Weight 60 _
To Manufacturing _ (10% of 600 ton)
Wages & Exp.
34,500 By Sale of Scrap 30 1,500
(30 ton * Rs.50)
By Transfer to 255 1,11,500
Warehouse(1/2)
By Process III
A/c(1/2)@
Rs.437.25 per ton 255 1,11,500

600 2,24,500 600 2,24,500

Process III Account
Particulars Ton Rs. Particulars Ton Rs.

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 COST ACCOUNTING

To Process II A/c 255 1,11,500 By Loss of Weight 51 _

To Manufacturing (20% of 255 Ton)
Wages & Exp.
_ 10,710 By Sale of Scrap 51 2,550
(51 Ton * Rs.50)
By Transfer to
Warehouse
@Rs.782.09 per 153 1,19,660
ton

255 1,22,210 255 1,22,210

Statement of Profit
Rs. Rs.
Sales price of Output:
Process I=300 Ton * Rs.350 1,05,000
Process II=255 Ton * Rs.500 1,27,500
Process III=153 Ton * Rs.800 1,22,400 3,54,900

Less: Cost of production in each Process:

Process I=300Ton 95,000
Process II=255Ton 1,11,500
Process III=153 Ton 1,19,660
3,26160

Gross Profit
Less: Management Expenses 17,500 28,740

Selling Expenses 10,000

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 COST ACCOUNTING

27,500

Net Profit 1,240

NUMERICAL QUESTIONS
Q1. A product passes through three processes. The normal wastages of each process is. Process
A 3% Process Rs- 5% and process C- 8% the wastage of each process were sold at 0.25, 0.50
and Re 1/- Per unit respectively. 20,000 units were issued to process A at a cost of Re 1/- Per
unit. The other expenses were as under:
Process A Process B Process C
Rs Rs Rs
Materials 2,000 3,000 1,000
Wages 10,000 16,000 13,000
Direct expenses 2,000 3,000 4,000
Actual output 19,000 units 18,200 units 16,200 units

Prepare process Account.

Q2. A product passes through there processes as X, Y and Z. The information is given as
under:
Process X Process Y Process Z
Raw Material 2,000 tons - -
Cost per ton Rs 200 - -
Manufacturing exp. 1,75,000 80,000 20,000

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 COST ACCOUNTING

Weight of loss 5% 10% 20%

Scrap sold per ton 100 200 100
Sale price per ton 400 500 1000
2/3 of output of process X and ¼ output of process Y are passed to next process and balance
are sold out. Prepare processes Account.
Q 3. From the following particulars, prepare Process X account showing the cost per tonne of
output:
Materials in tonnes 1,000
Manufacturing expenses Rs. 10,000
Wages Rs. 26,000
Output in tonnes 830
Cost of material per tonne 125
It is ascertained that in .the process normally 5% of the total weight is lost and 10% is Scrap
which realizes Rs. 80 per tonne. There was no stock or work-in-progress.
Q 4. A product passes through two processes. The output of Process I becomes the input of
Process II and the output of Process II is transferred to Warehouse. The quantity of raw materials
introduced into Process I is 20,000 kg at Rs. I0 per kg. The cost and output data for the month
under review are as under:
Process I Process II
Direct materials Rs. 60,000 Rs. 40,000
Direct labour Rs. 40,000 Rs. 30,000
Production overhead Rs. 39,000 Rs. 40,250
Normal loss 8% 5%
Output Rs. 18,000 Rs. 17,400
Loss realization of Rs/unit 200 300

The company’s policy is to fix the selling price of the end product in such a way as to yield `a
profit of 20% on selling price.
Required:
(i) Prepare the Process Accounts
(ii) Determine the selling price per unit of the end product.
Q 5. Product B is obtained after it passes through three distinct processes. The following
information is obtained from the accounts for the week ending 31st October, 2008:

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 COST ACCOUNTING

Items Total Process

I II III
Rs. Rs. Rs. Rs.
Direct materials 7,542 2,600 1,980 2,962
Direct wages 9,000 2,000 3,000 4,000
Production overhead 9,000 - - -
1,000 units at Rs. 3 each were introduced to Process 1. There was no stock of material or work-
in-progress at the beginning or at the end of the period. The output of each process passes
direct to the next process and finally to finished stock.

Production overhead is recovered on 100% of direct wages. The following additional data are
obtained:

Process Output during the Percentage of nor- Value of scrap

week mal loss to input per unit
Process I 950 units 5% Rs.2 /-
Process II 840 10% 4
Process III 750 15% 5

Prepare process cost accounts and abnormal gain or loss accounts.

Q 6. A product manufactured by the standard Chemicals Ltd. passes through three processes I,
II and III. The following cost have been incurred for the month of September 2009:
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Process I Process II Process

III
(Rs.) (Rs.) (Rs.)
1. Materials Consumed 40,000 75,000
5,000
2. Direct Wages 22,500 10,000
10,000
3. Direct Expenses 20,5002,2502,505
Total Rs. 83,00019,75017,505
Units Units
Units
4. Output 3,900 3,850
3,200
5. Finished Process Stock:
(i) 01-9-2009 600 550
800
(ii) 30-9-2009 500 800 Nil
6. Stock Valuation on 01.9.2008 (Rs. per unit) 24.50 31.00
37.00
7. Percentage of wastage 2 5
10
8. Net Realizable Value of wastage per unit (Rs.) 13.50 16.25
21.00

Four thousand units of raw materials were introduced in Process No. 1 at a cost of Rupees
twenty thousand.
Stocks are valued and transferred to subsequent processes at weighted average cost. The
percentage of wastage is computed on the number of units entering the process concerned.
Prepare (i) Process A/cs; (ii) Process Stock A/cs; (iii) Normal Wastage A/c: (iv) Abnormal
wastage/Effective A/c.

Q 7. Product passes through three processes-A, B and C. The details of expenses incurred on
the three processes during the year were as under:
Processes A B C
Units introduced- 10,000

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Cost per unit Rs. 100/-

Rs. Rs. Rs
Sundry materials 10,000 15,000 5,000
Labour 30,000 80,000 65,000
Direct expenses 6,000 18,150 27,200
Selling price per unit of output 120 165 250

Management expenses during the year were Rs. 80,000 and selling expenses were Rs. 50,000.
These are not allocable to the processes.
Actual output of the three process was: A—9,300 units, B-5,400 units and C—2,100 units. Two-
thirds of the output of Process A and one-half of the output of Process B was passed on to the
next process and the balance was sold. The entire output of Process C was sold.
The normal loss of the three processes, calculated on the input of every process was: Process A-
Wo, B-15% and C-20%. The loss of Process A was sold at Rs. 2 per unit, that of B at Rs. 5 per
unit and of Process C at Rs. 10 per unit.
Prepare the three Process Accounts and the Profit and Loss Account.
Q 8. The following details are extracted from the costing records of an oil refinery for the week
ended 30 September, 2008.
Purchase of 500 tonnes of copra Rs. 2,00,000.
Crashing plant Refinery plant Finishing
Cost of labour 2,500 1,000 1,500
Electric power 600 360 240
Sundry material 100 2,000 —
Repairs to machinery and plant 280 330 140
Steam 600 450 450
Factory expenses 1,320 660 220
Cost of casks — — 7,500

300 tonnes of crude oil was produced.

250 tonnes of oil was produced by refining process.
248 tonnes of refined oil was finished for delivery.
Copra sack sold Rs. 400.
175 tonnes of caprin residue sold Rs. 11,000.

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Loss in weight in crushing 25 tonnes.

45 tonnes by-product was obtained from refining process valued at Rs. 6,750. You are required
to show the accounts in respect of each of the following stages of manufacture for the purpose
of arriving at the cost per tonne of each process and also the total cost per tonne of finished oil.
(a) Copra crushing process, (b) Refining process, (c) Finishing process.

LESSON 15
COSTING OF JOINT PRODUCT AND BY PRODUCT

CONTEXT OF THE LESSON

In case of processing industry some time more than one products are produced from the common
raw material which are classified into joint products or by-products on the basis of significance of
their value. In this lesson we will deal with the criteria for differentiating between joint products
and by products and the method of costing of these products.

OBJECTIVES OF THE LESSON

INTRODUCTION
A manufacturing organization which deals in multi-product/ multi-process and multi service
industries are always uncertain on one of the major issue of identifying and allocating and
apportioning joint cost or common costs to various products or output services. The final
product/service cost will reflect the full cost only if the joint/ common costs are allocated or
apportioned on some suitable basis to the individual final products. The problem of allocation and
apportionment of common or joint costs becomes more significant in process industries, where
there is common process being applied up to a certain stage and then segregates into two or
more process lines to produce more than one product from a common initial process.
The essence of joint product/by-product costing lies in the allocation/apportionment of
joint processing costs to the individual products in an equitable manner as possible. The
ascertainment of joint costs is very much essential for valuation of work-in-progress inventory,
external financial reporting and for the purposes of valuation under various statutory and tax
legislations. It is necessary to understand the cost practices for the apportionment of joint costs
to individual products in the cost statements in case of those industries where a product has to
pass through various process in order to become a finished product.
Following are some examples of the industry where more than one product are produced
simultaneously through various process with their joint products:
Coal mining washing and Coke production resulting in the production of Coal, Coke, Gas,
Benzene, and Tar and Ammonia.
Petroleum refining resulting in the production of Petrol, Kerosene, Diesel, Furnace oil etc. In this
industry a very large number of joint and by-products occur in cracking or refining crude oil.

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Agricultural Product industries such as vegetable oil - crushing of oil seeds resulting in production
of oil and cake. From the process of refining oil, soap stock arises which could be further
processed into soap and allied products. The refined oil can be further hydrogenated to produce
Vanaspati.
In sugar industry, the three by-products are bagasse, molasses and pressmud.
In Milk industry , the three joint products are Cream, Liquid Milk and Skim. The cream is again
processed into Butter and ghee. The liquid milk and skim is processed to produce whole milk, full
cream milk and standard milk.
Chemical industry: Processing of naphtha results in Ethylene, Propylene, Methane, Ethane,
Butane etc.
Terminology
Joint-Products:.
Multiple products deriving out of same raw materials through a common process
simultaneously which have substantial market value is termed as joint product

Two or more products separated in the course of processing, each having a sufficiently
high saleable value to merit recognition as a main product.
Example: Ethylene and Propylene arising from the cracking of Naphtha
By-Product:
A product, which is secondary to the main product and obtained during the course of
manufacture of recognized main product. It is called a by-product because it is less
significant as compared with the main product or products.
A product which is produced incidentally from the material used in the manufacturing of
main products, having either a net realizable value or a usable value which is relatively
low in comparison with the saleable value of the main products is termed as by product.
By-product may be subjected to further processing after separation from the main product,
if such processing will increase the value added or promote the sale of the main product.
It is called a by-product because of the relatively lower importance or lower market value
or lower ultimate value at the end of the value chain it has, compared with the main product
or products.
Example: Groundnut crushing in which oil is the main product and cake is a by-product.
Cake is used as raw material for manufacture of cattle feed.
The productions of the by-products are incidental to the production of main product. A by-
product may get promoted to the status of joint product if the market perception changes
or a joint product could be relegated it the position of a by-Product in future. The
classification could vary over a period time. For example, in a Petroleum Refinery, gas
was earlier considered as a by-product. Now, it has assumed importance like petrol,
diesel, etc. and it is being treated as a joint product.
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Split off point:

It is the stage in the manufacturing process where joint products are separated and can
be identified as separate product.
Scrap:
Scraps are discarded material which has some recovery value and are either disposed of without
further treatment (other than reclamation and handling), or reintroduced into the
production process in place of raw material.
Waste:
The discarded material or substances having no significant value (as distinct from scrap) is treated
as waste.
Joint Costs:
Joint Costs are the common cost of facilities or services employed in the output of two or
more simultaneously produced or otherwise closely related operations, commodities or
services. The costs incurred in the joint process cannot be separately traced to the individual
product outputs. The specific feature of joint products is that they incur joint costs up to the
stage of production, known as the split-off point, when they become recognisable as separate
products. The costs incurred in the joint process cannot be separately traced to the individual
product outputs.
Separate cost or Separable cost:
Any cost incurred after the split off point e.g. the additional processing costs, which can
be identified with specific products may be termed separate costs. For a cost to be treated
as separate cost, it must be possible to trace it with reasonable certainty to a single
product.

Costing Principles for Joint Product / By-product costing:

There are two basic principles or approaches for costing of joint product and by-products, which
are as follows:
Joint Product Approach:
More than one product is treated as joint product under this approach and the joint
processing costs are allocated between the products on an appropriate basis.

Main Product / By-product Approach:

Only one product is considered as a main product under this approach and all other
products arising from the process will be treated as by-products.
In this approach, the joint costs are not allocated between the products but the amount of
sales revenue (sales value less further processing expenses, selling expenses, etc. if any)
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realised from the products is credited to the joint costs and the remaining joint cost is totally
absorbed by the main product.

Recognition of a Product as Joint Product or By-Product

Whether a product is to be recognised as a joint product or by-product, in this regard there is

no specific rules or guidelines. Products which are incidental to the production of main
products and products which are insignificant in value compared to the main product are
treated as by-products. However, the status of a product may change from by-product to main
product or vice versa due changes in market price, competition, demand or technology and
thus may require a re-classification. Therefore, the classification between the main product
and by-product has to be reviewed continuously. Recognition of joint products and by-
products is purely by relative commercial values. Further, such relative values are not
permanent as their relative importance of joint and by-products is evanescent in nature.

Methods of Apportionment of Joint Costs

The following are the methods which are used for the apportionment of Joint cost:
Market Value Bases:
The total joint cost of production is apportioned among the joint products on the basis of
their relative sales value in this method.

The fundamental principle of this method is that joint products should absorb joint costs
according to their ability to pay as reflected by the market values of the individual products.

The market value or the sales value for the purpose of joint cost can be as follows-
(i) Market value after further processing i.e. the final sales value.
(ii) Net Realisable value i.e. the final sales value less the further processing costs.
(iii) Gross Margin Percentage.
(iv) Market value at the point of separation.

(i).Market value after further processing i.e. the final sales value:
When there is a wide parity in selling prices of final products, this base is to be adopted.
While choosing a selling price, it is important to choose a representative period considering
the normal cycle of fluctuations which may be the daily average of the past month or

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quarterly average or any suitable period.

Example 1
Joint production cost of the Products
Total Prod A Prod B Prod C

Raw Materials 1,20,000

Chemical 10,000

Labour 50,000

Manufacturing overhead 45,000

2,25,000

Apportioned on the basis of use of

services
- Administration Overhead 25,000 10,000 10,000 5,000
- Selling & Distribution Overheads 30,000 15,000 5,000 10,000
Total cost 2,80,000

i) Unit produced 1150 400 400 350

ii) Sales Price per unit ( Rs) 250 300 200

iii) Sales Value ( Rs) 2,90,000 1,00,000 1,20,000 70,000

iii)Joint production cost 2,25,000 77,586 93,104 54,310
apportioned on the basis sales
value (Rs)
iv) Administration overhead (Rs) 25,000 10,000 10,000 5,000
v) Selling & Dist. Overheads ( 30,000 15,000 5,000 10,000
Rs)
vi) Total Cost 2,80,000 1,02,586 108,104 69,310
iv) Cost per Unit 256.47 270.26 198.03

(ii). Net Realisable value i.e. the final sales value less the further processing costs: If a
product require further processing after split-off point, then the further processing cost has
to be determined and deducted from the sales value to arrive at the basis for apportionment

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of joint cost among the products.

Example 2
Apportionment of joint costs on the basis of net realisable value
Total Prod. A Prod.B Prod.C

I. Units produced 1150 400 400 350

II. Sale Price per unit (Rs.) 300 350 200

III. Sale Value 3,30,000 1,20,000 1,40,000 70,000

IV. Further Processing Cost 22,000 10,000 12,000 --
V. Net Realisable Value 3,08,000 1,10,000 1,28,000 70,000
VI. Joint Cost Apportioned on the Basis of 2,25,000 80,357 93,507 51,136
V (35.71%, 41.56%, 22.73%)
VII. Administration Overhead 25,000 10,000 10,000 5,000
VIII. Selling & Distribution Overhead 30,000 15,000 5,000 10,000
IX. Total Cost 2,80,000 1,05,357 1,08,506 66,136
X. Joint Cost Per Unit 200.89 233.77 146.10

XI. Further Processing Cost Per Unit 25.00 30.00

XII. Cost Per Unit Of Finished Goods 225.89 263.77 146.10

(iii). Gross Margin Percentage: When the products have same profitability on sales, Joint costs
shall be allocated on the basis of Gross Margin Percentage

Example 3
(iii).Apportionment of Joint Cost on the Basis of Gross Margin Percentage.
Total Prod A Prod B Prod C

Unit produced 1150 400 400 350

Sales Price per unit ( Rs) 300 350 200

Sales Value ( Rs) 3,30,000 1,20,000 1,40,000 70,000

Joint cost 2,25,000

Further Processing Cost 22,000

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Gross Margin 83,000

Gross Margin Percentage 25%

Deduct Gross Margin @ 25% 83,000 30,000 35,000 18,000

Cost of Goods Sold 2,47,000 90,000 1,05,000 52,000
Less: Further Processing Cost 22,000 10,000 12,000 -
Joint Cost Allocated 2,25,000 80,000 93,000 52,000

The obvious assumption in this method is that all the products have the same profitability
ratio on sales.
(iv). Market value at the point of separation:
Joint costs apportionment on the basis of sales value of the products shall be followed when
no other rational basis for apportionment of joint cost is available and joint products are sold
without further processing at split off point.

Physical unit base method

Where individual products are from a common input, and none of the products can be
categorised as by-product, the benefits received by individual products from the common
input is to be measured by physical units e.g. weight, length, volume, etc. The joint costs
are to be allocated to individual products on the basis of this measurement.
Example 4:
Joint production cost of the Products:
Total Prod A Prod B Prod C

Raw Materials 1,20,000

Process Chemical 10,000

Employees cost 30,000

Production Overhead 40,000

2,00,000

Apportioned on the basis of

use of services
- Administration Overhead 15,000 40% 30% 30%
- Selling & Distribution 20,000 20% 40% 40%
Overheads

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Total cost 2,35,000

Total Prod A Prod B Prod C

i) Unit Produced (No) 1,00,000 50000 30000 20000

ii) Joint production cost 2,00,000 1,00,000 60,000 40000
apportioned on the basis of
Units of production (Rs)
iii) Administration overhead 15,000 6,000 4,500 4,500
(Rs)
iv) Marketing expenses (Rs) 20,000 4,000 8,000 8,000
v) Total Cost 2,35,00 1,10,000 72,500 52,500
iv) Cost per Unit (Rs) 2.20 2.42 2.63

Treatment of cost of by-products:

The by-products are normally additional output in the production of main products. The
standardization of treatment of by-product costs is important from the point of cost accounting.
The uniform system of treatment of cost accounting for by-product shall be followed. Sales value
of by-products less further processing cost, administrative expenses and selling and
distribution expenses shall be credited to the total cost of main product.

Example 5
Joint Cost Rs 2, 80,000
Sales value of by-product Rs 15,000
Less: Further processing cost. Rs. 3,000
Administration & selling and Rs 2,000
Distribution Cost -------------
Amount to be credited to Joint Cost Rs 10,000
----------------
Joint Cost to be apportioned among joint products Rs 2, 70,000

NUMERICAL ILLUSTRATIONS
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1 In a manufacturing concern in a certain product A yield by-products B and C. The joint

expenses of the manufacture are:
Material Rs. 10,200 Labour Rs. 11,500 and On cost Rs. 7,500
Subsequent expenses are as under:
Particular A B C
Material 2,500 1,200 1,400
Labour 1,900 1,600 2,000
Oncost 1,500 900 1,050
Total 5,900 3,700 4,450

Selling prices are: A = 30,000; B = 20,000 C = 15,000. Estimated profits on turnover are A = 40%
B = 30% C = 25%.
Show how would you apportion the joint expenses of manufacture and prepare necessary
accounts.
Solution: -
Apportionment of joint Expenses
Particular A B C
Selling Price 30,000 20,000 15,000
Less: Estimated Profit 12,000 6,000 3,750
Total cost 18,000 14,000 11,250
Less : Total Separate Expenses 5,900 3,700 4,450
Share in Joint Expenses( Rs29,000) 12,100 10,300 6,800

A (Main Product) Account

Particular Amount Particular Amount
To Joint Expenses
Material 10,200 By By-product B 10,300
Labour 11,500 By By-product C 6,800
Oncost 7,500 By Balance c/d 12,100
29,200 29,200

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 COST ACCOUNTING

To Balance c/d 12,100

To Separate Expenses 18,000
Material 2,500 By Cost of Production
Labour 1,900
Oncost 1,500
18,000 18,000

To Cost of Production 18,000 30,000

To Profit 12,000
By Sales
30,000 30,000

B (By-Product) Account
To A (Main Product) A/c 10,300
To Material 1,200 By Cost of Production 14,000
To Labour 1,600
To Oncost 900

14,000 14,000

To Cost of Production 14,000 20,000

By Sales
To Profit 6,000
20,000 20,000

C (By-Product) Account
To, A (Main Product) A/c 6,800
To Material 1,400 By Cost of Production 11,250
To Labour 2,000
To Oncost 1,050

11,250 11,250

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 COST ACCOUNTING

11,250 15,000
To Cost of Production 3,750
To Profit 15,000 By Sales 15,000

2. A factory providing articles X also Y and Z as by product. The joint cost of manufacturing is:
Material 10,000
Labour 2,000
Factory and office Overhead 8,000
Total 20,000
Subsequent separate costs are as under:
Particular A B C
Material 1,500 1,300 1,000
Labour 200 150 100
Factory and office Overhead 800 550 400
Total 2,500 2,000 1,500
Sales value 20,000 15,000 10,000
Estimated profits on sales value 30% 25% 20%

Assume that selling and distribution expenses are in proportion to sales value.
Show how you would propose to apportion the joint cost f manufacture and prepare the necessary
accounts of X, Y and Z
Solution:
Apportionment of joint Expenses
Particular X Y Z Total

Sales 20,000 15,000 10,000 45,000

Less: Profit 6,000 3,750 2,000 11,750

(30%) (25%) (20%)

Total cost 14,000 11,250 8,000 33,250

Less : Total Separate Expenses 2,500 2,000 1,500 6,000

Share in Joint Expenses(Net Value) 11,500 9,250 6,500 27,250

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The difference between Rs. 27,250 and in joint cost of Rs. 20,000, i.e., Rs. 7,250 is that of selling
and distribution cost which is further apportioned in the ratio of sales values n the three products
as under:
Particular X Y Z Total
Estimated joint cost 11,500 9,250 6,500 27,250
Less: selling and distribution cost 3,222 2,417 1,611 7,250
Share in joint cost

8,278 6,833 4,889 20,000

X (Main Product) Account

Particular Amount Particular Amount
To Joint Expenses
Material 10,000 By By-product Y 6,833
Labour 2,000 By By-product Z 4,889
Factory and office Overhead 8,000 By Balance c/d 8,278
20,000 20,000
To Balance c/d 8,278 By Sales 20,000
To Separate Expenses
Material 1,500
Labour 200
Factory& office Overhead 800
To Selling and Distribution 3,222
To Profit 6,000
20,000 20,000
Y (By-Product) Account
To X (Main Product) A/c 6,833 By Sales 15,000
To Material 1,300
To Labour 150
To Fact.& office Overhead 550
To Selling and Distribution 2,417

To Profit 3,750

15,000 15,000

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 COST ACCOUNTING

Z (By-Product) Account
To X (Main Product) A/c 4,889 By Sales 10,000
To Material 1,000
To Labour 100
To Factory and office
Overhead
400
To Selling and Distribution
1,611
To Profit
2,000
10,000 10,000

3 Product P yields by-product Q and R. The joint expenses and subsequent expenses are
as follows :

Joint Subsequent expenses

expenses
Particular P Q R
Rs.
Material 10,000 2,000 1,600 1,800
Labour 8,000 2,400 1,400 1,700
On cost 9,000 2,600 1,000 1,500
27,000 7,000 4,000 5,000
Sales 42,000 20,000 18,000
Percentage of profit on sales 50% 50% 33.1/3%

Show how you would apportion the joint expenses and prepare the necessary accounts.
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 COST ACCOUNTING

Solution:
Statement of Apportionment of Cost

P Q R
Particular Rs. Rs. Rs.

Sales 42,000 20,000 18,000

- Profit (50%, 50%, 331/3%) 21,000 10,000 6,000
Total 21,000 10,000 12,000
-Post Separation Cost( Total) 7,000 4,000 5,000
Joint cost to be Apportioned 14,000 6,000 7,000
Ratio 14: 6: 7
14 6 7
10,000 × 10,000 × 10,000 ×
27 27 27
Material
= 5,185 = 2,222 = 2,593

Labor 14 6 7
8,000 × 8,000 × 8,000 ×
27 27 27
= 4,185 = 1,778 = 2,074
14 6 7
O.H 9,000 × 9,000 × 9,000 ×
27 27 27
= 4,667 = 2,000 = 2,333

P Account
Particular Amount Particular Amount
To Joint Cost By Sales 42,000
Material 5,185
Labor 4,148
O.H. 4,667 14,000
To Separate Cost:
Material 2,000

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 COST ACCOUNTING

Labor 2,400
O.H. 2,600 7,000
To Profit (50% of 42,000) 21,000

42,000 42,000

Q Account
Particular Amount Particular Amount
To Joint Cost By Sales 20,000
Material 2,222
Labor 1,778
O.H. 2,000 6,000
To Separate Cost:
Material 1,600
Labor 1,400
O.H. 1,000
4,000
To Profit (50% of 20,000)
10,000
20,000 20,000

R Account
Particular Amount Particular Amount

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 COST ACCOUNTING

To Joint Cost By Sales 18,000

Material 2,593
Labor 2,074
O.H. 2,333 7,000
To Separate Cost:
Material 1,800
Labor 1,700
O.H. 1,500
5,000
To Profit (50% of 18,000)
6,000
18,000 18,000

4. Three products, viz, Nima, Bima, Rima are prepared out of a single process. The joint
expenses are: Material Rs. 2, 20,000; Labour Rs. 1, 00,000 O.H. Rs. 80,000. Post separation is:
Particular Nima Bima Rima
Other Material 30,000 20,000 15,000
Labour 20,000 30,000 10,000
O.H. 5,000 6,000 5,000
55,000 56,000 30,000
Sales value 5,00,000 3,00,000 2,00,000
Profit on Sales 50% 30% 25%

Prepare statement showing apportionment of joint expenses, and Account for each product.
Solution: Statement of Apportionment of Cost
Particular Nima Bima Rima Total
Sales 5,00,000 3,00,000 2,00,000
- Profit (50%, 30%, 20%) 2,50,000 90,000 50,000
Total 2,50,000 2,10,000 1,50,000

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 COST ACCOUNTING

- Post Separation Cost( Total) 55,.000 56,000 30,000

Cost before selling expenses 1,95,000 1,54,000 1,20,000 4,69,000
-Selling expenses (Note) 34,500 20,700 13,800 69,000
Joint cost to be apportioned 1,60,500 1,33,300 1,06,200 4,00,000

Ratio 1,605 1,333 1,062

Materia 1,605 1,333 1,062
× 2,20,000 = 88,275 × 2,20,000 = 73,315 × 2,20,000 = 58,410
l 4,000 4,000 4,000

Labour 1,605 1,333 1,062

× 1,00,000 = 40,125 × 1,00,000 = 33,325 × 1,00,000 = 26,550
4,000 4,000 4,000
O.H. 1,605 1,333 1,062
× 80,000 = 32,100 × 80,000 = 26,660 × 80,000 = 21,240
4,000 4,000 4,000

Nima Account
Particular Amount Particular Amount
To Joint Cost By Sales 5,00,000
Material 88,275
Labour 40,125
O.H. 32,100 1,60,500
To Separate Cost:
Material 30,000
Labour 20,000
O.H. 5,000
55,000
To Selling Expenses
34,500
To Profit (50% of 5,00,000)
2,50,000
5,00,000 5,00,000

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Bima Account
Particular Amount Particular Amount
To Joint Cost By Sales 3,00,000
Material 73,315
Labour 33,325
O.H. 26,660 1,33,300
To Separate Cost:
Material 20,000
Labour 30,000
O.H. 6,000
56,000
To Selling Expenses
20,700
To Profit (30% of 3,00,000)
90,000
3,00,000 3,00,000

Rima Account
Particular Amount Particular Amount
To Joint Cost By Sales 2,00,000
Material 58,410
Labor 26,550
O.H. 21,240 1,06,200
To Separate Cost:
Material 15,000
Labor 10,000
O.H. 5,000
30,000
To Selling Expenses
13,800
To Profit (25% of 3,00,000)
50,000
2,00,000 2,00,000

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SELF CHECK QUESTIONS

1. What do you mean by joint cost? Discuss the method of apportionment of joint cost?
2. Diffrenceate between joint product and by product and discuss the method of costing of
joint product.
3. What do you mean by- product? Discuss the method of costing of by product?
NUMERICAL QUESTION
Q.1.Product A yields bye-products B and C and the joint expenses of manufacture are:
Particular A B C

Materials 8,000 4,000 2,000

Labour 4,000 3,000 1,000
On Cost 600 500 500
12,600 7,500 3,500
Selling Price 51,000 21,000 10,000
Estimated profit on sale 40% 30% 20%

Show the manner in which you would apportion the joint expenses of manufacture. Also
prepares accounts showing cost of each product.
Ans. Share in joint expenses A Rs.18,000;B Rs.7,200;and C Rs.4,500;Cost of Production A
Rs.30,600;B Rs.14,700,and C Rs.8,000.

Q.2.In a manufacturing concern a certain product A yields bye-products B and C. The joint
expenses of the manufacture are: Materials Rs.8,500;Labour Rs.9,000 and Overheads
Rs.7,500.Subsequent expenses are as follows.
Particular A B C
Materials 2,500 1,200 1,400
Labour 1,900 1,600 2,000
Overhead 1,500 900 1,050
5,900 3,700 4,450
Selling Price 30,000 20,000 15,000
Estimated profit on turnover 40% 30% 25%

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Show how would you apportion the joint expenses of manufacture and prepare the
accounts.
Ans. Apportionment of joint expenses: A Rs.10, 360, B Rs.8,818, C Rs.5,822

Q.3.The joint products X,Y and Z are produced from a common process. The joint expenses
of manufacture are:
Rs.
Material 57,000
Labour 30,000
Overhead 2,100
Total 89,100

Subsequent expenses are as follows

X Y Z
Rs. Rs. Rs.
Materials 24,000 12,000 6,000
Labour 12,000 9,000 3,000
Overhead 1,800 1,500 1,500
Total
37,800 22,500 10,500
Sales
Estimated profit on sale 1,53,000 63,000 30,000
40% 30% 20%

Show the manner in which you want to apportion the joint expenses of production.
Ans. Joint expenses will be apportioned in the ratio of 20:8:5; Total Cost A-Rs.91, 800, B-
Rs.44, 100 and C-Rs.24, 000.

Q.4.A Factory producing article A also yields B and C as by-products. The joint cost of
manufacture is:
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Rs.
Materials 10,000
Labour 2,000
Overheads 8,000
Total 20,000
Subsequent costs are as follows:
A B C
Rs. Rs Rs.
Materials 1,500 1,300 1,000
Labour 200 150 100
Overheads 800 550 400
2,500 2,000 1,500
30,000 24,000 20,000
Selling Price 30% 24% 20%
Estimated Profits on Selling Prices

Show how you would propose to apportion the joint costs of manufacture and prepare the
necessary statement in respect of A, B and C.

Ans. Share in joint cost of manufacture; A Rs.6, 743; B Rs.6, 595; C Rs.6, 662

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