B.B.A.

NEW SYLLABUS and

CBCS PATTERN B.B.A.
(International Business]
Semester-ll

BASICS OF
COST ACCOUNTING
Dr. SUHAS MAHAJAN Dr. MAHESH KULKARN

Accounting

Cost
PARA
A Book OfF

BASICS OF
COST ACCOUNTING
F.Y.B.B.A. and F.Y.B.B.A. (International Business) Semester II
As Per Savitribai Phule Pune University New Syllabus
Effective From June, 2019

Dr. Suhas Mahajan

B.A., M.Com., Ph.D. (Finance)
Dr. Mahesh Kulkarni
M.Com., M. Phil., L.L.B., D.T.L., Ph.D. (Management)
Research Guide, Research Guide,
Savitribai Phule Pune University and YCMOU, Savitribai Phule Pune University and YCMOU,
Nashik. NashiK

Price 240.00

NIRALT ADVANCEMENT OF KNOWLEDGE

N4904
Basics of Cost Accounting ISBN 978-93-89825-11-4
FirstEdition January 2020
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Preface..
There are a number of books on the subject of 'Basics of Cost Accounting' available in
the learner's market, but they do not meet the basic requirements of B.B.A. (Bachelor of
Business Administration) Semester II of Savitribai Phule Pune University. This book is
written as per the syllabus for B.B.A., Semester L students of Savitribai Phule Pune
University from November, 2019. We do hope that this book will definitely help to meet the
growing requirements of students of B.B.A., from the faculty of commerce. This book adopts
a modern and novel approach towards the study of Cost Accounting in view with the
specific requirements of the readers and practitioners of this subject.
All the topics included in the syllabus are explained in simple, but apt language so that
the students coming from different faculties can also understand them very easily. Besides
the language, care is also taken to solve the problems at the end of each unit with the help
of appropriate illustrations, wherever necessary. This will help the students in understanding9
the different topics properly. We have taken tabular representation of classified cost
statements. Proper emphasis is also given on charts and graphs to simplify the cost
accounting theories and practices. This book has been designed to serve as a self sufficient
text for B.B.A. students. It will definitely add to our satisfaction if this book would be more
useful as a reference for practicing accountants, professional managers, dynamic
entrepreneurs and enthusiastic teachers of the subject concern. This book is also useful for
M.Com., D.B.M., M.B.A, M.C.M., Diploma in Hotel Management and Diploma in Hospital
Management and many other professional courses.
We are very thankful to Shri. Dineshbhai Furia, Shri. Jignesh Furia, Mr. Malik Shaikh,
Mr. Prasad Chintakindi, Mrs. Anjali Muley and the entire staff of Nirali Prakashan, Pune, for
their earnest help in bringing out this book with vigour and accuracy. We have put in
maximum efforts to make the text error free. Nevertheless, we do not rule out the possibility
of certain shortcomings or misprints still remaining. We will be grateful to the readers, if
such errors are being pointed out from time to time.
We must concede that this book would never have been written without the support,
encouragement and inspiration of our family members, many, many thanks to them.
Any criticism or valuable suggestion for further improvement of this book will be
greatfully acknowledged and highly appreciated.

Vinayaki Chaturthi Dr. Suhas Mahajan

30h December, 2019 Dr. Mahesh Kulkarni
Pune 411 021
Syllabus
FY BBA- Semester-Il: Basics of Cost Accounting
Course Code 204
Credit 3
Depth of the syllabus Reasonable working knowledge
Objectives:
1. To develop rational understanding regarding concept of cost expenditure in
business.
2. To develop understanding how overheads influence the cost structure of cost.
3. To develop skills for computation of total cost for a particular product.
Unit Unit Title Contents Purpose and skills to be developed
No.
1. Basic Concept Concept of Cost, Costing, Cost To understand importance of costing
inCost ACCOunting and Cost in decision making.Ability to
Accountancy, Origin, Objectiv understand importance of costing
and Feature of Cost Accounting -
and role of costing
Difference between Financial and
Cost Accounting, Conceptual
analysis of Cost Unit and Cost
Centre
2. Elements of Material, Labour and other To understand how to prepare a cost
Cost and cost Expenses, Classiication or Coststatement and analyze impication ot
sheet and 1ypes of Costs, Preparationelements of cost on total cost Ability
of Cost Sheet to examine different aspects of cost
as they influence total cost structure
and sales price. Ability to prepare
comprehensive cost sheet.
3. Overheads Meaning and Definitions, To understand concept of overhead
or Overheads as t coniridutes to total cost Or
SCuon
Collection, Allocation, product or service
APporuonment, Ability to ascertain ability to
Reapportionment of Overheads distinguish different types of
Under and Over Absorption- Overheads as it iniuences the total
Definition and Reasons
cost in a given situation.
Contact and Contract Costing- Meaning and To understand role of contract
Process. Cost Features of Contract Costing.costing in ascertaining cost of a
and Methods of Works Certified and Uncertified,| particular project or activity.
Costing Escalation Clause, Cost Plus To know how cost is ascertained 1or
Contract, Work in PTOgress, different types of procesSes.
Profit on Incomplete Contract,
Process Costing Meaning,10 develoP abiity to ascertain cost of
Features of Process Costing,a particuar contract under different
Preparation of Process CostingCrcumstances.
Including Normal and Abnormal To learn how cost of a particular
Loss/Gains, process is ascertained especially in
case of single or multiple process as
well as for joint products.
***
 FY BBA-IB- Semester - I1: Basics of Cost Accounting
Course Code 201
Credit 3
Depth of the syllabus Reasonable working knowledge
Objectives:
1. To develop rational understanding regarding concept of cost expenditure in
businesS.
2. To develop understanding how overheads influence the cost structure of cost.
3. To develop skills for computation of total cost for a product._
Unit Unit Title Contents Purpose and skills to be
No. developed
1. Basic Concept of Cost, Costing8 Cost To understand importance of
Concept in Accounting and Cost Accountancy, costing in decision making.
Cost Origin, Objectives and Features or Ability to understand importance of
Cost Accounting. Drerence costing and role of costing
between Financial and st
Accounting, Conceptual analysis of
Cost Unit and Cost Centre.

2.| Elements of| Material, Labour and other| To understand how to prepare a
Cost and Expenses, cost statement and analyze
pucauon ot elements of cost on
Cost Sheet Classification of Cost and Types of
Costs, total cost Ability to examine
difierent aspects of cost as they
Preparation of Cost Sheet intuence total cost structure and
sales price. Ability to prepare
comprenensive cost sneet.
Overheads Meaning Definitions,| To understand concept of overhead
and
lassitication of Overheads as it contributes to total cost of a
Collection, Allocation, product or service
Reapportionment
"Ppuonment,
verhea eDefinition
rerAbility to ascertain ability to
gusn as different types totalof
and overheads
Dsorption
Absorption Dennnon ad
it influences the
Keasons
costin a given situation.
Contact and Contract Costing Meaning and To understand role of contract
Process Features of ontract Costing, costing in ascertaining cost ofa
Works Certified and Uncertified, particular project or activity. |

Cost and
Methods of
scalation
Contract,
Clause,
Work in Progress, Fro
Cost
us To know how cost 1s ascertainea 10r

different types ot procesSes.

Costing on Incomplete Contract, Process
Costing Meaning, Features of To develop ability to ascertain cost
Process Costing, Preparation of
Costing Including Normal
o a particular contract under
Process dilerent circumstances.
and Abnormal Loss/Gan8. To learn how cost of a particular
process is ascertained especialy in
case of single or multiple process
as wel as tor joint products.
***
Contents...

1. Basic Concept in Cost 1.1 1.24

2. Elements of Cost and Cost-Sheet 2.1 2.74

3. Overheads 3.1 3.44

4. Methods of Costing 4.1-4.80

AT A GLANCE

Glossary G.1 G.6

Objective Questions

-True or False Statements T.1 T.4

Fill in the Blanks F.1 F.6

Bibliography B.1 B.1
List of igures, Graphs and Charts..

1.1 Basic Cost Concepts 1.2

1.2 Limitations of Pinancial Accounting 1.6

1.3 Objectives of Cost Accounting 1.10

1.4 Features of Cost Accounting 1.12

1.5 Advantages of Cost Accounting 1.13

L.6 Types of Cost Centres 1.22

2.1 Elements of Cost 2.2

2.2 Division of Costs 2.9

2.3 Need of Cost Classification 2.10

2.4 Methods Cost Classi on 2.11

2.5 Classification of Costs on basis of Traceability, Elements and Functions 2.14

2.6 Types of Costs 2.19

2.7 Composition of Conversion Cost 2.20

3.1 Composition of Overheads 3.4

3.2 Classification of Overheads 3.6

3.3 Panchasutri of Overheads Accounting 3.14

3.4 Methods of Re-apportionment of Service Department Overhead Costs 3.29

3.5 Accounting Treatment for Disposal of Under or Over-absorbed Overheads 3.36

4.1 Methods of Costing 4.3

4.2 Joint Process Cost 4.52

4.3 Process Cost Flow 4.59

****
 Unit ... .1
BASIC CONCEPT IN COST
Synopsis.
1.1 Basic Cost Concepts
1.1,1 Cost
1.1.2 Costing
1.1.3 Cost Accounting
1.1.4 Cost Accountancy
1.2 Cost Accountinng
1.2.1 Origin
1.2.2 Objectives
1.2.3 Features
1.3 Difference between Financial Accounting and Cost Accounting
1.4 Conceptual Analysis of Cost Unit and Cost Centre
1.4.1 Cost Unit
1.4.2 Cost Centre
Questions for Self-Study

In today's competitive environment, the nature and functioning of business organisations

have become very complicated. Various parties viz., owners, creditors, employees, government
agencies, tax authorities, investors, management of the business etc. are interested in the
functioning of the business. Accounting provides substantial intormation to all these parties. In
order to satisfy their needs, a sound organisation of accounting system is essential. The needs of
the majority of the users of accounting intormation can be satistied by Finarncial Accounting
Financial Accounting is mainly concerned with preparation of two important financial
statements, viz. Profit and Loss Account and Balance Sheet. This information serves the needs of
all those who are not directly associated with the management of business. To carry out the
functions of planning, decision-making and control more etticiently, the management require
more analytical information relating to cost. The Financial Accounting system fails to some extent
to provide all these required informatiorn to management and hence a new system of accounting
necessitates, which fulfils all the needs of management. Thus, Cost Accounting is developed to
offset the limitations of Financial Accounting. Broadly speaking, there are three branches of
accounting viz., Financial Accounting, Cost Accounting and Management Accounting which are
concerned with presenting business data to the ultimate users.
The following example clearly indicates the need and importance of Cost Acounting as a
separate branch of accounting, which has emerged mainly because of the limitations of Financíal
ACcounthting
EXAMPLE
Godrej Ltd., Gorakhpur leading s0ap manufacturer runs three separate divisions
a
viz. Hamam, Rexona and Liril. Their books of accounts for the year 2018-19 discloses the annual
results as follows: Actual Turnover 3,00,000, Expenses incurred R 2,00,000.
Evaluate their business performances.
(1.1)
Basics of Cost Accounting 12 Basic Conceptin Cost

ANSWER
A) Evaluation of Business Performance by Finance Department
In the books of Godrej Ltd., Gorakhpur
Profitability Statement for the year ended 31* March, 2019
Particulars
Sales 3,00,000
Less: Expenses 2,00,000
Profit 1,00,000
Percentage of Profit to Sales_ 331/3%
Comments:
During the year 2018-19, the overall company's financial performance considerably good
is
as the profits are 33 /3% of actual sales.
B) Evaluation of Business Performance by Cost Accounting Department
In the books of Godrej Ltd., Gorakhpur
Profitability Statement for the year ended 31-t March, 2019
Divisions Total
Particulars Hamam Rexona Liril

Sales 1,50,000 1,00,000 50,0003,00,000

Less:COsts 90,000| 70,000 40,000 2,00,000
Profit 60,00U S0,000 10,000 1,00,000
Percentage of Profit to Sales 40o 30%L 20% 33 1/1%
Comments:
During the year 2018-19, all divisions are working satisfactorily as the overall performance
shows a substantial profit of 33 1/3% of actual turnover. Hamam division is earning higher profits
as compared to Kexona and Liril. Rexona division is more proitable as compared to Liril
division. t is advisable to exercise additional ettorts to control the costs and increase the turnover
of particularly Liril division to increase their profit margins substantially.
1.1 BASIC coST CONCEPTS
It is necessary to understand some of the
OsACC cOUNTANC
NCY
important Basic Cost Concepts which are used
CCOUNTINA
very often in the business world, as shown in COSTA
Figure 1.1 as follows.
As its name implies, Cost Accounting cOSTING N

accounts tor costs - the use of planning and

control of costs. It is the process of assigning
cOsts to cost objects. Cost represents some
sacrifice made of resources foregone to obtaina
benefit. It is the amount measured in terms of
money in consideration of goods or services.
Fig. 1.1: Basic Cost Concepts
The term Cost, Costing, Cost Accounting and Cost Accountancy are some of the basic cost
concepts which are widely used by cost accountants frequently. By aiming at cost ascertainment
Basics of Cost Accounting 1.3 Basic Concept in Cost

cost accountancy serves the basic purpose of costing. By aiming at controlling the cost and
ascertaining profitability, cost accountancy serves other important purposes of cost accounting.
By adding an innovative dimension to its function (i.e. providing substantial information for
managerial decision-making) cost accountancy becomes much broader than both the concept
costing and cost accounting
However, it is observed minutely that the academicians and professional experts use costing,
cost accounting and cost accountancy interchangeably. Hence, no such distinction is made among
these concepts by the users unless and otherwise it is stated specifically.
The important cost concepts very often used in cost and management accounting science aree
simplified below.
1.1.1 COST
Meaning and Definitions:
The term "Cost" may be defined as a noun or a verb as follows:
i) As a noun:
The amount of expenditure (actual or notional) incurred on or attributable to specified thing
or activity.
ii) As a verb:
To ascertain the cost of specified thing or activity.
The term 'Cost is defined, in difterent ways by various authorities as follows:
i) I.C.M.A., London:
Cost is the amount of expenditure (actual or notional) incurred on or attributable to a
specified thing or activity".
ii) Crouwningshield:
Tt is an expenditure made to secure an economic benefit, generally resources that promise to
produce revenue. The resources may have tangible substance (material or machinery) or
they may take the form of services (wages, rent, power)
ii) Shillinglaw:
"Cost represents the resources that must be sacrificed to attain a particular objective".
iv) The Committee on Cost Concepts and Standards of the American Accounting Association:
"It is the foregoing, in monetary terms incurred or potentially to be incurred to achieve a
specific objective".
v)Anthony and Welsh :
Cost is a measurement in monetary terms, ot the amount of resources used for some
puposes
vi) A.l. C. P.A. Committee on terminology:
Tt is the amount measured in money or cash expended or other property transferred, capital
stock issued, services pertormed, or a liability incurred in consideration of goods or services
received or to be received".
vii) W. M. Harper :
"Tt is the value of economic resources used as a result of producing or doing the thing
costed .

viii)Oxford Dictionary:
"Cost is the price paid for something".
Again, the general concept of Cost which is most widely used is the "money cost of
production. Another concept of cost is the real cost according to Marshall. Again "Opportunity
Cost concept is there which means the sacrifice made for not utilising the other alternatives.
From the above definitions, we can conclude that Cost is the total of all expenses incurred,
whether paid or outstanding, in the manufacturing and sale of product or thOse incurred in
Basics of Cost Accounting 4 Basic Concept in Cost

giving a service. Costs are calculated from the point of view of management which expects costs
to perform three functions 1.e. cost computation, cost control and cost analysis. Thus, the concept
of Cost depends upon the purpose for which it is used, the conditions under which it is employed
and the people who intend to use this concept. From the management point of view, the cost may
be direct, indirect, prime, conversion, joint product, period, controllable, out of pOcket, imputed,
differential, marginal, standard etc. In short, Cost is a sacrifice made to achieve something and
measured in terms of money and has always been used with some specific objective. It depends
upon many factors and it changes with the changes in factors.
1.1.2 COsTING
Meaning and Definitions:
Costing is simply 'cost finding. It is the process, technique and procedure of ascertaining
the costs. It includes all the principles, rules and regulations of calculating the costs.
The term Costing' is defined in different ways by various authorities as follows
i) I.C.M.A., London:

ii)
t is the technique and process of ascertaining costs
Wheldon:
Costing is the classifying, recording and appropriate allocation of expenditure for the
determination of the costs of products or services and tor the presentation of suitably
arranged data for the purposes of control and guidance of the management. It includes the
ascertainment of the cost of every order, job, contract, process, service or unit as may be
appropriate. It deals with the cost of production, selling and distribution".
iii Harold James
Costing is the proper allocation of expenditure, whereby, reliable cost may be ascertained
and suitably presented to aftord guidance to the producers in control of their business.
From the above definitions we can summarise that, Costing is a technique of ascertaining the
cost. This technique is however, dynamic and changes with the changes in time. Costing can be
carried out by the process of arithmetic, memorandum, statements etc. The costs may be either
ascertained from the historical records i.e. after they have been incurred or by the pre-determined
standards and analysis of variances between the standard and the actuals or by using the
marginal costing method ie. by differentiating the fixed and variable costs.
1.1.3 COST ACCOUNTING
Meaning and Definitions:
Cost Accounting is the process of accounting tor cOsts. It begins with the recording of
income and expenditure and ends with the preparation of periodical statements.
The term 'Cost Accounting' is defined in different ways by various authorities as follows
i) Kohler:
"It is that branch of accounting dealing with the classification, recording, allocation,
summarisation and reporting of current and prospective costs".
ii) Wheldon:
"It is the classifying, recording and appropriate allocation of expenditure for the
determination of the costs of products or services, the relation of these costs to sales values
and the ascertainment of profitability".
ii) Van Sickle:
Cost Accounting is the science of recording and presenting business transactions pertaining8
to the production of goods and services, whereby these records become a method of
measurement and means of control".
Basics of Cost Accounting 1.5 BasicConcept in Cost
iv) Shillinglow:
Cost Accounting as a body of concepts, methods and procedures used to measure, analyse
or estimate the costs, profitability and performance of individual products, departments and
other sequences of a company's operations, tor either internal or external use or both and to
report on these questions to the interested parties".
v)1L.C.M.A., London:
is the process of accounting for cost from the point at which expenditure
t 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.
The comparative analysis of the above comprehensive detinitions reveals some of the
important functions of Cost Accounting Cost Accounting refers to the formal mechanism or a
systematic procedure by means of which costs of products and services are computed. This is one
of the important aspects which distinguishes Cost ACcounting trom Costing

1.1.4 COST ACCOUNTANCY

Meaning and Definition:
It is the application of Costing and Cost Accounting principles, methods and techniques. It is
also the science, art and practice of controlling the costs and ascertainment of profitability. Cost
Accountancy is mainly concerned with the presentation of costing data to the management in aa

precise form, so that vital decisions can be taken by the management.

It is a science because there are certain definite principles which are followed in cost
accountancy.
It is an art because it is the ability and skill of the cost accountant to apply the principles
of cost accountancy to solve the intricate and complex problems of the management.
It is a practice because a cost accountant has to keep himself abreast of the latest
developments. He has to present the data to the management in a most up-to-date
manner with latest techniques and methods for taking various decisions.
The termcost Accountancy is defined by different authorities as follows:
1)1.C.M.A. London:
"It is the application of costing and cost accounting principles, methods and techniques to
the science, art and practice of cost control and the ascertainment of profitability. It includes the
presentation of information derived therefrom, for the purpose of managerial decision-making
Thus, Cost Accountancy is a comprehensive term and includes the various aspects such as
costing,cost accounting, cost control and cost audit and budgetary contro.
Difference between Costing, Cost Accounting and Cost Accountancy
The Difference between Costing, Cost Accounting and Cost Accountancy can be shown as
follows:
Points of Costing Cost Accounting Cost Accountancy
Distinction
DScope t is broader in its scope t ts scope It is broadest in its SCope
is narrow in
i) Function It is concened with the | It is concened with It is concerned with the formulation of
ascertainment of costsrecording ot cost Costing principles, methods and techniques
O DE ddopied Dy a Dusiness
ii) Periodicity
ofIt begins where cost| t begins, where costing| Itis a starting point
functioning accountancy ends ends
) Persons The person involved is The persons involved are The persons involved are experts in the
involved cOst accountant cost clerks field of Cost accOuntancy Sucn
ds
management accountant.
Basics of Cost Accounting Basic Concept in Cost

Limitations of Financial Accounting

Financial Accounting is mainly concerned with recording of business transactions in the
books of accounts for the purpose of presenting final accounts to the Board of Directors,
Shareholders and Tax Authorities etc. The objective of Financial Accounting is to present a true
and tair view of the company's income, financial position and funds at regular intervals.
In the modern business world, business concerns need some methods and ways by which
they can measure their pertormance. Financial Accounting cannot serve this purpose at al. The
indications given by the Financial Statements i.e. Profit and Loss Account and Balance Sheet, are
generally inadequate. It is just like thermometer which only indicates the temperature of human
body. Only judgements can be made on the basis of such thermometer and a good doctor will
have to conduct a number ot other checks in order to see what the patient is sutfering from. The
profit shown by Profit and Loss Account should not be taken as a sign of success because there
may be a loss on certain items which might have been compensated by the profit of certain other
items. Valuable information regarding wastages and losses is very dificult to be obtained from
financial accounts and it is only Cost Accounts which makes such information available to the
management. So Cost Accounting, has emerged mainly because of certain Limitations of
Financial Accounting which are shown in Figure 1.2 as follows.

data
historical
peroic tixaton_
only naure
overan price
rovides informaiontor
Staticin
oniy
Controic0st
provide
Shows
Fails to Failsto classificaton or
costS
proper
NO
pErrommanice appralsa
proper system tor
Does not provide
Falls to analyse
DOes
losses
Fais not provide a proper
Istoprovide
to
basis of cost
provide adequate
Possibility comparison
Does
adequate nrormnaon
aiis not to
toascertain
make ofmanipulation
data Teporis
use tomanagement
of control
break-even offinancial
techniques accounts
point

Fig. 1.2: Limitations of Financial Accounting

Basics of Cost Accounting 1.7 Basic Concept in Cost

i) It shows only Overall Performance:

Financial Accounting provides information about profit, loss, cost etc. of the collective
activities of the business as a whole. It does not provide data for each and every product,
process, department or operatiorn separately.
ii) It provides only Historical Data:
Financial Accounting is historical in nature and it provides data of past activities. It does not
provide current data which management requires for making effective plans for future. So it
is rightly said that financial accounts provide only a post-mortem analysis of past activities. It
does not help in fixation of selling price.
ii) It is Static in Nature:
Modern business IS dynamic and not static. Financial Accounts does not incorporate the
changes that takes place within the business.
iv) It fails to provide information for Price Fixation:
In Financial Accounting, costs are not available by division, products, process etc. So, price
fixation becomes difficult and estimates cannot be prepared.
vIt fails to Control Cost:
Financial Accounts fail to exercise control over materials, labour and other expenses incurred
in a business enterprise. As a result, avoidable wastages and losses remains as it is under this
system.
vi) No proper Classification of Costs:
In Financial Accounting, expenses are not classified into direct and indirect, fixed and
variable and controllable and uncontrollable. These classifications have utility of their own.
vii) It does not provide proper System for Performance Appraisal :
In Financial Accounting there is no system of developing norms and standards to appraise
the efficiency in the use of materials, labour and other costs by comparing the actual
performance with what should have been accomplished during a given period of time.
viii)It fails to Analyse Losses:
Financial Accounting does not fully analyse the losses due to idle time, idle plant capacities,
inefficient labour, sub-standard materials etc.
ix) It does not provide a proper Basis of Cost Comparison:
Financial Accounting does not provide cost data regarding operations of the enterprise tor
the purpose of comparing such data with other periods of operations or other concerns in the
industry.
to provide Adequate Intormation for Reports:
xTtIt fails
does not provide adequate information for reports to outsicde agencies like banks,
government, insurance companies and trade associations.
xi) It fails to provide adequate Data to Management:
Financial Accounting fails to supply useful data to management for taking various decisions
ike replacement ot labour by machines, introduction of new products, make or buy
decisions, selection of the most protitable product mix etc.
xii) Possibility of Manipulation of Financial Accounts :
Very often Financial Accounts are manipulated at the whim and fancies of the management so
as to project a better image in the minds of prospective investors. Financial Accounts may be
manipulated by making under or overvaluation of machinery, excessive or inadequate
provisions for depreciation, creation of secret reserves etc.
Basics of Cost Accounting Basic Concept in Cost
xiii) It does not make use of Control Techniques:
Financial Accounts tail to make use of certain important cost control techniques, such as
Budgetary Control, standard Costing, and so on. Thus, financial accounts do not facilitate in
measuring the etficiency of the business with the help of control techniques.
xiv) It fails to ascertain Break-Even Point :
Financial Accounting does not help in ascertaining the break-even point. i.e. the sale or
output where the revenue equals the cost. Hence, the point of no profit-no loss cannot be
found out under financial accounts.
ACCOUNTING
1.2 CoST
Cost Accounting is a method of accounting for cost, wherein all the costs involved in
pertorming any Process, project or product are recorded systematically and analysed
scientiicaly. Such analysis helps the management in taking strategic decisions The cost corncepts
which are relevant to business operations and decisions can be studied on the basis of their basic
purpose, under the two overlapping categories
1)Concepts used for accounting purposes 1.e. opportunity cost, actual cost, business costs,
full costs, explicit and implicit costs etc.
i) Concepts used in economic analysis of the business activities i.e. fixed and variable costs,
marginal costs, short-run and long-run costs, incremental costs, sunk costs etc.
Tt is, therefore necessary to have a reasonably good working knowledge about the important
concept of Cost Acounting' in a broader Sense.
1.2.1 ORIGIN
The science of Cost Accounting is of recent origin. The idea of Cost Accounting started in the
early years of the 20 century, when the concept of large scale production in the factories started
growing. It made the traditional accounting system bulky. The new problems in accounting faced
by the factories were numerous. With the increase in the production, difterent types of costs were
tound to have ditferent rules on the cost structures of the products. Thus, the variety of
expenditures increased and many new items of costs entered the calculations and became vital
tor taking important decisions by the managemen
Cost Accounting is a branch of accounting, which has developed because of the limitations of
FinancialAccounting t was developed because ot certain needs of management which financial
account could not meet. The modern industrial requirements were different and to fulfil these
requirements some new methods and principles of accounting became necessary over the old
traditional method of financial accounting system. This resulted into the outcome of the "Cost
Acounting systems The requirements of management may be summarised as tollows:
i) Measurement of Performance and Efficiency:
To face severe competition in the business world, management always needs to maintain
their customers. Theretore, to evaluate the present product and market it, it is necessary to
measure the performance and business efficiency. Financial accounts cannot serve this
purpose at all. In normal times, we can say that profit or loss shown by Profit and Loss
account is an indicator of overall etficiency or inefficiency. But im the periods of inflation or
depression this may not be true. So the management, would be well advised to ascertain the
protit or loss of each product separately. Besides this, management must also try to see that in
producing each unit of product there 1s no unnecessary wastage or loss as regards materials,
Basics of Cost Accounting 9 Basic Concept
in Cost
labour and other expenses. This intormation is available to the management only under Cost
Accounting system. Again the management can know the exact reason of profit or loss byy
making proper cost analysis which is posSible only in cost accounts.
ii) Pricing
For fixing prices of products or services, it is necessary to have information regarding each
product or unit of service rather than total expenditure. Only, Cost Accounting system can
provide this intormation to the managemernt.
ii) Control:
To maximise protits by minimising costs, it is necessary to set up standards and then compare
actual costs with these standards. The reason for the discreparncy may be ascertained and
then only possible action can be taken to rectify the situation. Such action is possible only in
COst Accounting
iv) Forecasting:
For planning in future, preparation of budgets are necessary. Budgets are prepared on the
basis of torecasts of future costs and revenue. In this field also, Cost Accounting is more
capable of helping management than Financial Accounting.
v) Day-to-Day Decisions:
Besides price fixing decisions, various other decisions have to be taken continuously such as
make or buy, whether an old machine should be replaced by a new one, when operational
activities be stopped or started, whether an order at concessional rate should be accepted or
not etc. Cost accounting is able to provide the necessary information for such decisions.
Thus, the need for Cost Accounting arises because of the management's requirement to
know the cost of various activities in various circumstances. Costing has a vital role to play in
almost any activity which involves expenditure of money, whether it is a business house or a
charitable concern or whether it is a Government Department.

Development of Cost Accounting Phenomenon

The growth of Cost Accounting could be seen during the First World War i.e. 1914-1919
which was rapid, due to the control on the prices imposed by the Government. The Government
entered into the "Cost-Plus" contract systems. Cost plus contract provides for the payment by the
customers or the contractee of the actual cost of manufacture or of rendering service plus a
stipulated profit. This necessitated the maintenance of cost records, ascertainment of cost and cost
control tor a job or service rendered. Due to increase in competition and rapid growth in the
international trade, industries became more cOst conscious. In 1929, there was a great depression
in the economy during which survival of most of the industries became a problem. Hence, cost
reduction techniques had to be adopted for survival.
In today's world of competition, cost consciousness is the key factor for determining the
growth of the industrial economy. Ours is a developing country, where we have mixed economy
and hence we are having mixed problems. We are facing acute inflation problem, depression in
the industries and stagnation in the economy. Hence, cost reduction has become the need of the
hour. Therefore, the industrialists must have a perfect knowledge of costs, so that they can take
various decisions regarding planning, pricing, budgeting, policy making of the company
regarding fixation of wages etc. Ihus, the study of COst Accounting is of utmost importance in
our country because unless we reduce the costs, we cannot survive in the competitive world and
have progress of our economy.
Basics of CostAccounting 1.10 Basic Concept in Cost

Cost Accounting in Indian Context

The application of Cost Accounting methods in Indian industries was felt from the beginning
of the 20" century. 1The following factors have accelerated the system of Cost Accounting in our
country.
i) Increased awareness of cost consciousness by Indian industrialists with a view to
ascertain costs more accurately for each product or job.
Growing competition among manufacturers led to fixation of prices at a lower level, so
as to attract more customers.
111) Government economic policy emphasising on planned economy.
iv) Increased Government control over pricing led the lndian manutacturers to give more
importance to the installation of cost accournts.
v) The establishment of National Productivity Council in 1958 and a statutory body
viz. Institute of Cost and Works Accountants of India.
By realising importance of Cost Accounting techniques, benefits available to the industries,
Government of India has made compulsory the maintenance of cost accounts to most oft the
industries in the corporate sector. For development of cost accounting profession in India,
Government passed an Act viz. "Cost and Works Accountants Act, 1959, and established a
statutory institute styled as "Institute of Cost and Works Accountants of India". The Companies
Act, 1956 has been amended and provision has been made to make it obligatory to industries to
maintain the Cost Accounting records. Besides this, Government made Cost Audit compulsory
to these industries.
Duringthe last years, Cost Accounting emerged as an important tool to the management
50
for improving etticiency and the protitability of the corporate organisation, with inereasing
complexities in business for etficient management, costing data became important and hence the
importance of Cost Accounting is increasing day-by-day.
1.2.2 OBJECTIVES OF COST ACCOUNTING
The important Objectives of Cost Accounting are indicated in Figure 1.3 as tollows

ccoUNTING
OBJECTIVES
Determination OF C
coST A
Dric
data
fot
eduction
enst
To provIde Freque
asis orepardts
perating of
atef
policy orts

Fig. 1.3: Objectives of Cost Accountings

Basics of Cost Accounting9 1.11 Basic Concept in Cost
i) Ascertainment of Cost:
This is the primary objective of Cost Accounting. For the purpose of ascertaining the cost of a
product, process or operation, it is necessary to record the expenses incurred, classify them
properly and then allocate or apportion it amongst the respective products, processes or
departments for calculating total cost of each of these. If there is only one product, cost per unit
can be found out by dividing the total expenditure by the total number of units produced. But if
there are many products manutactured, then the cost is to be split up between the various
products. For this purpose various techniques may be used.
ii) Control of Cost:
Cost control aims at improving efficiency by controlling and reducing cost. Cost control is
exercised at ditferent stages in a factory, viZ, acquisition of materials, recruiting and deployment
of labour force, during production procesS and so on. As such, we have material cost control,
labour cost control, production control, quality control and so on. Control over cost is exercised
through the techniques of budgetary control and standard costing. In these techniques, cost is
controlled by comparing actual cost with predetermined cost. Cost control is becoming more and
more important because of growing competition.
ii) Determination of Selling Price:
Cost accounting provides information on the basis of which selling prices of products or
services may be fixed. Total cost of production constitutes the basis on which selling price is fixed
by addinga margin of profit. COst accounting furnishes both the total cost of production as well
as cost incurred at each and every stage of production. In fixation of selling price other factors are
also important such as market conditions, the area of distribution, volume of sales etc. But no
doubt, cost plays the dominating role in price fixation.
iv) To provide a basis for Operating Policy:
Cost data to a great extent helps the management in formulating the policies of a business
and in decision-making. Hence, availability of cost data is a must for all levels of management.
Some of the decisions which are based on cost data are make or buy decision, manufacturing by
mechanisation or automation, whether to close or continue operations, inspite of losses, selling
below cost decision, introduction of new products etc.
v) Frequent Preparation of Accounts and Other Reports:
Every concern rely upon the reports on cost data to know the level of efficiency regarding
purchase, production, sales and operation results. Financial accounts provide information only at
the end of the year because value of closing stock is available at the end of the year, But cost
accounts provide the value of closing stock at frequent intervals by adopting. "continuous stock
verification" system. Using the value of closing stock it is possible to prepare final accounts and to
know the operating results of the business.
vi) To provide Data for Cost Reduction:
For survival in the world of competition, it is necessary to keep the prices of products or
services as low as possible. It is only possible when cost of production is less. So the management
has to make continuous efforts to reduce the cost. To provide data for cost reduction is one of the
important objectives of Cost Accounting. It helps the management in finding out new and
improved methods to reduce costs.
Basics of Cost Accounting 1.12 Basic Concept in Cost
vii) Preparation of Cost Estimates:
Many times, it is required to take new jobs by the manutacturing concern or introduce new
product as per customer's requirements. Betore manufacturing cOst estimates are to be made.
Under cost accounting system, preparation of cost estimates is possible. So the preparation of cost
estimates is also one of the important objective of Cost Accounting
vii) Standards for measuring efficiency:
For measuring the pertormance of various business activities, management requires some
base for evaluating the performance. Standard Cost is one of the means for evaluating the
performance. So the development of Standard Cost is also an important objective of Cost
Accounting
1.23 FEATURES OF COST ACcoUNTING
Cost Accounting is the science of recording and presenting business transactions pertaining
to the production of goods and services, whereby these records become a method of
measurement and means of control. Thus, it is nothing but the application of cOst accounting
principles, methods and techniques to the science, art and practice of controlling the costs of
operating the business, ascertainment of costs tor fixing selling prices of the products and
presentation of costs in the form ot statements, reports, with appropriate analysis to the different
levels of management as and when they require. The important features of Cost Accounting are
shown below in Figure 1.4.

Cost
ASCertainment

FEATURESS
OF COST
ACCOUNTING
Cost
2) 3 Presentaton
Control

Fig. 1.4:Features of Cost Accounting

i) Cost Ascertainment:
The basic feature of any method of cost accounting is to ascertain the cost of each unit, job,
process or department, not only the actual costs incurred but also the predetermined. The timely
and reliable cost information about the cost of output is to be ascertained appropriately by using
various methods of costing viz. job costing and process costing. Such analytical intormation about
the cost of products is provided to the management which becomes the actual basis of the
managerial decisions such as pricing, planning and control.
ii) Cost Control:
The basic feature of any technique of cost accounting is to utilise the detailed cost information
to controlling the costs at ditferent stages by using different techniques of cost control to keep the
cOsts at the minimum possible extent, in order to survive in the competitive market. Cost
Basics of Cost Accounting 1.13 Basic Concept in Cost

accounting ultimately aims at improving the overall profitability by controlling the cost more
strictly by using various techniques like standard costing, budgetary control, marginal costing etc.
ii) Cost Presentation:
The data collected and re-classified systematically is presented scientifically by the Cost
Accounting department in the form of cost statements and cost reports to the different levels of
management as and when it is required. The analytical cost reports are basically used by the
management internaly at various levels for pertormance appraisal and planning, control and
decision-making functions.
Role and Importance of Cost Accounting in Decision Making
The cost accountants are insiders who create internal analysis to guide the overall business
strategy. The most important job of cost accountant is to conduct a relevant cost analysis to
determine the existing expenses and provide better suggestions for further activities. Therefore,
the cost information system plays an important role in every organisation within the decision
making process. The detailed analysis of costs, the calculation of production cost, the loss
quantification, the estimating of work efficiency provides a solid basis for the financial control.
Actually, cost accounting uses information from your questions to prepare reports that provide
ongoing insight into business pertormance such as profit margin and labour utilization, so you
and your managers have data driving input to make every decisions. Cost Accounting is
important in accumulating data and reporting results to all levels of management describing how
the organisation is pertorming in a competitive market at national and international level, too.
COst Accounting has a number of advantages. It hold importance to many ditterent parties of
business. Management, investors, employees, state and central government and even consumers
themselves benefit from the upcoming SCience of Cost Accounting
In short, Cost Accounting is a specialised
branch of modern accounting that deals with
the classification, recording and allocation of Overnment Management
current costs and prospective costs. In modern
commercial world, it is oneof the most
important techniques or process tor a business.
ciety
Cost Accounting is a
tool with the
management for making decisions as regards
Advantages
sales, purchases, production, finance, inventory of Cost B Workers
Accounting
control etc. if the costing system is sound, it
provides the tollowing benetits to the Customers
management. D

Advantages of Cost Accounting

The Figure 1.5 shows the graphical InvestorS Creditors

presentation of Advantages of Cost

Accounting as follows
ig. 1.5: Advantages of Cost Accountin8
A) Advantages to the Management:
i) Helps in Decision-Making:
Decision-making is concerned with choosing between alternative courses of action. An
important factor involved in the choice is the financial implication of the available
alternatives. Cost Accounting is a decision-making tool. It provides suitable cost data
and other related information to enable management to evaluate alternative courses of
action.
Basics of Cost Accounting 1.14 Basic Concept in Cost
ii) Supplies detailed Cost Information:
Cost Accounting classifies cost and revenue by every possible division of the business
and supplies management with detailed and regular cost information. Such information
is useful for ascertaining the cost of product, process, department, division or unit of
service.
ii) Guides in Price Fixation :
Cost is one of the most important factor to be considered while fixing prices. It assists the
management in fixation of selling price both in normal conditions and during the period
of depression. With the help of costing, it is possible to prepare estimates, tenders and
quotations.
iv) It reveals Operating Efficiency:
Cost information reveals, profitable and unprofitable activities, so that steps may be
taken to reduce or eliminate wastages and inefficiencies occurring in any torm such as
idle time, under-utilisation of plant capacity, spoilage of materials etc.
v) It Facilitates Planning:
It enables the management to know the future costs, so that appropriate plans and
decisions can be made.
vi) It reveals Idle Capacity :

A concern may not be working to full capacity due to reasorns such as shortage of
demand, machine breakdown or other bottlenecks in production. A Cost Accounting
system can easily find out the cost of idle capacity so that the management may take
immediate steps to improve the position.
vii Helps in Inventory Control :
Perpetual inventory system which is an integral part of cost accounting, helps in the
preparation ot interim profit and loss account. Other imventory control techniques like
ABC Analysis, Level setting etc., are also used in Cost Accounting8
viii) Helps in Cost Control:
Cost Accounting helps in controlling costs with special techniques like standard costing
and budgetary control.
ix) Helps in Cost Reduction:
It helps in the introduction of cost reduction programme and finding out new and
improved ways to reduce costs.
x) Checks the Accuracy of Financial Acounts:
Cost Accounting provides a reliable check on the aceuracy of tinancial accounts with the
help of reconciliation between the two at the end of the accounting period.
xi) It Facilitates Cost Comparison :
Cost Accounting enables management to make cost comparison of jobs, products,
departments, sales territories etc. within the same concern. It provides inter-tirm cost
comparison also.
xii) It Prevents Frauds and Manipulation :
It helps in preventing manipulation and frauds through cost audit system. Thus, reliable
cost data can be furnished to management and others.
B) Advantages to the Workers:
From the cost records, we can find out the efficiency of the workers. Thus, the efficient
workers are rewarded and the slow workers are given more incentives to come up to a certain
level of efficiency. A sound costing system, therefore, increases the profitability and the workers
get more wages. Workers are benetited by the introduction of incentive plans which is an integral
part of a cost system.
Basics of Cost Accounting 1.15 Basic Concept in Cost

C) Advantages to the Creditors:

The creditors feel secured, where there is a good system of costing in a concern because they
can verify the creditworthiness of the concern. Thus, the creditors extent credit facilities on a
longer term which is beneticial to the business.
D) Advantages to the Investors:
The investors also feel secured if there is prosperity in a business as they feel that their money
remains secured. Hence, more and more people are attracted to invest in the concern whichh
further increases the prosperity of the business.
E) Advantages to the Customers:
The customers always feel that the products which they are buying are the cheapest in the
market but at the same time best in quality. Hence, when the prices are quoted in the products to
the nearest paisa the customer feel that there is much accuracy in fixing the selling price.
F) Advantages to the Society:
As costing removes all the types of wastages, scraps the general public, gets the products at
lower prices, Again when a unit grows in size its requirements also grow. For example, more
man-power is needed, more raw material requirements arise, more sales are made etc. Hence, it
leads to more employment of the local people, more suppliers of raw materials enter the markets
etc. When the sales are more, there can be large scale production and hence the advantages of
economies of scale can be achieved, which in turn reduces the prices. Due to reduction in costs,
intlation in the economy can be controlled. This is because people will have to pay less price for
the products and hence, can save their income.
G) Advantages to the Government:
A cost system provides ready figures to use for Government, wage tribunals, trade unions
etc. for use in problems relating to price fixing, wage level fixation, settlement of industrial unions
disputes etc. The Government can plan its policies based on the techniques and procedures of cost
accountin8 Cost accounting, theretore, promotes economic development. To reduce cost of
production and sales price, the Government has introduced cost audit in most of the industries
for e.g, the industries which are engaged in production, processing, manutacturing and minin8
activities.Such companies are now required to keep certain costing records and have to submit
certain statutory returns to the Government periodically. By doing all these, the advantage to the
Government is that there can be price stability in the economy.
Limitations of Cost Accounting
Besides the various advantages of Cost Accounting system, it suffers from certain limitations
which are as followS:
i)Expensive:
Highly paid cost accountants and the organisation of costing system involve additional
expenditure. However, before installing it, care must be taken to ensure that the benefits
derived are more than the investment made on this system of accounting
ii) More Complex:
Cost accounting system involves a number of steps in ascertaining cost such as collection
and classification of expenses, allocation and apportionment of expenses etc. These steps
are considered as complicated and requires several forms and documents in preparing
the reports. This will lead to delay in the preparation of accounts
ii) Limited Applicability:
All business enterprises cannot make use of a single method and technique of costing. It
all depends upon the nature of the business and type of product manufactured by it. If a
wrong technique and method is used, it misleads the results of the business.
Basics of Cost Accounting 1.16 Basic Concept in Cost

iv) Not applicable to Small Concerns:

A cost accounting system is applicable only to large sized business and not suitable for
small sized business because it is more expensive.
vLack of Uniformity:
This is the greatest limitation of cost accounting system. It fails to confirm to any
unitorm procedure. It is possible that two equally competent cost accountants may
arrive at difterent results from the same information. so it is said that all cost accounting
results are mere estimates and not reliable.
vi) Lack of Accuracy:
Accuracy in Cost Accounting is relative. Certain assumptions are always made while
ascertaining cost to suit a particular situation.
vii) Confusion regarding Non-cost Items :
There may be confusion regarding non-cost items for e-g, interest in capital, cash
discount etc. should be included or to be excluded from cost accounts.
vii) Not useful for Handling Futuristic Situations:
The contribution of Cost Accounting for handling futuristic situations has not been
much. eg the science of Cost Accounting has not evolved any tool so far, tor handling
inflationary situation.
ix) Failure in many Cases:
It is argued that the adoption of costing system failed to produce the desired results in
many cases and so it was not ettective.
xIt fails in considering Social Obligations :

Cost Accounting fails to take into account the social obligations of the business. In other
Words, social accounting is outside the purview of the cost accounts.
Thus, Cost Accounting cannot be termed as an exact science like physics, or mathematics but
it is a subjective art which is practised based on the accounting theories, reasoning and most
important the common sense. Hence, all the decisions of the management are based upon the best
judgement of the cost accountants who take into account the various factors while preparing the
cost statements, which may not be the same with other cost accountants.
But apart from the above limitations, Cost Accounting helps the management to take vital
decisions with valuable cost figures without which management today, cannot solve the complex
business problems.
1.3 DIFFERENCE BETWEEN FINANCIAL AccoUNTING AND
coST ACcoUNTING
Financial Accounting refers to recording of all money transactions on double entry principles
in a set of books with an object to prepare final accounts of the business. Cost Accounting refers
to accumulation, classification, analysis and presentation of costs for managerial control. Both the
systems of accounting makes use of the same items of expenditure but in different ways, to serve
their own purposes. Due to the complexities ot large scale production in the modern business
activities, the financial accounting falls short of meeting these challenges. Hence, cost accounting
has come into existence to solve all the managerial problems.
Basics of Cost Accounting 1.17 Basic Concept in Cost

The following are the points of differences between Financial Accounting and Cost
Accounting
Points of Distinction|| FinancialACCOunting Ost Accounting
i) Coverage: tcovers accOunts of whole business relating to allit covers the transactions relating to certain
commercial transactions. specific activíties only for e.g. producton, sales,

Purpose ts purpose Is extermal reporing mainly to owners,Is purpose is the intemal reporting 1e. to the
creditors, tax authontes, Government and management of every buSiness
prospective investors.
Statutory These accounts have to be prepared according to These AcoOunts are generally prepared to meet
Requirements the legal requirements of the companies Act and tne requirements of the management. But now it
Income Tax Act. has been made obligatory to keep cost records
underthe Companies ACt.
iv) Recording t records, classities and analyses the transactons it records the expenditure in an objective manner

of Transactions: in a subjective manner 1.e. according to the nature 1e. according to the purposes for which cOst are
of expenditure ncurred.
Nature of Costs t records only historical costs. Cost Accounts records both historical and
eSUmaled costs.
vi) Nature of In Financial Accounts expenses are recorded in
In Cost Accounts, cost are expressed by proper
Expenses totals. analysis and classification in order to find out cost
incurred
vil) Analysis of
and Profit
Costt disclose profitis for the entire

whole. It does not show the

business as a
tgures of cost and
tProduct,
show the profitability or otherwise of each
process or operatiorn, so as to reveal the
proft tor individual products, departments and areas of profitability.
processes e
vii) Duration of The reports are prepared periodically, usually onIt is a continuous process and may be prepared
Reporting an annual basis daily, weekly, monthly etc.
ix) Control Aspect: t does not make use of any control techniques makes use of someimportant control
does not control material and labour cOst. techniques such as Standard costing, Marginal
cOsting, Budgetary costing etc. t exercises
control over material cost by ABC Analysis, level
setting. EO0 etc. and over labour cost by
im
minimising overume etc.
ile time,
ypes or t prepares general purpose statements like Proit | t generates special purpose statements and
Statements and Loss Alc and Balance Sheet. reports like Report of Loss of Materials, Idle Time
prepared Reports, Variance Report etc.
Pricing t fails to guide the fomulation of pricing policy. It provides adequate data tor tormulating picing
pollcy.
Xl Valuation of Stock is valued at cost price or market price,| Stock is always valued at cost price.
Stock wicnever S ess.
Xi Evaluation of The information provided by the Accounts is not The cost data helps in evaluating the efficiency of
Sufficient to evaluate the efficiency of the business. | the business.
Efficiency:
xiv) Break-up of Costs are not broken up, according to their nature The costs are analysed according to their nature
ndiTunctions. and functions for further analysis and control.
Costs
Basics of Cost Accounting 1.18 Basic Concept in Cost

Points of Distinction Financial Accounting Cost Accounting

Xv)Interlntra Firm Under Financial Accounting, Inter-firm or Intra-Under Cost Accounting it is possible to make
irm comparnson cannot De made. Inter-firm and Intra-irm companson.
Comparison
xvi) classification of There is no system of classification of costs into Since, there is classification of costs into
Osts. fixed and variable or controllable and controllable and uncontrollable costs, the
uncontrollable. management can reduce the controllable costs.
The distinction between fixed costs and varnable
cOsts also helps the management to take vital
Gecisions.
xvil) Reterence ACcounting rererence can oe made in cost ACCOUntng no suen rererence s
inin Financialot case possible. Guidance can be had only from a body
case difficuity to the company law,
decisions and to business ethics. conventiOns Tollowed by cost accOuntants.
f
xVil) Dealing of It deals with only monetary transactions and it | t deals with monetary as well as non-monetary
Transactions : deals only with actual facts and figures transactions and it deals partly with the facts and
ngures and parly witn estmates.

1.4 CONCEPTUAL ANALYSIS OF COST UNIT AND COST CENTRE

The entire accounting process of ascertaining the costs accurately and controlling the costs
strictly becomes a very simple task only after understanding the conceptual analysis of Cost Unit
and Cost Centre scientifically and more logically:
1.4.1 COST UNIT
|Meaning
Cost Unit is a quantitative unit of product or service or time in relation to which costs are
ascertained or expressed. Cost Units differ from industry to industry. The cost unit selected
should be the most natural to the business and accepted by all concerned. Therefore, utmost care
should be taken while selecting cost units. It should be neither too small nor too large. If unit is
too large, significant cost trends may pass unnoticed, due to averaging of cost. If the unit is too
small, it may necessitate detailed and expensive clerical work.

Definition
C.I.M.A., London, has defined Cost Unit as, "a unit of product or service in relation to which
costs are ascertained".
Costing means measuring the costs in relation to a unit. Hence, the unit of measurement must
be clearly defined and selected. This should be done before ascertainment of costs. For example in
a cement factory, the cost per tonne of cement is found out, in a cloth mill, the cost per meter is
ascertained, in case of machine, the cost per machine hour is found out and so on. Thus here,
tonne, metre and machine hour become the cost units. Hence, for manufacturing unit a cost unit
is nothing but a unit of measurement of production cost. eg a tonne of iron, a ream of paper, a
batch of medicine, a set of television, a bale of cotton, a quintal of sugar, a barrel oft petirol etc.
In case of a service unit, it is difficult to find out and decide a suitable cost unit, for example,
in case of a transport undertaking, the costs may be either related to the distance travelled in
kilometer, or the weight carried i.e. tonnes. While selecting proper cost unit for the transport, both
factors i.e. distance and weight should be considered. Theretore, tonne kilometer or passenger
kilometer will be a more suitable unit. Hence, for service unit a cost unit is nothing but a unit of
Basics of Cost Accountin9 1.19 Basic Concept in Cost

measurement of service rendering cost e.g. a student per bed, a patient per day, a tonne per
kilometer etc.
Thus cost unit is considered as a simple device of separating costs into smaller sub-divisions
attributable to products manutactured or services rendered. It is a unit of measurement in which
cost is expressed.
In actual practice, different cost units are adopted which usually depends upon the
applicability of a particular type of cost unit to the circumstances under consideration.
Types of Cost Units
Usualy CostUnits are of two types which are as follows :

i) Single Cost Unit:

t is a cost unit im which only one characteristic is used in measurement of cost eg. per
kilometre, per litre, per passenger, and so on.
ii) Composite Cost Unit:
It is a cost unit in which two characteristics are used simultaneously in measurement of
cost eg Per tonne-kilometre, per passenger-kilometre, per kilowatt-hour, per patient
bed, and so on.
The examples of costs units generally used for accounting purposes in various industries
manutacturing or service are given below, which are illustrative and not conclusive.
Industry/Product Cost Unit
Automobile Number
Advertising Job
Aircratt Number
Brick-Works Thousand Bricks
Building Feet Square metre
Bicycle
Square
Number
/
Bridge Construction Contract
Brewing
Boiler House
Barrel
Thousand Kilograms of Steam
Cotton/Jute Bale
Chemical Litre/Gallon/Kilogram/Tonne
Cement Tonne/ Bag
Cable Metre/Kilometre
Coal Mining Tonne
Cloth Meter
Confectionary Kilogram
Canteen Dish/Meal
Carpet quare Feet
Dairy Milk Litre
Electricity Board - Power ilowatt Hour
Furniture Unit
Fertilizer Tonne
Flour Mill Quintal
Foodgrains Kilogram
Basics of Cost Accounting 1.20 Basic Concept in Cost

Industry/Product Cost Unit

Gas Cubil Metre/Cubit Feet
Goods/Road Transport Tonne
Hotel Room
Hospitality Bed
.Hostel Student
Interior Decoration Job
Iron Ore Tonne
Mines and Quarries Tonne
Metal Plating Square Metre
Medicin Batch
Nuts and Bolts Gross/ Bags
Nursing Home Sed

Nickel Plating Square metre

Oil Refinery Tonne

P'aper Mill Ream/Kilogram
Pharmaceuticals Thousand Numbers/Tablets
Printing Press Thousand Copies
Pencil Dozen/Gross
Petroleur Barrel/Tonne/Litre
Passenger Transport Passenger
Paint Litre
Radio Set/Batch
Readymade Garment Number
Steel .Tonne
Shoes Pair
Sugar Quintal/1Tonne/Kilogram
Ship Buildings Ship
Soft Drink Crate of 12/24 Bottles
Soap Carton
Television Set
Timber Cubic Feet
Toy Making Batch
Textile Mill Meter/Yard
Tensil Kilogram/Tonne
Water Supply Works Thousand itres/Gallon
Wheat Quintal
Basics of Cost Accounting 1.21 Basic Concept in Cost

Characteristics
Betore the introduction of a simplified process of ascertaining the cost, it is absolutely
necessary that for every single product produced or service to be rendered, an appropriate cost
unit should be selected. The important characteristics of the more suitable cost unit should be,
i) same as being followed throughout the industry,
i1) very simple and easy to understand,
ii) neither too big nor too small,
iv) uniformally maintained over a period of time,
v)most natural to the business,
vi) more suitable to that business andd

vii) well-accepted by all concerned.

Factors to be Considered
The appropriate cost units for which costs are to be measured in various organisations
basically depends upona large number of important factors such as,
i) availability of cost data,
ii) works organisation,
ii) management policy,
iv) suitability of cost units,
v)condition of incidence of cost etc.
EXAMPLE

Suggest more suitable Cost Unit - Single and Composite, for the following enterprises
a) Passenger Transport, b) Canteen, c) Electric Power House, d) Goods Transport,
e) Hospital, f Educational Institution, g) Hotel.

ANSWER

Enterprises Single Cost Unit Composite Cost Unit

a) Passenger Transport Passenger |
Passenger- Kilometre
b) Canteen Meal Meal- person
c)Electric Power House Kilowatt Kilowatt- hour
d) Goods Transport Tonne Tonne Kilometre
-

e)Hospital Bed Patient Bed

fEducationalInstitution Student Student- Term
Hotel Customer |Customer - Day
Basics of Cost Accounting 1.22 BasicConcept in Cost

1.4.2 COST CENTRE

Meaning
For the purposes of administrative control, the entire organisation is divided into a number of
sub-units which may be in the form of departments, branches, processes etc., for ascertaining and
controlling costs. Because, the costs incurred will be charged initially to these sub-units which are
known as Cost Centres. A cost centre is therefore, a sub-urnit of the organisation for which costs
may be collected separately and used for cost ascertainment and control.
Definition
C.IM.A., England has defined Cost Centre as "a location, person or item of equipment
(or group of these) for which costs may be ascertained and used for the purposes of
control"
Types of Cost Centres
Production
An analysis of this definition reveals that a Cost Cost
Centre
Centre may be in the form of : a) a location, (such as a
department, division, section or process) or b) an item Process Service
Cost Cost
of equipment (like machine) or c) a person Centre Centre
(e.g. salesman), or a group of these. However, costs ypes
incurred are identified with the cost centres initially f Cost
(for distribution later amongst cost units). It helps to Centres
ascertain costs. Divisionalisation of an
the centre-wise Operating Personal
organisation into a number of cost centres, therefore, entre
assumes importance. The number and size of cost Lmpersonal
centres ditter from one organisation to another Cost
depending upon the nature ot production activities, Centre
size of the organisation, management's informational
needs, etc. The Figure 1.6 shows the various Types of of Cost Centres
Fig 1.6:1ypes
Cost Centres which are as follows:
i) Production Cost Centre:
It is a cost centre connected with production i.e. machine shop, welding shop, assembly
shop etc. The manufacturing and non-manufacturing cOsts are charged to product cOst
centres.
ii) Service Cost Centre:
A Service Cost Centre is one which provides services to the other cost centres. Only non-
manutacturing costs are charged to service cost centre. Examples of service cost centre
are canteen, machinery maintenance, office service etc.
ii) Personal Cost Centre
Personal Cost Centre consists of a persorn or group ot persons. Personal Cost Centre
followsthe organisational structure of a factory. Under this type of cost centre, the costs
are analysed and accumulated by Works Manager, Sales Manager, Store-keeper,
Foreman etc.
Basics of Cost AccountingL 1.23 Basic Concept in Cost

iv) Impersonal Cost Centre

It consists of a location or item of equipment. A cost centre relating to location may
represent a region of sales, a warehouse, or store-room. Cost centre relating to an item of
equipment could be a machine or group of machines.
V Operation Cost Centre:
It is a cost centre which consists of machines or persons carrying out similar operations
1e. machirnes and operations engaged in welding, turning or matching
vi) Process Cost Centre
It is a cost centre which consists of a specific process or continuous sequence of
operations.

Factors to be Considered
Whatever may be the type of Cost Centre, it is determined by taking into consideration, the
number of factors V1Z.

i) the volume of work to be performed,

ii) the extent of cost control that can be exercised,
ii) responsibilities to be identified and the uses of cost centres to the cost accounting
department.
Tracing of Cost to Cost Centres
A cost centre is a unit within a larger system that is responsible for a particular set of
activities that benefit the organisation. Keeping close track of the operating expenses, such a cost
center allow the organisation to control the total costs, allocate resources more strategically and
calculate the profitability on a product or departmental basis. The most important function of a
cost centre is the tracing of expenditures associated with a specific function. The management
focus in a cost centre is usually on keeping expenditures down to a minimum level, possibly by
using outsourcing, automation or capping pay levels.
However, a cost centre is a business unit that is only responsible for the costs that it incurs.
The manager of a Cost Centre is not responsible for revenue generation or asset usage. The main
function of a Cost centre is tracing of all expenses related with certain function. Cost Centres
try to update processes, be more ettective and save money so that they can reduce the expenses.

QUESTIONS FOR SELF-STUDY

L.
Theory Questions:
i) Define the term 'Cost Accounting. Explain in brief the objectives of Cost Accounting.
ii) "Cost Accounting begins where Financial Accounting ends". Discuss.
ii) Explain the following Cost Concepts,
a) Cost, b) Costing, c) Cost Accounting and d) Cost Accountancy.
Basics of Cost Accounting 1.24 Basic Concept in Cost

iv) Cost Accounting has developed out of the limitations of Financial Accounting"
v) Define Cost Accounting. State the scope of Cost Accounting.
vi) What is Cost Unit'? Suggest more suitable Cost Unit Single and Composite, for
following enterprises
a) Road Transport, b) Power House- Electricity, c) Hostel, d) Government Hospital.
vii) Define 'Cost Centre', State the types of Cost Centres.
vii) Write short notes on:
a) Cost Accounting, b) Objectives of Cost Accounting. c) Scope of Cost Acounting,
d) Cost Unit, e) Types of Cost Centres.
ix) Differentiate between
a) Cost Accounting and Financial Accounting
b) Cost Accounting and Cost Accountancy
)Simple Cost Unit and Composite Cost Unit
d) Production Cost Centre and Service Cost Centre
***
 Unit. .2
ELEMENTS OF COST AND COST SHEET
SynopsiS.
2.1 Elements of Cost
2.1.1 Material, Labour and Other Expenses
2.2 Classification and Types of Cost
2.2.1 Classification of Cost
2.2.2 Types of Cost
2.3 Cost Sheet
*ustrations
Questions for Self-Study

2.1 ELEMENT OF COST|

Meaning
The constituent elements which build up the cost of a unit are materials, labour, energy and
equipments. These elements are broadly divided into three major groups of Materials, Labour
and Other Expenses. Ihese three elements of cost or cost factors could then be further classified
into direct and indirect categories. The term 'Materials' refers to all commodities supplied to an
undertaking. Labour is an essential factor of production. It is a human resource and participates
in the process of production. Labour cost IS a signiticant element of cost of a product or service
All costs other than material costs and labour costs are termed as "Expenses. Direct expenditure
is one which is identifiable as belonging exclusively to a particular process, product, unit or
service. Indirect expenditure is one which, while still being part of the cost of production, is not
incurred exclusively tor a particular part of the job and must, therefore, be spread over the whole.
Purpose
Elementwise Classification of Cost is absolutely important for the following purposes:
i) ascertaining the relative share and importance of each of the elements of total cost of a
product manufactured or services rendered.
i) determining the cost per unit as well as total costs of the output.
ii) analyzing the total cost for effective planning, absolute control and in time decision-
making by the management.
iv) observing the trends in cost behaviour.
v)determining the accurate product cost for stock valuation and profit measurement.
Vi)understanding the components of total costs viz. prime cost, works cost, Ccost of
production and cost of sales.
2.1.1 MATERIAL, LABOUR AND OTHER EXPENSES
On the basis of the nature or elements of costs, costs may be classified into three broad
categories as Material Cost, Labour Cost and Other Expenses. Material Cost denotes the cost of
raw materials consumed in the process of manutacturing and marketing a commodity. Labour
(2.1)
Basics of Cost Accounting 2.2 Elements of Cost and Cost Sheet

Cost represents the wages, salaries, and so on, payable to the employees of a corporate entity,
Expenses reter to the costs other than material and labour costs (but including notional costs o
the use of owned assets) of other services provided and used in manufacturing and marketing the
goods and services of the company. Elementwise classification is important for the purpose o
ascertaining the costs of difterent elements of total cost of a product manutactured or services
generated. Further, it also helps to ascertain the relative share and importance of each of the
elements of total cost of goods and services.
For the protessional management, it is not just sutticient to have knowledge of total cost
control, but for effective control and decision-making the management must know further sub-
analysis and classification of costs. Hence, the total cost is analysed according to the elements of
cost. There are basically three Elements of Cost viz. material, labour and other expenses. Again
they are further analysed into different elements i.e. direct and indirect material, direct and
indirect labour and direct and indirect expenses. Indirect expenses are termed as Overheads or
on cost. The Overheads are Factory Overheads, Office and Administrative Overheads and Selling
and Distribution Overheads.
Figure 2.1 indicates the different Elements of Cost as follows

Total
Cost
N

**
*******
Material Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

Direct or Indirect
Pime Cost Or
Overheads
Cost

Factory and Office aand Selling and

*************'***********
Production Administration Distribution

Fig. 2.1: Elements of Cost

Thus, Elements of Cost are the different items or components of cost which are added to get
the total cost of any product or service.
Basics of Cost Accounting 2.3 Elements of Cost and Cost Sheet

According to LC.M.A., London, Elements of Cost means, "the primary classification of costs
according to the factors upon which expernditure is incurred viz. material cost, labour cost and
expenses
Analysis and classification of costs facilitates cost ascertainments, renders it possible to make
valid comparisons of the operating etficiency of various departments and assists in locating the
responsibility for off-standard performance. The total cost of a product consists of various
elements ot cost. These elements are summarised as under.
Material
According to I.C.M.A, London-Material Cost is, "the cost of commodities supplied to an
undertaking
Material Cost is further divided into Direct Materials and Indirect Materials as follows :

a) Direct Materials :
Direct Materials are those which can be identified in the product and can be measured.
They can also be charged to the product directly. Thus, direct materials enter into the product and
form a part of finished product. For example, cotton used in a textile mill, timber used in
furniture making, pig-iron in foundry et., are treated as direct materials. The cost of direct
material is termed as the 'direct material cost.
But sometimes, even it some materials go directly nto the production, they are not treated as
direct materials. For example, thread in dress making, nails in shoe making, glue in binding etc.
The reason for this is that the value of these materials is very less and the quantity used is also
negligible. Hence, attempt is not made to analyse their costs which wll otherwise be time
consuming and will add to extra cost because of spending more time on them, with their value
being negligible. Thus, such materials should conveniently be treated as indirect materials.
b) Indirect Materials :
Indirect Materials are those which do not form a part of the finished products. It is defined
as, "materials which cannot be allocated, but which can be apportioned to or absorbed by cost
centres or cost units. For example lubricants, oils, cotton wastes, small tools etc. Thus, materials
which cannot be conveniently identified with individual cost units are termed as indirect
materials. These are minor in importance. But sometimes, the cost of small items which have less
value like the nails in furniture, thread in the dress manufacturing, paper used in polishing, etc.
are treated as indirect materials though they go directly into production. The cost of these indirect
materials is termed as 'indirect material cost'.
Generally, the materials are purchased from market or directly from manufacturers. The
materials purchased have to be brought to the factory for converting them into finished product.
So all the expenses which will be incurred for bringing the materials to the place of production
will have to be considered for ascertaining the cost of materials. Materials purchased are stored in
godowns, therefrom, they are issued for production. The valuation of material issued for
consumption is done by Costing Department. This value of materials consumed is charged as
Material Cost.
Following are the points of differences between Direct Materials and Indirect Materials
Direct Materials Indirect Materials

i) They can be conveniently identified with | i) These are certain materials which cannot
and allocated to cost units. be conveniently identified with
individual cost units.
Basics of Cost Accounting 2.4 Elements of Cost and Cost Sheet

Direct Materials Indirect Materials

i) They generally form a part of the finished ii) These are minor in importance, such as
product. e.g, cotton used in a textile mill, a) small and relatively, inexpensive
clay in bricks, leather in shoes, timber in items which may become a part ot
furniture, milk in dairy products, primary finished product e.g, pins, screws, nuts
packing materials e.g. cans for tinned food and bolts, thread, etc. b) those items
and cold drinks etc. which do not physically become a part
of the finished products eg coal,
lubrication oil and greece, sand paper,
etc. c) Secondary packing materials
eggunny bags, iron strips, wooden|
cases etc.
ii) They directly enter the product and fornma ii) The costs which relate to the factory
part of the finished product. torma part of the factory overhead.
Labour
According to I.C.M.A, London, Labour Cost is defined as, "the cost of remuneration (wages,
salaries, commissions, bonus etc.) of the employees of an undertaking".
Generally worker's eforts are necessary for producing any particular thing or giving any
service. In spite of computerisation and automation, the importance of labour force in

manufacturing a product or giving service is increasing day-by-day. The expenses incurred for
obtaining the services of human being are known as Labour Cost of a Job. Labour Cost is further
divided into Direct Labour and Indirect Labour as follows:
a) Direct Labour
All the workers who are directly engaged in a manufacturing activity such as operating
machines, doing assembly work etc., are known as direct workers and wages paid to them are
known as Direct Labour Cost. These wages can be conveniently identified with a particular
product, job or process. For ascertaining direct labour cost, it is necessary to know how much and
what work has been done by an individual worker. For this purpose, various records should be
maintained by the management. Wages of skilled and unskilled labour may be included in this
item. Examples of direct labour are : Baker, Shoe-maker, Carpenter, Weaver, Tailor, Bus Drivers
and conductors etc.
b) Indirect Labour :

and cannot be conveniently identified with a particular cost unit.

It is of a general character
In other words, indirect labour is not directly engaged in the production operations, but only to
assist or help in production operations. Thus, the wages which cannot be allocated but which can
be apportioned or absorbed by cost centres or cost unit is known as Indirect Labour. Examples of
indirect labour are : salaries and wages paid to foreman, supervisors, chargeman, inspectors,
clerical staff etc., working in production department, overtime and night shift allowance paid and
any other benefits paid to them.
Basics of Cost Accounting 2.5 Elements of Cost and Cost Sheet

Following are the points of differences between Direct Labour and Indirect Labour.
Direct Labour Indirect Labour

i)It consists of wages paid to workers i) They are not directly engaged in the
directly engaged in converting raw production operations but only assist or
materials into finished products. help in production operations.
11) These wages can be conveniently | 11) They are of a general character and
identified with a particular product, job or| cannot be conveniently identified with a
process. particular cost unit.
ii) Wages paid to Baker, Shoe-maker, ii) Wages paid to Supervisor, Inspector,
Carpenter, Weaver and Tailor are Cleaner, Clerk, Peon, Watchman are
examples of Direct Labour. examples of Indirect Labour.

iv) 'All labour expended in altering the | iv) The wages which cannot be allocated,
construction, composition, confirmation or but which can be apportioned to or
condition of the product' is known as absorbed by cost centres or cost units i
Direct Labour. known as Indirect Labour.

Other Expenses
All costs, other than material and labour are termed as Other Expenses. According to
I.C.M.A., London, Expense is defined as, "the cost of services provided to an undertaking and the
notional cost of the use of owned assets"
Expenses are further divided into Direct Expenses and Indirect Expenses as follows:
a) Direct Expenses:
Direct Expenses include all types of expenses other than direct materials and direct labour
which are incurred specifically for a particular product or process. It is defined as expenses
which can be identified with and allocated to cost centres and cost units". Direct expenses are also
known as 'chargeable expenses'. Direct expenses forma part of the Prime Cost for e.g. chargeable
expenses, Hire of special plant, Royalties, Cost of patents and patterns, Engineers Fees, Cost of
special drawings, Designs and layouts, Architect's fees, Direct expenses payable, Surveyor's fees,
Productive expenses outstanding, Consultants fees, Process expenses due but not paid, Prime cost
expenses etc.
b) Indirect Expenses:
All indirect costs other than indirect material and indirect labour costs are termed as
Indirect Expenses. These expenses are not charged directly to production. Indirect expenses
cannot be allocated, but they can be apportioned to or absorbed by cost centres or cost units.
Examples of indirect expenses are : rent, ra tes and taxes, salary of general manager, staft welfare
expenses, canteen expenses, telephone expenses, ighting, power, fuel, depreciation, insurance
bank charges and interest paid, etc.
Basics of Cost Accounting 2.6 Elements of Cost and Cost Sheet

The aggregate of direct expenses ie. direct material cost, direct labour cost and direct
expenses Is termed as Prime Cost while the agEregate of indirect expenses 1.e. indirect material
cost, indirect labour cost and indirect expenses is termed as "Overheads
Following are the points of differences between Direct Expenses and Indirect Expenses
Direct Expenses Indirect
Expenses
"Expenses which can be identified with i) "All indirect costs other than indirect
and allocated to cost centres and cost unif" materials and indirect labour costs, are
is known as Direct Expenses. termed as lIndirect Expenses.
ii) These are those expenses which are ii) These cannot be directly identified with a
specitically incurred in connection with a particular job, process or work order and
particular job or cOst unit. are common to cost units and cost
centres.
11) These are also known as "chargeable" ii) These are also known as non-chargeable
expenses. expenses or on costs or overheads.
iv) These form a part of the Prime Cost. iv) They form a part of the Overheads.
v) Cost of Drawings and Patterns, Royalty v) Rent and Rates, Depreciation, Light and |

paid, Excise Duty, Architect Fees are the Power, Advertising, Insurance, Carriage
examples of Direct Expenses. Outward are the examples of Indirect
Expenses.

Overheads
Overhead Costs are the operating costs of a businesS enterprise which cannot be ídentified
with a particular unit of output. Overheads consists of all expenses incurred for in connectionn
with the general organisation ot the entire concern or a part of it, i.e. cost of operating supplies
and services used by the undertaking. It also include maintenance of capital assets. There are tour
main Types of Overheads which are as follows:
a) Factory or Production or Works or Manufacturing Overheads:
These are the overheads which are concerned with the production function. It includes
indirect materials, indirect wages and indirect expenses in producing goods or services. Thus,
Overhead covers all types of indirect expenses incurred by a concern right from the receipt of an
order to the final delivery of goods to the customer or for storing the finished goods in the
godowns. Examples of factory verheads are: depreciation of plant and machinery, depreciationn
of factory buildings, insurance charges and repairs on plant and machinery and factory buildings,
power consumption, coal and other fuel charges, wages of indirect workers, welfare services etc.
b) Office or Administration or Establishment or Management Overheads:
These are the indirect expenditure incurred in general administrative function i.e. in
formulating policies, planning and controlling the function, directing and motivating the
personnel of an organisation in the attainment of its objectives. Examples of office and
administration overheads are : Office rent, rates and taxes, salaries of otfice statt, postage,
telegrams and telephone, printing and stationery, office lighting repairs and depreciation of
office building and equipmens, legal expenses, audit fees, director's fees, bank charges and
interest paid, etc.
Selling Overheads:
It is the cost of promoting sales and retaining customers. It is the skill of any business to
attract new customers by offering extra tacilities and services by giving them free samples etc., so
Basics of Cost Accounting 2.7 Elements of Cost and Cost Sheet

that they get attracted to the company. Similarly, the existing customer should be retained by
providing the best services for which certain expenses are incurred. Thus, if a concern wants to
expand its business it must incur selling expenses which cannot be avoided. Examples of selling8
overheads are: salaries of the sales manager and sales staft, commission paid to salesman and
selling agents, advertising charges, packing charges, free catalogues, pamphlets and price lists,
mail order house expenses, showroom expenses, bad debts, after sales service expenses, travelling
expenses etc.
d) Distribution Overheads:
These are the expenses incurred in moving the goods from the company's godowns to the
customers premises. It means that distribution overhead starts with all indirect material, indirect
wages and indirect expenses incurred upto the point of packing the product, for making available
tor despatch and ends with making the re-conditioned returned empty packages and tins
available for reuse. The actual definition of distribution expenses is "the cost of the sequence ot
operations, which begins with making the packed product available for despatch and ends with
making the re-conditioned returned empty package, if any available for reuse. Examples of
distribution overheads are : warehouse rent and insurance, salary of warehouse keeper and other
cost of transportation of goods, insurance of goods in transit, cost of maintenance of vehicles,
loading expenses, carriage outward, special packing expenses, cost of repairing and re-
conditioning of empty packages etc.
EXAMPLE
Classify the overhead costs given below into the categories viz. 1) Works Overheads,
2) Office and Administration Overheads, 3) Selling Overheads and 4) Distribution Overheads.
a) Workshop Insurance, b) Maintenance of Furniture, c) Market Research, d) Printing and
Stationery, e) Calenders, ) Warehouse Rent, 8) Machinery Repairs, h) Telephone and Telegrams,
i) Upkeep of Delivery Vans, j) Freight Outward, k) Salary to shop floor helpers, ) Counting8
House Salary, m) Depreciation on Plant and Machinery, n) Commission to traveling salesmen,
) Consumable Stores, p) Advertising, g) Carriage Outward, r) Show-room Expenses, s) Works
ldle fime, t) Directors Fees, u) Loading and Unloading of Finished Goods, v) Loss of Profit
Insurance, w) Motive Power, x) Bad Debts, y) Legal Fees, z) Delivery Vehicle Running Charges.
ANSWER
1) Works Overheads:
a), 8), k), m), o), s), w).
2) Office and Administration Overheads:
b), d), h), I), t), v), y).
3) Selling Overheads:
c), e), n), P), r), x).
4)
, ), ),
Distribution Overheads:
g), u), z).

tems to be excluded from Cost or Non-cost Items

There are certain items of expenses which are purely of financial nature and hence they are
simply excluded, while recording the business transactions into the books of cost accounts. The
following is the summarised list of financial items which are to be excluded from the computation
of total cost.
Basics of Cost Accounting 2.8 Elements of Cost and Cost Sheet

Financial Incomes:
Capital Profits, Dividend Received, Brokerage and Commision Received, Share
Transfer Fees Received, Interest on Investments, Interest on Bank Deposits, Rent
Received, Bad Debts Recovery, Interest on Loan given, Discount Received etc.
2) Financial Charges:
Capital Losses, Cash Discount, Trade Discount, Penalties and Fines, Share Transfer
Fees Paid, Interest on Bank Loan, Interest on Debentures, Preliminary Expenses,
Underwriting Commission, Discount on Issue of Shares and Debentures, Loss on
Investments, Capital Expenses, Interest on Capital, Salary or Commission paid to
Partners, Income Tax, Wealth Tax, Interest on Debentures, Reconstruction
Expenses, Development Expenses, Keorganisation Expenses etc.
3) Appropriations:
Bad Debts Reserve, Dividends or Bonus Paid, Charitable Donations, Transfer to
Reserves, General Reserves, Sinking Fund, Debenture Redemption Fund,
Machinery Replacement Fund, Investment Fluctuation Fund, etc.
4) Abnormals:
Abnormal Wastage, Abnormal Idle Time, Loss by fire, Loss by Theft, Loss of Stock,
etc.

Division of Costs
The division of costs are obtained with the help of Elements of Cost. The following are the
various divisions of costs of an article or a product.
1) Prime Cost:
This is the total of Direct material, Direct labour and Direct expenses.
Prime Cost = Direct Material + Direct Wages + Direct Expenses.
2) Works Cost:
This consists of Prime cost plus Works overheads.
Works Cost = Prime Cost + Works Overheads
3) Cost of Production:
This is made up of Works Cost plus Office and Administrative Overheads. Cost of
production is termed as Gross Cost".
Cost of Production = Works Cost +Office and Administration Overheads.
4) Total Cost or Cost of Sales:
This is the cost of production plus selling and distribution overheads. In other words, it
is the total expenditure incidental to production, administration, selling and
distribution of commodities manufactured. Total Cost is termed as "Net Cost".
Total Cost / Cost of Sales = Cost of Production + Selling and Distribution Overheads.
5) Selling Price:
Total Cost / Cost of Sales + Profit or- Loss.
Basics of Cost Accounting 2.9 Elements of Cost and Cost Sheet

The Division of Costs may be shownin the following chart indicated in Figure 2.2.
Division of Costs

Direct Material Works on Cost or

Factory Overheads
Direct Labour or
Direct Expenses
Manufacturing Expenses

- - - - -
Prime Cost/ Direct Cost/ Basic Cost/Operating Cost/Original Cost First Cost / Flat Cost

Add
-

Factory Cost/ Works Cost/ Manufacturing Cost

Add

Office Overheads or Administration on Cost or Management Expenses

Cost of Production/ Gross Cost/ Office Cost

Selling and Distribution Overheads

Cost Price/ Total Cost /Cost of Sales/ Cost of Turnover /Sales Cost/ Net Cost/ Turnover Cost)

Add Less
Profit/LOsS

/
Inflated Price/ Invoice Price Seling Price/Sales
MarketingPrice / Value of Sales / Value of Tumover/ L0aded Price

Fig. 2.2: Division of Costs

2.2 CLASSIFICATION AND TYPES OF coSTS

The suitable classification and systematic and scientific analysis of costs resulting into
number of types of costs, is ot vital importance for ascertairnment of exact cost, absolute control
Over the cost, fixation of affordable prices, determination of accurate income and for number of
other managerial decision making objectives.
Basics of Cost Accounting 2.10 Elements of Cost and Cost Sheet

2.2.1 CLASsIFICATION OF COST|

Meaning
Cost Classification means grouping of costs according to their common characteristics. It is
the process of grouping the items together which are alike.
Definitions
i) According to Dickey,
Classification is the process of grouping like facts under a common designation on the basis
of similarities of nature, atributes or relations
ii) The Committee on National Association of Accountants defines Classification as,
"The identification of each item and the systematic placement of like items together
according to their common features
Items grouped together under common heads are further defined according to their
fundamental ditterences. Suitable classification of costs is of utmost important, so that these
costs can be identified with the cost centres or cost units.
Need of Cost Classification
The need for classification arises having to use cost data tor a variety of purposes. For
difterent purposes different kinds of cost intormations are required. Theretore, costs must be
arranged and classified in sucha manner that they can be combined in ditferent ways to serve
difterent purposes. Generally, Cost Classification is required tor the attainment of the following
purposes shown in igure 2.3.

In Budgeting Controlling Pricing

and
Planning Policies
Costs (IV)
Process (n)
(i)

Current
Ascertainment
Application of
ial
Periodically Plans and
Policies

Need of Cost
Classification
Fig. 2.3: Need of Cost Classification

Methods of Cost Classification

Costs are classified in different ways according to their elements i.e. material, labour and
expenses. Other basis of cost classification are function, variability, controllability, nornmality,
period, investment etc. The costs may be the same, but the classification of costs are made in
difterent ways depending upon the specific requirement and the purpose to be achieved in a
Basics of Cost Accounting
2.11 Elements of Cost and Cost Sheet

particular organisation. The Figure 2.4 shows the graphical presentation of Methods of Cost
Classification as follows.

Fig. 2.4: Methods of Cost Classification

Basics of Cost Accountingg 2.12 Elements of Cost and Cost Sheet

1) Elements
The cost elementsS of a product are Material, Labour and Expenses.
i) Materials:
The I.C.M.A., London defines material cost as, "the cost of commodities, other than fixed
assets, introduced into products or consumed in the operation of an organisation. Material cost
may be either direct material cost or indirect material cost.
Direct material cost is defined as "the cost of materials entering into and becoming constituent
element of a product or saleable service. Thus, materials which can be identified with the
production of a product or which can be traced to the finished product are known as direct
materials. Examples of direct materials are cotton in cotton textile, timber in furniture makingg
industries, leather in shoe making industries etc.
Indirect material cost has been defined as, "material cost other than direct material cost". In
other words, material cost which cannot be identified with a product, job or process or traceable
to the same, is known as indirect material cost. Examples of indirect materials are consumable
stores such as oil, cotton waste, small tools, works stationery etc.
But in some cases, even direct materials which can be traced to the product concerned may be
treated as indirect materials because ot time and labour involved in ascertaining their cost for the
purposes of a direct charge. For example, thread, buttons, nails, gum, metal strips etc. which are
used in production are treated as indirect, although they are direct in nature.
ii) Labour :
Labour is the physical or mental effort expended in production. The remuneration for such
efforts is known as wages. Labour cost may be either direct labour cost or indirect labour cost.
Direct labour cost is defined as, "the cost of remuneration for employee's efforts and skills
applied directly to a product or saleable service"
Indirect labour cost is defined as, "labour cost other than direct labour cost. Thus, indirect
labour is not directly engaged in the production operations, but only to assist or help in
production operations. Examples of indirect labour are: salaries and wages paid to foreman,
supervisors, chargeman, inspectors, maintenance workers, clerical staff etc. Working in
production department, overtime and night shift allowance paid and any other benefit paid.
ii) Expenses
The term Expenses denotes the cost of servicess provided to an undertakin8. Expenses may
be direct or indirect.
ICMA, defines direct expenses as "Costs other than materials or wages which are incurred for
specific product or a saleable service. Direct expenses torm a part of Prime Cost. Examples of
direct expenses are: Cost of drawings and patterns, Repairs and maintenance of plant and
equipment taken on hire, Architect's fees, Research expenditure, Excise duty, Royalty etc.
Indirect expenses are expenses other tnan direct expenses. 1hese exPenses are not charged
directly to production. Examples of indirect expenses: Kent and rates, Salary of General Manager,
Staft weltare expenses, Canteen expenses, Lighting, Telephone expenses etc.
2) Functions
Costs may be classified on the basis of business functions like manutacturing,
administration, selling and distribution, research and development etc. Ascertainment of costs for
all these functions is necessary and hence they are classified as follows:
i) Factory Costs:
This is the cost which is incurred for a series of operations ie. right from the supply of
materials, labour and expenses incurred, till the completion of production. Thus, materials, labour
and expenses, both direct and indirect, constitute production cost. Examples of manutacturing
cOst are: material, labour, factory rent rates and taxes, depreciation on factory building and plant
Basics of Cost Accounting 2.13 Elements of Cost and Cost Sheet

and machinery, factory lighting and power, store keeping expenses, insurance of factory building
etc.
ii) Administration Costs:
This is the cost of running a concern i.e. for framing the policies, directing and controlling all
the activities of the organisation other than manutacturing and selling and distribution expenses.
According to I.C.M.A., it defines as, "the sum of these costs of general and management and of
Secretarial, accounting and administrative services which cannot be directly related to
production, marketing, research and development function of the enterprise. Examples of
administration cost are: Director's fees and allowances, Salaries of otfice statt, Audit fees, Legal
expenses, Office rent and taxes, Office lighting, Expenses of secretarial and accounting
department, Postage and telegram, Printing and stationery etc.
iii) Selling and Distribution Costs:
Selling costs are those costs which are incurred for attracting the potential customers and
retaining the existing customers. Thus, demand is created in the market through advertisement
and publicity, so that new orders can be secured.
Selling costs include : Advertisement, Hoarding/ Neon signs ete. Salaries and commission to
salesman and sales staft, Costs of free samples/ brochures etc. Showroom expenses, Travelling
expenses of salesman etc.
Distribution expenses are incurred for despatching the products which are ready after
:
packingIhese expenses include Carriage outward, Warehouse expenses, Packing costs,
Running and maintenance cost of delivery van, Salary of the godown staff etc.
iv) Research and Development Costs:
Research Cost is defined as, "the cost of seeking new or improved products, applications of
material or methods. Development Cost is defined as, "the cost of process which begins with the
implementation of the decision to produce a new or improve methods and ends with the
commencement of formal production of that product or by that method".
3) Identifiability
According to the identifiability with the cost units, jobs or processes the costs are classified
into direct and indirect. In costing, Direct and Indirect costs have much significance.
1) Direct Costs:
All the costs which can be conveniently allocated to cost unit or cost centre is known as
direct cost. For example, the cost of cotton in case of textile industries, the cost of timber
in furniture industries etc.
ii) Indirect Costs:t is a cost which is of a general character and which cannot be
identified with a particular unit of cost. Ihese cost cannot be allocated, but can be
apportioned to cost unit or cOst centre. Ihe terms direct and indirect relate to the
methods of allocating them because it depends upon whether the same cost should be
treated as direct or indirect. Thus, same item may be treated as a direct cost in one case
and indirect cost in another case. 1his bifurcation depends upon the nature of business
and also cost unit decided by the management. For example, we can treat depreciation
as a direct cost, if there is only one machine or cost centre, but if there are many cost
units it becomes dificult to allocate the cost accurately. In this case, it is treated as an
indirect cost, tor e.g. in cost of construction sites, the depreciation of machinery etc. is
taken as direct cost, while in case of a factory where there are many departments which
use the same machine, it is treated as an indirect cOst.
Tdentifiability classification is important because,
t facilitates accurate ascertainment of cost.
it facilitates controlling of costs.
it enables in fixing the responsibility to the executives.
Basics of Cost Accounting 2.14 Elements of Cost and Cost Sheet

Direct Costs are those costs which are incurred for and may easily and conveniently be
identified with a particular cost unit or cost centre. Direct costs include direct material cost, direct
labout cost and other direct expenses. Indirect Costs, on the other hand, represent the costs which
are of general nature and which cannot easily and conveniently be identified with a particular
cost unit or cost centre. They include indirect material cost, indirect labour cost and other indirect
expenses. The indirect costs are theretore called Overhead Expenses. 1hese indirect or overhead
expenses can further be divided into three sub-categories as factory overhead expenses,
administration overhead expenses, and selling and distribution overhead expenses (on the basis
of the functions). The Classification of Costs on the basis of Traceability Elements and
Functions is shown in Figure 2.5,
Direct Material Cost
Direct
Classification Direct Labour Cost
Prime Cost
Direct Expense

Classifi- On th
cation basis of
Traceability
of Costs

Indirect Production
Overhead
atera

Elementwiseindirect Functional ministrative

OverheadClassihication Classification
Expense Cost Eses
Selling and
Indirect
Distribution
Expenses
Overhead
EXpenses
Fig. 2.5: Classification of Costs on the basis of Traceability, Elements and Functions
4) Behaviour
On the basis of this characteristic, costs are classified according to their nature or behaviour
in relation to changes in the level of activity or volume of production. On the basis of variability,
costs are classified as under:
i) Fixed Costs
According to I.C.M.A., London Fixed Cost is defined as, "a cost which accrues in relation
to the passage of time and which within certain output or turnover limits tends to be unaffected
y fluctuations in volume of output or turnover"
In other words, fixed costs remain fixed in total amount and do not increase or decrease with
volume of production. But the fixed cost per unit increases when volume of production decreases,
and decreases when the volume of production increases. Thus, fixed costs are constant in total
amount, but fluctuate per unit as production changes. The characteristics of fixed cost are:
Basics of Cost Accounting 2.15 Elements of Cost and Cost Sheet

fixed total amount within a relevant output range.

increase or decrease in per unit fixed cost, when volume of production changes.
fixed costs are apportioned to departments on some equitable basis.
fixed cost can be controlled mostly by the top level management.
Examples of fixed cost are Rent, Rates, Taxes, Insurance of Factory Buildings, Manager's
Salary, Ofice staff Salaries, Municipal Taxes etc
The following is the graph indicating the Behaviour of Fixed Cost.

Total Fixed Cost

FIxed Cost per unit

Volume of Production
Behaviour of Fixed Cost
i) Variable Costs:
11.CMA, London defines Variable Cost as, "a cost which in aggregate ternds to vary in
direct proportions to changes in the volume of output or turnover". In other words, when volume
of output increases, total variable cost also increases and vice-versa, when volume of output
decreases, total variable cost also decreases. But the variable cost per unit remains fixed.
Example of variable costs are: Direct Material Cost, Direct Labour Cost, Direct Expenses,
Power, Repairs, Royalties, Commission of Salesman, Normal Spoilage etc.
The following is the graph indicating the Behaviour of Variable Cost.

cost
variable

1otal
Variable Cost per unit

P
Volume of Production
Behaviour of Variable Cost
Thus, variable costs, in general, indicate the following characteristics
they vary in direct proportion to volume of output or turnover.
the variable cost per unit ot product remains constant.
it is easy for allocation and apportionment to departments.
such costs can be controlled by departmental heads.
Basics of Cost Accounting 2.16 Elements of Cost and Cost Sheet

ii) Semi-Variable or Semi-Fixed Costs:

1LC.M.A, London defines Semi-Variable Cost as, "a cost containing both fixed and
variable elements, which is therefore partly affected by fluctuations in the volume of output or
urnover". Thus, these costs are partly fixed and partly variable. A semi-variable cost has often a
fixed element below which it will not fall in any level of output. The variable element in semi
variable costs changes either at a constant rate or in lump-sum. For example, if there is additional
shift in the factory, it will require additional supervisors and certain costs will increase in lump-
sum. In case of telephone charges, there is a minimum rent and after a specified number of calls,
the charges are according to the number of calls made. Thus, there is no fixed pattern of
behaviour of semi-variable costs. The following is the graph indicating the Behaviour of Semi-
Variable Cost.

Semi-variable Cost Semi Variable Cost

A
O Volume oft Producton Volume of Production

Behaviour of Semi-Variable Cost

Following is the graph indicating the Behaviour of Fixed, Variable and Semi-Variable Cost in
Figure 2.9.

A= Fixed Cost
B Semi-Variable Cost
C Variable Cost

Volume of Production

Behaviour of Fixed, Variable and Semi-Variable Cost

Examples of semi-variable costs are Telephone Charges, Depreciation, Repairs and
Maintenance of Plant and Machinery, Buildings, Supervision, Compensation for Accidents, Light
and Power etc.
Basics of Cost Accounting 2.17 Elements of Cost and Cost Sheet

5) Controllablity
On this basis, costs are classified into two types which are as follows
i) Controllable Costs:
1.C.MA., London defines Controllable Costs as, "a cost chargeable to a cost centre, which
can be intluenced by the actions of the person in whom control ot the centre is vested.
In other words, these are the costs which may be directly regulated at a given level of
management authority. Variable costs are generally controlled by department heads.
Practically, all variable costs are controllable cost.
ii) Uncontrollable Costs
I.C.M.A., London defines Uncontrollable Cost as, "a cost chargeable to a cost centre,
which cannot be influenced by the actions of the person in whom, control of the centre is
vested". In other words, these are those costs which cannot be influenced by the action of
the specified member of an enterprise. It means, these costs are not within the control of
management. Practically, all fixed costs are uncontrollable.
6) Normality
Under this method, costs are classified according to whether these costs are normally
incurred ata given level of output in the condition in which that level of activity is normally
attained. On this basis, costs are classified into two types which are as follows
i) Normal Cost:
Normal Cost defined as, "the cost which is normally incurred to a given level of
output in the condition in which that level of output is normally attained". It is a part of
the cost of production.
ii) Abnormal Cost:
It is defined as, "a cost which is not normally incurred at a given level of output in the
condition in which that level of output is normally attained". It is not a part of cost of
production and charged to Costing Profit and Loss Account.
7) Time
On this basis, costs are classified into two types which are as follows
i) Historical Costs
It is defined as, "the costs which are ascertained after these have been incurred", Thus,
such costs are available only when the production of a particular thing has already been
done. Such costs are only of historical value and not useful for cost control purposes. The
characteristics of such costs are:
they are based on recorded facts.
these costs may be verified with the help of supported documents.
these are objective in nature because they relate to the past events.
ii) Pre-determined Costs:
It is defined as, "the costs which are ascertained in advance of production on the basis of
a specification of all factors affecting cost". These costs are set up from analysis and
forecast made betore the event and thus, represent not what has happened, but what is
expected to happen. Pre-determined cost determined on scientific basis becomes
standard cost. Such costs when compared with actual costs determines the reasons of
variance. Thus, by these cOsts, management can fix the responsibility and can take
remedial action to avoid its recurrence in future. Pre-determined costs may be in various
forms like budgeted cost, estimated cost, standard cost and so on.
Basics of Cost Accounting 2.18 Elements of Cost and Cost Sheet

8) Association
On this basis, costs are classified into two types which are as tollows:
i) Product Costs:
It is described as the costs which are directly associated with the product. Thus, unit
product is sold, these costs provide no benefit. When the products are sold, the total
product costs are recovered as an expense. This expense is called the cost of goods sold.
Examples of product costs are: Direct material, Direct labour and Factory overheads.
ii) Period Costs:
It is described as the costs which are associated with a particular accounting period.
These are not related with the products delivered to the customers. Such costs are
charged to Profit and Loss Account of the period. Examples of period costs are : Rent,
salaries of office staft, travelling expenses etc. These costs are inventoried 1.e. these are
not included in the value of closing stocks.
This classification is important for ascertainment of profit. Product cost can be carried
forward to the next accounting period as a part of unsold finished stock, whereas period cost is
written off in the accounting period in which it is incurred.
9) Investment
On this basis, costs are classified into two types which are as tollows:
i) Capital Costs:
It is defined as, "a cost which is intended to benefit in future period". Capital cost is
treated as purchase of an asset. Examples of capital cost are purchase of premises, plant
and machinery, furniture etc.
ii) Revenue Costs :
It is defined as, "a cost which is incurred to benefit the current period". Revenue cost is
treated as an expense. Examples of revenue costs are : salaries, pOstage, printing and
stationeryY, rent, rates ana taxXes, însurance etc.

10) Relevancy:
On the basis of whether the cost items are relevant or irrelevant to the decisions under the
consideration of the management, costs may broadly be classified into two types which are aas
follows:
i)Relevant Costs
Relevant costs are those costs which have a bearing, or which have an effect on the
decisions under the consideration of the management. That means, they are the most
pertinent costs and therefore their effects are to be reckoned before taking a decision.
ii) Irrelevant Costs:
Irrelevant costs represent the costs which have no effect on the decisions under the
consideration of the management. For instance, marginal cost is an example to relevant
cOsts. It may be noted here that the marginal costs represents the extra cost tor an
additional unit. On the other hand, sunk cost is a good example to irrelevant costs.
Because, sunk cost represents the costs incurred in the past. They are therefore called
past costs. Since they represent the costs which have already been incurred, no present
or future decision is able to alter them. Hence, they are irrelevant.
Thus methods of cost classification are simply based on different cost characteristics and
the basic objective behind each type of classification.
Basicsof Cost Accounting Elements of Cost and Cost Sheet
2.19
2.2.2 TYPES OF COSTS

These costs are not used for recording purposes, but mostly used for decision-making.
From this point of view, Types of Costs may be classified as indicated in Figure 2.6 as follows.

Marginal
Other Standas
Cost
Cost

Types of (RE
Costs

nO/
sopajndw s00
ueu
-aoeja
F1g: 2.6: ypes of Costs
1) Marginal Cost:
Marginal Costs are the sum total of variable costs. I.c.M.A., London defines it as, "the variable
cost of one unit of product or a service i.e. a cost which would be avoided if the unit was not
produced or provided". It consists of all direct costs and variable overheads. It is based on the
distinction between fixed and variable costs. Fixed costs are ignored and only variable costs are
taken into consideration for determining the cost of products and value of work in progress and
finished goods. Thus, marginal cost is the additional cost of producing additional units. It
remains the same per unit irrespective of the volume of output.
For example, if the cost of producing 50 T. V. sets is given as follows

Variable Costs I,00,000

(50 T.V. sets x 2,000)
Add Fixed Costs (+)25,000
Total Costs 1,25,000
If the output is increased by 10 units of T.V. sets, the cost will be as follows:

Variable Cost 1,20,000

(60 T.V. sets x 2,000)
Add: Fixed Cost (+) 25,000
Total Cost 1,45,000
Basics of Cost Accounting 2.20 Elements of Cost and Cost Sheet

Thus, the additional costs of producing 10 units of T.V. sets is 20,000 which is known as the
"Marginal cost or Variable cost.
2) Standard Cost:
This is a pre-determined estimated cost which an organisation tries to attain under standard
normal conditions. Thus, estimates of costs are made before incurring them and then the actual
results are compared with the standards to find out the efficiency of a business.
3) Conversion Cost:
It is the term used to denote the sum total of Direct Labour, Direct Expenses and Overhead
Costs in the production of a certain product where Material Cost is negligible as in the case of
Brick Manufacturing 5usiness. Hence, Conversion Cost 1s the total of Direct Labour COst, Direct
Expenses and Overhead Costs incurred to convert raw materials - input into finished goods -
output. As it includes only the conversion of raw materials from one stage of production to
another, it does not consider the negligible Direct Material Cost. Under these circumstances,
Labour Cost becomes the major part of Prime Cost as well as Total Cost i.e. Conversion Cost. The
Composition of Conversion Cost is shown in Figure 2.7 as follows

Raw Maenalis (inputs)

Direct Direct Overhead Conversion Cost

Labour EXpenses Costs

(Output) Finished Goo0

-
Fig. 2.7: Composition of Conversion Cost
4) Sunk Cost:
The National Association of Accountants, defines a sunk cost as, an expenditure for
equipment or productive resources which has no economic relevance to the present decision-
making process". As the name implies it is historical in nature. It is a cost which has been created
by a decision that was made in the past which cannot be changed by any decision that will be
made in the future. These costs are not relevant for decision-making about the future. Thus, the
book value of an asset currently being used is not relevant in making the decision to replace it.
5) Opportunity Cost:
I.C.MA., London defines it as, "the value of benefit sacrificed in favour of an alternative
course of action". Edward Hermanson and Salmonson defines it as "the benefit lost by rejecting
Basics of Cost Accounting 2.21 Elements of Cost and Cost Sheet

the best competing alternatives to the one chosen'". Thus, Opportunity cost is the sacrifice
involved in accepting the alternative under consideration. This concept is used in the problems of
alternative choices. Opportunity cost is a pure decision-making cost and is not entered in the
books of account. Suppose a company owns a building which is proposed to be used for a special
project, the likely rent of the building is the Opportunity Costs, which should be taken into
consideration that evaluates the profitability of the project.
6) Out of Pocket Cost:
These are the costs which require cash payments to be made (such as wages, rent etc.)
whereas many costs do not require cash outlay (such as depreciation). Out-otpocket costs are
those costs that involve cash outlays or require the utilisation of current resources. Out-ot-pocket
cost may be either fixed (such as manager's salary) or variable (such as raw material, direct wages
etc.) This cost is frequently used as an aid in make or buy decisions, price fixation during
recession and many other vital decisions.
7) Replacement Cost:
It is the current market price of replacing an existing asset. The present market price is always
considered for takin8 any decision for buying a machine and not the original cost at which it was
bought.
8) Imputed Cost:
1.C.MA., London defines it as, "a hypothetical cost taken into account to represent a benetfit
enjoyed by the undertaking in respect of which no actual expense is incurred" They are
computed for decision-makin8 purposes. These are the built-up costs which are imaginary. These
are the non-cash items. Examples of imputed costs are: rent of owned land, salary of owner,
interest on owned capital etc.
9) Differential Cost:
It is the increase or decrease in the total cost which results from taking alternative decisions
by the management from amongst the various choices. Thus, the difference between two
alternative course of action is known as 'Differential Cost'.
10) Avoidable and Unavoidable Cost:
Avoidable costs are those which can be eliminated if a particular product or department
with which they are directly related, is discontinued. For example, salary of the clerks employed
can be eliminated if a particular department in which they are employed is decided to
discontinue. Unavoidable costs are those costs which cannot be eliminated with the
discontinuation of a particular product or department. Such costs are merely allocated if the
product or department is discontinued. For example, salary of factory manager or factory rent
cannot be eliminated even if a product is eliminated.
11) Joint Cost:
When two or more products are produced from the use of a single raw material, we get
either two main products from it, or one may be a main product and the other a by-product. But
the cost to produce these are the combined costs. Then the management can take decisions
whether to take up manufacture of joint products or to go in for processing of the by-products
further, so that the total costs can be reduced.
Basics of Cost Accounting 222 Elements of Cost and Cost Sheet

12) Relevant and Irrelevant Cost:

Relevant costs are those costs that would be changed by the decision. Irrelevant costs are
those costs that would not be affected by the decision. It means a relevant cost is a cost whose
magnitude will be affected by a decision being made. Management is concerned only with those
things which it can affect. For example, management cannot change the cost of equipment
purchased in 1980. It can change future costs by its current decisions. Hence, relevant costs are
future costs that will ditfer depending on the action of the management. For each decision the
management must decide which costs are relevant. For example, when a manutacturer decides to
close a certain unit, the wages associated with the maintenance of such unit is relevant cost as
wage payment cease if the unit is closed. But rent which was already paid under lease agreement
which cannot be recovered is irrelevant cost.
13) Other Types of Cost:
Other types of costs are described as under:
i)DiscretionaryCost
These are also called managed costs or programmed costs and consist of fixed costs that
arise from periodic appropriation decisions that directly retlect top management
policies
ii) Engineered Cost:
These are costs which vary directly with the level of production. These are opposed to
managed or discretionary costs.
ii) Shut Down Cost
A cost which is still incurred although a plant is shut down temporarily, for e-g, rent,
rates, depreciation, maintenance of plant, etc.
iv) Traceable Cost :
These are cost which can be easily identified with cost unit or cost centres. The term is
used to distinguish it from joint or common costs.

2.3 COST SHEET

Meaning
A Cost Sheet is an important document prepared by the costing department which showS
the analysis tor the different elements of cost of the job or a product. The cost data incorporated in
Cost Sheet are collected from various statements of accounts which have been recorded in cost
accounts, either on day-to-day basis or regular basis. It analyses and classifies the various
expenses on ditferent items tor a particular period in a tabular form. It may be prepared tor a day,
a week, a month or so on, as per the specific requirement for a particular period.

Definitions
The term Cost-sheet is defined by various authorities as follows:
i) CIM.A., London:
'a document which provides for the assembly of the estimated detailed cost in respect of a cost centre
or a cost unit.
Basics of Cost Acounting 2.23 Elements of Cost and Cost Sheet

ii) W. W. Bigg:

"the expenditure which has been incurred upon production for a particular period is extracted from
the financial books and stores records and set out in a memorandum statement. f the statement is confined
to the disclosure of the cost of the units produced during the period, it is termed as 'Cost-Sheet but where
the statement records cost, sales and profit, it is usually known as "Production Statement'
But nowadays, the practice is to prepare the "Cost-Sheet to show the profit and sales also,
hence it is termed as Statement of Cost and Profit'.
Thus, Cost Sheet is a statement usually prepared to present the analytical cost of total
production during a particular period hence termed as comprehensive cost sheet. There is no
fixed form for preparation of cost sheet but, in order to make the cost sheet more useful, it is
generally presented in columnar form. A Cost Sheet may include as many columns as is desired
to show in detail eg. cost per unit of product, total cost for all the units produced, total cost and
per unit cost for the previous year, estimated cost for the future period and so on. A Cost Sheet
not only shows the total cost but also the various components of total cost. Thus, a cost sheet is a
comprehensive statement prepared to show the detailed analysis of the total cost of production
and cost of sales.

Purposes
A Cost Sheet serves the following purposes
i) It discloses the cost per unit as well as the total cost of output.
ii) It discloses the various elements of cost.
ii) It is useful for calculation of tender price as selling price may be fixed in advance.
iv) It helps the management to find out the causes of variations and take steps to eliminate
the factors which are responsible for increasing total cost. It is possible by making
comparative study of the current cost with the past results and standard costs.
v)It enables a manufacturer to keep a close watch and control over the cost of production.
vi) It helps the management in formulating a definite useful production policy.
Thus, a Cost Sheet is a statement prepared by showing the items of cost of production and
services which are analysed by their nature, elements, functions and behaviour. It should also be
noted that the non-cost items like the dividends and income-tax paid should not be included in
the cost sheets, because they are the appropriations of profits.

A Cost Sheet, including sale, and profit is also known as Production Account. Like
expanded form of Cost Sheet, the product account consists of two parts. The first part shows the
cost of production in total and break-up of costs and the second part known as the statement of
Profit shows sales and profit. Thus, a Cost Sheet is a statement which shows the break-up and
built-up of costs. It is a basic document that provides for the assembly of the detailed cost centre
or a cost unit.
Basics of Cost Accounting 224 Elements of Cost and Cost Sheet

Proforma of Cost Sheet

(A) Simple Cost Sheet
In the books of a Company
Cost Sheet for the period ended..
Name of the Product... Units Produced. Units Sold..
Total Cost Unit Cost
Particulars
Direct Materials
Add: Direct Labour +)

Add: Direct Expenses

Prime Cost
Add: Factory Overheads +)

Factory Cost/ Works Cost i)

Add: Office Overheads +)

Cost of Production / Office Cost

Add: Selling and Distribution Overheads +)
Total Cost / Cost of Sales IV)

Add: Profit v) (+)

Less: Loss
Sales

(B) Cost Sheet with Stock Adjustments

In the books of a Company
Cost Sheet for the period endedd.. ***

Name Or the ltroauct.. Units Produced. Units Sold...

Particulars
Total Cost Unit Cost

Opening Stock of Raw Materials

Add: Purchases of Raw Materials
Add: Expenses on Purchases of Raw Materials +)

Less: Closing Stock of Raw Materials (9

Less: Purchases Returns
Less: Sale of Scrap or Defectives of Raw Materials
Basics of Cost Accounting9 2.25 Elements of Cost and Cost Sheet

Total Cost| Unit Cost

Particulars

Cost of Materials Consumed

Add: Direct Labour
Add: Direct Expenses

Prime Cost

Add: Factory Overheads

Add: Opening Stock of Work-in-Progress

Less: Closing Stock of Work-in-Progress

Less: Sale of Scrap or Defectives of Work-in-Progress

Factory Cost/ Works Cost 11)

Add: Office Overheads

Cost of Production/Office Cost v)

Add: Opening Stock of Finished Goods

Less: Closing Stock of Finished Goods

Cost of Goods Sold

Add: Selling and Distribution Overheads

Total Cost/ Cost of Sales vi)

** Add Profit or vii) (+)

Less Loss

Sales

In present day practice, a Comprehensive Cost-Sheet' is prepared in columnar form to show

the actual cost details for current period, historical costs for previous period and cost estimations
for future period with total cost and unit cost calculations shown separately. The comparative
analysis of the cost helps the management to make use of such analytical cost sheet as an
instrument of cost planning and cost control. The Proforma of such Comprehensive Cost Sheet is
as follows
 Accounting
Basics of Cost 226 Elements of Cost and Cost Sheet

Name of the Product..

Previous Period
(C) Comprehensive Cost Sheet
In the books of a Company
Cost-Sheet for the period ended
Units Produced ....
.
Current Period
Units
Future Period
Sold.

Historical Costs Actual Costs Estimated Costs

Total Unit Particulars Total Unit Total Unit Remarks
Cost Cost Cost Cost Cost Cost

Direct Materials
Add: Direct Labour
Add: Direct Expenses
Prime Cost
Add: Works Overheads
.Works Cost i)
Add: Office Overheads
Cost of Production ii)
Add: Selling and
Distribution
Overheads
Cost of Sales IV)

Add: Profit or
Less: Loss
. Sales

Thus, Cost Sheet is an analytical statement of cost prepared periodically to show the details
of cost incurred during a particular period, on production of a specific unit of cost. It gives cost
details regarding total cost, various components of total cost and unit cost. The actual cost built
up and the details of cost components are as follows
i) Cost of Materials Consumed:
= Opening Stock of Raw Materials (+) Purchases of Raw Materials (+) Expenses for
Purchases of Raw Materials (-) Closing Stock of Raw Materials (-) Purchases Returns
(Sale of Scrap of Raw Materials.
ii) Prime Cost:
Direct Materials (+) Direct Labour (+) Direct Expenses.
ii) Works Cost:
Prime Cost (+) Factory Overheads (+) Opening Stock of Work-in-Progress (-) Closing
Stock of Work-in-Progress
Basics of Cost Accounting 2.27 Elements of Cost and Cost Sheet

iv) Cost of Production

Works Cost (+) Office Overheads

v)Cost of Goods Sold:
Cost of Production (+) Opening Stock of Finished Goods (-) Closing Stock of Finished
Goods
vi) Cost of Sales:

Cost of Goods sold (+) Selling and Distribution COverheads

vii) Sales:
Cost of Sales (+) Profit or Loss

Summary List
Following is the Summary List of various items of cost included in the major group of cost
and the synonymous terms used for the same in the simplified preparation of a Cost Sheet,
Tender, Quotation and Estimates.
(DM) Direct Materials :

Viz. Direct Materials Cost, Prime Cost Materials, Cost of Materials Consumed, Process
Materials, Cost of Materials Purchased, Operating Materials, Value of Raw Materials
Used, Basic Materials, Productive Materials Cost.
eg. Opening Stock of Raw Materials
Add: Purchases of Materials
Add: Primary Packing Charges
Add: Expenses for Purchases of Raw Materials, e-g. Carriage Inward, Freight Inward, Carriage
and Cartage, Octroi Duty and Customs, Excise Duty, Dock Charges, Clearing Charges,
Forwarding Charges, Loading and Unloading, Transportation Charges etc.
Less: Closing Stock of Raw Materials
Less: Sale of Scrap or Defectives of Raw Materials
Less: Returns Outward or Purchases Returns or Returns to Suppliers or Defective Materials
Returned to Creditors.
(DL Direct Labour:
Viz. Direct Labour Cost, Prime Cost Labour, Direct Wages, Process Labour, Operating
Labour, Basic Labour, Productive Labour.
eg. Productive Wages, Wages paid to direct Workers, Outstanding Wages etc.
(DE) Direct Expenses:
Viz. Chargeable Expenses, Prime Cost Expenses, Productive Expenses, Basic Expenses.
e.g. Royalty, Hire of Special Plant, Cost of Patterns, Layout, Designs or Drawings,
Architects Fees, Engineers Fees, Surveyors Fees, Licence Fees, Outstanding Direct
Expenses etc.
Basics of Cost Accounting 2.28 Elements of Cost and Cost Sheet

(PC) Prime Cost:

viz. Direct Cost, Basic Cost, Operating Cost, First Cost, Productive Cost, Flat Cost.
(F) Factory Overheads:
viz. Works on Cost, Manufacturing Expenses, Factory Burden.
e.g. Indirect Materials, Factory Lighting Expense, Materials, Motive Power, On Cost
Materials, Factory Rent, Rates, Taxes and Insurance, Indirect Labour, Property Tax on
Factory Premises, On Cost Wages, Electric Power, Indirect Expenses, Rent of Raw
Material Stores, On Cost Expenses, Workshop Rent, Heating and Lighting, Coal and
Coke, Steam, Gas and Water, Power and Fuel, Wages to Indirect Labourers i.e. Shop
Floor Helpers, Supervisors, Cleaners, Oilers etc. Remunerations to Watch and Ward Staff,
Instructors, Factory Clerical Staff, Works Manager, Production Engineer, etc., Technical
Directors Fees, Labour Welfare and Amenities to Production Staff, Expenses on Workers
Canteen, Entertainment Room, Creches etc., Consumable Stores, Cotton, Oil and Wastes,
Haulage, Lubricants, Expenses of Testing Labs., Laboratory Expenses, Drawing Office
Salaries, Repairs, Maintenance, Renewals and Depreciation on Plant and Machinery,
Tools and Equipments, Fixtures and Patterns, Factory Buildings etc. Cost of Factory
Supervision, General Works Overheads, Sundry Factory Expenses, Other Manufacturing
on Cost, Factory Cleaning Charges, Storekeeping Expenses, Upkeep of Raw Materials
Stores, Time-keeping Expenses, Time Oftice Expenses, Normal Wastage and spoilage,
Miscellaneous Production Expernses, Works Stationery, ldle Time Wages, Subscription of
Technical Journals and Magazines, Works Office Expenses, Internal Transport, Materials
Handling Charges, Unproductive Wages, Wages and Salaries, Power and Lighting etc.
(FC) Factory Cost:
Viz. Works Cost, Manufacturing Cost, Production Cost.
(O) Office Overheads:
Viz. Administration Expenses, Management on Cost, Establishment Overheads.
e.g. Indirect Materials, Indirect Labour and Indirect Expenses of Administrative Office,
Office Rent, Rates, Taxes, Insurance, Lighting Expenses, Petrol and Maintenance on
Vehicles etc. Property Tax on Office Premises, Office Salaries, Salaries and Wages,
Directors Fees, General Managers Salaries and Allowances, Counting House Salaries,
Directors Travelling Expenses, General Ottice Overheads, Electric Lighting, Electricity
and Lighting Charges, General on Cost, Sundry Expenses, Other Adminstrative Charges,
Miscellaneous Otfice Expenses, Expenses of Management, Branch Office Expenses, Oftice
Cleaning Charges, Repairs, Maintenance, Renewals and Depreciation on Office Furniture,
Office Buildings, Office Equipments, Ofifice Appliances, etc. Renovation of
Administrative Office, Lighting and Power, Salaries and Wages, Printing and Stationery,
Postage and Telegrams, Telephone Charges, Legal Fees, Audit Fees, Accountancy
Charges, Office Conveyance, General Fees, Air-conditioning to Administrative Office,
Office Supplies and Expenses, Bank Charges, General Establishment Charges, Office
Lighting, Subscription of Trade Journals, Public Relation Expenses, Petrol and
Maintenance of Office Vehicles etc.
Basics of Cost Accounting 2.29 Elements of Cost and Cost Sheet

(COP) Cost of Production:

Viz. Gross Cost, Office Cost.
(S) Selling and Distribution Overheads:
viz. Selling Expenses, Distribution on Cost, Marketing Overlheads.
e.g. Indirect Materials, Indirect Labour and Indirect Expenses of Sales Office, Salaries and
Allowances to Sales Manager, Marketing Executive, Publicity Officer, Travelling
Salesmen, Sales Oftice Statt, etc.; Travelling Salesmen Salaries and Commission, Selling
Agents Salaries and Commission, Carriage on Sales, Commission on Sales, Travelling
Expenses, Carriage and Cartage Outward, Freight Outward, Loading and Unloading of
Finished Goods, Kecurring Expenses of Delivery Varns, Show-room Expenses, Sales
Branches and Sales Depat Expenses, Packing Charges, Secondary Packing Charges,
Advertisement, Publicity Charges, Cost of Specíal Advertisement, After Sales Service
Expenses, Distribution of Free Samples and Gifts, Diaries and Calendars, Gift Articles
and Folders, etc, Bad Debts, Debts Collection Charges, Cash Discount Allowed,
Catalogue Expenses, Tendering Expenses, Repairs, Maintenance, Renewals and
Depreciation on Delivery Vans, Sales Depats, Show-rooms, Sales Premises etc., Delivery
Van Running Expenses, Upkeep of Delivery Vans, Warehouse Expenses, Sales Promotion
Expenses, Rent, Rates, Taxes, Insurance and Lighting of Sales Oftice, Selling on Cost,
Warehouse Labour Charges, Other Expenses tor Handling of Finished Goods in Stores,
Sales Printing and Stationery, Market Research Expenses, Estimating Expenses,
Demonstration Expenses, Loading8 and Unloading of Finished Goods, Price List,
Catalogue, Banners, Hand Bills, Posters, etc. Export Duty, Drivers, Conductors, Cleaners
Salaries and Wages, Cost of Mailing Literature, Sales Promotion Expenses etc.
(TC) Total Cost:
Viz. Cost of Sales, Cost Price, Cost of Turnover, Sales Cost, Turnover Cost, Net Cost.
(P) Profit:
Viz. Net Margin
(L) Loss

(S) Sales:
Viz. Selling Price, Value of Sales, Market Price, Value of Turnover, Invoice Price, Inflated
Price, Loaded Price.
(NCD Non Cost Items
Viz. Items to be excluded from Cost.

1) Financial Incomes
Capital Profits, Dividend Received, Brokerage and Commission Received, Share
Transfer Fees Received, Interest on Investments, Interest on Bank Deposits, Rent
Received, Bad Debts Recovery, Interest on Loan given, Discount Received etc.
Basics of Cost Accounting 2.30 Elements of Cost and Cost Sheet

2) Financial Charges:
Capital Losses, Cash Discount, Trade Discount, Penalties and Fines, Share Transfer
Fees Paid, Interest on Bank Loan, Interest on Debentures, Preliminary Expenses,
Underwriting Commission, Discount on Issue of Shares and Debentures, Loss on
Investments, Capital Expenses, Interest on Capitals, Salary or Commission paid to
Partners, Income Tax, Wealth Tax, Interest on Debentures, Reconstruction
Expenses, Development Expenses, Reorganisation Expenses etc.
3) Appropriations:
Bad Debts Reserve, Dividends Paid, Charitable Donations, Transfer to Reserves,
Sinking Fund, Debenture Redemption Fund, Machinery Replacement Fund,
Investment Fluctuation Fund, etc.
4) Abnormals
Abnormal Wastage, Abnormal Idle Time, Loss by fire, Loss by Theft, Loss of Stock,
etc.

EXAMPLE
Prepare a Statement of Cost from the following information relating to Mumbai Traders,
Mumbai for the year ended 31* March, 2019.

Cost of Direct Materials 2,00,000

Sales 4,00,000
Direct Wages 1,00,000
Office Indirect Materials 5,000
Cost of special patterns 40,000
Postage and Telegrams 2,000
Factory Rent and Insurance 5,000
Outstanding Chargeable Expenses 2,000
Carriage Outward 2,500
Interest on Loan 2,150
Printing and Stationery 500
Factory Indirect wages 3,000
Selling on cost 4,000
Travelling Salesman's salary 4,000
Factory Indirect Material 1,000
Royalties 8,000
General Works Overheads 2,000
Bad Debts written-off 1,000
Also calculate the percentage of profits earned to sales.
Basics of Cost Accounting 2.31 Elements of Cost and Cost Sheet

ANSWER
In the books of Mumbai Traders, Mumbai
Statement of Cost for the year ended 31st March, 2019
Particulars Amount Amount

Cost of Direct Materials 2,00,000

Add: Direct Wages (+)1,00,000
Add: Direct Expenses :
Cost of Special Patterns 40,000
11) Outstanding Chargeable Expenses 2,000
ii) Royalties (+) 8,000
PRIME COST a)3,50,000 3,50,000
Add: Factory Expenses
1) Factory Rent and Insurance 5,000
ii) Factory Indirect Wages 3,000
ii) Factory Indirect Material 1,000
iv) General Works Overheads (+ 2,000
FACTORY COST 3,61,000 3,61,000
Add: Office Expenses
i) Office Indirect Materials 5,000
Postage and Telegrams 2,000
ii) Printing and Stationery (+) 500
CoST OF PRODUCTION 3,68,500 3,68,500
Add: Selling and Distribution Expenses:
) Carriage Outward 2,500
i) Selling on Cost 4,000
111) Travelling Salesman's Salary 4,000
iv) Bad Debts written-off (+ 1,000
TOTAL CoST d 3,80,000 3,80,000
Add: PROFIT FOR THE YEAR e)(+)20,000 20,000
4,00,000 4,00,000
LWorking Sales
Notes :

i) Calculation of percentage of Profits earned to Sales :

For 4,00,000 Sales 20,000 Profits
100 =?
100 X K 2U0
4,00,0000
5o

ii) Interest on Loan is an item of financial nature hence it should be excluded from cost.
 Elements of Cost and Cost Sheet
Basics of Cost Accounting 2.32
ILLUSTRATIONS
ILLUSTRATION 1
Voltas Industries, Vikroli has supplied you the following yearly cost-information for 2018-19
from which prepare Simple Cost Sheet showing a) Cost of Raw Materials consumed, b) Prime
Cost, c) Works Cost, d) Cost of Production, e) Total Cost and f Selling Price to earn a profit of
25% on cost of salees.

Productive Wages 4,500

Ol and otton Waste
Stock of Raw Materials as on 31st March, 2019 25,000
Wages of Security Guards of Storehouse 1,500
Bad Debs Provisions 7,500
Carriage on Purchases 5,000
Workshop Rent +,000
Rent and Taxes 500
Machinery Repairs 1,000
Stock of Raw Materials as on 31st March, 2018 70,000
Motive Power 3,000
Purchases of Raw Materials 35,000
Office Equipments Kepaits 2,000
Sales Promotion EXpenses 2,000
3,000
nargeabe Expenses
5ad Debts Kecovery
LDirect Wages Fayable 500
Electricity Charges 2,000
Managers Salary 12,000
Carriage on Sales 6,500
Allocate manager's salary among administrative office, factory office and sales otfice in the
ratio of 3 :7:2 respectively.
SOLUTIONN In the books of Voltas Industries, Vikroli
Statement of Cost for the year ended 31st March, 20199
Particulars Amount Amount
Or Kaw Materials as on 1s April, 2018 7
OC
A
Add: urcasesa
Carriage on rurcnases
ateriais
(+) 5.000
1,10,000
|Less: Stock of Raw Materials as on 31st March, 2019 "5000
COST OF RAW MATERIALS CONSUMED 85,000 85,000
Add Productive Wages 14,500
Add: Direct Wages P'ayable S00
Add: Chargeable ExpensesS +) 3,000
PRIME CoST b 1,03,000 1,03,000
Add: Works Overheads:
Oil and Cotton Waste 1,500
ii) Wages of Security Guards of Storehouse 1,500
11) Workshop Rent 4,000
Machinery Repairs 1,000
Motive Power 3,000
vi Manager's Salary- Factory Office (7/12 x 12,000) (4)| 7,000
Basics of Cost Accounting 2.33 Elements of Cost and Cost Sheet

Particulars Amount Amount

WORKS CoST c)1,21,O00 1,21,000 |

Add: Office Overheads

) Rent and Taxes 1,500
ii) Office Equipments Repairs 2,000
Electricity Charges 2,000
Manager's Salary Administrative Office (3/12 xR 12,000)
- (+) 3,000
CoST OF PRDOUCTION d) 1,29,500 1,29,500
Add: Selling and Distribution Overheads:
i) Sales Promotion Expenses 2,000
Manager's Salary Sales Office (2/12 xR 12,000)
-
2,000
ii) Carriage on Sales 6,500
TOTAL COST e1,40,000 1,40,000
Add: Profit (25% on Cost of Sales ie. Total Cost) 35,000
SELLING PRICE 1,75,000 1,75,000
Working Notes:
i) Non-Cost Items:
Bad Debts Provision, Bad Debts Recovery etc. are the items of financial nature, hence they
should be excluded from cost.
LLUSTRATION 2
From the following particulars relating to M/s Chandmal Bros., Chinchwad, prepare a Cost
Sheet showing a) Prime Cost, b) Factory Cost, c) Cost of Production, d) Cost of Sales, e) Profit /
Loss for the period for six months ended 31st March, 2019.

Cost of Materials Consumed 40,000

Oil and Waste 100
Operating Labour 9000
Wages of Foreman O00
Direct Expenses 2,000
Store Keepers Wages 500
Sales 1,00,000
Commission paid to the partner, Chandmal 350
Electric Power 200
Salary paid to the partner, Rajmal 650
Consumable Stores 1,000
Direct Wages payabie O00
Lighting
actory 00
11 Ofice
Carriage Outward 150
Rent
Office ,O00
11) Factory 2,000
Warehouse Charges 200
Repairs and Renewals:
1) Factory Plant 500
i) Machinery ,000
Basics of Cost
Accounting 2.34 Elements of Cost and Cost Sheet

111 Office Premises 00

iv) Warehouse IU0
Advertising 400
Depreciation:
i) Office Premises
ii) Machinery 200
Travelling Expenses 200
Office Manager's salary 2,250
Salesmen's Commission and Salaries 500
Director's Fees
Printing and Stationery U0
Telephone Charges
Postage 00
Bad Debts 450
SOLUTION
In the books of Chandmal Bros. Chinchwad
Cost-Sheet for the six months ended 31st March, 2019
Particulars Amount Amount
Cost of Materials Consumed 40,000
Add: Direct Labour:
Operating Labour 9,000
Direct Wages payable 1,000
Add: Direct expenses (+) 2,000
PRIME CoST a) 52,000 52,000
Add: Factory Expenses
Oil and Waste 100
i) Wages of Foreman 1,000
Store keepers Wages 500
Electric Power 200
Consumable Stores 1,000
vi) Factory Lighting 500
vii) Factory Rent 2,000
vii) Repairs and Renewals- Factory Plant 500
ix) Repairs and Renewals - Machinery
Depreciation Machinery -

FACTORY COST p) 59,000 59,000

Add: Office Expenses:
200
i1) Office Lighting
Office keent 1,000
ii) Repairs and Renewals Office Premises
- 200
Depreciation -Office Premises U0

v) Ofice Manager's Salary 2,250

Director s Fees 500
i) Printing and Stationeryy 200
Vii) Telephone charges 50
IX) Postage 100
Basics of Cost Accounting 2.35 Elements of Cost and Cost Sheet

COST OF PRODUCTION c)64,000 64,000

Add: Selling and Distribution Expenses:
1) Carriage Outward 150
ii) Warehouse charges 200
ii) Repairs and Renewals Warehouse 100
iv) Advertisins 400
v) Travelling Expenses 200
vi) Salesmen's Commission and Salaries 500
vii) Bad Debts (+) 450
CoST OF SALES d) 66,000 66,000
Add: PROFIT FOR THE PERIOD e) (+ 4,000 34,000
Sales 1,00,000 1,00,000
Working Notes:
Commission paid to the partner Chandmal and salary paid to the partner Rajmal, are
the items of financial nature, hence they should be excluded from cost.
LLUSTRATION3
The expenditure incurred in the manufacturing and selling of product '* for the three
months ended 31* March, 2019 is as given below:

Direct Material cost 30,000

Engineers Fees 1,000
Power and Fuel 7,000
Wages Payable 2,000
Office Salary 5,000
Trade Discount 500
Chargeable Expenses 4,000
Haulage 3,000
General on Cost 1,000
Catalogue Expenses 1,500
Process and Operating Wages 13,000
Time-keeping Expenses 2,000
Electricity Charges 2,000
Donations for Poor Boy's Fund 1,000
Tendering Expenses 1,000
Commission on Sales 2,500
Tons manufactured and sold, 1000
Prepare a Cost-Sheet of Modern Manufacturers, Malad showing the cost for each element,
the total cost per ton and the profits if the sales are made at ? 100 per ton.
Basics of Cost Accounting 2.36 Elements of Cost and Cost Sheet

SOLUTIONN In the books of Modem Manufacturers, Malad

Cost-Sheet for Product X for the three months ended 31t March, 2019
Units Produced - 1000 Tons
Units Sold -
1000Tons
Particulars Amount Total Cost Per Ton

Direct Material Cost U,000 30

Add: Direct Labour:
i Process and Operating Wages 13,000
i) Wages Payable 2,000 15,000 15

Add: Direct Expenses

i)EngineersFees 1,000
ii) Chargeable Expenses (+) 4,000 5,000
(+)
PRIME COST 50,000 50
Add: Factory Expenses :

i) Power and Fuel 7,000

ii) Haulage 3,000
iii) Time-keeping Expenses (+)2,000 12,000 12
(+)

FACTORY COST b) 62,000 52

Add: Office Expenses:

i) Office Salary 5,000
ii) General Cost 1,000
ii) Electricity Charges (+) 2,000 8,000

(+
CoST OF PRODUCTION 70000 /0

Add: Selling and Distribution Expenses :

i) Catalogue Expenses 1,500

ii) Tendering Expenses 1,000
ii) Commission on Sales 2,500 5,000
+)

TOTAL COST 75,000

Add: PROFITS e)
(+ 25,000 25

SALES:(1,000 tons x 100) | 1,00,000

Working Notes:
i) Trade Discount and Donations for Poor Boy's Fund are the items of financial nature,
hence they should be excluded from cost.
Basics of Cost Accounting 2.37 Elementsof Cost and Cost Sheet

LLUSTRATION 4

The following is the Trading and Profit Loss Account of Sarabhai Chemicals Ltd. Sion for the
year ended 31st March, 2019.
Particulars Particulars
To Opening Stock of Raw 18,000 By Sales 5,10,000
Materials
To Purchases of Raw 2,52,000 Less: Returns Inward ( 10,000 5,00,000
Materials
Less: Returns Outward 2.000 2,50,000 By Closing Stock of Raw 10,000
Materials
To Direct Wages 1,02,000 By Sale of Scrap of Raw 1,000
To Carriage 25,000 Materials
To Royalty 7,200
1o Gas and Water 19,000
To Custom Charges 8,000
To Wages Payable 8,000
To Chargeable Expenses
Outstanding 2,800
To Heating and Lighting 11,000

To Gross Profit C/D 60,000

5,11,000 5,11,000
To Carriage 5,000 By Gross Profit B/D 60,000
To Preliminary Expenses 5,500 By Discount Received 10,000
To Underwritting Commission ,500 By Interest on Investment 12,000
To Commission on Sales 7,600 | By Commission 8,000
To Sales Depot Expenses 2,400
To Discount on lssue of Shares 6,000
To Salaries 16,000
To Bad Debts Provision 1,000
To Property Tax on Office Buildings 2,000
To Income Tax 5,000
To Depreciation on Office Furniture 2,000
To Donations 4,000
To Net Profit C/D 29,000
90,000 90,000
You are required to prepare a Cost Statement for the year ended 31st March, 2019 showing
a) Cost of materials consumed
b) Prime Cost
c)Works Cost
d) Cost of Production
e) Total Cost
)Profits for the year
Also calculate the percentage of profit on sales.
Basics of Cost Accounting .38 Elements of Cost and Cost Sheet

SOLUTION
In the books of Sarabhai Chemicals Ltd.; Sion
Cost-Statement for the year ended 31s* March, 2019
Particulars Amount Amount

Opening Stock of Raw Materials 18,000

Add: Purchases of Raw Materials 2,52,0
Add: Expenses for Purchases: 33,000
i) Carriage 25,000
i) Custom ChargesS +) 8,000
(+)3,03,000
Less: Closing Stock of Raw Materials 10,000
Less Sale of Scrap of Raw Materials 1,000
Less: Returns Outward 2,000

CoST OF MATERIALS CONSUMED a) 2,90,000 2,90,000

Add: Direct Labour:
i) Direct Wages 1,02,000
ii) Wages Payable (+) 8,000 1,10,000
Add: Direct expenses:
i) Royalty ,200
ii) Chargeable Expenses Outstanding (+) 2,800 10,000
PRIME COST b)4,10,000 4,10,000
Add: Factory Expenses:
Gas and Water 19,000
i) Heating and Lighting +) 11,000 30,000
wORKS CoST 4,40,000 4,40,000
Add: Office Expenses:
i)Salaries 16,000
i) Property Tax on Office Buildings 2,000
11) Depreciation on Office Furniture 2,000 20,000
CoST OF PRODUCTION d 4,60,000 4,60,000
Add: Selling and Distribution Expenses
Carriage 5,000
Commission on Sales
ii) 7,600
ii) Sales Depot Expenses () 2,400 15,000

TOTAL COST e 4,75,000 4,75,000

Add: PROFITS FOR THE YEAR (+) D| 25,000 25,000
Sales 5,00,000 5,00,000
Basics of Cost Accounting 2.39 Elements of Cost and Cost Sheet

Working Notes:
i) Calculation of percentage of protit on sales.
If5,00,000 sales 25,000 Profit
100 = ?

100 x 25,000
5o
5,00,000
i) Preliminary Expenses, Underwriting Commission, Discount on issue of Shares, Bad debts
provision, Income Tax, Donations given, Discount received, Interest on Investment, Commission
received etc. are the items of financial nature, hence they should be excluded from cost.

LLUSTRATION 5

The cost of turnover of a particular product is made up of the following cost as on

31st March, 2019.

Loading and Unloading on Materials Purchased 950

Productive Wages Payable 900
Materials used in Factory 2,100
Sale of Scrap- Raw Materials 750
Salary to Watch and Ward Staff ,100
Materials Used in Office 600
Godown Rent ,500
Materials Used in manufacturing-Direct 55,750
abour required for Factory Supervision ,800
Cost of Special Drawings 3,300
Expenses of Management 1,200
Materials Used in selling and distribution 1,500
Freight Inward 4,050
Delivery Van Running Expenses 1,000
Hire of Plant 1,700
Labour required in production-Direct 9,100
Office Supplies and Expenses 2,200
Materials Used in Primary Packing 10,000
Assuming that all goods manutactured are sold, what should be the selling price to obtain a
protit ot 20% on value of turnover?
Prepare a Cost-Sheet of Super Ltd., Saswad showing:
a) Direct Material Cost
b) Prime Cost
c)Factory Cost
d) Cost of Production
e) Cost of Turnover
Selling Price
Basicsof Cost Accounting 2.40 Elements of Cost and Cost Sheet

SOLUTIONN
In the books of Super Ltd., Saswad
Cost-Sheet for the year ended 31* March, 2019
Particulars Amount Amount

Materials Used in Manufacturing-Direct 55,750

Add: Materials Used in Primary Packing (+ 10,000
Add: Expenses on purchases of materials:
i) Loading and Unloading 50
in) Freight Inward (+)4,050_
70,750
Less: Sale of Scrap-Raw Materials L 750
DIRECT MATERIAL COST a) 70,000 70,000
|Add: Direct Labour
1)Labour required in Production - Direct (+) 9,100
i) Productive Wages payable (+) 900 10,000
Add: Direct Expenses:
i) Cost of Special Drawings 3,300
ii) Hire of Plant (+) 1,700 5,000
PRIME COST b)85,000 85,000
Add: Factory Overheads :
i) Materials Used in Factory 2,100
ii) Salary to Watch and Ward Staff 1,100
ii) Labour required for factory supervision +) 1,800
FACTORY coST c 90,000 90,000
Add: Office Overheads:
i) Materials Used in Office 600
i) Expenses of Management I,200
ii) Office Supplies and Expenses +) 2,200
COST OF PRODUCTION d)94,000 94,000
Add: Selling and Distribution Overheads:
i)GodownRent 3,500
i) Material Used in Selling and Distribution 1,500
) Delivery Van Running Expenses (+)1,000
coST OF TURNOVER e) 1,00,000 1,00,000
Add: Profits (+)25,000 25,000
(20% on Value of Turnover)
SELLING PRICE 1,25,000 1,25,000
Basics of Cost Accounting 2.41 Elements of Cost and Cost Sheet

Working Notes:
i) Calculation of profit i.e. 20% on value of turnover.
SP= CP+P
i.e. Value of Turnover 100 = S0 +20
If 80 CP== 20 P
R1,00,000 C.P. ?

1,00,00O X 20
80
=25,000
ILLUSTRATION 6
The following data have been extracted from the books of M/s Sunshine Industries Ltd.,
Sholapur tor the calendar year 2019.

Opening Stock of Process Materials 25,000

Wages- Direct 70,000
Rent and Taxes 5,500
(Factory 10/11, Office-1/11)
Freight on Purchases of Raw Materials 5,000
Indirect Materials 500
Sales Promotion Charges 2,000
Purchases of Raw Materials 85,000
Interest on Debentures 5,200
Depreciation:
i) Plant and Machinery 1,500
ii) Office Equipments 1,000
Closing Stock of Process Materials 35,000
Wages - Indirect 10,000
Cost of Designs and Drawings 12,000
Salaries :

i) Office Staff 2,500

i) Travelling Salesmen 2,000
Productive Expenses 3,000
Defective Materials returned - Process Material 5,000
Other Works on Cost 5,700
Office Overheads 4,900
Manager's Remuneration:
i) Works 2,300
Office 6,100
Productive Wages due but not paid 5000
Irrecoverable Debts 1,000
Sales 2,50,000
Debt Collection Charges I,100
Aavance payment ot income 1ax 20,000
Selling on Cost 3,900
Prepare a Statement of Cost, showing profits earned during the year 2019.
Basicsof Cost Accounting 242 Elements of Cost and Cost Sheet

SOLUTIONN
In the books of M/s Sunshine Industries Ltd. Sholapur
Statement of Cost for the calendar year 2019
Particulars Amount Amount
Opening Stock of Process Materials 25,000
Add: Purchases of Raw Materials 85,000
Add: Freight on Purchases of Raw Materials 5,000
1,15,000
Less: Closing Stock of Process Materials
1O00
Less: Detective Material returned - Process Materials 5,000
COST OF MATERIALS CONSUMED 75,000 75,000
Add: Direct Labour:
Wages Direct 70,000
i -

ii) Productive Wages due but not paid 5,000

Add: Direct Expenses:
i)Cost of Designs and Drawings 12,000
ii)Productive Expenses (+) 3,000
PRIME COST b)1,65,000 1,65,000
Add: Factory Expenses:
i) Rent and Taxes - Factory (/11x 55,00) 5,000
ii) Indirect Materials 500
1) Depreciation on Plant and Machinery 1,500
iv) Wages- Indirect 10,000
v) Other Works on Cost 5,700
vi) Works Managers Remuneration *) 2,300
WORKS COST C) 1,90,000 1,90,000
Add: Office Expenses:
i) Rent and Taxes- Office (/11 x7 5,500) 500
i) Depreciation on Office Equipments
iii) Salaries Office staft
-
00
2,500
Iv) Office Overheads 4,900
VOffice Managers Kemuneration (+) 100
COST OF PRODUCTION a) 2,05,000 2,05,000
Add: Seling and Distribution Expenses:
i) Sales Promotion Charges 2,000
1) Salaries - Iravelling Salesmen 2,000
ii) Irrecoverable Debts 1,000
iv) Debts Collection Charges 1,100
VSelling on Cost (+) | 3,900
TOTAL cOST e) 2,15,000 2,15,000
Add: PROFITS EARNED () 35,000 35,000
Sales 2,50,000 2,50,000
Working Notes:
1) Interest on Debentures, Advance payment of Income-Tax etc. are the items of financial nature,
hence they should be excluded from cost
Basics of Cost Accounting 2.43 Elements of Cost and Cost Sheet

ILLUSTRATION 7
The accounts of Dorabjee Manufacturers, Deolali for the year ended 31t March, 2019 show
the following.

Stock of Raw Materials as on

Bad Debts written-off
Raw Materials Purchased
1st April, 2018
,
67,200
IO0
2,59,000
Motive Power 20

Traveler's Commission 10,780

Depreciation on Office equipments
Carriage Inwards 720
Interest on Bank Loarn 80
Factory Taxes 11,900
Productive Wages 1,76,40
Directors Travelling Expenses 8,40

Coal and Coke 6U

General Overheads
Gas and Water -
Factory 680

Packing charges 40
Sales of Finished Goods 6,00,000
Manager's Salary 15,000
(Factory -4/3, Office- /3)
Delivery Van Expenses 4,060
Depreciation on Factory Buildings 18,200
Publicity Charges 000
Repairs to Plant 6,340
Carriage Outward 7,120
Hire Charges of Special Machinery 9,010
Office Rent 2,800
Surveyor's Fees 590
Legal Charges 20
Stock of Raw Materials as on 31st March, 2019 87,920
Prepare a Cost-Statement giving the following details for the year ended 31* March, 2019.
a) Cost of Material Consumed
b) Prime Cost
c)Works Cost
d) Cost of Production
e)Total Cost
f) Net Profit for the year.
Basics of Cost Accounting
2.44 Elements of Cost and Cost Sheet

SOLUTION
In the books of Dorabjee Manufacturers, Deolali
Cost-Statement for the year ended 31st March, 2019
Particulars Amount Amount
Stock of Raw Materials as on 1st April, 2018 6/,200
|Add: Raw Materials Purchased 2,59,0D00
Add: Carriage Inward
3,26,920
Less: Stock of Raw Materials as on 31st March, 2019 87920
COST OF MATERIALS CONSUMED a)2,39,O00 2,39,000
Add: Productive Wages (+)| 1,76400
Add: Direct Expenses
i) Hire Charges of Special Machinery 9,010
i) Surveyor's Fees 590
PRIME COST b)| 4,25,000 4,25,000|
Add: Factory expenses:
1) rower
Motive 520
ii) Factory laxes 11,900
111) Coal and Coke
iV)Gas Water -Factory
and 1,680
v)Manager's Salary Factory (/3 x 15,000) 10,000
vi Depreciation on Factory Buildings 18,200
vii) Repairs to Plant +) 6,340
WORKS CoST c4,74,000 4,74,000
Add Office Expenses:
i)Depreciation on Office Equipments 420
ii) Director's Travelling Expenses 8,400
ii) General Overheads 4,760
iv) Manager's Salary Office (/3x 15,000) 5,000
v) Office Rent 2,800
vi) Legal Charges
coST OF PRODUCTION d) 4,96,000 4,96,000
Add: Selling and Distribution Expenses:
i) Bad Debts written-off 9,100
i) Traveler's Commission 10,780
ii) Packing Charges 940
iv) Delivery Van Expenses 4,060
v) Publicity Charges 2,000
v1) Carriage Outward 7,120
TOTAL COST e5,30,000 5,30,000
Add: NET PROFIT FOR THE YEAR (+) D |70,000 70,000
Sales of Finished Goods 6,00,000 6,00,000
Working Notes:
1)interest on Bank Loan is an item of financial nature, hence it should be excluded from Cost.
Basics of Cost Accounting 2.45 Elements of Cost and Cost Sheet

LLUSTRATION S

Following details have been obtained from the cost records of Colgate Ltd., Kolkata for the
year ended 31st March, 2019.

Stock of Operating Materials as on 1t April, 2018 30,000

Wages paid to Direct Workers 55,000
Interim Dividend paid 2,000
Purchases of Raw Materials 87,000
Heating and Lighting 6,000

Counting House Salaries 20,000

Carriage and Cartage on Purchases of Raw Materials 3,000

Commission on Sales 5,000

Wages Payable 5,000

Technical Director's Fees 10,000

Stock of Operating Material as on 31t March, 2019 40,000
Show-Room Expenses 7,000
Establishment on Cost 12,000
Share Transfer Fees 2,000

Expenses of Testing Labs 4,000

Branch Office Expenses 8,000
After-Sales service Expenses 8,000
Selling Price 2,50,000
Prepare a Cost-Sheet showing:
a) Cost of Raw Materials Consumed
b) Prime Cost
c)Works Cost
d) Cost of Production
e)Total Cost
Profit or Loss
Also calculate the percentage ot
Factory Overheads to Direct wages
Office on-Cost to Works Clost
i) Selling and Distribution Expenses to Cost of Production.
Basicsof Cost Accounting 2.46 Elements of Cost and Cost Sheet

SOLUTION
In the books of Colgate Ltd., Kolkata
Cost-Sheet for the year ended 31st March, 2019
Particulars Amount Amount
Stock of Operating Material as on 1st April, 2018 30,000
Add: Purchases of Raw Materials 87,000
Add: Carriage and Cartage 3,000
1,20,000
Less: Stock of Operating Material as on 31st March, 2019 40,000
COST OF RAW MATERIALS CONSUMED a) 80,000 80,000
Add: Direct Labour:
i) Wages paid to Direct Workers 55,000
i) Wages Payable (+)5,000 60,000
(+
PRIME COST b)1,40,000 1,40000
Add: Factory Expenses:
i) Heating and Lighting 6,000
i) Technical Director's Fees 10,000|
ii) Expenses of Testing Labs +) 4,000 20,000
(+
wORKS CoST c1,60,000 1,60,000
Add: Office Expenses:
1) Counting House Salaries 20,000
11) Establishment on Cost 12,000
ii) Branch Oftice Expenses (+) 8.000 40,000
(+)
COST OF PRODUCTION d) 2,00,000 2,00,000
Add: Selling and Distribution Expenses :

i) Commission on Sales 5,000

i) Show Room Expenses 7,000
ii) After Sales-Service Expenses +) 8,000 20,000
(+)
TOTAL CoST e)2,20,000 2,20,000
Add: PROFIT (+) 30,000 30,000
Selling Price 2,50,000 2,50,000
Working Notes:
i) Calculation of percentage of factory overheads to direct wages.
IfR 60,000 D.W. = R20,000 F.O.
2
100 =

100 xR 20,000
60,000
33. .33%
Basics of Cost Accounting 2.47 Elements of Cost and Cost Sheet

i) Calculation of percentage of Office on Cost to Works Cost.

IfR 1,60,000 W.C. = 40,000 O.0.C.
100
100 x 40,000
1,60,000
25o
ii) Calculation of percentage of Selling and Distribution expenses to Cost of Production.
If 2,00,000 C.O.P. = R20,000 S. and D.E.
100
100 x 20,000
2,00,000
10%
iv) Interim paid, share transter fees etc. are the items of financial nature, hence
dividend
they should be excluded from Cost
1LLUSTRATION 9
Following intormation of Finolex Ltd., Faizpur relates to a commodity for the year ending
31st March, 2019.

Opening Stock as on 1st April, 2018

i) Raw Materials 5,000
ii) Work-in-Progress 1,200
ii) Finished Goods (1,000 Tons) 4,000
Closing Stock as on 31st March, 2019
i) Raw Materials 3,000
ii) Work-in-Progress 3,200
ii) Finished Goods (2,000 Tons) 9,000
Purchases of Raw Materials 35,000
Prime Cost Labour 25,000
Excise Duty on purchases of Raw Materials 2,000
Administration Overheads 8,000
Cost of Factory Supervision 12,000
Income Tax 5,000
Carriage and Cartage 1,000
Management Expenses 1,000
Accountancy Charges ,000
Preliminary Expenses 3,200
Sales of Finished Goods 1,17,500
Advertising, Bad Debts and Selling on Cost amounted to 50 paise per ton sold. 16,000 tons of
commodities were produced during the year 2018-2019.
Prepare a Cost-Sheet showing
a) Cost of Materials Consumed, b) Prime Cost, c) Works Cost, d) Cost of Production, e) Cost
of Goods Sold, ) Cost of Sales, g) Profits for the period, h) Profits per ton of commodity sold.
Basics of Cost Accounting 2.48 Elementsof Cost and Cost Sheet

SOLUTION
In the books of Finolex Ltd., Faizpur
Cost-Sheet for the year ended 31s* March, 2019
Units Produced 16,000 Tons
Units Sold 15,000 Tons
Particulars Amount Amount
Opening Stock as onApril, 2018 Raw Materials
1st ,000
Add: Purchases of Raw Materials 35,000
Add: Expenses for purchases of Raw Materials
i) Excise Duty 2,000
ii) Carriage and Cartage (+) 1,000
43,000
Less: Closing Stock as on 31s March, 2019 Raw Materials 3,000
COST OF MATERIALS CONSUMED a) 40,000 40,000
Add: Prime Cost Labour (+)25,000
PRIME CoST b)| 65,000 65,000
Add: Cost of Factory Supervision 2 000
Add: Opening Stock as on 1st April, 2018 Work-in-Progress +) 1,200
78,200
Less: Closing Stock as on 31st March, 2019 Work-in-Progress 3,200
WORKS coST C) 75,000 5 ,000
Add: Office Expenses:
i) Administration Overheads 8,000
ii) Management Expenses 1,000
ii) Accountancy Charges +) 1,000
cOST OF PRODUCTION 85,000 85,000
Add: Opening Stock as on 1st April, 2018 Finished Goods (+)
000
89,000
Less: Closing Stock as on 31st March, 2019 Finished Goods (F 9000
COST OF GOODS SOLD 80,000 80,000
Add: Advertising, Bad Debts and Selling on Cost
(50 ps. x 15,000 Tons) (+) 7500
COST OF SALES D87,500 87,500
Add: PROFITS FOR THE PERIOD )930,000
1,17,500
30,000
1,17,500
Sales of Finished Goods |
Working Notes:
i) Calculation of Units Sold during the year 2018-2019
Tons
Opening Stock of Finished Goods as on 1t April, 2018 1,000
Add: Production during the year +) 16,000
17,000
Less : Closing Stock of Finished Goods as on 31st March, 2019 2,000
Units Sold 15,000
Basics of Cost Accounting 2.49 Elements of Cost and Cost
Sheet
ii) Calculation of Profits per ton of commodity sold -

If 15,000 Tons Profit 7 30,000

Ton = ?

Ton x 30,000
15,000 Tons
=2 per Ton
ii) Income Tax, Preliminary Expenses etc. are the items of financial nature, hence they
shouldbe excluded from cost.
ILLUSTRATION 10
The cost accounts of Eagle Ltd. Allahabad for the year ended 31st March, 2019 showed the
following information.
Types of Stock As on 1t April, 2018 As on 31t March, 2019

Raw Materials 65,000 50,000

Work-in-Progress 10,000 7,500

Finished Stock 15,000 5,000

Underwriting Commission 0,000

Purchases of Raw Materials 2,60,000
Selling Overheads 8,000
Drawing Office Salaries 12,000
Productive Labour 1,65,000
Audit Fees 7,000
Establishment on Cost 2,000
Steam, Gas and Water 1,500
Sales 5,50,000
Rent 15,000
(Factory -66 73%, Office -33 /3%)
Architect's Fees 0,000
Wages Outstanding 5,000
Octroi and Duty 5,000
Distribution on Cost 2,000
Prepare a Cost-sheet showing
a) Cost of Materials Consumed, b) Basic Cost, c) Works Cost, d) Cost of production, e) Cost
of Turnover, f) Profits.
Basics of Cost Accounting 2.50 Elements of Cost and Cost Sheet

SOLUTIONN
In the books of Eagle Ltd., Allahabad
Cost-Sheet for the year ended 31st March, 2019
Particulars AmountAmount
Stock as on April, 2018 Raw Materials
1st 65,000
Add: Purchases of Raw Materials 2,60,000
Add: Octroi and Duty (+ 5,000
3,30,000
Less: Stock as on 31st March, 2019 Raw Materials OL50,000
COST OF MATERIALS CONSUMED a)2,80,000 2,80,000
Add: Direct Labour :
i) Productive Labour 1,65,000
i) Wages Outstandings 5,000
Add: Direct Expenses
i) Architect's Fees (+ 10,000
BASIC COST b)4,60,000 4,60,000
Add: Factory Expenses
i) Drawing Office Salaries 12,000
i) Steam, Gas and Water 1,500
ii) Rent- Factory (66 2/3% i.e. 2/3 of R 15,000) 10,000
Add: Stock as on 1t April, 2018 Work-in-Progress (+ 10,000
4,93,500
Less: Stock as on 31st March, 2019 Work-in-Progress L 7500
WORKS CoST 4,86,000 4,86,000
Add: Office Expenses:
i) Audit Fees 7,000
Establishment on Cost
ii) 2,000
ii) Rent-Office (33 /3% i.e. /3 of R 15,000) (+) 5,000
COST OF PRODUCTION d) 5,00,000 5,00,000
Add: Selling and Distribution Expenses:
i) Selling Overheads 8,000
i) Distribution on Cost (+) 2,000
Add: Stock as on 1st April, 2018- Finished Stock +) 15,000
5,25,000
Less: Stock as on 31st March, 2019- Finished Stock 5,000
COST OF TURNOVER e)5,20,000 5,20,000
Add: PROFITS (+) 30,000 30,000
Sales T5,50,000 5,50,000
Working Notes
i) Underwriting Commission is the item of financial nature, hence it should to be excluded
fromcOst.
Basics of Cost Accounting 2.51 Elements of Cost and Cost Sheet

ILLUSTRATION 11
Jindal Manufacturers, Jalgaon furnished the following data relating to the manufacturers of a
standard product during the month of March 2019.

Carriage on Purchases of Basic Materials

Raw Materials Stock as on 31st March, 2019 2,850

Sale of Scrap-Raw Materials 150

Operating Wages Payable 600
Stock of Raw Materials as on 1st March, 2019 1,200
Royalty 1500
Machine Hour Rate 2.50
Purchases of Raw Materials 14,600

Administration Overheads: 10% of Works Cost

Selling and Distribution on Cost:R3.60 per unit
Direct Labour Charges 4,400
Cost of Layout 500
Operation of Machine Hours- 1,600
Monthly Production-1,000 units
Units sold-900 units (@R 40 per unit)
You are required to prepare a Cost-Sheet showing total cost per unit for the month ended
31st March, 2019. Also calculate profit for the month and profit per unit sold.
SOLUTION

Working Notes
i) Calculation of Factory Overheads:
Machine Hours operated Machine Hour Rate
1,600 Hrs. 2.50
-z 4,000
ii) Valuation of Closing Stock of Finished Goods
Units Produced Units Sold Closing Stock of Finished Goods
1,000 100
If 1,000 units = R 26,400

100units =?
100xR26,400
1,000
2,640
Basics of Cost Accounting 2.52 Elements of Cost and Cost
Sheet
SOLUTION
In the books of Jindal Manufacturers, Jalgaon
Cost-Sheet for the month ended 31st March, 2019
Units Produced - 1000 units
Units Sold 900 units
Particulars TotalCostPer Ton
Stock of Raw Materials as on 1st March, 2019 ,200
Add: Purchases of Raw Materials 14,600
Add: Carriage on Purchases of Basic Materials +)
200
16,000
Less: Raw Materials - Stock as on 31s* March, 2019 2,850
Less : Sale of Scrap - Raw Materials 150
CoST OF RAW MATERIALS CONSUMED 13,000 13.00
Add: Direct Labour:
i)Direct Labour Charges 4,400
i) Operating Wages Payable (+) 600 |
5 5.00

Add: Direct Expenses (+)

i) Royalty 1,500
ii) Cost of Layout (+). 500 2,000 2.00
(+)
PRIME COST b)20,000 20.00
Add: Factory Overheads (+)4,000 4.00
WORKS CoST 24,000 24.00
Add: Administration Overheads
(10% of Works Cost i.e. 7 24,000) 2,400 2.40

COST OF PRODUCTION d)26,400 26.40

Add: Opening Stock of Finished goods
Less: Closing Stock of Finished goods 2,640

cOST OF GOODS SOLD e) 23,760

Add: Selling and Distribution on Cost
(900 units x R 3.60) 3,240 3.60
(+)|
COST OF SALES 27,000 30.00
Add: PROFIT (+) 8 9,000 10.00
SALES (900 units x? 40) 36,000 40.00
Basicsof Cost Accounting 2.53 Elements of Cost and Cost Sheet

LLUSTRATION 12
The following information has been obtained from the records of Quality Manufacturing Co.
Ltd., Bharatpur for the year ended 31st March, 2019.
Summary of Stock Position
ypes of Stock As on 1st April, 2018 As on 31st March, 2019

Finished Goods-Stock 50,000 75,000

Raw Materials 20,000 25,000
Stock of Work-in-Progress 5,000 7,000

Other Particulars
Purchases of Raw Materials 1,30,000

Wages Outstanding 3,000

Indirect Material 12,000
Discount on Issue of Debentures 8,000
Freight Inward 15,000

Property Tax on Factory Buildings 8,000

Director's Travelling Expenses 8,000
Carriage on Sales 5,000
Defective Raw Materials returned 5,000
Direct Chargeable Expenses 2,000
Workshop Rent 7,000
Expenses for participating in Industrial Exhibition 3,000
Value of Sales 3,00,000
Office Cleaning Charges 2,000
Sales Promotion Charges 6,000
Miscellaneous Overheads 7,000
Upkeep of Delivery Vans 1,000
Motive Power 5,000
Productive Wages 60,000
Postage and Telegrams 3,000
Prepare a Statement of Cost showing:
a) Value of Raw Materials Consumed, b) Direct Cost, c) Manufacturing Cost, d) Cost of
Production, e) Cost of Goods Sold, Cost of Turnover, g) Profit.
Also calculate the percentage of profit on cost price and on selling price separately.
Basics of Cost Accounting 2.54 Elements of Cost and Cost Sheet

SOLUTION
In the books of Quality Manufacturing Co. Ltd. Bharatpur
Cost Statement for the year ended 31st March, 2019
Particulars Amount Amount
Raw Materials as on 1st April, 2018 20,000
Add: Purchases of Raw Materials 1,30,000
Add: FreightInward (+)15,000
1,65,000
Less: Raw Materials as on 31st March, 2019 25,000
Less: Detective Kaw Materials returned 5,000
VALUE OF RAW MATERIALS cONSUMED a) 1,35,000 I,35,000
Add: Direct Labour:
i) Productive Wages 60,000
ii) Wages Outstanding 3,000
Add: Direct Chargeable Expenses +) 2,000
DIRECT CoST b) 2,00,000 2,00,000
Add: Factory Overheads:
i)Indirect Material 12,000
ii) Property Tax on Factory Buildings 8,000
ii) Workshop Rent 7,000
iv) Motive Power 5,000
Add: WNork-in-Progress as on 1s* April, 2018 +) 5,000
2,37,000
Less: Work-in-Progress as on 31t March, 2019 9 7,000
MANUFACTURING COST )2,30,000 2,30,000
Add: Office Overheads:
i)Director's Travelling Expenses 8,000
ii) Postage and Telegrams
ii) Miscellaneous Overheads 7,000
iv) Office Cleaning Charges ,000
COST OF PRODUCTION d)2,50,000 2,50,000
Add: Finished Goods- Stock as on 1st April, 2018 (+)50,000
3,00,000
Less: Finished Goods - Stock as on 31st March, 2019 75000
COST OF GOODS SOLD e)2,25,000 2,25,000
Add: Selling and Distribution Overheads:
i Carriage on Sales 5,000
i) Expenses for participating in Industrial Exhibition 3,000
ii) Upkeep of Delivery Vans 1,000
iv) Sales Promotion Charges 6,000
COST OF TURNOVER 2,40,000 2,40,000
Add: PROFITS (+) g)60,000 60,000
Value of Sales 3,00,000 3,00,000
Basics of Cost Accounting 2.55 Elements of Cost and Cost Sheet

Working Notes:
1) Calculation of percentage oft profit on cost price:
IfR 2,40,000 CP 60,000 P.
100 =?
100 x R 60,000
2,40,000
25%
i) Calculation of percentage of profit on sales
IfR 3,00,000 S.P. = 60,000 P.
100

100 X * 60,000
3,00,000
20%
ii) Discount on Issue of Debenture is an item of financial nature, hence it should be
excluded from cost.
ILLUSTRATION 13
The Cost of Sale of product 'Butanol' is made up as tolows:

Royalties 1,000
Materials used in Production - Direct 12,000
Carriage on Sales 1,250
Materials used in Primary Packing 9,000
Carriage on Purchases 5,000
Materials used in Secondary Packing 1,500
Bad Debts 3,250
Materials used in Factory WorkshopP 750
Coal and Coke 1,750
Materials used in Administrative Office 1,250
Administration on Cost 50
Labour required in Manufacturing- Direct 9,500
General Overheads 1,000
Purchases of Raw Materials ,000
Labour required for Works Supervision 2,500
Motive Power 1,000
Productive Wages Payable 500
Chargeable Expenses 4,000
Assuming that all products manufactured in Peterson Chemicals Ltd. Bhosari are sold, what
should be the Invoice Price to obtain a profit of 20% on Selling Price as on 31st March, 2019 ?
Basics of Cost Accounting9 2.56 Elements of Cost and Cost Sheet

SOLUTION
In the books of Peterson Chemicals Ltd., Bhosari
Cost Sheet for the period ended 31t March, 2019
Name of the Product: Butanol
Amount Amount
Particulars
Direct Materials 70,000
1) Materials used in Production - Direct 12,000
) Materials used in Primary Packing8 9,000
Purchases of Raw Materials 44,000
Carriage on Purchases (+) 5,000
Add: Direct Labour: 10,000
1) Labour required in Manutacturing -
Direct ,500
i) Productive Wages Payable (+)500
Add: Direct Expenses: +) 5,000
) Royalties 1,000
ii) Chargeable Expenses (+)4.000
PRIME CST a) 85,000 85,000
Add: Factory Overheads: 6,000
1) Materials used in Factory Workshop 750
ii) Coal and Coke 1,750
ii) Labour required for Works Supervision 2,500
IV) Motive Power (+) L000

FACTORY coST b) 91,000 91,000

Add: Office Overheads: 3,000
i) Materials used in Administrative Office 1,250
ii) Administration on Cost 750
General Overheads 1,000
t
cOST OF PRODUCTION 94,000 94,000
|Add: Selling and Distribution Overheads 6,000
i) Carriage on Sales 1,250
1) Materials used in Secondary Packing 1,500
11) Bad Debts (+) 3,250
(+)
TOTAL COST d) 1,00,000 1,00,000
Add: PROFIT e) 25,000 25,000
(20% on Seling Price) +)
INVOICE PRICE f1,25,000 1,25,000
Basics of Cost Accounting 2.57 Elements of Cost and Cost Sheet

Working Notes
i) Calculation of Proit i.e. 20% on Selling Price
Selling Price = Total Cost + Profit
100 0
If 80 TC = 20P
1,00,000 TC = ?

1,00,000 xR20
800
= 25,000

ILLUSTRATION 14

Majestic Furnitures Ltd., Manmad, manufactures Cots, Tables, Chairs and Cupboards. The
following are the cost details available for the year ended 313t March, 2019.
Prime Cost Process Labour Productive Value of
Particulars Materials ExpensesS Turnover

Cots 50,000 30,000 16,000 1,50,000

T'ables 45,000 20,000 19,000 1,20,000
Chairs 70,000 000 18,000 2,00,000
Cupboards (+)| 28,000 50,000 2,000 1,30,000
140,000
Total 1,93,000
I 55,000 6,00,000
Additional Information:
Works on Cost ... 80%% of Direct Wages
Bad Debts Provision 600
Administrative Overheads 15,000
Bad Debts Recovery 250
Selling and Distribution Expenses *
12,000
Book Debts 41,000
Allocate Management on Cost on the basis of Works Cost and Selling and Distribution
Overheads on the basis of Actual Sales.
You are required to prepare a Simple Cost Statement showing the following in case of each
of the product in the columnar torm.
a) Direct Cost,
b)Factory Cost,
c)Cost of Production,
d) Cost of Sales
e) Profit or Loss.
Basicsof Cost Accounting 2.58 Elements of Cost and Cost Sheet

SOLUTION
In the books of Majestic Furnitures Ltd., Manmad
Cost Statement for the year ended 31st March, 2019

Particulars Cots Tables Chairs Cupboards Total

Prime Cost Materials 50,000 45,000 70,000 28,000 1,93,000

Add: Process Labour 30,000 20,000 40,000 50,000 1,40,000
Add: Productive Expenses (+)16,000 19,000 18,000 2,000 55,000
DIRECT COST a)96,000 84,000 1,28,000 80,000 3,88,000
Add: Works on Cost
(80% of Direct Wages
i.e. Process Labour) (+)24,000 16,000 32,000 40,000 1,12,000
FACTORY COST b)1,20,000 1,00,000 1,60,000 1,20,000 5,00,000
Add: Administrative Overheads
(+)3,600 ,000 4,8001 3,600 15,000
COST OF PRODUCTION )| 1,23,600| 1,03,000 164,800 1,23,600 5,15,000
Add : Selling and Distribution
Exper (+)3,000 2,400 4,000 2,600 12,000
COST OF SALES d) 1,26,600 1,05,400 1,68,800 1,26,200 5,27,000
Add: PROFITS e) (+)23,400 14,600 31,200| 3,800
75,000
Value
Working Notes:
of Turnove 11,50,000 |1,20,000 2,00,000
L 1,30,00016,00,000

i) Allocation of Management on Cost (i.e. Administrative Overheads) on the basis of Works

Cost (i.e. Factory Cost)
Particulars Cots Tables Chairs Cupboardss
Factory Cost 1,20,000 1,00,000 1,60,000 1,20,000
Ratio 6
Allocation of Administrative Overheads 3,600 3,000 4,800 3,600
15,000 x6:5:8:6)
ii) Allocation of Selling and Distribution Overheads (i.e. Selling and Distribution Expenses) on
the basis of Actual Sales (i.e. Value of Turnover)
Particulars Cots TablesChairsCupboards
Value of Turnover |1,50,000 1,20,000 2,00,000 1,30,000
. Ratio 15 12 20 1
Allocation of Selling and Distribution Expenses
(R 12,000 x 15: 12:20: 13)_ 3,000 2,400 4,000 2,600
ii) Bad Debts Provision, Bad Debts Recovery and Book Debts are the items of financial nature
hence they should be excluded from cost.
ILLUSTRATION 15
Sudarshan Chemicals Ltd., Satana, produces a standard product, the cost data relating to the
same tor April, 2019 is given below. You are required to prepare a Cost Sheet showing separately
aCOst,Cost of Materials Consumed, b) Prime Cost,
t) Net Profit and g) Market Price.
c) Works Cost, d) Cost of Production e) Total

Purchases of Materials-Cash 4,000

Establishment Overheads: 20o of Factory Cost
Wages Payable 800
Purchases of Materials-Credit 12,000
Basics of Cost Accounting9 2.59 Elements of Cost and Cost Sheet

Works Overheads : 80% of Direct Wages

Cost of Special Designs 850
Clearing Charges on Purchases ,200
Productive Wages 3,200
Selling on Cost: R 4 per unit sold
Chargeable Expenses Payable 50
Defective Materials Returned FUU

Distribution Overheads: 1
per unit dispatched
Trade Discount 85
During the month of April, 2019 units sold and dispatched were 1,300 units only. Also find
out the market price per unit on the basis that profit mark-up is unitormly made to yield a profit
of 40 on Cost ot Sales.
SOLUTION In the books of Sudashan Chemicals Ltd., Satana
Cost Sheet for the month ended 30th April, 2019
Units Produced -1,300
Units Sold_ 1,300
Amount| Amount
Particulars
Purchases of Materials 16,000
1) Cash 4,000
11) Credit (+) 12000
Add: Clearing Charges on Purehases (+) 1,200
17,200
Less: Defective Materials Returned 400
COST OF MATERIALS CONSUMED a) 16,800 16,800
Add: Direct Labour: 4,000
1) Wages Payable 800
ii) Productive Wages (+) 3,200
Add: Direct Expenses ,000
i) Cost of Special Designs 850
11) Chargeable Expenses Payable (+) 150 |

PRIME coST b) 21,800 21,800

Add: Works Overheads
(80% of Direct Wages ie. T 4,000) +) ,200
25.000
00 25,000
WORKS CoST C)
Add: Establishment Overheads:
(20%% of Factory Cost i.e. 25,000) +) 5,000
CoST OF PRODUCTION a) 30,000 30,000
Add: Selling and Distribution Overheads
i) Selling on Cost 5,200

i)
4x Units Sold: 1,30 i.e. 5,200)
Distribution Overheads -
(+) 1,300
(R1xUnits Dispatched: 1,300 i.e. R 1,300)
TOTAL COST 36,500 36,500
Add: NET PROFIT
(4% on Cost of Sales i.e. 36,500) (+) 1,460 1,460|
MARKET PRICE 8| 37960 37,960
Basics of Cost Accounting 2.60 Elements of Cost and Cost Sheet
Working Notes:
i) Calculation of Net Profit i.e. 4% on Cost of Sales.
=4% of 36,500 i.e. Cost of Sales
=1,460
i) Calculation of Market Price per unit.
arKet Iice
Number of Units Sold
R 37,960
Units 1,300
29.20 per unit.
TLLUSTRATION 16
Mafatlal Cotton Textiles Ltd., Bhandup, submits the following information for the year ended
31 March, 2019.

Inventories as on 31st March, 2018:

Raw Materials
Work-in-Progress
12,500
16,400
FinishedGoods 17,300
Inventories as on 31st March, 2019:
Raw Materials 9,3
Work-in-Progress 00
Finished Goods 5,300
Additional Information:
Special Trade Discount 275
Annual Turnover:
1)
Cash 45,000
ii) Credit 1,55,000
Excise Duty on Purchases 3,200
Defective Materials Returned 1,400
Materials Inventory Purchases 62,700
Prime Cost Labour 29,400
Raw Materials Scrap Sold 200
Hire of Cutting Machinery 10,800
Dock Charges 1,400
Carriage Inward 1,100
Productive Wages Payable 10,600
Preliminary Expenses 1,300
Cost of Patterns 5,200
Productive Expenses 4,000
Factory Overheads- 50% of Basic Wages
Management on Cost-5% of Sales Value
Selling Expenses - 3% of Invoice Price
Distribution Overheads-1% of Loaded Price
You are required to prepare a Statement of Cost showingg-
a) Cost of Raw Materials Consumed, b) Prime Cost, c) Works Cost, d) Cost of Production,
e) Cost of Goods Sold, f) Cost of Sales and g) Profits for the year.
Basics of Cost Accounting 2.61 Elements of Cost and Cost Sheet

SOLUTION
In the books of Mafatlal Cotton Textiles Ltd., Bhandup
Statement of Cost for the year ended 31st March, 2019
ParticulaTs Amount| Amount

Inventories of Raw Materials as on 1st April, 2018 12,500

Add: Materials Inventories Purchases 62,7
Add: Expenses for Purchases of Raw Materials
i) Excise Duty on Purchases 3,200
ii) Dock Charges 1,400
ii) Carriage Inward (+) 1,100
80,9
Less: Inventories of Raw Materials as on 31st March, 2019 9500
Less: Defective Materials Returned 1,400
Less: Raw Materials Scrap Sold 200
COST OF RAW MATERIALS CONSUMED a 70,000 70,000
Add: Direct Labour +) 40,000
i) Prime Cost Labour 400
i) Productive Wages P'ayable (+) 10.600
Add: Direct Expenses 20,000
Hire of Cutting Machinery 10,800
Cost of Patterns 5,200
ii) Productive Expenses (+)
T
PRIME COST D) L,30,000 1,30 ,000
Add: Factory Overheads T 20,000
(50% of Basic Wages i.e. Direct Labour 40,000)
Add: Inventories of Work-in-Progress as on 1t April, 2018 400
1,66
Less: Inventories of Work-in-Progress as on 31st March, 2019 6,400
WORKS COST ,60,000 1,60,000
Add: Management on Cost 10,00
(5% of Sales Value i.e. Annual Turnover 2,00,000)
COST OF PRODUCTION 1,70,000 1,70,000
Add: Inventories of Finished Goods as on 1st April, 2018 ) 300
1,87,300
Less: Inventories of Finished Goods as on 31st March, 2019 ( 5,300
COST OF GOODS SOLDD e) 1,82,000 1,82,000
Add: Selling and Distribution Overheads:
ellng ExpensesS 6,000 8,000
(3% of Invoice Price i.e. Annual Tumover R 2,00,000)
i) Distribution Overheads
(1% of Loaded Price i.e. Annual Turnover (+) 200
000)OFSALESs
PROETT 1,90,000 1,90,000
Add:
Add: PROFITS FOR THE YEAR 8 10,000
Annual Turnover 2,00,000 2,00,000
(Cash 45.000 + Credit R1,55,000)
Basics of Cost Accounting 2.62 Elements of Cost and Cost Sheet

Working Notes:
i)Special Trade Discount, Preliminary Expenses etc. are the items of financial nature hence
they should be excluded from cost.
ILLUSTRATION 17

The Accounts of Goodluck Ltd., Goregaon for the year ending 31s* December, 2019 shows the
following

Stock of Materials on 1st January, 2019 16,/20

Materials Purchased 25,900
Bad Debts written off 10

Traveller's Salaries and Commission 1,078

Depreciation on Office Furniture 42

Rent, Rates, Taxes and Insurance (Factory) 1,190

Productive Wages 17,640
Director's Fees 840
General Expenses 76

Gas and VWater (Factory) 68

Travelling Expenses 294

Sales 70,000
Manager's Salary (2/3 factory, 1/3 office) 1,500
Depreciation on Plant and Machinery 1,820
Discount Allowed
Repairs to Plant and Machinery 623
Carriage Outward 602
Direct Expenses 1,001
Rent, Rates, Taxes and Insurance (office) 80
Gas and Water (office) 6

Stock of Materials on 31* December, 2019 8,792

Prepare a Statement of Cost showing:
a) Cost of Materials Consumed
b)Prime Cost
)Factory Cost
d) Cost of Production
e) Total Cost
Basics of Cost AccountingL 2.63 Elements of Cost and Cost Sheet

SOLUTION
In the books of Goodluck Ltd., Goregaon
Statement of Cost for the year ended 31* December, 2019
Particulars Amount Amount

Stock of Materials on 1st January, 2019 16,720

Add: Materials Purchased 25,900
42,620
Less: Stock of Materials on 31t December, 2019 8,792
COST OF MATEIRALS CONSUMED a) 33,828 33,828
Add: Productive Wages 17,640
Add: Direct Expenses 1,001
PRIME CoST b) 52,469 52,469
Add: Factory Expenses:
i) Rent, Rates, Taxes and Insurance (Factory) 1,190
ii) Gas and Water (Factory) 168
ii) Factory Manager's Salary (2/3 x z1,500) 1,000
iv) Depreciation on Plant and Machinery 1,820
v)Repairs to Plant and Machinery +)
623
FACTORY COST 57,270 57,270
Add: Office Expenses
i) Depreciation on Office Furniture
i) Director's Fees 840
ii) General Expenses 476
iv) Travelling Expenses 294
v)OfficeManager's Salary (1/3 xR1,500) 5U0

Rent, Rates, Taxes and Insurance (Office) 280

vi
vii) Gas and Water (Office) +) 56
COST OF PRODUCTION d 59,758 59,758
Add: Selling and Distribution Expenses
i) Bad Debts written off 910
ii) Travellers Salaries and Commission 1,078
ii) Carriage Outward +) 602
TOTAL CoST e) 62,348 62,348
Add: Profits (+)7,652 7,652

Sales 70,000 L
Working Notes:
Discount allowed is an item ot financial nature hence it should be excluded from cost.
Basics of Cost Accounting 2.64 Elements of Cost and Cost Sheet

ILLUSTRATION18)
The following information has been obtained from the records of Rotex Ltd., Raipur.
Types of Stock 1 January, 2019 31 December, 2019

Stock of Raw Materials 40,000 50,000

Stock of Finished Goods 1,00,000 1,50,000
Stock of Work-in-Progress 10,000 14,000

Other Particulars:
Indirect Labour 50,000

Lubricants 10,000
Insurance on Plant 3,000
Purchase of raw materials 4,00,000
Sales Commission 60,000
Salaries of Salesman 1,00,000
Administrative Expenses 1,00,000
Carriage Outward 20,000
Power 30,000
Direct Labour 3,00,000

Depreciation on Machinery 50,000

Factory Rent 60,000

Property Tax on Factory Buildings 000

Sales 12,00,000
Prepare a Statement of Cost showing:
a) Value of Raw Materials consumed
) Prime Cost
c) Factory Cost
d) Cost of Production
e) Cost of Goods sold
) Cost of Sales
Profit
Basics of Cost Accounting 2.65 Elementsof Cost and Cost Sheet

SOLUTIONN
In the books of Rotex Ltd., Raipur
Statement of Cost for the year ended 31t December, 2019
Particulars Amount Amount
Stock of Materials as on 1st January, 2019 A0,000
Add: Purchase of Raw Material 4,00,000
4,40,000
Less: Stock of Materials on 31st December, 2019
VALUE OF RAW MATERIALS CONSUMED 1
3,90,000 3,90,000
Add: Direct Labour +) 3,00,000
PRIME COST b) 6,90,000 6,90,000
Add: Factory Overheads:
1)Indirect Labour 0
ii) Lubricants 0,0
ii) Insurance on Plant 3,000
Iv Power 30,000
Depreciation on Machinery 50,000
vi) Factory Rent 60,000
vil) Property Tax on Factory Buildings 11,000
Add: Stock of Work-in-Progress 1* January, 2019 10,000
9,14,000
Less: Stock of Work-in-Progress 31st December, 2019 14,000
FACTORY COST 9,00,000 9,00,000
Add: Administrative Expenses +) 1,00.000
COST OF PRODUCTION 10,00,000|10,00,000
Add: Stock of Finished Goods 1" January, 2019 ) 1,00,000
11,00,000
Less: Stock of Finished Goods 31s* December, 2019 50,000
COST OF GOODS sOLD e) 9,50,000 9,50,000
Add: Selling and Distribution Overheads
1Sales Commission 60,000
Salaries of Sales 1,00,000
1) Carriage Outward +) 20,000
COST OF SALES 11,30,000 11,30,000
Add: PROFITS (+)8) 70,000 70,000
Sales 12,00,000|
LLUSTRATION 19
ahe following information has been obtained from Samarth Ltd., Surat fora quarter ending
31st March, 2019.

Cto aterials on 1st January, 2019 O00

March, 2019
urchases of Raw Mater 000
Travelling Expenses 000
Carriage Inward 10,000
Carriage Outward 15,000
Depreciation on Plant 18,000
Basics of Cost Accounting 2.66 Elements of Cost and Cost Sheet

Factory Rent 12,000

Office Re nt 10,000
Bad Debt 7,000
Productive Wages 20,000
Travellers Salaries and Commiss1on 4,000
Expenses regarding Purchases of Material 4,000
Gas, Fuel and Water 8,000
Manager's Salaries 9,000
He devotes 2/3 of his time to factory)
Sales A8,000
Prepare a Cost Sheet showing
a) Cost of Material Consumed, b) Prime Cost, c) Works Cost d) Cost of Production, e) Total
Cost, ) Profit.
SOLUTION
In the books of Samarth Ltd., Surat
Cost-Sheet for a quarter ending 31st March, 2019
Particulars Amount Amount

Stock of Raw Materials as on 1st January, 2019 1,00,000

Add: Purchase of lRaw Material 6,00,000
Add: Expenses for Purchases of Raw Material
1) EXpenses regarding Purchases of Material1 4,000
ii) Carriage Inward 10,000
7,14,000
Less: Stock of Raw Materials on 31st March, 2019 74,000
COST OF RAW MATERIAL CONSUMED 6,40,000 6,40,000
Add: Productive Wages 20,000
PRIME COST b) 6,60,000 6,60,000
Add: Factory Overheads
i)Depreciation on Plant 18,000
ii) Factory Rent 12,000
ii) Gas, Fuel and Water 8,000
iv) Factory Manager's Salaries (2/3 x*9.000) b,U00
WORKS CoST 7,04,000 7,04,000
Add: Office Overheads:
1 Travelling Expenses 5,000
ii) Office Rent 10,000
ii) Office Manager's Salaries (1/3 x*9,000) (+) 3,000
COST OF PRODUCTION a) 7,22,0 7,22,000
Add: Selling and Distribution Overheads:
1)Carriage Outward 15,000
i) Bad Debts 7,000
ii) Traveller's Salaries and Commission (+) 4,000
TOTAL COST A8,000 7,48,000
3,00,000
Add: PROFITS +)D300,000
Sales L 10,48,000
Basics of Cost Accounting 2.67 Elements of Cost and Cost Sheet

|LLUSTRATION 20
The following cost data have been extracted from the books of Femina Ltd., Fattepur for the
year ended 31st March, 2019.

Motive Power 1,00,000

Purchases of Raw Materials 2,82,500
Branch Office Expenses 30,000
Quarterly Machinery Depreciation 20,000
Interest on Bank Loan 5,400
Wages Due but not paid 12,500
Auditors Fees 2,000
Monthly Production Supervisor's Salary 2,000
Bad Debts Recovery 1,250
Stock of Raw Materials as on 1st April, 2018 27,800
Counting House Salary 18,000

Drawing Office Salary 24,000

Printing arnd Stationery 4,100
Chargeable Expenses 27,250
Rent-Administrative Office 50,000
Coal and Coke 20,000
Director's Fees 30,000
Storekeepers Wages 12,000

Sales Depot Expenses 10,900

Stock of Raw Materials as on 31s* March, 2019 20,000
Time Oftice Expenses 2,000
Advertisement 12,100
Hire of Special Plant 5,480
Bad Debts written off 1,700
Underwriting Commission 4,250
Carriage and Cartage Inward 9,700
Labour required in Production 87,500
Warehouse Rent 5,200
Sales Promotion 4,000
Direct Expenses Outstanding 7,270
What should be the selling price to obtain a profit of 12% on invoice price?
Prepare a Cost-Sheet for the year ended 31st March, 2019.
Basics of Cost Accounting 2.68 Elements of Cost and Cost Sheet

SOLUTION
Inthe books of Femina Ltd., Fattepur
Cost-Sheet for the year ended 31st March, 2019
Particulars Amount Amount Amount
Stock of Raw Materials as on 1st April, 2018 ,800
Add: Purchases of Raw Materials 2,82,500
Add: Carriage and Cartage Inward 9,700
S20,000
Less: Stock of Raw Materials as on 31st March, 2019 20,000
COST OFRAW MATERIALS CONSUMED d 3,00,000 3,00,000
Add: Direct Labour
1Labour required in production
Wages Due but not paid (+
87,500
12,500
ii)
Direct Expenses: 50,000
1Chargeable Expenses 27,250
ii) Hire of Special Plant 15,480
ii) Direct Expenses Outstanding (+) 7,270
(+)
PRIME COST 4,50,000 4,50,000D
Add: Works Overheads: 2,62,000
Motive Power 1,00,000
ii) Machinery Depreciation 80,000
11) Supervisor s salary 24,
iv) Drawing Office Salary 24,0
and Coke 20,000
VCoal
vi) Storekeepers Wages 12,000
vii) Time Office Expenses (+) 2,000
(
wORKS CoST 7,12,000 7,12,000
Add:Office Overheads:
30,000 1,34,100|
Dranch Ortice Expenses
11 Auditors Fees 2,000
11) Counting House Salary 18,000
iv) Printing and Stationery ,100
vRent-Administrative Office 50,000
vi) Directors Fees (+ 30,000
(+846,100 8,46,100
COST OF PRODUCTION
Add: Selling and Distribution Overheads: 33,900
i) Sales Depot Expenses 10,900
ii) Advertisement ,100
ii) Bad Debts written off 1,700
iv) Warehouse Rent 5,200
v) Sales Promotion (+)| 4,000

CoST OF SALES 8,80,000 8,80,000

Add: Profits 1,20,000 1,20,000
(12%% on Invoice Price)
SELLING PRICE 10,00,000 10,00,000
Basics of Cost Accounting 2.69 Elements of Cost and Cost Sheet

Working Notes:
i) Calculation of yearly Machinery depreciation:
Per Quarter 20,000x4Quarters = R 80,000
ii) Calculation of yearly Production Supervisors Salary:
per month 2,000 x 12 months = R 24,000.
i) Calculation of profits i.e. 12% on Invoice Price:
SP CP+P
100 = 88 + 12
If 88 CP = 12P
8,80,000 CP = ?

8,80,000
88
X2_z1,20,000.
iv) Non-Cost Items:
Interest on Bank Loan, Bad Debts Recovery, Underwriting Commission etc. are the items of
financial nature, hence they should be excluded from cost.
QUESTIONS FOR SELF-STUDY
I. Theory Questions:
i) Explain in brief the following basic concepts of Cost Accounting : a) Cost, b) Costing,
c) Cost ACcounting and d) Cost Accountancy.
i) Detine the term Cost. Costis a sacrifice made to achieve something. Explain.
ii) What is 'Costing. State the primary functions of costing.
iv) Explain the term Cost Accounting. State the objectives and importance of Cost
Accounting
v)Define the concept 'Cost Accounting. Explain in brief the advantages of Cost Accounting.
vi) "Cost Accountancy is a comprehensive term which includes Costing and Cost
Accounting. DIscuss.
vii) What is Cost Centre ? State the various types of cost centres.
vii) What is Cost Unit? Explain in brief the types of cost units.
ix) Define the term Elements of Cost. State the various elements of cost with suitable
examples.
x)What is Cost Classification? Explain the need for cost classification.
xi) Define 'Cost Classification'. Explain in brief the following methods of cost classification.
a) Elementwise classification, b) Functional classification and c) Behavioural
classification.
xii) "Fixed Costs are variable per unit while variable costs are fixed per unit". Discuss.
xii) What is 'Variable Cost? Explain in brief the important characteristics of Variable Cost.
xiv) What is 'Analysis of Costs'? Explain the various types of Cost Analysis.
xv) What is Cost Sheet? State the important purposes of preparing a cost sheet.
xvi) What is 'Cost Sheet? Give a proforma of Simple Cost Sheet.
Basics of Cost Accounting 2.70 Elements of Cost and Cost Sheet

xvii) Write short notes on:

a) Basic Concepts of Cost Accounting, b) Objectives of Cost Accounting, c) Importance of
Cost Accounting, a) Cost ACCOuntancy, e) Froduction ostentre, t) Composite COst
Unit, g) Material Cost, h) Overheads, 1) Non-cost ltems, j)Cost Classification, k) Kesearch
and Development Cost, 1) Characteristics of Fixed Costs, m) Semi-variable costs,
n) Historical Cost, o) Opportunity Cost, p) Differential Cost g) Relevant Cost,
r) Irrelevant Cost, s) Sunk Cost, t) Out ot Pocket Cost, u) Committed Cost, v) Analysis of
Costs, w) Life Cycle Cost Analysis, x) Cost Benefit Analysis, y) Analytical Cost Sheet,
z) Costof Goods sola.
xviii) Differentiate between
a) Costing, Cost Accounting and Cost Accountancy, b) Personal Cost Centre and
Impersonal Cost Centre, c) Single Cost Unit and Composite Cost Unit, d) Direct Materials
and Indirect Materials, e) LDirect Labour and ndirect Labour, f) Direct Expenses and
Indirect Expenses, g) FixedCost and Variable Cost, h) Controllable and Uncontrollable
Cost, i) Product Cost and Period Costj) Cost of Sales and Value of Sales.
IIL Practical Problems
i) From the following information supplied by Bajaj Ltd., Jamnagar prepare a statement
showing the cost ot production and the goods sold tor the period from 1st January, 2019
to 31st January, 2019

Stock of raw materials as on 1st January, 2019 40,000

Raw materials purchased during the month 5,00,000
Wages paid 2,50,000
Factory Overheads ,000
Work-in-progress as on 1st January, 2019 T0,000
Work-in-progress as on 31st January, 2019 20,
Closing stock of raw materials as on 31st January, 2019 30,000
Opening stock of finished goods as on 1st January, 2019 80,000
Closing stock of finished goods as on 31st January, 2019 10 JO0
eng ana Distribution Overheads
Administrative Overheads 25,000
Sales 10,00,000
ii) M/s Strong and Weak Co., Matunga manufacture plastic buckets and furnishes you the
following particulars. You are required to prepare a Cost Sheet for the year ended
31st December 2019, showing therein the Prime Cost, Works Cost, Cost ot Production and
Cost of Sales alongwith Cost per unit and percentage of each element of cost to total cost.

Unit Produced- 10,000

Material consumed 1,00,0000
Wages paid to workers 40,000
Power and Fuel (Factory) 20,000
Repairs to machines 8,000
Depreciatio
- e
Depreciation Office Furniture
Furniture
5,000
1,000
Supervision expenses (ractory) 2,000
Hire charges for machines of special purposes ,000
Wages paid to maintenance workers 20,000
Audit fees 1,500
Director's tees 7,500
Bad debts
Office expenses 3,500
Salaries 2,000
Rent, rates and taxes (Factory) 5,000
Basics of Cost Accounting 2.71 Elements of Cost and Cost Sheet

Sales 3,00,000
Salesman salary 8,000
Advertising expenses 2,000
Delivery van expenses 8,000
Warehouse rent 6,000
Frinting and Stationery
Direct expenses 8,000
i) From the following particulars of FOX and Co., Faizpur prepare a Cost Sheet showing:
a) Prime Cost, b) Factory Cost, c) Total Cost of Production and d) Cost of Sales for the
period ended 30th June, 2019.

Raw Material Consumed 50,000

wages paid to workers 20,000
Direct Expenses incurred for production 2,500
Lonsumable Stores 500
Supervisor s wages 2,000
Wages paid to shop tloor helper 600
Electric Power (Factory) 800
Electric Power (Office) 500
Rent
Rent (Ofice) 2,000
Repairs and Renewals on :
Plant and Machinery 5,000
Renovation of Office Buildings 1,000
Depreciation on Plant and Machinery 500
Depreciation on Oftice Buildings 200
Manager's Salary 3,000
Telephone Charges 200
Printing and Stationery 400
Postage and Telegrams 150
Director's Fees 800
Advertisement 800
Iravelling expenses 300
Salesmen's salary and commission 1,000
vdrenouse rent 900
Delivery van expenses 1,000
iv) M/s Favourite Industries Ltd., Faizabad produce auto parts. From the following
particulars prepare Cost Sheet for the period ended 31° December 2019.

Opening Stock of Raw Materials 20,000

Raw material purchased 70,000
Closing stock of Raw Materials 15,000
Direct Labour Cost (20%% of Factory on Cost)
Factory on Cost 30,000
Administrative Overhead (10% of Works Cost)
Selling and Distribution Expenses 10,000
Details of the finished goods are as tollows
Opening Stock of Finished Goods 2,000 units 25,000
Finished Goods produced during the period 20,000 units
Closing Stock of Finished Goods E,O00 units
You are required to find out the profit made during the year 10% on the Selling Price.
Note: a) There was no balance of opening or closing stock of work-in-progress.
b)Show the working of profit ascertained.
Basics of Cost Accounting 2.72 Elements of Cost and Cost Sheet

v) The accounts of Zia Manufacturing Co., Nashik for the year ended 315t December, 2019
shows the following8:

Drawing Office Salaries 6,500

Counting-House Salaries 00
Cash-Discount Allowed
Carriage and Cartage Outwards
Carriage and Cartage Inwards 7,150
Bad debts written off 6,500
Repairs of Plant, Machinery and Tools 4,450
Rent, Rates, Taxes and Insurance Factory 8,500
Rent, Rates, Taxes and Insurance -
Office 2,000
Sales 4,61,100
Stock of Materials-31st December 2019 62,800
Stock of Materials -31st December 2018 48,000
Materials Purchased 5,000
Travelling Expenses 2 ,100
Traveller's Salaries and Commission 7,700
Productive Wages 1,26,000
Depreciation Plant, Machinery and Tools
-
6500
Depreciation- Furiture
Director s Fees 6,000
Gas and Water Factory
-
1,200
Gas and Water- Otfice 400

10,000
Manager's Salary 7 Factory and Office
General Expenses ,400
ncome-1ax 1,000
Dividend 2,000
Prepare a statement Eiving the following intormation:
a) Materials consumed; b) Prime cost c) Factory on cost and the percentage on wages;
d) Factory cost; e) General on cost and percentage on Factory cost; 1) Total Cost; 8) Net
profit.
vi) Tata Ltd., Tatangar produces a standard product. The tollowing intormation is given to
you from which you are required to prepare Cost Sheet for the period ended
31s* July 2019.

Opening Stock of Raw Materials 10,000

Purchases ot Raw Materials 85,000
Closing Stock ot Raw Materials +,000
Direct wages 20,000
Other Direct Expenses 10,000
actory Overheads 100% of Direct Labour
Office Overheads 10% of Works Cost
Selling and Distribution Expenses 2 per unit sold
Finished Products:
n hand at the beginning of the period 1000 (value? 16000)
roduced during the periOd T0,000
In hand at the end of the period
Also find out the selling price per unit on the basis that profit mark up is uniformly made
to yield a profit ot 20% of the selling price. There were no work-in-progress either at the
beginning or at the end ot the period.
vii) The following details have been obtained from the cost records of Cement India Ltd.,
Chennai for one month.
Basics of Cost Accounting 2.73 Elements of Cost and Cost Sheet

Stock of Raw Materials on 1st April, 2019 ,000

Stock of Raw Materials on 30th April, 2019
Direct Wages J0
Indirect Wages 2,750
Sales ,1 11,000
Work-in-Progress 1st APril, 28,000
Work-in-Progress 30th April 2019 35,000
Purchases of Raw Material b6,000
Factory Rent, Rate, Power 15,000
Depreciation on Plant and Machinery 3,500
Expenses on Purchases 1,500
Carriage Outward 2,500
Advertising 3500
Office Rent and Taxes 2,500
Travellers Wages and Commission 6,500
Stock of Finished Goods 1st April 2019 54,000
Stock of Finished Goods 30th April 2019 31,000
Prepare Cost-Sheet for the month ended 30th April 2019.
vii) Following information has been obtained from the records of Quality Manufacturing Co,
Bandra.
1st January, 2019 31st December, 2019

Stock of Raw Materials 40,000 50,000

Stock of Finished Goods 1,00,000 ,50,000
Stock of Work-in-progress 10,000 14,000
Other P'articulars
ndirect Labour 50,000
Lubricants 10,000
Insurance on plant 3,000
Purchase on raw materials 4,00,000
Sales Commission 60,0
Salaries of Salesmen 1,00,0
dministrative Expenses O,O00
Carriage Outward 00
TOwer
Direct Labour 3,00,000
Depreciation on Machinery 50,000
Factory Rent 60,000
Property Tax on Factory Buildings 11,000
Sales 12,00,000
Prepare a statement of cost and profit showing:
a Value or Kaw Materials Consumed b) Prime Cost
c) Factory Cost Cost of Production
d)
ost of Sales Profit
ix) The following information are received from the books of ABC Co. Ltd., Allahabad for
the quarter ending 31st March, 2019.

Stock of Materials 31st March, 2019 5,000

Purchases of Material 7,95,00
Sstock of Material on January, 2019 1,05,000
Travelling Expenses 5,100
Carriage Inward 8,290
Carriage Outward 9,150
Basics of Cost Accounting 2.74 Elements of Cost and Cost Sheet

Labour Welfare Expenses 14,200

Depreciation on Plant 18,000
Factory Rent 11,200
Office Rent 29,100
Bad Debts 9,000
Productive wages 2,27,000
Travellers Salary and Commission
Expenses regarding Purchase of Materials 500
Director's Fees ,700
Fuel, Gas and Water 7,900
Manager's Salary 18,000
(He devotes 2/3 of his time to factory)
Air conditioning Charges of Office 9,000
Outstanding Productive Wages 3,000
Sales 14,29,500
Prepare Cost-Sheet giving
a) Prime Cost, b) Works Cost, c) Cost of Production, d) Total Cost
x) The following data have been extracted from the books of Sunshine Industries Ltd., Surat
for the year 2019.

Opening Stock of Raw Materials 25,000

Purchase of Kaw Materials 000
Closing Stock of Raw Materials 40,000
Carriage Inward 5,000
Wages -
Direct 75,000
Wages-Indirect 10,000
Other Direct Charges 15,000
Kent and Rates
Factory 5,000
Office
Indirect Consumption of Material 500
Depreciation -

1,500
.Plant and Machinery
Office Furniture 100
Salary
Office 2,500
Salesmen 2,000
Other Factory Expenses 5,700
Other Ottice Expenses 900
Manager s Kemuneration 12,000
Bad Debts written oft 1,000
Advertisement Expenses 2,000
Travelling Expenses of Salesmen 1,100
Carriage and Freight Outward 1,000
Sales ,50,000
Advance Income Tax paid 15,00
Cash Discount D00
The manager has the overall charge ot the company and his remuneration Is to be
allocated atR 4,000 to factory, 2,000 to office and 6,000 to the selling expenses.
From the above particulars prepare a statement showing:
a) Prime Cost, b) Factory Cost, c) Cost of Production, d) Cost of Sales, and e) Net Profit.
 Unit.
..
oVERHEADS
Synopsis.
3.1 Overheads
3.1.1 Meaning
3.1.2 Definitions
3.1.3 Classification
3.2 Accounting of Overheads
3.2.1 Collection
3.2.2 Allocation
3.2.3 Apportionment
3.2.4 Re-apportionment
3.2.5 Absorption
3.3 Under and Over Absorption of Overheads
3.3.1 Definition
3.3.2 Reasons
* Questions for Self-Study

3.1 OVERHEADS

On the basis of the identifiability of cost items with the cost centres or units, costs may be
classified into Direct and Indirect Costs. Direct Cost can be conveniently traced into or identified
with the product manufacturers. Direct costs which are also called Prime Costs or Basic Costs
which represent the cost which can be easily and directly be identified with the cost centres or the
cost units. On the other hand, Indirect Costs represent the costs which are not directly identifiable
with the cost centres or cost units. These indirect costs are called Overheads.
The conceptual understanding of an item of cost viz. "Packing Charges", and its accounting
treatment gives a clear idea about Direct Cost which differs from Indirect Cost.
Packing Charges are certain expenses incurred on wrapping, tying, sealing the bottles, boxes,
containers, bags etc. Accounting of packing charges simply depends upon its basic purposes for
which it is incurred and its treatment can be classified as follows :

i) Packing Charges are treated as Direct Material Costs' in case of those products which
cannot be sold without the use of packing materials. Such packing is necessary to protect
(3.1)
Basics of Cost Accounting 3.2 Overheads
and preserve the quality and convenient handling of the product. e.g. Bottling Mineral
Water, Tooth-Paste, Ink-Pot, Medicine, Basic Packing for Biscuits and Bread etc. Primary
Packing
ii) Packing Charges are treated as Factory Overhead Costs if packing is done in the
factory of a number of products e-g. making one single pack of different chocolates etc.
Secondary Packin8
i) Packing Charges are treated as "Selling Overhead Costs if they are incurred for
attractive-tancy packing mearnt to attract customers is an advertisement cost
e.g. wrappers of contectionary items and cosmetics etc. (Secondary Packing).
iv) Packing Charges are treated as Distribution Overhead Costs' if it is incurred to
facilitate transportation of finished product e.g. Packing of TV sets, Refrigerators,
Washing Machines etc. (Secondary Packing8)
v)Cost ot any special packing incurred as per customers request, is directly charged to that
job or order separately (Primary Packing).
Thus, a cost is treated as direct when it can easily, conveniently and directly be identified
with the cost centres or cost units, whereas a cost is treated as indirect when it is conveniently be
allocated to the cost or cost units. Accounting and control of overhead costs is more complicated
than that of direct material costs and direct labour costs.
3.1.1 MEANING
Overhead is the aggregate of indirect material cost, indirect labour cost and indirect expenses
which cannot be conveniently identified with and directly allocated to a particular cost centre or
cost object in an economically feasible way. It is also known as indirect cost or burden on cost
Difterent terminologies such as overheads, overhead expenses, overhead cost, overhead
charges, overhead expenditure, on cost, supplementary costs, non-productive costs, burden,
loading etc. are used by different authors to denote the indirect costs incurred over and above the
prime costs.
It may be recalled that the total cost is broadly divided into direct cost and indirect cost.
The total of all direct costs i.e. direct materials, direct wages and direct expenses, is termed as
Prime Cost whereas the total of all indirect costs i.e. indirect materials, indirect wages and
indirect expenses is known as 'Overheads'.
Thus, Overhead is the aggregate of indirect material cost, indirect wages and indirect
expenses. The word indirect is that which cannot be allocated, but which can be apportioned to,
or absorbed by cost centres or cost units. All expenses over and above the prime cost are known
as 'Overhead' charges. Hence,
Overheads = Indirect Material (+) Indirect Wages (+) Indirect Expenses
3.1.2 DEFINITIONS
Following are some of the authoritative definitions of the term 'Overhead'.
i) Certified Institute of Management Accountants, London
"overhead is an aggregate of indirect materials, indirect wages and indirect expenses".
ii) Blocker and Weltmer:
"Overheads are the operating costs of a business enterprise which cannot be traced directly to
particular unit of output".
iii) Wheldon:
"Overheads are the cost of indirect materials, indirect labour and such other expenses,
including services as cannot conveniently be charged directly to specific cost units. Alternatively,
Overheads are all expenses other than direct expenses"
Basics of Cost Accounting 3.3 Overheads

10) Harper ?
Overheads are those costs which do not result from the existence of individual cost units
v) The National Association of Accountants (U.s.A.) :

Overheads are the costs that have to be incured although they have no directly measurable,
observable relationship to specific activity units, production or cost objectives"
vi) W. W. Bigg:

"All indirect costs are termed as overheads.

Thus, Overhead is the total of all indirect material, indirect labour and indirect expenditure. It
comprises of those costs which the cost accountant is either unable or unwilling to allocate to
particular cost units.
The term 'Overheads' is used interchangeably with such terms as "burden", "supplementary
cOsts, "operating expenses" and 'indirect expenses'.
FEATURES
With the help of above definitions the Features of Overhead Expenses can be summarised as
follows:
i) Overheads are indirect costs,
i) They are common costs,
iil) Overheads comprise of both cash expenses i.e. rent, taxes, insurance etc. and non-cash
expenses 1.e, depreciation.
iv) Overheads consist of both production and non-production expenses.
v)Overheads are both variable and fixed and
vi) They include both escapable and inescapable.

All Overheads are Costs, but all Costs are not Overheads
CONCEPT
Generally overheads infuences the cost structure of a cost more logically. In traditional cost
accounting the concept 'Overhead' refers to all expenses that are not associated readily with the
production of particular product units, specitic service erngagements or designated sales.
Manutacturing business plan, measure and analyse overhead costs as transactions in specific
expense category accounts. As a result, overhead expenses will have an ultimate impact on
income statements i.e. on profits, it means which expenses increase, profit decreases. Note that
overhead can attect gross, operating profit and bottom line net protit, too.
Expenses that quality as overhead can appear under significant expenses categories on the
income statement. Business enterprises set overhead objectives' while planning their cost
strucure. Overhead targets are in fact a vital component of the firm's high level business strategy.
Overheads provide a critical support for the business to carry out profit making activities,
Overheads are also very important cost element alongwith direct materials and direct labour.
Overheads are very often related to accounting concepts such as fixed costs and indirect costs.
Therefore, in corporate businesses, the concept of overhead or overhead expense refers to an
ongoing expense of operating a business more viably.
Basics of Cost Accounting 3.4 Overheads

In the United States, the word burden' is used in place of overhead. So difficult and
confusing are some of the basic problems relating to overhead and its treatment in cost accounts
that one may perhaps be pardoned for saying that the cost accountant's "burden is overhead",
Other synonymous terms in use tor overheads are on-cos, suPplementary costs, non
productive costs', etc. Of all the terms, overhead is the most common and C.I.M.A. London does
not recommend the use of the terms 'on-cost and burden.
In certain manufacturing concern, the actual overhead costs are much higher than direct
material cost or direct labour cost and at times even both put together in beverage eg
manufacturing company overhead cost (i.e. advertisement expenses) is more than its total
production cost. Therefore, it will be a very serious mistake to overlook the overhead costs either
for the purpose of ascertaining the total cost by the cost accounting department or for controlling
theoverhead costs by the management people.
Any increase in overhead costs, withouta corresponding improvement in the quality and
quantity of output and, without a marginal reduction in direct cost, indicates total
inefficiency of the organisation.
Overhead is becoming an increasingly important element of cost in todays competitive
environment as a result of several factors such as increased mechanisation, plant automation and
use of modern advanced technology. Use of costly plant and machinery result in higher overhead
costs because of higher amounts of plant depreciation, repairs and maintenance etc. Use off
automatic machines also require less human ettort thereby resulting in employment of less
number of workers. Thus, the proportion of overhead costs in total cost in modern industry is
appreciably high and careful planning and control of overhead costs can result in significant
saving in the total cost of production.
cOMPOSITION OF OVERHEADSs
Following Figure 3.1 shows very clearly the Composition of Overheads.
Overheads

L Indirect Labour
IndirectMaterials Indirect Expenses
Fig. 3.1: Composition of Overheads

To understand such composition of overheads mentioned above, the following illustrative

chart showing examples of overheads will clarify the concepts well.
Type of Department IndirectMaterials Indirect Labour Indirect Expenses
Overhead Concerned
CoStS
Works Factory or vorkS of Lubnicanits, COnsumable alary to Foremen, dnop Coal and Coke, Gas and
Production or Stores, Coton Waste, Olil, Supervisor, Technical Directors, Water, Heating and lighüng,
Manufacturing Dusters, Brooms, Works Manager, Store-keeper, Motive Power, Haulage,
Cleaning Matenals Shop-floor Inspectors etc. ime-keepng Expenses etc.
Industrial Oil and Grease,
Soaps and Detergents elc. |
Basics of Cost Accounting 3.5 Overheads

Type o Department Indirect Materials Indirect Labour Indirect Expenses

Overhead Concerned
Costs
Office Administration or Printng and Statonery Salary to Oifice Manager, Public Relation Expenses,
Ortice or Management etc. Cashier, Telephone Operator, Audit Fees, POstage and

or Establishment Computer Slaf, Accountants,. Telegrams, Accountancy

Administrative Officer etc. Charges, Branch Ofce
Expenses, Legal Charges,
Management Expenses elc.

Selling Sales or Marketing Catalogues and Price Salary to Sales Manager, Market Research Expenses,
Lists, Banners and Hand Traveling Salesmen, Sales Advertisement, Bad Debts,

5ils, Free Samples and Depat Manager, Marketing Staff Debt Colection Charges,
Gits, Posters etc. tC. Traveling Expenses,
Publicity Charges, Export

uyyetc.
Distribution Distribution or DeliverySecondary Packing alary to Dstributon Stat, Packing Charges, Camiage
Materials etc. Wages of Packers, and Dispatch on Sales, Freight Outward,
Clerks, Delivery Van-Drivers and Delivery Van Running9
Conductors etc. Charges, Repalirs and
Maintenance of Delivery
Vans, Warehousing Charges

w*

3.1.3 CLASSIFICATION

Meaning
Classification is the process of grouping like facts under a common designation on the basis
of similarities of nature, attributes or relations. Classification of Overheads is the process of
grouping of indirect costs on the basis of common characteristics and clear objectives. Al
overhead expenses are grouped together under common heads and are further classified
according to their fundamental differences. Suitable classification of overheads of utmost
importance, so that overhead costs can be classified and appropriately used by the management
to exercise better control, to plan the future activities in advance and to take important decisions
in time.

Defit
Definition
Classification may be defined as, "the process of grouping of overhead costs on the basis of
common characteristics and specific objectives.
The basic need for overhead classification arises because of the requirement of different types
of cost data for a number of purposes. Hence, overhead costs must be suitably arranged and
sub-classified in such a manner that they can be utilised analytically in different ways to serve
different purposes.
Basics of Cost Accounting9 3.6 Overheads

Figure 3.2 shows the graphical presentation of Classification of Overheads as follows:

Overhead
******
--- - ----
e

ctional twis Behaviourwise Controliwise Normality

Classification
Elenation
Classitication Classitication Classification Classification

Controllable lor al
nd ct
Overho
Overneau
Matoriale
Viaternais hd
Overneads Oable
OvefnedOS
Noads
Overnead5

() i) )
Administrative Indirect Variable Uncontrollable Abnormal
Overneaas Labour verheads Overheads Overheads

ii)
Semi-
Selling ndirect variable
Overheads Expenses
Overheads

iv)
Distribution
Overheads

Fig. 3.2: Classification of Overheads

a) Functional Classification
The main groups of overheads on the basis of functional classification are as follows:
i) Factory Overheads:
These are the costs associated with manufacturing activities, the sequence of which begins
with the Procurement of materials and ends with primary packing of the product.
Factory overheads are also termed as production overheads, works overheads or manufacturing
Basics of Cost Accounting 3.7 Overheads
overheads, and so on. It means indirect expenditure incurred in connection with production
operations. It is the aggregate of factory indirect material cost, indirect wages and indirect
expenses. Unlike direct material and direct labour, production overhead is an invisible part of the
finished product. e.g lubricants, consumable stores, indirect wages, tactory power and light
depreciation of plant and machinery, depreciation of factory buildings, insurance of plant and
factory building, storekeeper expenses, repairs and maintenance etc.
ii) Administration Overheads:
These are the cost of formulating the policy, directing the organisation and controlling the
operations of an undertaking which is not related directly to production, selling, distribution
research or development activity. Administration overheads are also termed as office overheads
or management overheads or establishment overheads, etc. For example, General Manager's
salaries, audit fees, legal charges, postage and telephone, stationery and printing, otfice rent and
rates, office lighting, and salaries of oftice staft, management expenses, etc.
Though Cost of Training and Education to administrative staff is accounted as Office
Overhead, it is much more beneficial to treat the same as an investment in human assets,
ii) Selling Overheads:
These are the costs of seeking to create and stimulate demand or of securing orders. It is the
cost incurred tor transterring the ownership of goods to the buyer. These are the expenses
incurred for promoting sales and retaining customers. e.g. advertising, salaries and commission
of sales personnel, showroom expenses, travelling expenses, bad debts, catalogues and price lists
etc.
iv) Distribution Overheads:
lt comprises of all expenditure incurred from the time, product is completed in the factory,
until it reaches its destination or customer. e-g- packing cost, carriage outward, delivery van costs,
warehousing costs etc.
Both selling and distribution costs are incurred after the production work is over and thus
taken together, these are known as "After Production Costs".
The distinction between Selling Overheads and Distribution Overheads can be shown as
follows:
Selling Overheads Distribution Overheads
i) It includes the costs incurred in selling the i) It includes costs incurred for the
product. distribution of the finished product.
ii) It includes the costs of the selling ii) It also includes all costs incurred for
department and involves primarily the making products available to the
marketing costs. customers
ii) It may also be divided into fixed and ii) It may also be divided into fixed and
variable overheads. variable overheads.
iv) Showroom rent, electricity, advertisement, iv) Warehouse rent, electricity, salary and
salary and commission to salesman, bad wages paid to delivery van driver,
debts, travelling and market research warehouse keeper, carriage outwards,
expenses are the examples of Selling packing charges, insurance, depreciation
Overheads. of delivery van are the examples of
Distribution Overheads.
v) They are incurred for promoting the v) They are incurred in relation to the
product or securing and executing orders. delivery and despatch of the products
rom the tactory to the warehouse and
from warehouse to the customers.
Factory Overheads are the part of manufacturing operations cost, the Selling and
Basics of Cost Accounting .8 Overheads

Distribution Overheads are the results of policy.

b)Elementwise Classification
This type of classification is based on the definition of overheads given above. The main
classes under this head are; indirect materials, indirect labour, and indirect expenses.
i) Indirect Materials:
In the course of manutacturing of a product, indirect materials do not form part of finished
product.The indirect materials are consumable items, electrodes, coolants, cotton waste etc.
which are required for completion of a finished product. Indirect materials cost is the cost which
cannot be allocated, but which can be apportioned to or absorbed by cost centres or cost units.
ii) Indirect Labour:
Indirect wages are the actual wages and overtime wages paid for all labour, other than direct
labourers, in the factory, viz. helpers in factory, toremen, supervisors, inspection statt and
production manager etc. who do not help directly in converting the raw materials into a finished
product. It also includes salary paid to office and selling and distribution staff.
ii) Indirect Expenses:
Indirect expenses are all expenses of the factory such as rent, rates, taxes and insurance of
factory, repairs of factory machinery, power etc. including depreciation of plant, machinery,
equipment, loose tools and factory buildings. It also includes indirect expenses incurred for office
_
andselling and distribution.
c) Behaviourwise Classification
Different overhead costs behave in different ways when volume of production increases or
decreases. On the basis of behaviour or variability, overheads may be classified as folloWs.
i) Fixed Overheads:
These overheads remain unaffected or fixed in total amounts by fluctuations in volume of
output. e8. rent and rates, managerial salaries, buildings depreciation, postage, stationery, lega
expenses etc.
Fixed Overheads have the following important characteristics
Total fixed overheads do not vary with the change in the volume of production uptoa
given range
Fixed overheads per unit varies with change in the volume of production i.e. fixed
overheads per unit decreases as the production increases and vice-versa.
Fixed overheads are uncontrollable in nature.
They are classified into i) Cash fixed overheads e-g. rent and taxes and i) Non-cash fixed
overheads ie. depreciation on buildings.
Graphically the important features of fixed overheads may be shown as follows.

Total Fixed Overheads

Fixed Overheads Per Unit Cost

A
O Outputs in Units
Basics of Cost Accounting 3.9 Overheads

Example:
Output in units Total Fixed Overheads Fixed Overheads per unit
in in
(A) C=B/A)_
00 100.
100.
10.
100 100
1,000 100
Thus, the above mentioned example clarifies that, Fixed Overheads per unit goes on
decreasing as the total number of output increases.
ii) Variable Overheads:
This is the cost which, in aggregate, tends to vary in indirect proportion to changes in the
volume ot output. Variable overhead per unit remain fixed. e.g. indirect materials, indirect
labour, salesman's commission, power, light, fuel etc.
Variable Overheads have the following important characteristics
Total variable overheads vary in direct proportion to the volume of production i.e. total
variable overheads decrease as the production decreases and vice-versa.
Variable overheads per unit remains fixed.
Variable overheads are controllable in nature.
They are classified into: i) Material variable overheads e-g indirect material and
ii) Labour variable overheads e g. indirect labour.
Graphically, the important features of variable overheads may be shown as follows:

Overmeads

Variable

Total

Variable Overheads Per Unit Cost

Volume of Production Output in Units

Example:
Output in units Total Variable Overheads Variable Overheads per unit
in in
A) (B) (C= B/A)
1 100. T00.
1,000. 100.
100 ,000. 100.
1,000 1,00,000 100.
Basics of Cost Accounting 3.10 Overheads

Thus, the above mentioned example clarifies that Variable Overheads per unit remains
constantas the total number of output increases.
Thedistinction between Fixed Overheads and Variable Overheads can be showWn as follows.
Fixed Overheads Variable Overheads
i) They do not change with change in i) They vary in direct proportion with
production or activity. change in level of activity.
ii) The cost per unit decreases with increase i) The cost per unit remains unaffected with
n ouput ana vice-versa. increase or decrease in volume.
ii) They are related to period hence they are ii) They are related to product hence they are
termed as capacity costs. termed as inventoriable costs.
iv) Rent, insurance, salary to office staft are iv) Power consumption, salesman's
the examples of fixed overheads. commission, indirect materials, heating
and lighting are the examples of variable
Overheads.
v)They does not vary with output. v)They vary with output.
vi) They are uncontrollable. | vi) They are controllable.
ii) Semi-Variable Overhead:
These overheads are also termed as semi-fixed overheads, mixed overheads or step
Overheads. Ihis type ot overhead is partiy fixed and partly variable. In other words, such costs
vary in part with the volume of production and in part they are constant, whatever be the volume
of production. eg supervisory salaries, depreciation, repairs and maintenance, lectricity
charges, telephone charges, delhvery van expenses, material handling, storage costs etc.
Semi-Variable Overheads have the following important characteristics
These overheads stand mid-way between fixed overheads and variable overheads.
They change by small steps.
They change in the same direction as change in the level of activity but not in the same
proportion.
They remain fixed in total over a short range of variation in output.
The per unit semi-variable overheads decline with increase in output, and vice-versa.
These overheads are controllable in nature.
Graphically, the important features of semi-variable overheads may be shown as follows:

vea
Semi-variable nit
Per
Total Semi-Variable
Overheads

X X
Output in Units Output in Units
Basics of Cost Accounting 3.11 Overheads

Example
Semi-variable Overheads of R 1,50,000 are constant upto 75% capacity (7,500 units) but
increases by 10% over 75% but upto 85%o, and then increases by 20o over 85% but upto 100%
capacity._
Capacity Output in units Total Semi-variable Semi-variable Overheads
Overheads in per unit in
A) (B) (C B/A)
50% 5,000 1,50,000 30.00
60% 6,000 1,50,000 25.00
70% 7,000 1,50,000 21.43
80% 8,000 1,65,000 20.62
90% 9,000 1,98,000 22.00
100% 10,000 1,98,000 19.80
Thus, the above mentioned example clarifies that Semi-Variable Overhead costs vary in
part
with the volume of production and in part they are constant.
Behavioural classification of overheads is highly helpful to the management for
effective and efficient running of the business enterprise.
Importance of Overhead Classification according to Behaviour:
Behaviourwise cost classification is of maximum importance in planning, decision-making
and control as explained below:
i) Decision-Making:
As most of the problems of decision-making relate to changes in volume, this classification
acquires a special importance in managerial decision-making This is so because fixed and
variable costs behave in different ways when volume of output changes.
ii) Control of Costs:
From control point of view, cost may be controllable or uncontrollable. The fixed costs are
mostly uncontrollable and if, at all, any control can be exercised, it can be done by the topP
management. Variable costs, on the other hand, are mostly controllable. e.g., rent of building
fixed) is not easily controllable but cost of materials (variable) may be controlled by purchasing
in economic lots, seasonal purchasing etc. classifying costs into fixed and variable, theretore,
helps in the ettective control of costs by pointing out where management should concentrate to
control.
ii)Preparation of Budget:
This classification helps in the preparation of budget. For instance, when flexible budgets are
prepared for different levels of activity, the fixed cost remains constant at all levels of activity,
whereas variable cost varies according to the actual level of output.
iv) Absorption of Overhead:
By classifying cost into fixed and variable, separate rates of absorption of overhead may be
used tor fixed and variable overheads. Ihe under / over absorption arising out of two types of
overheads are different in nature and need different managerial action. For example, under
absorption of fixed overhead means the existence of surplus or idle capacity so that suitable steps
may be taken to effectively utilise idle capacity.
Basics of Cost Accounting 3.12 Overheads
v)Marginal Costing and Break Even Analysis:
This technique is totally dependent on segregation of cost into fixed and variable.
vi) Other uses:
In addition to points stated above, fixed-variable cost classification is useful in many other
areas. e-g while planning capital expenditure, effect of the project on total fixed and variable
cOsts should be studied. Moreover, ditterential and comparative cost analysis are based on this
classification.
d) Controlwise Classification
There are two aspects in control of overheads, one is accounting aspect of control which
consists of classification,collection, apportionment and absorption of overheads and also analysis
according to function and variability. This is helpful for ascertainment of overheads with
accuracy and control thereof. According to controlwise classification, overheads are classified as
follows
i) Controllable Overheads:
These are the indirect costs which may be directly controlled at a given level of management
authority. Variable overheads are generally controllable by the departmental heads e.g. indirect
material cost may be controlled by purchasing these materials in larger quantities.
ii) Un-controllable Overheads:
These are the indirect costs which cannot be influenced by the action of a specific member of
an organisation e.g. rent and taxes, office salaries, etc.
The distinction between Controllable Overheads and Uncontrollable Overheads can be
shown as tollows.
Controllable Overheads Uncontrollable Overheads
i) These overheads are the costs which can be i) These overheads are the costs which can
verified or regulate by conducting a not be controlled or governed.
parallel experiment or by comparing with
another standard.
ii) These overheads are those which can be ii) These overheads are those which cannot
controlled by management with proper management and are
be controlled by the
care and etficient planning eg costs not predictable in nature. e-g. loss of
incurred due to strikes can be avoided by production due to earthquakes, floods,
giving proper working facilities, due share heavy rain, etc.
of bonus to the workers and negotiation
with the union.

111) These overheads are influenced by 111) These overheads are not intluenced by
managerial action and are within their managerial action and are not within
control. their control.
iv) Controllability depends upon the level of | iv) In case of these overheads, their
management, the time period (short-term controllability cannot be predicted.
or long-term), location of the units, etc.
VControllable overheads incurred in a V) Uncontrollable overheads not incurred in
particular responsibility centre can be a particular responsibility centre.
influenced by the action of the executive
heading that responsibility centre.
While Variable Costs are controllable, Fixed Costs are not.
Basics of Cost Accounting 3.13 Overheads

e) Normality Glassification
According to normality classification overheads are classiied as follows:
i) Normal Overheads:
These are the expenses which are expected to be incurred in producing a given output. They
cannot be avoided. They are included in production cost. e.g. indirect material cost.
ii) Abnormal Overheads
These are the expenses which are not expected to occur in producing a given output.
e.g. abnormal idle time, abnormal wastage etc. These expenses are transterred to costing profit
and loss account.
The classified cost data collected from the i
a
ods discussed above, is further analysed
and interpreted by the cost accounting department on scientific basis and finally submitted to the
management. The cost accountant does not make any pricing decisions of the products. Actually,
pricing is the domain of top management, as it is based on demand and supply forces available in
the market. The cost accountant only helps the management in providing significant cost data
and determines the financial effects of price fixation or change in prices on the overal
profitability of the manufacturing unit.
Therefore, classification of overhead cost is of utmost importance, as it helps the
management to perform their peculiar functions of planning, controlling and decision-making
more ettectively and efficiently.

3.2 ACCOUNTING OF oVERHEADSs

In order to ascertain the manufacturing cost of goods produced which is a pre-requisite to
determine the cost of sales, fixation or revision of selling price etc. it is necessary to add
production overheads to the prime cost.
That means,
Prime Cost + Production Overheads = Manufacturing Cost (of goods produced)
Therefore,
Production Overheads = Manufacturing Cost (-) Prime Cost
Actually, Production Overheads = (Factory Indirect Material Cost + Factory Indirect Labour
Cost +Other Factory Indirect Expenses).
From the above, it is observed that the production overheads represent all indirect costs
incurred in the production of goods and services. This is in addition to the direct cost or prime
cost. These production overheads cannot be allocated directly to the cost units like the direct
material cost and direct wages. Therefore, a systematic procedure is to be followed to account for
production overheads. Accounting treatment required following important steps for the same.
Collection and Classification of Overheads.
Allocation and Apportionment of Overheads to production and service departments.
Re-apportionment of service department costs to production departments and
Absorption of Overheads.
Basics of Cost Accounting 3.14 Overheads
Direct Costs are charged directly to the cost centre or cost units without any difficulty. But
this is not possible in overhead costs. Distribution of overhead costs to cost units is one of the
most complicated problems of cost accounting. This is because overhead costs cannot be
identified with individual cost units and there are no accounting means of exact distribution,.
Therefore, such costs are analysed and distributed to various cost centres and cost units on an
arbitrary basis. For e,8, it is not possible to exactly calculate the amount of rent that should be
charged to a particular cost unit and thus it has to be distributed on the same arbitrary basis. The
cost accountant is constantly searching for equitable basis to distribute overheads costs to units
and divisions of business enterprises and quite often he needed to exercise his own judgement in
this regard. e-g., he may apportion rent to various departments of the tactory on the basis of area
OCcupied by each and such department, similarly, labour welfare expenses may be apportioned
on the basis of number of workers in each department. The procedure of distribution of
overheads costs in overhead accounting is as follows:
Steps in Overhead Accounting:
Unlike direct materials and direct wages, overheads cannot be allocated to cost units directly.
The various steps involved in the distribution of overhead costs are as follows:
1) Collection and Classification of Overheads.
2) Allocation of Overheads
3) Apportionment of Overheads.
4) Re-apportionment of Overheads and
5) Absorption of Overheads.
Figure 3.3 shown below indicates a Panchsutri of Overheads Accounting.

Collection and
Classification of
Overheads

(Panchsutri(
in Overhead
ACCounting

Juawu0Iuodde-0H
pee

Fig. 3.3: Panchasutri of Overheads Accounting

Basics of Cost Accounting 3.15 Overheads
1) Collection and Classification of Overheads:
a) Collection of Overheads:
t is a routine procedural work concerned with the collection of overhead expenses under
correct accounting heads already provided for. Usually, the overhead expenses are collected
through a system of "standing orders, under which a standing order denotes sanction for
overhead expenses under various heads of expenses. The important sources from which
overhead expenses are collected regularly are: i) Purchase Day Book; ii) Invoice; and ii) Stores
Requisitions.
These three are meant for collection of indirect material costs;
iv) Wages Analysis book for indirect wages; v) Cash book and Petty Cash Book. vi) Nominal
Ledgers and vi) Other Registers like Plant and Machinery Registers and Reports.
These tour are meant tor collection of indirect expenses including depreciation of plant and
machinery.
b) Classification of Overheads :
Overheads classification is the systematic process of grouping of overheads on the basis of
common characteristics and specitic objectives.
There may be three broad categories of factory overheads viz. : i) Plant overheads;
i) Overheads relatin8 to production cost centres and; ii) Overheads relating to service cost
centres.
All the factory overheads are to be classified to suit the basic purpose of cost accounting
Standing order numbers are used for covering the factory overheads. Cost account numbers are
used for covering the administration, selling and distribution overheads.
2) Allocation of Overheads:
Allocation is the allotment of whole items of cost to cost units or cost centres, whether they
may be production cost centres or service cost centres, e.g, indirect wages of production
department 'A' is to be allocated to Department 'A' only. Similarly, wages of services department
Sis to be allocated to Department S only.
3) Apportionment of Overheads :
Apportionment is the allotment of proportion of items of cost to cost centres or cost units on a
suitable basis after they are collected under separate standing order numbers. It may be the basis
of services rendered by a particular item of expense to ditferent departments or by survey
method. Sometimes, the basis will be the Ability to pay method ie. ability of the department too
bear such share of items of overheads.
4) Re-apportionment of Overheads:
The service departments do not engage directly in the production of goods and services. But
they render valuable services to the production departments which produce goods and services.
Hence, it is necessary to distribute the costs of service departments to the production departments
on some suitable bases so that the product, output, job etc. bear ultimately, an equitable share of
costs of service departments. This is called secondary distributiorn or secondary overhead
distribution summary.
5) Absorption of Overheads:
Charging overheads to individual product or job is known as absorption. Thus, purpose
behind absorption 1s that, expenses allocated and apportioned to departments or cost centres
should be absorbed in the cost of output of the given period.
Basics of Cost Accounting 3.16 Overheads

3.2.1 COLLECTION
The first step involved in the accounting of overheads is collection and classification of
overheads. Systematic classification and codification are a pre-requisite to the collection of
overheads.

Meaning
Production overheads should be collected through standing order numbers. The main
sources from which overhead costs are collected are as follows:
i) Invoice:
For collection ot indirect expenses like rent, insurance etc.
ii) Stores Requisitions :
For collection of indirect materials.
iii) Wages Analysis Sheet:
For collection of indirect wages.
iv) Journal Entries:
For collection of those overheads items which do not result in current cash outlay and
need some adjustment, tor e.g, depreciation, charge in lieu of rent, outstanding rent etc.

Definition
Collection may be defined as,
"the process of gathering together of overhead costs from the source documents made
available"
To unders tand the systematic procedure of assigning standing order numbers, there is a need
to know about 'Standing Order System'.
Standing Order System :

The production overheads are usually collected through a system of standing order numbers.
Standing Order System is a system under which a distinct number is allocated to each item o
cOst for the purpose of identification.

Standing Order Numbers (S.O.N.):

After overheads are classified, it is found useful to allot each group of expenses a number of
symbols so that each such group is easily distinguished from others. Such number of symbols are
codes for overheads and are sometimes called 'standing order numbers. Each standing order
number denotes a particular type or expenditure so that items of expenses or similar nature, as
and when they are incurred are appropriately classified into one of these. A schedule or manual
is maintained enlisting all standing order numbers. There cannot be a standard list of standing
order nunmber as the number and type under which overheads may be sub-grouped vary with the
Sze of the factory, type of expenses, and the extent of control necessary.
An essential requisite tor an effective system of standing order number is that such numbers
should be clearly defined so that individuals responsible for booking expenditure may easily
understand the classification. Secondly, the classification into standing order numbers should
have the quality of tlexibility, so that as and when the need arises, suitable changes can be
incorporated without seriously dislocating the existing system.
Basics of Cost Accounting 3.17 Overheads
Methods of Allotting Standing Order Numbers:
Each standing order number is identified by a code number or symbol. The allocation of code
numbers or symbols can be done by any of the following methods:
Methods of Coding:
The important methods of coding are as follows:
a) Serial number system, b) Decimal system, c) Alphabetical system, d) Combination of
Alphabetical and Numerical system, and e) Field method or Numerical code.
a) Serial Number System:
In this method, each type of expenditure is allotteda number in serial order as shown below
Standing Order Expenditure
Number
Furnace O
7 Works Manager Salary
23 Power
4 Factory Lighting
2 Factory Rent
A group of numbers is set apart to classify the items under a broad head. e.g., 1 to 20 for
indirect nmaterials, 21 to 40 for indirect labour, and so on.
b) Decimal System:
This is also a numerical system with the difference that instead of full numbers, decimals are
used. The whole numbers are used to indicate the main group and the decimal represents the
Sub-groups. For example,
Sr. No. Item Standing Order Item
Number
I. Factory Overheads
1.1 Indirect material .2 Indirect Labour
1.1.1 Furnace Oil 1.2.1 Inspectors
1.1.2 ubricating Oil 1.2.2 Foremen
1.1.3 Cotton Waste, etc. 1.2.3 Sweepers
1.14 Repairs and Maintenance, Stores 1.2.4 Repair Wages
1.1.5 Tools For General Use 1.2.5 Idle Time Wages
Similarly,
2. Administration Overheads 2.2 Accounting Services
2.1.1 Travelling expenses 2.2.1 Salaries
2.1.2 Salaries / Honorarium .2.2 Depreciation of accounting
2.1.3 Maintenance of cars Machine
2.1.4 Telephone expenses 2.2.3 Stationery, Xerox
2.2.4 Postage / Courier
Basics of Cost Accounting 3.18 Overheads

c)AlphabeticalSystem:
This system has the advantage that it may be formed into a mnenmonic code. e.g
P= Purchases
PD Purchase Discount
PM Purchase Manager
PO Purchase Outdoor
PR Purchase of Raw Material
Purchase Indoor
PC Purchase Components
On account of limited number of alphabets, this method has a imited coverage and lacks of
flexibility.
d) Combination of Alphabets and Numbers System:
The alphabet denotes the main group and the sub-group or type of expenditure is indicated
by the numerical 1. The following codes illustrate this method:
R1-Repairs to Plant and Machinery DI-Depreciation to Plants and Machinery
R2-Repairs to Buildings D2-Depreciation of Buildings
R3-Repairs to LDelivery vans D3-Depreciation of Delivery Vans
R4 Repairs to Office cars D4-Depreciation of Office Cars
e)Field Method or Numerical Code:
Under this method, codes used are numeric in nature and each code number usually consists
of nine digits. The first two digits indicate the nature of expenses viz. variable or fixed, the next
three digits indicate head of expenses, the next two digits stand for the analysis of expenses, and
last two digits indicate the cost centre, where expenses have been incurred. eg, in code
223035985, 22 stands for variable costs, 303 for idle time, 59 for waiting for materials and 85 for
lathe shoP
Code Particulars
22/303/59/85 Variable Cost/Idle Time/Waiting for Material/Lathe Shop.
3.2.2 ALLOCATION
Meaning
Certain items of overhead costs can be directly identified with a particular department or cost
centre as having been incurred for that cost centre. Allotment of such costs to departments or cost
centres is known as allocation.

Definition
Allocation may be defined as,
assignment or allotment of an entire item of cost to a particular cost centre or cost unit'.
In other words, allocation is charging to a cost centre those overheads that result solely from
the existence of that cost centre. A point to be clearly understood is that allocation can be made
only when the exact amount of overhead incurred in a cost centre is definitely known. For
example, rent cannot normally be allocated since rent is payable for the factory as a whole and
exact amount for each department cannot be known. Indirect materials, on the other hand, can be
easily allocated to various departments in which they are incurred. Other items which are
allocated include indirect wages, overtime and idle time cost, power (when sub-metres are
installed in departments), depreciation of machinery, supervision etc. In brief, in order that an
Overhead can be allocated, it should meet both of the following conditions:
i) the cost centre must have caused the overhead to be incurred; and
11) the exact amount incurred in a cost centre must be krnown.
Basics of Cost Accounting 3.19 Overheads

Allocation of Overheads is always direct

In short, Allocation of Overheads is the process of charging the full amount of an individual
item of cost directly to a cost centre for which this item of cost was incurred. The usual format of
statement showing allocation of overheads is as follows
In the books of a o. ..
Statement showing Allocations of Overheads
Production Departments Service Departments
Particulars 2

Direct Material
Direct Wages
Drect Expenses
Indirect Material
Indirect Wages
Indirect Expenses
Total
It should be noted that, all cOsts of service departments only are cosidered as overheads.
EXAMPLE
Atlas Ltd., Anand has two production departments and two service departments, they
provide you the following data for the period ended 31* March, 2019.
Production Departments Service Departments
Particulars 2 2

Direct Material
Direct Wages
000
20,000
20,000
15,000
20,000
10,000
10,000
5,000
Direct Expenses 10,000 10,000 5,000 2,500
Indirect Material 8,000 8,000 8,000 8,000
Indirect Wages (+) 2,500 2,500 5,000 2,500
Total 10,500 10,500 48,000 28,000
Common Indirect Expenses during the period were 20,000. You are required to prepare
Statement showing Allocation of Overheads for the period ended 31st March, 2019.
ANSWER
In the books of Atlas Ltd., Anand
Statement showing Allocation of Overheads for the period ended 31st March, 2019
Production Departments Service Departments
Particulars P2

Direct Materials 20,000 10,000

Direct Wages 10,000 5,000
Direct Expenses 5,000 2,500
Indirect Materials 8,000 8,000 8,000 8,000
IndirectWages (+)| 2,500 2,500 5,000 4,500
Total_ 10,500 10,500 48,000 28,000
Basics of Cost Accounting 3.20 Overheads

3.2.3 APPORTIONMENT
Meaning
Certain overhead costs cannot be directly charged to a department or cost centre. Such costs
are common to a number of cost centres or departments and do not originate from any specific
department. Distribution of such overhead costs to various departments is known as
apportionment.

Definition
The Institute of Cost and Management Accountant (U.K.) defines Cost Apportionment, as
the allotment ot proportions of items of cost to cost centres or cost units
In other words, it is chargng to a cost centre as fair share of an overhead. Where an item of
Overhead is common to various cost centres, it is allotted to difterent cost centres, proportionately
on some equitable basis. Again taking the case of rent, as it cannot be allocated, it is apportioned
to various departments on sOme eguitable basis e.g. in the ratio or area occupied. similarly, salary
ot a general manager cannot be allocated wholly to any one department as he attends in general
to all the departments. It should, therefore, be apportioned on some equitable basis. Other items
which generally cannot be allocated but are apportioned include fire insurance, lighting and
heating, time keeping expenses, canteen expenses, medical and other welfare expenses etc.
In short, apportionment of Overheads is the process of charging the proportion of common
items of cost to two or more cost centres on some equitable basis 1.e. actual benefit/ or potential
benefit/ or ability to pay/or service or use etc. e.g.
i) Where only one electric meter is installed in a factory, the common electricity charges
should be apportioned to all the departments on the basis of number of light points or
floor area occupied.
ii) Factory Rent is incurred for the factory as a whole and benefits all the departments in
the factory. Hence, it should be apportioned to all the departments on the basis of floor
area occupied.
Distinction between 'Allocation of Overheads' and Apportionment of
Overheads'
The distinction between Allocation of Overheads and Apportionment of Overheads can be
shown as follows
Allocation of Overheads Apportionment of Overheads
i)It deals with the whole items of costs. It deals with proportions of ftems of cost.
i) Here, the cost is allotted directly. Here, the oosts are distrnbuted on a proportionate
asis.
It
i) tis a direct process. ii) is an indirect process according to Suitabie
Jdsis.
iV) Overheads cannot be allocated directly to the v) tthrough
is possible to charge the expenses indirectly
apportionment and absorb the cost in the
products.
inal producis.
vOverheads should always be allocated, if possible. overhead cannot be allocated, it is apportioned.
vlf
vi) This is known as Departmentalisation of Overheads' vi) This i diso a part of primary distribution of
or Primary Distributon of Overheads. Overnead cOStS.
vi) t is the process of alloting or charging the whole vii) It is the 'allotment of proportions or items of cost to
amount of an item of overhead to a department or cost centres or cost units, It is the distribution of
COst centre. common Costs to diferent department on some
suitable basis.
Allocation and Apportionment of Overheads aims at
ascertaining the exact cost of cost units
Basics of Cost Accounting 3.21 Overheads

Types of Department
The organisation of business enterprise is administratively classified into different
sub-divisions, termed as 'departments'. These departments are classified as either production or
service department.
i)Production Department:
A production department is one that engages in the actual manufacture of the product
by changing the shape, torm or nature of material wOrked upon or by assembing the
parts into finished product.
ii) Service Department:
A service department, on the other hand, is one rendering a service that contributes in
an indirect manner to the manutacture of the product but which does not itselt change
the shape, form or nature of material that is converted into the finished product.
Examples of production departments and service departments are as follows:
Production Departments Service Departments
Weaving Department Purchasing Department
Spinning Department Stores Department
Crushing Department Time-Keeping Department
Mixing Department Personnel Department
Grinding Department Inspection Department
Annealing ShopP Canteen
Picking shop Labour Welfare Department
Polishing Department Production Control Department
Finishing Department Internal Transport Department
Kiln Burning Shop Tool Room
Melting Shop Accounting Department
The distinction between Production Department and Service Department can be shown as
follows:
Production Department Service Department
i) t is one that is engaged in the actual 1) t is one rendering a service that
manufacturing of the product by changin8 contributes in an indirect manner to the
the shape, form or nature of material manufacture of product but which does
worked upon or by assembling the parts not, itself change the shape by form or
into finished product nature of material, that is converted into
finished product.
1) Weaving department, spinning i) Time-keeping department, canteen,
department, mixing department, grinding8 stores department, labour welfare
department, etc. are some of the examples department, etc. are some of the
of production department. examples of service department.
ii) It works on things. iii) It works on people.
iv) It produces goods, goods can be stored in iv) It produces on output that is by nature,
inventory until sold at a later date. intangible. Its services are perishable
and cannot be stored.
Basics of Cost Accounting 3.22 Overheads
ii) Partly Producing Department:
There may be certain departments which are normally treated as service departments, but
sometimes they are also required to undertake direct production work. These may be known as
partly producing or partly service departments. For example, a carpentry shop which is mainly
engaged in the work of repairs and maintenance of fittings and fixtures, is a service department
but may be occasionally required to manutacture woden boxes tor packing ot goods which may
be charged direct to output. Similarly tool room, though a service department, may manufacture
special tools against job orders. As these departments are sometimes engaged in direct
manufacturing activities, they are called partly producing departments.

Principles of Apportionment
Apportionment of overheads to various production and service departments is based on the
following principles:
1) Service or Use:
his is the most common basis of apportionment of overhead costs. It is based on the theory
that greater the amount of service or benefit received by a department, the larger should be the
share of the cost to be borne by that department. e.g. rent is apportioned to various departments
according to the floor space occupied, telephone charges according to the number of extension
telephones in each department and so on. The guiding principles of apportionment of common
overheads on the basis of service or use are as follows:
i) Actual Benefit:
According to this principle, common overheads are apportioned on the basis of actual benefit
received. This method is adopted where measurement of actual benefit is possible. e.g. rent can
be apportioned on the basis of area occupied by each department
ii) Potential Benefit:
According to this principle, common overheads are apportioned on the basis of potential
benefit i.e. benefit likely to be received. This method is adopted where measurement of actual
benefit is not possible at all or if possible, is uneconomical. eg. cost of transport for workers, can
be apportioned on the basis of the number of employees in each department.
2) Survey Method:
This method is used tor those overhead costs that are not closely related to departments and
whose remoteness necessitates an arbitrary distribution. For e-g, salary of a General Manager of a
company may be apportioned on the basis of the results of a survey which may reveal that s07% of
his salary should be apportioned to sales, 10%% to administration and 60% to various producing
departments. Similarly, lighting expenses may be apPportioned on the basis of a survey of the
number of lights, size, estimated hours of use etc.
3) Ability to Pay Method:
This is based on the theory of taxation which holds that those who have the largest income
should bear the highest proportion of the tax burden. n overhead distribution, those departments
which have the largest income may be charged the largest amount of overhead. This method is
generally considered inequitable because it penalises the efficient and the profitable units of the
business to the advantages of inefficient ones.
If allocation of overheads is not possible, they should be apportioned to different cost
centres on the most equitable basis.
Basics of Cost Accounting 3.23 Overheads

Common Bases of Apportionment of Overheads

The following table indicates the various basis of apportionment for the usual items of factory
overheads.
Common Items of Factory Overheads Basis of Apportionment
1) Factory Rent, Rates and Taxes
a) Floor area occupied
b)Repairs and Maintenance of Factory Floor area occupied
Buildings, Air conditioning
)Insurance of Factory Buildings IOOr area occupied
d) Depreciation of Factory Buildings, Floor area occupied

2) a)
if
owned
cost of Plant and Machinery or
Repairs and maintenance of plant Capital
and machinery Machine hours
b) Insurance of Plant and Machinery Capital cost of Plant and Machinery
c)Depreciation of Plant and Machinery Capital cost of Plant and Machinery
3) Insurance of Stock Insured value of stock
4) a) 5upervision Number of workers/Direct labour hours
b) Canteen, expenses
Staff welfare Number of workers
c)Time-keeping and Personnel Office
Expenses Number of workers
d) Medical Expenses Number of workers
) a) Compensation to workers Wages
b) Employees' State Insurance
Contribution Wages
c)Provident Fund Contribution Wages
6) Stores Overhead or Store keeping Value of direct materials
Expenses
7) Material Handling Charges Weight of direct materials
8) Lighting and Heating Number of light points or floor area
Occupied or Kilowatt hours.
9) Power or Steam consumption Horse power of machines or machine
hours.
10) Technical Estimates Fort aPportioning the expenses for which
is not poSible to use any conventional
basis. The apportionment is made on the
basis of the assessment made by the
technical experts.
11) Fire Insurance Value of Asset
12) Machine Shop Expenses Machine hours or Labour hours
13) General Expenses Direct wages or number of employees
14)Audit Fees Sales or Total cost.
Basics of Cost Accounting 3.24 Overheads
The basis of apportionment can be arrived at on a trial basis and reviewed annually. It should
be noted that some overheads in the above ist can be apportioned on more than one basis. The
choice of an appropriate basis is really a matter of judgement. e-8, welfare expenses may be
apportioned on the basis of employees or total wages. Similarly, lighting expenses may be
apportioned on the basis of number of light points in each department or on the basis of technical
estimates or on the basis of floor area. General format of statement showing the apportionment of
overheads is as follows
Statement showing Apportionment of Overheads
Production Service
Particulars Basis of Apportionment Departments Departments
P 2 Ps S1

Fixed Power Generation Cost Normal Capacity

Variable Power Actual Power
Generation Cost Consumption (kwh)
Lighting Number of Light Points
Depreciation Asset Value
Insurance Asset Value
Kent, Kates and Taxes Floor Area
Repairs Floor Area
Stores Overheads Direct Material
Employee's Insurance
Charges Direct Wages
Staff Welfare Expenses Number of Workers
Supervision Expenses Number of Workers (+)
Total ** **

Departmentalisation of Overheads
After overhead costs have been collected under various standing order numbers, the second
step is to allocate and apportion the overheads to production and service departments. This is
also known as Departmentalisation or Primary Distribution of Overhead.
Departmentalisation of Overheads is the process of allocation and apportionment of
overheads to different departments or cost centres. For smooth and efficient working, a factory isS
sub-divided into a number of departments each of which denotes a particular activity of the
factory. For eg, Purchase Departments, Stores Department, Time-Keeping Department,
Personnel Department, Crushing Department, Melting Shop etc. These departments are mainly of
various types viz. Production Departments, and Service Departments and Production cunm
Service Department.
Basics of Cost Accounting 3.25 Overheads
The following factors are taken into account while organising a concern into a number of
departments.
i)Similarity of operations, processes, machines and equipment in a department,
ii) Location of operations and processes and the sequence of operations,
ii) Division of responsibility for control of production and control of cost, and
iv) Optimum number of centres. Too many cost centres make the system of cost accounting
detailed and quite expensive, whereas too few cost centres will not be able to provide
requisite cost intormation and thus will fail to serve the main objectives of cost
accounting.
Jecd for Departmentalisation of Overheads
Need
Departmentalisation of Overheads is necessary for the following reasons:
i) Control of Overhead Costs:
Effective control of overhead costs is possible because departmentalisation makes the
incurrence of costs in a department or cost centre the responsibility of someone who heads the
department or the cost centre. Thus, with the help of departmentalisation, responsibility
accounting can be effectively introduced for control purposes.
ii) Forecasting and Estimating:
Because of greater accuracy in cost ascertainment and cost control, departmentalisation
ensures more accurate forecasting and estimating and decision-making.
iii) Ensures Greater Accuracy in Cost Ascertainment:
By proper allocatiorn and apportionment of overheads for accurate costing of each function or
operation, overhead absorption rates should be determined separately for each cost centres. This
is possible only with the help of departmentalisation.

iv) Use of different Methods of Absorption:

Basis of absorption of overhead may be different for different cost centres. For e-g, machine
hour rate may be suitable for one cost centre whereas direct labour hour rate may be more
appropriate for another cost centres. Different basis may be used for different cost centres only
when overheads are departmentalised.
vValuation of Work-in-Progress :

Correct cost of work-in-progress cannot be ascertained unless overheads are

departmentalised.
vi) Cost of Service Departments :

Departmentalisation helps in ascertaining the cost of various service departments which is

Lusefulfor making estimates and submitting quotations for those items which make use of the
services of various cost centres.
Basics of Cost AccountingL 3.26 Overheads

EXAMPLE
Britania Ltd., Baroda has three production departments "X, Y and "Z and two service
departments, 'A' and "B. The following figures are extracted from the records of the company for
the period ended 31st March, 2019.

Rent and Rates... 5,000 General Lighting 600

Indirect Wages ************************ 1,500| Power 1,500
|Depreciation of Machinery.. 10,000 Sundries 10,000
are
The following further details available._
F'aruculds Total X LY A_ B
Floor Space (Sq.ft) 10,000 2,000 2,500 3,000 2,000 500
Light Points (Number 60 10 15 20 10 5
Direct Wages 10,000 3,000 2,000 3,000 1,500 500
H.P. of Machines (H.P:)| 150 50 30 10
Value of Machinery 2,50,000 60,000 80,000 100,000 5,000 5,000
Apportion the costs to various departments on the most equitable basis.
ANSWER
In the books of Britanía Ltd., Baroda
Primary Departmental Distribution Summary for the period ended 31st March, 2019
Particulars Basis of Total A B
Apportionment
Direct Wages Actual 2,000 - 1,500 500
Rent and Rates FloorSpace 5,000 1,000 1,250 1,500 1,000 250
General Lighting Light Points 600 100 150 200 100 50
Indirect Wages Direct Wages 1,500450 300 45075 225
Power HP. of Machines 1,500600 300 500 100
Dep. of Machinery Value of Machine 10,000 2400 3,200 200
4,000 200
Sundries Direct Wages (+)10,000 3,000 2,000 3,000 1,500 500
Total 30,600 7,550 7,2009,650 4,625 1,575
EXAMPLE
Coment Ltd., Chembur, has two production departments and two service departments and
provides you the following data for the period ended 31st March, 2019.
ProductionDepartmentsService Departments
Particulars P2

Direct Materials 40,000 ,000 20,000 10,000

Direct Wages 15,000 20,000 5,000 10,000
Floor Area (sq. Teet) 5,000 4,000 3,000 2,000
Value of Plant and Machinery 1,00,000 1,20,000 40,000 20,000
Value of Stock 35,00 25,000 000 5,000
Number of Workers No. 00 50 25 25
Number of Light Points LP 200 50 25 25
Horse Power of Machines HP| 25 15
Basics of Cost Accounting 3.27 Overheads
The indirect expenses for the period were:

Factory Rent, Rates, Taxes and Repairs 14,000

Depreciation, Insurance and Repairs of Machinery 6,
nsurance of Stock 700
Supervision and Staff Welfare Expenses 2,000
Stores Overheads 1,000
Lighting and Heating 3,000
Power 1,000
Prepare a Statement showing Apportionment of Overheads for the period ended
31st March, 2019.
ANSWER
In the books of Coment Ltd. Chembur
Statement showing Apportionment of Overheads for the period ended 31st March, 2019
Basis of Production Service
Particulars Apportionment Total Department Departments
1 2

Factory Rent, Floor Area 14,000 5,000 4,000 3,0002,000

Kates, Taxes and
Repairs
Depreciation, Value of Plant and 56,000 20,000 24,000 8,0004,000
Insurance and Machinery
Repairs of
Machinery
Insurance of Stock| Value of Stock 700
Supervision and Number of workers 2,000 1,000 500 250 250
Staff Welfare
EXpenses
Stores Overhead Value of Materials 1,000 400 300 200 100
Lighting and Number of light 3,000 2,000 500 250 250
Heating points
Power |
H.P. of Machinery (+) 1,000 500 250 150 100
Total 77,700 29,250 29,800 11,900 6,750
3.2.4 RE-APPORTIONMENT
Meaning
Once the overheads have been allocated and apportioned to production and service
departments and totalled, the next step is to re-apportion the service department costs to
production departments. This is necessary because our ultimate object is to charge overheads too
cost units, and no cost units pass through service departments. Therefore, the costs of service
departments must be charged to production departments which directly comes in contact with
cost units. This is called 'Secondary Distribution of Overheads'.
Basics of Cost Accounting 3.28 Overheads

Definition
Reapportionment may be detined as,
"the process of assigning service departments overheads to production departments".
The method of re-apportionment of service department costs is similar to apportionment of
overheads as mentioned above. Some of the important bases of re-apportionment of service
department costs are as follows.
Basis of Re-apportionment of Overheads of Service Departments:
The following is the general summary of the basis of re-apportionment ot some common
items of overheads ot service departments.
Service Department Basis of Re-apportionment
i) Purchase Dept. Number ot purchase orders or number of
purchase requisitions or value of
materials purchased.
i) Stores Dept. Number of material requisitions or value|
of materials issued.
ii) Time-keeping Dept., Payroll Dept. Number of employees or total labour|
hours or machine hours
iv) Personnel Dept., Canteen, Welfare, Number of employees or total wages.
Medical and Recreation Dept.
v)Repairs and Maintenance Number of hours worked in each
department.
vi) Power House Dept. Meter reading or H.P. hour for powers.
Meter reading or tloor space for ighting
heat consumed.
vii) Inspection Dept. Inspection hours or value of items
inspected.
vii) Drawing Office Dept. Number of drawings made or man-hours
worked.
ix) Accounts Dept. Number of workers in each department
or time devoted.
x) Tool Room Dept. Direct labour hours or Machine hours or
wages.
xi) Factory Office Dept. Number of employees.
xii) Boiler House Dept. Percentage of steam utilised.
xiin Internal Transport Dept._ Weight and distance.
Secondary Distribution of Overheads:
Secondary Distribution means the re-apportionment ot overheads
of Overheads of service
departments among the production departments on some suitable basis.
Methods:
The costs of service departments are re-apportioned on the basis of services rendered i.e. the
benefits received by the beneficiary departments. The various Methods of Re-apportionment of
Service Department Overhead Costs are summarised in this chart shown in Figure 3.4.
Basics of Cost Accounting 3.29 Overheads

Methods of Re-apportionment of Service Department Overhead Costs

Re-apportionment to Production Re-apportionment to Production

Department only and other Service Departments

(A) Non-reciprocal (B) Reciprocal

|i) Simultaneous ii) Repeated ii) Trial and Error|

Equations Method Distribution Method Method

Fig. 3.4: Methods of Re-apportionment of Service Department Overhead Costs

1) Re-apportionment to Production Departments Only:
In this case, cost ot a service department is re-apportioned only to production departments
without re-apportioning it to other service departments.
EXAMPLE
Continuing the example given on page number 3.26 by taking the total overhead as per
departmental distribution summary and the following additional information, apportion the
service department costs to production departments, only ignoring inter-service departmental
transter.
X Y Z
Number of Employees NO. 75 30
Value of Materials Purchased 10,000 8,000 7,000
Further assume that Service Department 'A is Purchasing Department and "B' is
Time-keeping Department.
ANSWER
In the books of Britania Ltd., Baroda
Secondary Distribution Summary for the period ended 31st March, 2019
Production Depts, Service Depts.
Particulars Basis of Total
Re-apportionment
Total as per PnmarySummary 30,600 7,550 7.200 9,650 4,625 1,575
Service Dept. A Value of materials 1,850 1,480 1.295 4,625
purchased
Service Dept. B Number of employees () 88 315 472 - 1575
30,600 10,188 8,995 11,417|
Total
Basics of Cost Accounting 3.30 Overheads
2) Re-apportionment to Production as well as Other Service Departments:
Quite often, a service department renders service not only to production department but also
to other service departments. For example, maintenance department looks after not only the plant
and machinery of production department but also the equipment of other service departments
like power house, materials handling, etc. Similarly, power house supplies electricity not only to
production departments but also to canteen, maintenance department etc. This type of
nter-service department apportionment may be either on reciprocal basis or non-reciprocal
basis:
A) Re-apPportionment on Non-reciprocal basis:
This is done when service departments are not interdependent. In this method, the service
departments are arranged in the descending order of their serviceability. The cost ot the most
serviceable departments 1.e. the department which serves the largest number of departments is
first apportioned to other service departments. The service department whose services are the
next largest is taken up next and its cost (including the prorated cost of the first service
department) is apportioned to other service and production departments excepting the first
service department. In the same way, while apportioning the third service department in this
order, the first two service departments are ignored. This process is continued till the cost of the
last service department is apportioned. It should be noted that the cost of the last service
department is apportioned only to production department.
EXAMPLE
This method has been illustrated with assumed figures which are as follows
Secondary Distribution Summary for the period ended 31* March, 2019
Production Depts. Service Depts.
Total C D
25,350 8,000 7,250 5,600 1,200 1,000 800 1,500
350 300 200 100 1,500
300 250 150 900
200 50 250 1,200
600 700 00 1,900

25,350 9,450 8,800 7,100

It is assumed that the descending order ot serviceability of service departments is "D, 'C,B
and A. This means service department "D' is the most serviceable department i.e. it renders
service to the largest number of production as well as other service departments. t does not
receive any service from other service department. Theretore, cost of l,500 of service
department D is aPportioned to all other departments in the ratio it renders its services. The next
most serviceable department is C which renders its services to all other departments except D.
Theretore, its cost is apportioned to all departments except service department D. Then "B
department's cost is apportioned which is next in the order of serviceability and lastly A's cost is
apportioned.
Basics of Cost Accounting 3.31 Overheads
B) Re-apportionment on Reciprocal basis:
This method is used when service departments are mutually dependent. Thus, in the above
example, position will be different it in addition to serving production departments, each service
department also renders services to each other service department. For example, service
department "A renders service to 'B,Cand 'D, service department B renders service to "A,C
and D' department and so on. In such a case, until B's charge to A, C and D is known A, C and D
cannot allot any cost to B. Similarly, until A's charge to "B, "C and D' is known, B, 'C' and 'D
cannot allot any costs to 'A'. Thus, there are many unknown variables as the number of service
departments.
There are three methods for breaking this vicious circle which are, i) Simultaneous
Equations Method, ii) Repeated Distribution Method and ii) Trial and Error Method.
i)Simultaneous Equations Method :
In this method, the following algebraic equations help in finding out the unknowns:

a+ by
a+ bX
This is illustrated as follows:
EXAMPLE
The departmental distribution summary showed the following departmental totals :
Particulars Production Service
|Departments Y Z A
'B'
Amount 7,550 7,200 9,650 4,625 1,575
The costS of Service Depts. A and B are to be charged on the basis of the following
percentage
Departments Z B
A' 20% 30% U70 10%
4070 1U7o
Find the total overheads of production departments as per Simultaneous Equation Method.
ANSWER
Let X denote the total overheads of Service Dept. 'A
Y denotes total overheads of Service Dept. B
X
=4,625 + 100 YY
()
TU
Y
=1,575 + 100 x . (11)

X = 4,625 +0.10 Y (1)

-X+ 10Y =15,750 (1)

Again mutiplying equation (i) by 10 to eliminate X and adding:

10X-Y = T46,250 1)
-10X+ 100 Y = 1,57,500 . (ii)
99Y 2,03,750
2,05,750
99
Y
=R 2,058
Substituting the value of Y in equation ()
10X-72,058= 46,250
10X =746,250 +R 2,058
Basics of Cost Accounting 3.32 Overheads

10X R48,308
or R 4831 (Approx.)
=4,830.8
Thus, X=R4,831 and Y =R 2,058.
Statement showing Secondary Distribution as per Simultaneous Equation Method
Tor the perou enaeu
Total Production Depts.
Particulars 'X'

Totalas per Primary Distribution Summary 24,400 ,50 ,200 9650

Service Department'A 4,831)|
Less: 10o to Dept. "B 4,348 966 1,450 1,932
Service Department "B 2,058)
Less: 10o to Dept. 'A 852 823 411 618
Total 30,600 9,339 9,061 12,200
This method of simultaneous equations gives scientific and more accurate results. But when
the number of service departments exceeds two, calculations become cumbersome and tedious.
ii) Repeated Distribution Method:
In this method, the following steps are taken to apportion the service departments costs:
a) The costs of the first service department are apportioned in the normal way according to
the given percentages. This will close the amount of the first service department.
b) Then apply the given percentages to the apportionment of second service department
costs which includes its own total plus amount apportioned from the first service
department. This closes the account of the second service department but re-opens the
account of the first service department.
c)The same procedure should be followed in the case of all other service departments.
d) The procedure should be repeated again starting with the first service department
whose total now consists only of amounts apportioned from other service departments.
In this way, service department costs keep on reducing with each process of distribution
because each time a substantial amount is charged to the production departments.
eThis process is continued until the amounts involved become insignificant.
The operation of this method is explained below continuing example given on page
number 3.31.
ANSWER

for the period ended

TotalProduction Depts.
.
Statement showing Secondary Distribution as per Repeated Distribution Method

Service Depts.|
Particulars T X Y 'Z'

Total as per Primary Summaryy 30,600 7,550 7,200 9,650 4,625 1,575
Dept. 'A 925 1,387 1,8504,625 463
Dept. B 815 408 611 204 2,038
Dept."A 41
Dept. 'B 9 7 920
30,600 9,340
Total 9,060| 12,200 |
Working Note
apportioned to X,
:"Y,In "Z
the above statement, first of all the cost of service department A is
and B in the ratio given. Then the cost of service department B'
2,038 (i.e. R 1,575 + 463) has been apportioned to departments "X, Y, "7 and A in the given
Basics of Cost Accounting 3.33 Overheads
percentage. The account of department A is again open with R 204, whose amount is distributed
to X, Y, Z and B in the given ratio. Then 20 allotted to department 'B' is distributed to
departments X, Y, 'Z. Nothing has been allotted to departmernt "A' as the share of department
A is quite negligible. In this way, the entire costs of service departments "A and "B are
apportioned to production departments X,Y and "Z.
It should be noted that, unlike Simultaneous Equations method, this method produces
approximate results. But the advantage ot this method is that it can be conveniently applied
where the number of service departments is more than two.
ii) Trial and Error Method:
In this method, the cost of first service department is apportioned to other service
departments in the given ratio. he cost of the next service department is aPportioned to first and
other service departments. In this way, when the costs of all service departments has been
aPportioned, the process is repeated till the service department cOsts are negHgible.
Distinction between Apportionment and Re-apportionment of Overheads
The Distinction between Apportionment of Overheads and Re-apportionment of
Overheads can be shown as follows.
APportionment of Overheads Re-apportionment of Overheads
i) It is the process to allot costs to the cost i) After primary distribution' the cost of
centres or cost units for ascertaining the service department is borne by the
total costs. Apportionment does not depend production departments. The process of
upon the nature of expenses to be incurred, redistribution of the service department
but depends upon the relationship with costs to the production department is
cost centre or cOst unit to which it is
required to be charged.
known
secondary
as Re-apportionment
overhead
or
distribution
summa
ii) This is necessary because certain overhead ii) This is necessary because the ultimate |

costs cannot be directly charged

department or cost centre.
to aim is to charge overheads to cost units,
and no cost unit pass through service
department.
ii) There is no hard and fast rule as regards iii) It is done on the basis of the benefits
the bases of apportionment of overheads. It received by each department.
depends on the nature of overhead
incurred.
Iv) There are some common bases for v) For selecting a suitable base for
apportionment of overhead costs on some re-apportioning the cost of service
equitable basis which is known as primary department, the same principles of
distributionmethod. apportionment may be applied here also.
3.2.5 ABSORPTION
Meaning
The process of apportioning the total overhead expenses of production department among
the units produced in that department is termed as 'Overhead Absorption.
In other words, absorption of overhead expenses reters to a systematic process of
distributing the overheads among the units produced by production departments. Overhead
Basics of Cost Accounting 3.34 Overheads
absorption is also called as overhead application, overhead recovery, levy of overhead,
overhead costing etc
After apportionment and re-apportionment of overheads to production departments, these
Overheads are to be charged to cost units. In essence, the procedure is to take each production
department and distribute its overheads among all cost units passing through that particular
department, this is technically known as 'Absorption'.
Definitions
Following are some of the important definitions of "Overhead Absorption'.
i) The Institute of Cost and Management Accountants, U.K.:
"It is the allotment of overhead to cost units".
i) The nstitute of Cost and Works Accountants, India :
"It is the allotment of overheads to cost units by means of rates separately calculated for
each cost centre.
After studying the methods of allocation and apportionment of overhead costs to cost centres,
the next step in accounting of overheads is absorption of overheads in the cost of production
i.e. recovery of overheads in the cost of production. All jobs, processes or services pass through
one or more producing cost centre. The overhead expenses are ultimately charged to cost centre
in such a manner that the cost of production of each unit includes an appropriate or equitable
share of overheads of the cost centre. This method of apportionment of overhead expenses of the
cOst centres to cost units is called absorption of overheads which is also known as application,
levy or recovery of overheads.
Distinction between Apportionment of Overheads and Absorption of Overheads
The distinction between Apportionment of Overheads and Absorption of Overheads can be
shown as follows:
Apportionment of Overheads Absorption of Overheads
i) It may be defined as "allotment of i) After apportionment and re-apportion-
proportions of items of cost to cost centre or ment of overheads to productiorn
cost units. In other words, distribution of departments, these can be charged to cost
common costs to difterent department on units. In essence, the procedure is to take
some suitable bases called each production department and
apportionnment of overheads distribute its overheads among all cost
units passing through that particular
department. This is technically known as
'absorption' and is defined as charging
of overheads to cost units.
i) It is the second step in the distribution of ii) It is the last step in the distribution
Overheads. process of overheads.
ii) It is the process to allot costs to the cost i) It is the charging of overheads to the cost
centre or cost units for ascertaining the total units.
cost.
iv) There are some common bases for iv) It is known as levy, recovery or
apportionment of overheads cost on some application of overheads.
equitable basis which is known as primary
distribution method.
Basics of Cost Accounting 3.35 Overheadss

3.3 UNDER AND OVER-ABSORPTION OF OVERHEADS

Meaning
Overheads may be absorbed either on the basis of actual rates or pre-determined rates.
Nh
When actual rates are used, the overheads absorbed must, if all the calculations are correctlyy
made, exactly equal to the overheads incurred. In such a case, there 1s no problem of under or
over-absorption of overheads. But when a predetermined rate is employed, overheads absorbed
may not be equal to the amount of actual overheads incurred. Thus, whenever the overheads
absorbed are not equal to the amount of actual overheads, it is a case ot either Under-absorption
or Over-absorption of Overheads. It should be noted that the overhead absorption rates are
pre-determined.
Factory Overheads Estimated
Pre-Determined Kate
Basis i.e. units of output etc.
Where a pre-determined rate is adopted, the overhead absorption may not be the same as
Overhead incurred actually for e-g. Factory overheads incurred are 5,500, whereas, factoryy
overheads absorbed to the final output are 5,000 @ R 2 per unit on the actual output of 2,500
units. Thus, there is under-absorption of factory overheads to the extent of K 500,.

3.3.1 DEFINITION
Usually, overheads are absorbed on the basis of predetermined rates. Since pre-determined
overhead rates are based on budgeted overheads and budgeted production, invariably the
Overhead absorbed by this process do not agree with he actual overhead incurred for the period.
f the absorbed overheads at predetermined rates are greater than actual overhead, this is
known as'Overabsorption.
On the other hand, if absorbed overheads are less than the actual overheads, this is known as
Under-Absorption'.
Therefore,
When the amount of overheads absorbed is less than the amount of overheads incurred, it is
called under-absorption or under-recovery. This has the eftect of under-stating the cost because
the overheads incurred are not fully recovered in the cost of jobs, processes etc.
When the amount of overhead absorbed is more than the amount of overhead incurred, it is
known as over-absorption or over-recovery". This has the effect of over stating the cost of jobs
processes etc.
3.3.2 REASONS
Under or over-absorption of overheads may arise due to one or more of the following
reasons.
i) Faulty estimation of overheads costs (or overhead incurred exceed the estimates) or
outputs are less than anticipated).
i) Faulty estimation of the quantity of output.
ii) Seasonal fluctuation in the amount of overhead in certain industries.
iv) Unforeseen changes in the production capacity.
v) Unexpected changes in the method of production affecting changes in the amount of
overhead.
vi) Non-utilisation of normal capacity.
Whatever may be the reason, under or over-absorption is caused manly due to the wrong
estimation either of the costs incurred or of the production over which they are to be absorbed.
Basics of Cost Accounting 3.36 OverheadsS

Distinction between Under-absorption and Over-absorption of Overheads

The distinction between Under-absorption of Overheads and Over-absorption of
Overheads can be shown as follows:
Under-absorption of Overheads Over-absorption of Overheads
i) When the amount of overheads absorbed is i) When the amount of overhead absorbed
less than the amount of overhead incurred is more than the amount of overhead
it is called "under-absorption or under incurred it is known as over-absorption
Tecovery. or over-recovery
ii) This has the affect of understating the cost i) This has the overstating cost of jobs, |
because the overhead incurred are not fully processes, etc.
recovered in the cost of jobs, processes, etc.
ii) In case of under-absorption, supplementary ii) In case Over-absorption,
rate is computed by dividing the under Supplementary rate is computed by
absorbed production overheads by the| dividing the over-absorbed production
actual value of the base This is overheads by the actual value of the base
Supplementary rate may be formed This supplementary rate may be called
positive, supplementary rate as the under negative supplementary rate as over
absorbed overheads is to be added. absorbed amount is to be subtracted.
IV) In case of under-absorption, under iv) In case of over-absorption, over-absorbed
absorbed production overheads are to be production overheads are to be deducted
added, applying positive supplementary from the cost of work in progress, unsold
rate, to the cost of various categories stockand units sold.
Accounting Treatment
The methods of Accounting Treatment for Disposal of Under or Over-absorbed Overheads
are shown below in Figure 3.5.

Supplementary
Rate Method

Disposa
/ of Under or
Over Absorbed
Overheads
Y

Fig. 3.5: Accounting Treatment for Disposal of Under or Over-absorbed Overheads

The under or over absorbed overheads may be disposed off by any one of the following three
methods.
1) Supplementary Rate Method, 2) Writing off to Costing Profit and Loss Account Method
and 3) Carry over to next Accounting Period Method.
Basics of Cost Accounting 3.37 Overheads
1) Supplementary Rate Method:
a) when to use:
This method is usually used when,
i)the amount of under/over-absorption of overheads is quite large and
i) the under or over-absorption of overheads is due to normal reasons like increase in
material prices or labour rates. Supplementary rate may be calculated as follows:
Amount of under/over-absorbed overheads
Supplementary Rate Actual Base
b) How to use :

1)In case of under-absorption

The cost of sales, stocks of finished goods and work-in-progress are increased
Dy aPply1ng positive supplementary rate.

in) In case of over-absorption

The cost of sales, stocks of finished goods and works-in-progress are reduced
by applying negative supplementary rate.
2) Write off to Costing Profit and Loss Account Method:
a) When to use:
This method is usually used when,
i) the amount of under/over-absorbed overheads is not very large, or
ii) the under or over absorption of overheads is due to abnormal reasons like defective
planning idle capacity etc. In this case, even large amounts are written off to
Costing Profit and Loss Account.
b) How to use:
The amount of under-absorbed overheads is transferred to the debit of costing profit and
loss account and amount of over-absorbed overheads is transferred to the credit of
costing profit and lo5s account.
3) Carry Over to Next Accounting Period Method:
a) When to use:
Ihis method is usually used when,

i)the period of normal business cycle is more than 1

year and overhead rates are
determined on a long-term basis
ii) in case of new projects, more output in the next period(s) than that in initial stages is
expected.
b) How t se:
The amount of under-absorbed overheads is transferred to the debit of overhead reserve
or suspense account and the amount of over-absorbed overheads is transterred to
the credit of overhead reserve or suspense account,
The under or over-recovered amounts are disposed off in accordance with any ot the
following methods depending upon the circumstances.
Basics of Cost Accounting 3.38 Overheads
1) Use of Supplementary Rates
Where the amount of under or over-absorbed overhead is not negligible, a supplementary
Overhead absorption rate is calculated to adjust this amount in the cost. However, adjustment is
made in the cost of i) work-in-progress, i) finished stock, and ii) cost of sales.
In the case of under-absorption, the overhead is adjusted by a plus rate since the amount is to
be added, whereas, Over-absorption is adjusted by a minus rate since the amount is to be
deducted.
EXAMPLE
Pre-determined overhead rate 10 per machine hour
Actual machine hours Hrs. 1,500
Actual overheads 18,000
ANSWER
Overhead absorbed Hrs. 1,500x7 10 = R 15,000
Under-absorption 18,000-7 15,000 = R 3,000
3,000
Under Supplementary Rate 1,500 units per unit
This is a plus rate because it is for under-absorbed overheads and will be used to add to the
overhead already recovered.
Supplementary Overhead Rate Under-absorption of Factory Overhead
Units ofOutput

3,000
1,500 Units
T2 per unit.
Accounting Entry:
Work-in-Progress A/c Dr. 3,000
To Factory Overhead Control A/c 3,000
2) Writing-off to Costing Profit and Loss Account or Transfer to Current year's Costing Profit
and Loss Account:
The method is used when the under or over-absorbed amount is quite negligible and it is not
worthwhile to absorb it by supplementary rates. Under-absorption due to abnormal factors like
idle capacity, defective planning etc. is also transferred to Costing Profit and Loss Account. This
method suffers from the shortcoming that stocks of work-in-progress and finished goods remain
under or over-valued and are carried over to the next accounting period at such values.
EXAMPLE
Considering the aboOve example, pass the Accounting Entry for the same
ANSWER
Accounting Entry :

Costing Profit and Loss A/c Dr. 3,000

To Factory Overhead Control A/c 3,000
Basics of Cost Accounting 3.39 Overheads

3) Carry over to the Next Year

Under this method, the under or over-absorbed amount is transferred to Overhead Reserve
Account or Suspense Account tor carry over to the next accounting year. This procedure is open
to criticism on the ground that it is not logical to carry over the overhead of one year to the
subsequent years for absorption. But, this method can be usefuly employed where normal
business cycle externds over more than one year and overheads are determined on a long-term
basis.

EXAMPLE
n a manutacturing unit, overhead was recovered at a pre-determined rate of 25 per man
day. The total factory overhead expenses incurred and the man-days actually worked were
a
41,50,000 and 1,50,000 days respectively. Out of the 40,000 units produced during period,
50,000 were sold. On analysing the reasons, it was found that 60% of the unabsorbed overheads
were due to detective planning and the rest were attributable to increase in overhead costs.
How would unabsorbed overheads to be treated in cost accounts?
ANSWER
Amount
Particulars

Actual Overhead Expenses incurred 41,50,000

Overhead expenses absorbed R 25. x 1,50,000 days) 37,50,000
Unabsorbed overheads 4,00,000
60%%of this amount of unabsorbed overheads which is due t detective planning (controllable
reasons) should be charged to Costing Profit and Loss Account and the remaining 40% should be
adjusted to the Cost of Sales and Closing Stock in the ratio of units sold and units in stock
respectively.
Amount
Particulars

Charge to Costing Profit and Loss Account 2,40,000

60% of 4,00,000
Add: Adjustment to the Cost of Sales: 1,20,000
40% of 4,00,000 = 1,60,000

1,60,000x 30,000units
u
1,20,000
40,000 nits

Add: Adjustment to Closing Stock: 40,000

10,000 units
T1,60,000 40,000
units
Unabsorbed Overhead 4,00,000
Basics of Cost Accounting 3.40 Overheads

EXAMPLE
A manutacturing company absorbs overheads on pre-determined rates, for the year ending
31st December, 2019, Factory overhead absorbed were 3,66,250. Actual amount of overhead
incurred totalled R 4,26,890. The following figures are also derived from the trial balance.
Particulars
Finished Stock 2,30,732
Cost of goods sold 8,40,5*

Work-in-progress 14145
Total Cost 12,12,80
Give two methods for the disposal of under-absorbed overheads and show the proit
implications of each method.
ANSWER
Under-absorbed overheads = 4,26,890-7 3,66,250 = R 60,640
This under-absorbed amount may be disposed ott by any of the following two methods.
Use of Supplementary Rate:
Here, under-absorbed amount will be charged to finished stock, cost of goods sold and work-
in-progress.
Unabsorbed Amount y 100
Supplementary Rate Total cost

60,640 100
12,12,800

5o
Accounting Entry:
Work-in-progress Ledger Control A/c ... Dr. 7,074.00
Finished Goods Ledger Control A/c Dr. 11,536.60
Cost of Goods Sold A/c Dr. 42,029.40
To Factory Overhead Control A/c 60,640.00
(Being the apportionment of under-absorbed factory overhead to work-in-progress, finished
goods and cost of goods sold @ 5% of cost)

The cost of goods sold increased by 42,029.40. Since, this is debited to Profit and Loss
Account, the profit will decrease by this amount. On the other hand, credit to Profit and Loss
Account orn account ot increase in the value of closing stocks of work-in-progress and finished
stock will be 18,610.60 (i.e. R 7,074 +R 11,536.60). Thus, the net effect of using this method is that
profit for the year will reduce by 23,418.80 (i.e. R 42,029.40-R 18,610.60).
2) Carry over to Next Year :
Alternatively, entire amount of under-absorbed overhead may be carried over to next year.
This will have no effect on the current year's profit or loss.
Basics of Cost Accounting 3.41 Overheads
Steps Involved in the Calculation of Machine Hour Rate
While computing the machine hour rate, the following steps should be kept in mind :
Step 1: lreat each machine or group of Similar machine, as a separate cost centre
Step 2: Calculate total fixed or standing charges i.e. those which do not vary with the use of
machine, of each machine cost centre tor a particular period 1e. tor a year, quarter,
month or week. Some of the fixed charges may be apportioned on the basis suggested
below:
Fixedor Standing Charges Basis of Apportionment
Rent and Rates Area occupied
Floor
Heating and Lighting Number of light points, (if given) or
floor area Occupied
Supervision Time devoted by the supervisor
Insurance Insured value of each machine
Lubricating Oil and Consumable Stores Machine hours or past experience
Cleaning Materials Number of Machines or past experience
|Miscellaneous Expenses Equitable basis based on facts.
Step 3: Calculate etfective Machine Hours of each machine cost centre for a particular period
(i.e.for a year, quarter, month or week) as follows
a) Number of Working Days (365-Holidays like Festivals, Sundays) ****

b) Number of Working Hours available per day

c)Total Number of Working Hours (a x b) ****

d) Less: Hours required for maintenance *

e)Productive Machine Hours (if set-up time is assumed to be productive)

)Less: Unproductive set-up time (if assumed to be unproductive)
8 Productive Machine Hours (e -f
Step 4: Calculate fixed or standing charges per machine hour as follows:
TotalFixed or Standing charges (as per step 22
Fixed or Standing charges per hour
Effective Machine Hours (as per Step 3)
Step 5: Calculate each of the machine expenses for each machine cost centre. Some of the
machine expenses may be apportioned on the basis suggested below:
Machine Expenses Basis of APportionment
Depreciation Original Cost (+) Installation EXpenses () Scrap Value
Eftective useful life (in hours)
Power Power Consumption units per hour x (Working Hours
Maintenance Hours- Set-up hours during which no
power is consumed X Kate of power per unit

Working Hours Maintenance Hours -

Unproductive
Set-up Hours
Repairs and maintenance Machine Hours
Miscellaneous expenses Equitable basis based on facts.
Basics of Cost Accounting 3.42 Overheads

Step 6: Calculate hourly rate for each of the Machine expenses as follows:
Individual Machine Expense
Machine expense per nourEffective Machine Hours
Step Calculate Machine Hour Rate as follows
7:
Particulars Amount
er Hour

Fixed or standing Charges per hour

Add: Depreciation per hour
Add: Power per hour
Add: Repairs and Maintenance per hour
Add: Any other Machine Expense per hour
Machine Hour Rate
Format of Statement showing the computation of Machine Hour Rate
Statement showing the Computation of Machine Hour Rate
Cost
Particulars Total per Per Hour
machine

A) Fixed or Standing Charges :

i) Rent and Rates

i) Heating and Lighting
iit) Supervision
iv) Insurance **

v) Lubricating Oil and Consumable Stores

vi) Sundry Shop Supplies
vi) Department and General Overheads
Total Fixed or Standing Charges
aeTotal Fixed or Standing Charges
Fixed or Standing Charges =
Effective Machine Hours
B) Machine Expenses per hour:
Original Cost + Installation Expenses- Scrap Value
i) Depreciation = Effective useful Lite (in hours)
i) Power = Power Consumption units per hour x (Working Hours-
Maintenance Hours Set-up hours during which no power
-

is consumed) x Rate of power per unit

Working Hours Maintenance Hours Unproductive Set-up
- -

Hours
ii) Repairs and Maintenance
iv) Other Running Expenses
Machine Hour Rate **
Basics of Cost Accounting 3.43 Overheads
Working Notes:
a) Number of Working Days (365 Less Holidays like Festivals, Sundays)
b) Number of Working Hours available per day
c) Total Number of Working Hours (a xb)
d) Less: Hours required for maintenance *

e) Productive Machine Hours (if set-up time is assumed to be productive) **

t) Less:Unproductive Set-up time (if assumed to be unproductive)

8) Productive Machine Hours

1. n the case of a leap year, the total number of days in a year are 366.

QUESTIONS FOR SELF STUDY

I. Theory Questions:

i Define the term 'Overheads, State the important features of Overhead Costs.
i) What is 'Overheads' ? Explain the various methods of classification of overheads.
i) Explain the concept 'classification of overheads'. Describe in brief the following methods
of classification of overheads giving suitable examples of the same.
a) Functional classification, b) Elementwise classification and c) Behaviourwise
classification.
iv) What is Behaviourwise classification of overheads' ? Explain the importance of
overheads classification according to behaviour.

vWhat
Overheads.
is 'Overhead Accounting' ? Explain the necessary steps involved in Accounting of

vi) What is 'Collection of Overheads' ? Explain the important sources from which overhead
costs are collected.
vii) What is "Allocation of Overheads ? How it is different from "Apportionment of
Overheads'?
vii) Define the term 'Apportionment of Overheads'. State the important principles of
APportionment of Overheads.
ix) What is "Production Department' ? How it differs from a "Service Departmen'? Give
at least five examples of each department.
x) What is meant by 'Re-apportionment of Overheads' ? Explain the methods of Secondary
Distribution of overhead costs.
xi) What is "Departmentalisation of Overheads ? Explain the need tor departmentalisation
of overheads.
xii) Explain various methods of Reapportionment of Overheads' on non-reciprocal basis.
xii) What is Overhead Absorption How does it differs from Apportionment of
Overheads?
Basics of Cost Accounting 3.44 Overheads
xiv) What is 'Under-absorption of Overheads' and 'Over-absorption of Overheads' ? State the
reasons for under and over-absorption.
xv) Define the term Under-absorption of Overheads'. State the methods of disposal of
under absorption of overheads.
xvi) Difterentiate between

a) Fixed Overheads and Variable Overheads, b) Selling Overheads and Distribution

Overheads, ) Controllable and Uncontrollable Overheads, d) Normal Overheads and
Abnormal Overheads, e) Allocation of Overheads and Apportionment of Overheads,
t) Production Department and Service Department, g) Apportionment of Overheads and
Reapportionment of Overheads, h) Apportionment of Overheads and Absorption of
Overheads, i) Under-absorption of Overheads and Over-absorption of Overheads.
xvii) Write short notes on:
a) Overheads costs, b) Features of Overheads costs, c) Elementwise classification of
Overheads, d) Importance of Overhead classification according to behaviour,
e) Importance of Overheads Accounting, ) Collection of Overheads, g) Allocation of
Overheads, h) Apportionment of Overheads, i) Reapportionment of Overheads on
Reciprocal basis, j) Overhead Absorption, k) Reasons for Under and Over absorption of
Overheads.
 Unit 4
METHODS OF COSTING

Synopsis
41 Contract Costing9
4.1.1 Meaning
4.1.2 Features
4.1.3 Contract Costing Concepts
4.1.3.1 Work Certified
4.1.3.2 Work Uncertified
4.1.3.3 Escalation Clause
4.1.3.4 Cost Plus Contract
4.1.3.5 Work-in-Progress
4.1.3.6 Profit on Incomplete Contract
*lustrations
Questions for Self-Study
4.2 Process Costing
4.2.1 Meaning
4.2.2 Features
4.2.3 Process Losses or Gains
4.2.3.1 Normal LossS
4.2.3.2 Abnormal Loss
4.2.3.3 Abnormal Gain
4.2.4 Joint Products and By-Products
4.2.4.1 Joint Products
4.2.4.2 By-Products
4.2.5 Preparation of Process Accounts
*llustrations
*Questions for Self-Study

METHODS OF COSTING
Costing is simply a method of cost finding. It is the technique and process of ascertaining the
costs. It is the classifying, recording and appropriate allocation of expenditure for the
aetermination or costs of products or services and ror the presentation or sultabily arranged data
for the purposes of control and guidance of the management. It includes ascertainment of the cost
of every order, job, batch, contract, process, service or unit as may be appropriate. It deals with
the cost of production, selling and distribution. Thus, costing is the proper allocation of
expenditure whereby reliable cost may be ascertained appropriately and suitably presented to
(4.1)
Basics of Cost Accounting .2 Methods of Costing

afford guidance to the manufacturers, traders or service-providers in control of their respective

businesses.
Cost Accounting is the process of accounting for cost, from the point at which expenditure is
incurred or to be incurred to the point of charging to the cost centres and cost units. It has many
uses which includes the preparation of statistical data, the application of cost control methods
and the ascertainment of the profitability of activities carried out or planned. It is the means
which consists of concepts, methods and procedures used to measure, analyse or estimate the
cost, proitability and pertormance of ndividual products, departments and other sectors of a
company's operations. It has internal and external use or both and it answers to all the questions
to the concerned parties. Thus, Cost Accounting is the process and technique of determination of
a product cost. It is a system of cost accumulation, ascertainment and classification for product
costing and managerial planning, control and decision-making process. In short, Cost Accounting
is a dynamic and diverse field of activity.
In modern manufacturing corporate world of severe competition, industries are usually
classified as mass production industries and jobbing industries.
In mass production industries, identical units are produced on a large scale and on a
continuous basis. Manufacturing of standard product is made without any customers order or
specifications. Thus, mass production industry is characterised by the continuous production of
uniform products as per standard specifications. Mass production includes coal mines, products,
cement, steel, paper, chemicals, bricks, rubber production. Their costing Is made for entire output
of a unitorm product produced during a specific period.
On the contrary in jobbing industries production is made only against special orders from
Customers. Production of non-standard jobs is made strictly as per the specific requirements of
customers, where each job is clearly distinguished from other jobs. ThuS, jobbing industry is
characterised by irregular production oft non-standard products as per customers specifications.
Special job order production includes printing press, construction work, heavy machinery,
toundry, general engineering works, machine tools, interior decoration, repairing works,
furniture makers. Their costing is made separately for each job as per customer specifications.
The method of cost accumulation and identifying them to products and services depends
upon the nature of operations in an enterprise. Cost accounting procedure varies from one
company to another company. e.g., a non-manufacturing enterprise may not follow the procedure
of accumulating costs with Specific customer orders. Similarly, a hospital may prefer to
accumulate costs in a manner as to provide the cost of out-patient treatment or a specific medical
treatment. A concern organising exhibitions and fairs may be interested in knowing the cost of an
exhibition to be organised in a particular season. On the contrary, a contractor accumulates costs
tor each separate contract. Although the procedure of accumulating costs may ditter amon8
different types of organisations, the basic principles underlying cost accumulatin8 procedures are
applicable to all types of organisations, Each cost accounting system aims to provide intormation
that is required by the management.

A standard method of costing cannot be used for all types of industries.

NEEDFOR VARIOUS METHODS OF COSTING

Methods of Costing indicates a systematic procedure established for ascertaining cost of a

product, job process or services by using the principles of costing. A Cost Accounting method is
merely the process of 'collecting and presenting costs. The nature of industries differs. Some are
Basics of Cost Accounting .3 Methods of Costing

very simple and produce only one product e.g. brick-making. Some industries may produce only
one product but it may really be an assembly of numerous components e.g. bicycle, motor car etc.
Again there may be a homogeneous product but involving many distinct stages and processes
Such as vegetable o1l. In some case there may be important by-products or joint products
eg. petroleum products, sugar etc. It is therefore, natural that the exact method employed to
ascertain cost per unit should depend on the nature of the industry. The general principle of
ascertaining cost of production per unit are the same, but the methods ascertaining and
presenting the costs vary with the type of production. One standard method of costing may not
be applied suitably to various types of industries because they differ in type of products, methods
of production, nature of industry, scale of operation, volume of output etc. Hence, there is a need
tor introducing various methods of costing which can be applied more suitably to a corporate
business.
In manufacturing organisations, the principles of cost accumulation and their identification
with products are more clear and visible and theretore the principles used by a manutacturing
enterprise is often used by other organisations also tor accumulating costs. In manufacturing
concerns, costs are accumulated and assigned to products on the basis of the following cost
accounting methods viz. A) Specific Order Costing and B) Operations Costing.
But according to Mr. Batty,
"Many costing systems do not fall neatly into the category of either job or process costing.
Often, systems use some features of both the main costing systems".
It is, for this reason, that he uses the term"hybrid costing systems" for all those methods that
combine the features of the basic costing methods. The Figure 4.l indicated below shows Various
Methods of Costing which are used in actual practice.
Methods of Costing

Specific Order Costing Operation Costing

ie. Job Costing i.e. Process Costing

Costing Multiple or Class

Job Batch Costing Onract Composie Cost
ing Method

Operatin9 Unit or Departme- Operation

Single or
Process
Costing ervice upu n ntal
Costing
Costing
Costing OStn

Fig. 4.1: Various Methods of Costing

Basics of CostAccounting Methods of Costing

A) Specific Order Gosting

The terminology of I.C.M.A. defines Specific Order Costing as, "the category of basic costing
methods applicable where the work consists of separate contracts, jobs or batches each of which is
authorised by a special order or contract.
This method is adopted in made-to-order type of products which depends entirely on the
specification of customers. As such there is no standardisation in the production process tor want
of uniformity. The following are the different methods of costing which fall under the category of
specific order costin8
1) Job Costing:
The terminology of I.C.M.A. defines Job Costing as, "that formn of specific order costing which
applies where work is undertaken to customers special requirements
Under this method, costs are collected and accumulated for each job, work order or project
separately. Each job can be separately identified, so it becomes essential to analyse the cost
according to each job. A Job Card is prepared for each job for cost accumulation. This method is
applicable to printers, machine tool manufacturers, foundaries and general engineering
Workshops, interior decorator, painters, repair shops etc.
2) Batch Costing:
The terminology of I.C.M.A. defines Batch Costing as, "that form of specific order costing which
applies wvhere similar articles are manufactured in batches either for sale or use within the
undertaking
This method is a variation of Job Costing In this method, the cost of a batch or group of
identical products is ascertained and, therefore, each batch of products is a unit of cost for which
costs are accumulated. This method is used in biscuit factories, bakeries, ready-made garments,
hardwares like nuts, bolts, screws, shoes, toys, drugs and pharmaceuticals etc.
3) Contract or Terminal Costing:
The terminology of L.C.M.A. defines Contract Costing as, "that form of specific order costing
which applies where work is undertaken to customers special requirements and each order is of long
duration".
The cost unit here is a contract which is of a long duration and may continue over more than
one financial year. A separate account is kept for each contract. This method is used by builders,
civil engineering contractors, constructional and mechanical engineering firms etc.
4) Multiple or Composite Costing
It is an aPplication of more than one method of cost ascertainment in respect of the same
product. This method is used in industries where a number of components are separately
manufactured and then assembled into a final product. In such industries each component differs
from the others as to price, material used and process of manufacture undergone. So it will be
necessary to ascertain the cOst of each component for this purpose, process costing may be
applied. To ascertain the cost of the final product, batch costing may be applied. This method is
used in factories manutacturing cycles, automobiles, engines, radios, TVs, typewriters, aeroplanes
etc. This method has been completely droPped out from the latest 1.C.M.A. TerminoloEY
5) Class Cost Method :
It is the method of Job Costing where the costing of goods is done by classes instead of the
unit or a piece. Instead of the cost being separately accumulated for each article or piece, the cost
will covera group of orders of the same class of product.
Basics of Cost Accounting

B) Operation Costing B
. Methods of Costing

The terminology of LC.M.A. detines Operations Costing as, "the category of basic costing
methods applicable where standardised goods or services result from a sequence of repetitive
and more or less continuous operations or process to which costs are charged before being
averaged over the units produced during the period,
The following are the different methods of costing which fall under the category of
Operations Costing.
1) Process Costing
The terminology of I.C.M.A. defines Process Costing as, "that form of operation costing which
applies where the standardised goods are produced".
It is a method of costing where cost is ascertained at the stage of every process and also after
completing the finished production. It is used in concerns where production tollows a series or
sequential process. Process type of industries do not manufacture individual items to the specific
requirements of customers. As such, production is not intermittent but continuous. Each process
represents a distinct stage of manutacture and the output of one process becomes the input of the
following process. The unit cost is arrived at by averaging the cost over the units produced, and
cost per unit of each process is ascertained. This method is used in a variety of industries such as
chemicals, oil refining, paper making, tlour milling, cement manufacturing, sugar, rubber,
textiles, soap, glass, tood processing etc.
2) Operating or Service Costing :
The terminology of l1.C.M.A. defines Service Costing as, "that form of Operation Costing which
applies where standardised services are provided either by an undertaking or by a service cost centre
within an undertaking"
This method of costing is used by those undertakings which render service as against
manufacturing and supply of tangible products. It is an essential method of costing where only
the services are rendered. It ascertains the cost of one unit of service rendered. This method is
applicable to transport undertakings, electricity supply undertakings, hospitals, hotels, canteen,
water works, gas companies, educational institutions etc. The cost unit depends upon the service
provided. Usually, in service undertakings a composite cost unit is used. e.g. tonne kilo-metre
passenger kilo-metre, patient per day or bed per day, KWH (kilo-watt-hours), meal served,
student hours etc.
3) Unit or Single or Output Costing:
It is a method of costing by the unit of production, where manufacturing is continuous and
the units are identical. In some cases the units may be differ in terms of SIze, shape, quality etc.
This method is also called as Single Costing because only one type of product alone is
manufactured. Examples of industries where this method is applicable are collieries, quarries,
tlour-mills, paper mills, textile mills, brick-making, radio, cameras, pencils, slates, diary products
etc. No separate set of books is generally required and costing information is presented in the
form of a statement known as Cost Sheet.
4) Departmental Costing:
A factory may be divided into a number of departments and sometimes good results are
obtained by allocating expenditure first to difterent departments and then to difterent products
manufactured in that department. Under this method, the cost incurred in maintaining a
particular department is ascertained. There are two objectives for using this method viz. to
control the cost of department and to charge the cost of a department or to the finished product.
Basics of Cost
Accountin9 +.0 Methods of Costing

5) Operation Costing:
It is a special type of Process Costing. It refers to the determination of cost of operations, the
cost unit is the 'operation' instead of the process. The per unit cost is arrived at by dividing the
cost of an operation by the number of units completed in the operation centre. For large
undertakings it is frequently necessary to ascertain the cost ot various operations. Cost control
can be exercised more ettectively with operation costing

4.1 CONTRACT COSTING

It is that form of specific order costing which is applied where the work is undertaken
according to special requirement of customers, each order is of long duration and the completion
of the same takes usually more than one accounting period. It is a special type of job costing. In
contract costing, similar accounting principles of job costing are tollowed. Here "contract means
long-term contracts relating to engineering projects and construction activity. Each contract
becomes basically a separate cost unit and for the purpose of exercising strict control, it is
regarded as a cost centre.
4.1.1 MEANING
Contract is a special type of Job Costing where the unit of cost is a single contract. This
method is also termed as "Terminal Costing as when the work is terminated the cost-sheet has to
be completed. It is a variant of Job Costing. In this method it is desired to find out the cost of
carrying out a complete contract for a customer involving numerous jobs and batches of jobs. The
costs are ascertained and analysed with respect to the contract accepted for execution. This
method of costing is adopted by those concerns undertaking definite contracts e.g. builders,
contractors and civil engineers who undertake long-term projects like construction of roads,
bridges, houses, large estates, irrigation schemes etc. It is also adopted by the concerns where the
unit ot output is heterogeneous eg. ship building companies, turbines and boilers manufacturing
company, motion pictures etc. Contract Costing is that form of specific order costing under which
each contract is treated as a separate cost unit and costs are accumulated and ascertained
separately for that contract.
DEFINITIONs
The term 'Contract Costing' and 'Contract Cost has been defined by different experts and
protessional institutions in the manner stated below.
The Terminology of 1.CM.A. defines Contract Costing as, "that form of specific order costing
which applies where workis undertaken to customers special requirements and each order is of long
duration"
The Terminology of C.IM.A. defines Contract Cost as, "the aggregated costs relative to a single
contract designated a cost unit".
APPLICABILITY
Contract Costing can suitably be applied in,
1) industries engaged in the construction of buildings, roads, ships, dams, boiler house,
bridges or other construction work.
i) industries undertaking engineering projects, civil engineering works, mechanical
engineering firm.
i) public works contractors involved in railway line contracts.
Basics of Cost Accounting .
Generally, two parties are involved in a contract viz. the contractor - the person who
Methods of Costing

undertakes the contract, and the contractee - the person who assigns the contract.
Under Contract Costing, a separate number is allotted for each contract and all related costs
are accumulated for each contract. That means, a separate set of accounts are kept and
maintained for each individual contract undertaken by the company.

4.1.2 FEATURES

Following are the Important Features of Contract Costing.

The work is carried out away from contractor's premises i.e. at the contractee's work
ite.

i) A contract is usually a big job of long-duration and may continue over more than one
accounting period.
11) As the contracts are of large size, a contractor usually carries out a small number of
contracts in the course of a year.
iv) Contract work involves too much of risk and uncertainty.
) A contract undertaken is treated as a cost unit.
vi) A separate account is prepared tor each contract to ascertain profit or loss orn each
contract.
vii) Apportionment of profit on contract to different accounting periods is very difficult.
vii) In case the contract is undertaken of long-duration, a percentage of notional profit
depending upon the progress of physical work may be accounted for in each year.
ix) Most of the materials are specially purchased for each contract.
Expenses chargeable to contracts are direct in nature, e.g. electricity, telephone charges,
insurance etc.
Allocation and apportionmentot overhead costs is a simple task.
xi) Specialists sub-contractors may be employed for say, electrical fittings, welding works,
glass work, plumbing work etc.
xii) Plant and equipment may be purchased or hired for the duration of the contract.
xiv) Nearly all labour will be direct
xv) The payment is received depending on the stage of completion of work.
xvi) A contract usually includes clause for 'penalty' for delayed completion.
xvii) A contract usually includes Escalation Clause under which the contractor is
compensated for increase in costs on account of inflation.
xvii) A percentage of the value of work done is deducted from the progress payment as
Retention Money.
A contract is a big job whereas a job is a small contract
Basics of Cost Accounting 4.8 Methods of Costing

DIFFERENCE BETWEEN JOB COSTING AND cONTRACT COSTING

The point of differences between Job Costing and Contract Costing are as follows:
Basis of Job Costing Contract Costing
Distinctioon
i) Size A job is small in size. A Contract is big in size.

ii) Execution Work under this method is A contract is executed generally in

work performed in the premises of the premises or Customer
manufacturer. 1.e. (contractee).

Time A job usually takes less time to A contract takes more time to
complete. Complete.
iv) Selling The selling price is paid after The price is paid in various
price completing the job in full. instalments depending upon the
progress of work.
v)Investment It involves heavy investment on Investment on assets in Contract
assets initially. cOsting is less than comparing for Job
cOsting
vi) Expenses Expenses under job costing takes the Under this method most of expenses
form of both direct and indirect are direct in nature.
vii) Treatment| Profit carried on Job is entirely taken | In case of incomplete contract, only
to Profit to Profit and Loss Account. proportionate profit is taken to Profit
|

_
and LOSs ACCount.
viii) Number A number of Jobs in hand may be Number of contract that may be
large undertaken at a time may be few,
ix) Pricing Pricing is influenced by individual Pricing is influenced by the specific
condition and general policy of the clauses of the contract.
Organisation.
x)Indirect Indirect costs are higher than those Indirect costs are lower than those
Cost under Contract Costing | under Job Costing.
IMPORTANT TERMS
Following are some of the important basic terms generally used in Contract Costing.
i) Material Costs :
The material required for the contract are debited to Contract Account which includes
a) Materials specifically purchased for the contract.
b) Materials issued from stores against requisition.
c) Materials urgently required transferred from another contract.
On completion of the contract the following types of materials should be credited to
Contract Account.
a) Materials returned to store.
b) Materials in hand on site at the end of the accounting period.
c) Materials transferred to another contract.
d) Sale of materials.
Basics of Cost Accounting Methods
of Costing

Any profit or loss arising out of such materials transactions must be recorded from Profit
and Loss Account. Following are certain items of losses which should be debited to
Profit and Loss Account and should be credited to Contract Account.
) Loss on sale of materials.
b) Materials which are stolen away or destroyed by fire.
Materials lost in accidents.
d) Cost of defective materials.
ii) Labour Cost:
All labour actually engaged at contract site is regarded as direct labour, irrespective of
the nature of the tasks performed by the workers concerned and charged to the contract.
The exact labour cost that should be debited to a Contract Account thus includes the
total remuneration paid and payable to all workers engaged on contract at the end of the
accounting period.
iii) Other Direct Expenses:
All other expenses incurred directly for the contract should be debited to Contract
Account. e.g. Architec's or Surveyors tee, Sub-contract costs, hire charges of Plant and
Machinery etc.
iv) Overhead Costs
Ihere are some common indirect expenses incurred ror various contracts, wnich cannot
be charged directly to the individual contract. These expenses are divided into works
expenses, office expenses and are distributed on various Contracts on some appropriate
basis. The ultimate proportionate industry expenses paid or payable should be debited
to Contract Account i.e. head office expenses, expenses of central stores, establishment
charges etc.
v) Plant and Machinery Costs:
In every Contract work some special plant, heavy machines and special tools are usually
employed.. The Plant and Machinery cost represents the cost for the use of Plant and
Machinery and tools for the contract. These costs are treated in Contract Account with
the following alternative methods.
If Plant and Machinery and tools are used for the contract only for a short period,
Contract Account may be debited with the amount of depreCiation on t.
b) if Plant and Machinery and tools are used tor the contract fora long period, the
full amount of it may be debited to Contract Account and at the end of the
accounting period or completion of the contract, the residual or written down
value of it may be credited to the Contract Account.
vi) Sub-Contract Cost:
if the contractor has entrusted some spectal work to some expertise sub-contractor, the
costs incurred for such sub-contract is treated as a direct charge to the contract and
hence should be debited to Contract Account e.g. a building contractor may entrust the
following types of specialised jobs as a sub-contractor to the sub-contractors e-8 task of
digging foundations, electrical installation, specialised flooring, installation of lifts,
painting work, plumbing work etc.
vii) Cost of Additional Work:
If a contractor is asked to do some extra work or alteration in the work which is not
included in the original contract, the cost of such additional work may be charged
separately to the contract as follows:
Basics of Cost Accounting 4.10 Methods of Costing

a) If the additional work is substantial and the amount involved is large, it is better
to treat the same as a subsidiary contract and a separate contract account should
be operated for the same.
b) If the additional work is not substantial, its cost should be debited to Contract
Account and should be added to the contract price.
viii) Architect's Certificate
In case of large contract which takes a long period, it is a normal practice for the
contractor to get interim advanced payments against the actual portion of contract
completed by him. The contractee appoints the architect or surveyor or engineer who
works as a technical assessor. Architect visits the site periodically, inspects the work
te necessary record in the measurement register and issues a
tdes
certificate showing the stage of completion of work and the value of work done
completely as on the date of issue of certiticate. Thus, as per the contract agreement,
the periodical payment is made to the contractor on the basis of architects certificate
only.
ix) Retention Money:
It is a common practice to include the clause of retention money in the contract
agreement. Under this clause the contractee will not make payment of the work certified
by the architect, but a certain portion thereof shall be retained by him which is called
Ketention Money. The object of this retention money is to place the contractee in a
favourable position in case of faulty work or penalty payable by the contractor.
Ihis amount will be paid to the contractor after the satistactory completion of the work
dependin8 upon the terms of contract. Ketention money is paid when it is ensured that
there is no tault in the work carried out by the contractor. It is calculated as
follows:
Retention Money = Value of Work Certified (Cash Received.
x)Cash Received:
Cash received is that portion of the value of work certified which is paid by the
contractee. It is usually expresed as percentage of work certified. Cash received is
calculated as follows:
Cash received = Value of Work Certified (-) Retention Money
OR
Value of Work Certified (X) Cash Received as % of Work Certified.
OR
Contract Price (X) o of Work Certified (x) % of Cash Received.
xi) Notional Profit:
Notional Profit is the difference between the value of work-in-progress certified and the
cOst of work-in-progress certified.
Computation of Notional Profit :
Notional Profit is computed as follows:
Notional Profit = Value of Work Certified ( Cost of Work Certified
OR
= Value of Work Certified (-) (Total Cost incurred till date
Cost of Work Uncertified)
Basics of Cost Accounting 4 Methods of Costing

CONTRACT COSTING PROCEDURE

The preparation of Contract Account is the essence of Contract Costing. The Contract
Account is prepared by the contractor in his books. In addition to this account he prepares
Contractee's Account also. A separate account is opened for each contract. The purpose of
Contract Account is to know the profit or loss on every contract executed. The basic procedure tor
costing of contract is as follows
i) Contract Account Number:
Each contract is allotted a distinct number in order to distinguish it from other contracts.
A separate account is opened for each contract.
ii) Direct Costs
Most of the costs ofa contract can be allocated direct to the contract. All such direct costs are
debited to the Contract Account. Direct costs for contracts include : i) Materials, i) Labour Cost,
ii) Direct Expenses, iv) Depreciation of Plant and Machinery, v) Sub-Contract Costs
a) Accounting for Material Costs:
Material Costs are accounted in the following manner:
For materials purchased for a contract: Contract Account is debited and Stores Supplier's
Account/Cash/Bank Account is credited.
For materials issued from stores: Contract Account is debited and Stores Control Account is
credited.
For materials returned to stores: Stores Control Account is debited and Contract Account is
credited.
For materials transferred to other contracts: Transferee Contract Account is debited and
Transferor Contract Account is credited on the basis of Materials Transfer Note.
For sale of materials : Cash/Bank Account is debited and Contract Account is credited.
For abnormal loss of materials: Costing Profit and Loss Account is debited and Contract
Account is credited.
For materials supplied by the contractee without affecting the contract price: Such
materials should not be charged to Contract Account.
b) Accounting for Labour Costs:
Labour Costs are accounted for as follows:
Wages paid to workers engaged on a particular contract: Such wages are charged
directly to respective Contract Account.
Wages paid to workers who move from one contract to another: Such wages are
distributed over the contract on the basis of time spent by workers on each contract.
c)Accounting for Direct Expenses:
Direct expenses if any) incurred are directly charged to the respective contract.
d) Accounting for Charge for the use of Plant and Machinery:
The Charge for the use of Plant and Machinery may be accounted for as follows:
Where a plant is specifically purchased for the contract: The Contract Account is debited
with the cost of the plant at the time of purchase and is credited with the depreciated value of
the plant at the end of accounting period.
Basics
of Accounung
Cost 4.12 Methods of Costing
Where a
a plant is issued from stores for short period: The Contract Account is debited
with the amount of depreciation for the period of use.
Where a plant is taken on hire: The Contract Account is debited with the amount of hire
charges.
e) Accounting for Sub-Contract Costs:
Sub-contract costs are also debited to respective Contract Account.
ii) Indirect Costs:
Contract Account is also debited with overheads which tends to be small in relation to direct
costs. Such costs are often absorbed on some arbitrary basis as a percentage of prime cost,
materials, wages etc. Overheads are normally restricted to head office and storage costs.
Accounting for Indirect Expenses or Overheads :
Indirect Expenses or Overheads (such as expenses of Engineers, Surveyors, Supervisors,
Storekeepers, Administration) are distributed over different contracts on some suitable basis like
percentage of material cost, percentage of labour cost, percentage of prime cost, per labour hour
etc.
Accounting for Extra Work:
The cost of extra work should be debited to Contract Account and the amount payable for the
extra work 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.
iv) Transfer of Materials or Plant:
When materials, plant or other items are transferred from the contract , the Contract Account
is credited by that amount.
v) Contract Price:
The Contract Account is also credited with the contract price. In some incomplete contract,
the Contract Account is credited with the value of work-in-progress as on that date.
vi) Profit or Loss on Contract:
The balance of Contract Account represents profit or loss which is transferred to Profit and
Loss Account. In case of incomplete contract, only a part ot profit arrived is taken into account
and remaining profit is kept as reserve to meet any contingent loss on the incomplete portion of
the contract.

ROLE OF CONTRACT COSTING

It isvery important to understand the Role of Contract Costing in ascertaining the cost of a
particular project or activity
Contract Costing is a special form of job costing wherein big projects or activities are
involved which requires considerable time to complete and comprises a number of typical
movements. Herein a separate account is opened for each contact in the Contract Ledger. The
account is debited with all direct and indirect expenses incurred and credited with the amount of
contract price on successful completion of the said contract. The balance of this account is
ultimately transferred to Profit and Loss ACcount.
A separate Contract Acount is maintained for a particular project. All costs relating to the
project undertaken are charged to respective contract account. In contract cost structure, majority
of the expenditure is of direct nature in the form of materials, wages, use of plant and machinery
will be charged as apportioned overheads.
Therefore, Contract Costing is the tracking of costs associated with a specific contract with a
particular project undertaken. Contract Costing can involve a considerable amount of overhead
allocation work. Every conceivable expenditure is charged to the concerned contract. Contract
Cost Accounts are applicable toa business concern which makes specific contracts involving huge
capital investments and requires to know the actual cost of each contract undertaken. Thus,
Basics of COstAccountin9 4.13 Methods of Costing

Contract Costing, as a separate method ot Job Costing, plays an important role in ascertaining the
cost of a particular project or activity undertaken.
4.1.3 CONTRACT CoSTING CONCEPTS
Following are some important contract costing concepts require to be studied in acounting of
a contract.
4.1.3.1 WORK CERTIFIED
It is the cost of that part of the contract work which is being completed by the contractor for
which a completion certificate has been issued by the contractee's architect. The amount of work
certified is debited to Contractee's Account and credited to Contract Account.
Computation of Value of Work Certified :
The value of work certified is calculated as follows
Value of Work Certified
= Contract Price x Work Certified as % of Contract Price
OR
Cash Received
Cash Received as % of Work Certified
Example
Calculate the value of Work Certified in each of the following cases:
a) Contract Price 5,00,000, Work Certified 60%.
b) Cash Received 2,40,000 being 80% of Work Certified.
Answer
a) Value of Work Certified
= Contract Price x Work Certified as % of Contract Price
5,00,000x 60%
3,00,000
b) Value of Work Certified
asn Keceived
Cash as % of Work Certified
2,40,000
80%
3,00,000
4.1.3.2 WORK UNCERTIFIED
It is the cost of that part of the contract work which is being completed by the contractor but
not certified by the architects because of the faulty work or the work not according to the
specifications. in respect of such work there will be no payment from the contractee. The cost
price of each work is debited to Work-in-Progress Account and credited to Contract Account.
Computation of Work Uncertified:
The cost of Work Uncertified is calculated as follows:
Cost of Work Uncertified
Total Cost incurred till date Cost of Work Certified
-

OR
. o
of Work Uncertified
Total Cost incurred till date x oo of Total Work done till date
Basics of Cost Accounting 4.14 Methods of Costing

Example
Calculate the Cost of Work Uncertified in each of the following alternative cases:
a) Total Costs incurred to date R 1,20,000, Cost of Work Certified R 1,00,000.
b) Total Costs incurred to date 1,20,000 to complete 60% of the contract work. However,
architect gave certificate only for 50% of the contract price.

Answer
a) Cost of Work Uncertified
Total costs incurred to date Cost of Work Certified
R1,20,000-7 1,00,000
20,000
b) Cost of Work Uncertified
% of Work Certified
of Total Work done till dateX 1otal Costs incurred
% till date

60%-50 x 1,20,000
60%%

20,000

DIFFERENCE BETWEEN WORK CERTIFIED AND wORK UNCERTIFIED

Thedistinction between Work Certified and Work Uncertified can be shown as follows:
Work Certified Work Uncertified
i) It is the cost of that part of the contract i) It is the cost of that part of the contract
work which is being completed by the work which is being completed by the |
contractor for which a completion contractor but not certified by the
certiticate has been issued by the architects because of the faulty work or
contractee's architect. the work not according to the
specifications.
ii) The amount of work certified is debited to ii) The amount of work uncertified is
Contractee's Account and credited to debited to Work-in-Progress Account
Contract Account and credited to Contract Accournt.
iii) The cost of work certified represents the ii) The cost of work uncertified represents
total expenditure incurred on the contract the cost of the work which has been
to date, less cost of work-uncertified, carried out by the contractor but has not
|

material in hand, plant at site, etc. been certified by the architect. Tt is

always shown at cost price.
iv) Cost of work certified may be ascertained iv) The cost of Work Uncertified may be
as follows: ascertained as follows
Cost of Work Certified = Cost of Work to Cost of Work Uncertified =
date (Cost of Work Uncertified + Total Cost to date
Materials on Hand + Plant at Site). (Cost of Work Certified + **

Materials on Hand + **

Plant at Site)
Basics of Cost Accounting 4.15 Methods of Costing

Generaly, contracts may be of three types viz. fixed price contracts, contracts with escalation
clause and cost plus contracts.

4.1.3.3 ESCALATION CLAUSE

Escalation Clause is usually provided in the contract as a safeguard against likely changes in
price and utilisation of material and labour. By adding this clause, the contractor makes it clear to
his customer that price quoted is dependent on prevailing market prices of cost elements. If the
prices of cost elements rise beyond a certain percentage cover the price prevailing at the time of
tendering, the customer has to bear the additional cost. Ihus, escalation clause Protects the
interest of the contractor against untavourable changes in cost ot raw materials, labour and
overheads e.g. it may be agreed that if the prices of raw materials go up by 20% the contract price
will be increased by 2.5% by providing for upward revision of the contract price. The escalation
clause may also be added to cover the risk involved due to change in utilisation of materal and
1abour, where the quantity ot material or labour time cannot be properly assessed under the work
has sufficiently advanced. Thus, the term of contract specify the procedure for making the
adjustment to avoid all further disputes. Properly constructed escalation clause should cover the
following points :
i) Description of the elements of cost that are subject to escalation.
i) Stipulation of the index to be applied to each cost category.
i) Indication of the frequency with which the contract price will be adjusted.
iv) Definition of the limits to which the cost elements concerned may be increased or
decreased during specific periods or over the length of the contract.
v)The contract should indicate whether changes mean only rises or also falis in prices. The
benetit of lower prices should be transterred to the cosnumer.
vi) Whether only price or rate variable should affect the total payment or also quantity
variance should be aken into consideration. Normally, the quantity variance is the
responsibility of the contractor and cannot be transterred to the contractee.
vil) Prices or rates variances normally means the purchase price of material or wage rates
incurred by the contractor from time to time. It is imperative that the contractee should
have power to investigate or audit the relevant invoices or pay roll. It may also need
certain provisions in the contract, whether the contractor is incurring such expenses
prudently at prevailing rates in the market.
Calculation of Escalation Claim:
Escalation Clause in a contract provides that if during the period of execution of a contract,
the prices of materials, rates of labour etc. rise beyond a specified limit, the corntract price will be
increased by specified rate or amount. Escalation claim so tar as rates are concerned may be
calculated as follows:
For Material = Standard Quantity x (Actual Price Standard Price)
-

For Labour = Standard Labour x (Actual Rate Standard Rate)

-

Escalation Clause does not cOver that part of increase in costs which is caused due to
inetticiency or wrong estimation.
Concept of De-escalation Clause:
Conversely, De-escalation Clause may also be provided for the downward adjustment of the
contract price in case the prices of materials, rates of labour etc. fall beyond a specified limit.
Basics of Cost AccOunting 4.16 Methods of Costing

Thus, de-escalation clause safeguards the interest of the contractee by providing for downward
revision of the contract price.

4.1.3.4 CoST PLUS cONTRACT

This is a modified method of Contract Costing. Under this the contractee agrees to pay to the
contractors the actual cost of work done plus an agreed percentage thereot to cover overhead
expenses and profits. Cost plus contract method is generally employed in those cases,
i) Where the estimated cost of contract cannot be ascertained accurately because of the
frequent changes in the prices of materials and labour rates.
ii) Where the work to be done is not fixed at the time of placing the contract.
ii) When the contract is totally new to the contractor
iv) Where the corntract requires fairly a long period to complete the same.
This method is, commonly used in the manutacturing of exceptional articles
produced very rarely eg. aircraft component, urgent repairing of power house,
constructions during war time etc.
Advantages to the Contractor
i) The Contractor will not suffer any risk of loss as he will receive the contract price as is
assured by the contractee.
ii) There is bargain in the contract price in future under this type of contract.
iil) The contractor is relieved from the botheration of preparing quotation price for the sake
of submitting it to the contractee.
Advantages to the Contractee:
i) Since the contract price is governed by the contract, the contractee will also not suffer
from risk of loss.
ii) The contractee also stands to benefit in a period of uncertain market condition as he is
expected to pay only a reasonable price after satisfying the ruling prices.
Disadvantages to the Contractor
i) No efforts are taken by contractor for cost reduction. Hence, he becomes inefficient.
ii) The profit percentage, though fixed, will necessarily vary in amount since it depends
upon the inerease in cost.
iii) The percentage of profit may either be excessive or inadequate to cover the overhead
expenses also.
Disadvantages to the Contractee
Ihis method is not desirable from the point of view of the contractee because the price
to be paid is depended upon the cost of contract.
(ii) Till complete execution of the contract, he cannot estimate his commitment accurately.

4.1.3.5 WORK-IN-PROGRESS
Contracts in progress mean contracts which have not yet been completed. Such uncompleted
contracts are also referred to as Work-in-Progress. All the expenditure incurred on the
uncompleted contracts should be shown on the asset side of the Balance Sheet under the heading
Basics of Cost Accounting 4.17 Methods of Costing

Work-in-progress. Where protit is taken in respect of incompleted contract, the work-in-progresS

stated in the Balance Sheet should also include the profit ie. valuation of work-in-progress is
done by addition of the profit to the cost of the contract.
It should be shown as follows.
Balance Sheet - Asset Side
Work-in-Progress:
Cost of Contract till date-
Cost of Work Certified
ii) Cost of Work Uncertified

Add: Profit taken to Profit and Loss Account

Less: Cash Received from the contractee

OR
Work-in-Progress:
i) Cost of Work Certified
i) Cost of Work Uncertified
Less: Reserve for unrealised profit
Less: Cash received from contractee
Accounting Treatment:
Depending upon the treatment of work certified, there are two methods of valuation and
disclosure of work-in-progress as follows:
i) When the amount of Work Certified is debited to Work-in-progress Account Amount

A) Value of Work Certified

B) Cost of Work Certified
C) Less: Credit balance on the Contractee's Account
Less: Amount transferred to Reserve
E) Value of Work-in-Progress
(A +B-C-D)

ii) When the amount of Work Certified is debited to Contractee's account Amount

A) Cost of Work Uncertified

B) Add: Debit balance on the Contractee's Account
C) Less: Amount transferred to Reserve
D) Value of Work-in-progress
(A +B-C)

4.1.3.6 PROFIT ON INCoMPLETE CONTRACT

If contracts are started and completed during the same accounting year there is no problem as
regards profit computation. But in case of those contracts which take more than one accounting
Basics of Cost Accounting 4.18 Methods of Costing

year, a problem arises whether profit on such contracts should be worked out only on the
completion of the corntract or at the end of each accounting year on the partly completed work.
profit is computed only on the completion of the contract profit will be high in the year of
completion of the contract, whereas in other years of working on contract, profit will be nil. This
would result not only in distorted profit patterns, but also higher tax liability because income
tax at higher rates may have to be paid accordingly. Hence, when contracts extends beyond a
year, it becomes necessary to take into account the profit earned (or loss incurred) on the work
performed during each year. This helps in avoiding distortion of the year to year profit trend of
the business. There are two aspects of profit computation viz. 1) Computation of estimated oor
notional profit at the end of the year when contract is not complete. i) Computation of the
portion of such profit to be transferred to Profit and Loss Account.
It is always better to anticipate the future losses and to make the necessary provision
forthe same, but do not recognise any profit till they are actually realised.
Principles to be followed while taking credit for profit on incomplete contract:
These principles are as follows
i) The costs incurred upto date should be clearly identified.
ii) The stage of contract performance completed should be reasonably estimated.
ii) The costs to complete the contract should be reasonably estimated.
iv) The total contract revenues to be received should be reliably estimated
v) The work certified should be valued in terms of contract price and its value should be
treated as contract revenue for the accounting period.
vi) The uncertified work should be valued at cost and should be treated like closing
inventory at the end or accounting period.
vii) The notational profit on incomplete contract should be estimated as under:
Notational Profit = Value of Work Certified + Cost of Uncertified Work Costs incurred to date
Conventional norms for determining the profit:
The amount of protit that is to be credited to Protit and Loss Account depends upon the fact
that how far the contract has advanced.
There are no hard and fast rules in this regard. However, the following are the conventional
norms for determining the profit to be taken to the Profit and LOSs Account at different stages of
completion.
i) It should be noted that the profit should be considered in respect of work certified only.
Work certified should always be valued at cost.
i) If a very small portion of the work has been done, it is neither desirable nor sound to
take into account profit on the work done and the Contract Account must then be closed by
balance. In such a case, the amount expended on account of the contract to the date of balancing
will be shown as Work-in-Progress on the asset side of the Balance Sheet and any cash received
from the contractee on account of work will be shown by way deduction thereform.
Basics of Cost Accounting 4.19 Methods of Costing_

No definite rule can be laid down as to what stage of the work it would be safe to take credit
for the profit on incomplete contractors. But the general rule may be laid down is that no profit
should be ascertained unless at least one fourth or less of the whole work has been completed.
ii) When the work certified is 25% or more but less than 50%% of the contract price, profit to
be taken to the credit of Profit and Loss Account will be computed as follows:
Received
Notional Profit xxash
3° Work Certified
iv) When the work certified is 50% or more but less than 90% of the contract price, profit to
be taken to the credit of Profit and Loss Account will be computed as follows
Received
=Notional Profitit xCash
*3* Work Certified
v) When contract is near completion, then the estimated profit should be calculated as of
the whole contract. This is computed as follows:

Contract Price
Less: Total Expenditure to date
Less: Estimated Additional Expenditure
Estimated Profit
The profit to be taken to the credit of Profit and Loss Account will be computed by applying
any of the following formula :

Estimated Profit x Work Certified

Contract Price
Work Certified Cash Received
Estimated Profit x Contract Price
-
^
Work Certified
OR

Estimated Profit x
Cash Received
Contract Price
Cost of Work to date
Estimated Protit Estimated Total Cost
Cost of work to date Cash Received
Estimated ront Estimated Total Cost Work Certitfied
vi) For Loss on incompleted contracts
If the cost of work certified exceeds the value of such certificate or loss is incurred. The
whole amount of such loss is to be charged to Profit and Loss Account. The entry will be passed
as tollows
Profit and Loss A/cC Dr.
To Contract A/c
vii)Provision for Foreseeable Losses:
When current estimates of total contract costs and revenue indicate a loss, provision
should be made for the entire loss on the contract irrespective of the amount of work done and
the method of accounting followed.
Basics of Cost Accounting 4.20 Methods of Costing

ACCOUNTING ENTRIES
Following are the accounting entries to be passed in the books of contractor for the
transactions transacted during the period of a contract.
i) For materials issued to Contract:
Contract A/c Dr.
To Materials A/c
ii) For surplus materials transferred to another Contract:
Receiving Contract A/c Dr.
To Supplying Contract A/c
iii) For expenses incurred or payable on contract:
Contract A/c
To Expenses A/c
To Outstanding Expenses A/c
iv) For Plant and Machinery and Equipments (at cost) issued to contract:
Contract A/c Dr.
To Plant and Machinery/Equipment A/c
v) For share of apportioned Overhead Expenses:
Contract A/c
To Overhead A/c
vi) For sub-contract cost
Contract A/c DI.
To Sub-contract A/cC
vii) For materials at site at the end or materials returned to stores or supplier:
Materials A/c or Material Returned A/c DI.

To Contract A/c
vii) For Plant and Machinery and Equipment at site at the end at written down value:
Plant and Machinery A/e Dr.
Equipment A/c Dr.
To Contract A/c
ix) For Work Certified:
Contractee's A/c
To Contract A/c
x)For Work Uncertified:
Work-in-Progress A/

.
D.
To Contract A/c
xi) For cash received against Work-Certified from Contractee:
Bank A/
To Contractee's A/c
xii) For materials or plant sold at site at profit :
Bank A/c Dr.
To Contract A/c (cost of material/plant)
To Profit and Loss A/c (with Profit on sale)
If there is a loss, the above entry will be reversed.
Basics of Cost ACcounting 4.21 Methods of Costing

xiii) For materials stolen or lost and Insurance Co. admitted claim for certain account:
Bank A/c Dr. (Recovery for Insurance Co).
Profit and Loss A/cC Dr. (LoSs on material)
To Contract A/c
xiv) For Abnormal Loss of materials, Plant etc. on site:
Profit and Loss A/c Dr.
To Contract A/c
xv) For Sale of scrapP:
Bank A/c Dr.
To Contract A/c
xvi) For Profit transferred to Profit and Loss Account or Profit to be reserved
Contract A/c Dr.
lo Profit and Loss A/c (with profit credited)
To Work-in-Progress/Profit Reserve A/c (with profit kept as Reserve)
LEDGER AccOUNTS
Various ledger accounts in the books of a contractor in a simplified format may be shown as
follows:
Format of Contract Account
Contract Account No.
. for 1st Accounting Period

ParticuiaS ParticulalS
To Materials
By Materials at Site
To Wages incurred (Paid + Ols - Prepaid) **
By Stores Ledger
To Direct Expenses (Paid + Ols - Prepaid) ... (Return to Store)
To Depreciation on Plant and Equipments) Bank
To Office and Administration Expenses incurred (Sale of Materials)
(Paid+O/s -
Prepaid) By Costing Profit and Loss
(LoSs on Sale)
By Cost of Contract C/D

ro Cost of Contract B/D .By Work-in-progress:

To Notional Profit C/D ** Value OT Work ertuned
Cost of Work Uncertified

To Profit and Loss Account By Notional Profit B/D

To Reserve AcCOunt

r
Contract Account No. . for 1st Accounting Period

Particuiars Particulars
To Work-in-progress B/D
Value of Wok Certified
Add: Cost of Work Uncertifed +)

Less: Reseve
Remaining portion same as in previouS format
Basics of Cost Accounting 4.22 Methods of Costing

Format of Balance Sheet of a Contractor|

Balance Sheet of ds d
Liabilities Assets
Capital Land and Buildings
Profit and Loss Account
...Less: Depreciation
Outstanding Expenses
idnt and Equipments
Less: Depreciation
At Stores
At Site
Materials
AtAt Stores
Site
Work-in-Progress

Value of Work Certified

Cost of Work Certified
Less: Contractee's Credit Balance
Less: Transfer to Reserve
Cash and Bank Balance
Prepaid Expenses

Format of Contractee Account

T. Contractee's Account
Particuials Particulars
To Balance B/D
By 5ank (Part Payment)

To Contract . |By Balance CID

(Contract Price) By Bank (Final Payment)

Alternative Format of Contract Account

Contract Account
Particulars Particulars
ToWork-in-Progress (Opening) ByMaterials:
'Work-certified *******
Returned to Store *******

Transferred to other contracts

'Work Uncertified
Plant at Site
*****

Materials at Site
By Costing Profit and LoSs ******

Less: Reserve (Loss on Sale if any)

By Plant returned to stores

Less Depreciation
To Materials: By Costing Profit and L0SS Account
(For items stolen/lost)
From Stores ByWork-in-Progress(Closing):
From outside (purchases) Work Certified
From Other Contracts Work Uncertified
To Wages (including Outstanding) Plant at site
Materials at site
To Direct Expenses (including Outstanding)_
Basics of Cost AcCountung 4.23 Methods of Costing

Particulars Particulars
To Plant at Cost/Tools at Cost OR
To Overheads (inciuding outstanding) By Contractee's Account ***

With totalcontract price in case of

contracts completed)
To Sub-contract Costs
To Cost of Extra-Work done
To Profit and Loss Ac
(Profit on sale, if any)
To Notional Profit C/D

To Profit and Loss Alc By Notional Profit B/D

ashReceived
( or x Notional Profit x Work Cerifed

To Work-in-Progress AVc (Reserve)

ILLUSTRATIONS
ILLUSTRATION 1
Amar Builders, Aurangabad is engaged on two contracts viz. A and B during the year
2018-2019. The following particulars are available on 31s* March, 2019 in respect of Contract-A
.

Contract Price 6,00,000

Materials issued to contract Contract A/C - Dr 1,60,000
Materials returned to stores Contract A/C - Cr 4,000
Materials on site on 31st March, 2019 Contract A/C - Cr 22,000
Materials transferred to Contract B' Contract A/C - Cr 9,000
Direct Labour Contract A/C - Dr 1,40,000
Chargeable Expenses Outstanding Contract A/C - Dr 6,000
Wages Payable Contract A/C - Dr 2,000
Direct Expenses Contract A/C - Dr 60,000
Hire of Special Machinery Contract A/C - Dr 10,000
Administration Overheads Contract A/C - Dr 25,000
Plant installed at site at cost Added to The Machinery for Depreciation 75,000
Cost of contract not yet certified - Work Uncertified - Contract A/C - Cr 23,000
Plant Installation Charges Added to The Machinery 5,000
Value of Work Certified Contract A/C - Cr 4,20,000
Value of plant on 31s March, 2019 Less from Plat Installed At Site 65,000
Cash received from Contractee Information to compute part of profit to be trf to P/L A/C 3,78,000
You are required to prepare Contract A' Account for the year ended 31st March, 2019.
Basics of Cost Accounting 4.24 Methods of Costing

SOLUTION
Working Notes:
i) Calculation of Depreciation on Plant :
Plant cost + Installation Charges- Value of Plant on 31st March, 2019
75,000+R 5,000-7 65,000
15,000
i) Calculation of amount of Notional Profits to be credited to Profit and Loss Account:
As the value of Work Certified (R 4,20,000) is more than "/2 of the Contract Price
R 6,00,000), the following formula is to be applied to find out the amount of notional profits to be

credited to Profit and Loss Account.

Cash Received
2/3x Notional Profits x Work Certified

60,000 x,78,000
=2/3x
= 36,000
In the books of Amar Builders, Aurangabad, Contract Price = Rs 6,00,000

r. Contract Account for ContractA' for the year ended 31st March, 2019 Cr.
Particulars Particulars
To Materials issued to Contract 1,60,000 By Materials returned to stores 4,000
To Direct Labour 1,40,000 By Materials at site on 31-3-2019 22,000
To Chargeable Expenses outstanding 6,000 By Materials transferred to 9,000
Contract B
To Wages Payable 2,000 By Cost of contract not yet certified 23,000
To Direct Expenses 60,000 By Value of Work Certified 4,20,000
To Hire of Special Machinery 10,000
To Administration Overheads 25,00 % of WC = WC / CP
To Depreciation on Plant 15,000 = 420000 / 600000
To Notional Protits C/D* 60,000 = 70%
4,78,000 78,000
To Profit and Loss Working Note 36,000 By Notional Profits B/D 60,000
To Reserve 24,000
60,000 60,000
ILLUSTRATION2
The following balances have been extracted from the books of Shanti Constructions, Surat on
31st March, 2019.

Contract Price 6,00,000

Plant and Machinery as on 1t April, 2018 30,000
Materials 1,70,600
Labour Charges 1,48,750
Engineer's Fees 6,330
Outstanding Wages 5,380
Basics of Cost Accounting 4.25 Methods of Costing

Uncertified Work 12,000

Overhead Expenses ,240
Materials Returned to Stores ,600
Materials on hand at site 3,700

Plant and Machinery on hand at site on 31st March, 2019 22,000

Value of Work Certified 3,90,000
Cash Received 3,51,000
Prepare Contract Account for the year ended 31st March, 2019 showing separately the
amount of profit that may be taken to the credit of Profit and Loss Account. Also calculate the
amount of work-in-progress as it would appear in the Balance Sheet as on 31st March, 2019.
SOLUTION
Working Notes:
i) Calculation of amount of Notional Profits to be credited to Profit and Lo5s Account
As the value of Work Certified ( 3,90,000) is more than '/2 of the Contract Price (R 6,00,000),
the following formula is to be applied to find out the amount of notional profit to be credited to
Profit and Loss Account.
Cash Received
x Notional Proftits X Work Certified

=x 51.00
60,000x T 3,90,000
36,000
ii) Calculation of amount of Work-In-Progress

Value of Work Certified 3,90,000

Add: Uncertified Work (+) 12.000
000
Less:Cash received 351.000
51,000
Less: Reserve 24000
Work-in-progress 27.000
ii) Calculation of depreciation on Plant and Machinery:

Plant and Machinery as on 1st April, 2018 30,000

Less: Plant and Machinery on hand at site on 31st March, 2019 922000
Depreciation on Plant and Machinery O00
Basics of Cost Accounting9 4.26 IMethods of Costing

In the books of Shanti Constructions, Surat

Dr. Contract Account for the year ended 31st March, 2015 Cr.
Particulars Particulars
To Depreciation on Plant and Machinery 8,000 By Uncertified Work 12,000
To Materials 1,70,600 By Materials returned to stores 1,600
lo Labour Charges 1,48,750 By Materials orn hand at site 3,700
To Engineer's Fees 6,330 By Value of Work Certified 3,90,000
To Outstanding Wages 5,380
To Overhead Expenses 8,240 |
To Notional Profits C/D* 60,0
4,07,300 4,07,300
To Profit and Loss 36,000 By Notional Profits B/D 60,000
To Reserve 24,000
60 60,000
ILLUSTRATION 3
Ramesh Builders, Raipur took a contract to build a society hall on 1st April, 2018. The contract
price was agreed at * 8,00,000. They have incurred following expenditure during the year
2018-2019.

Direct Materíals 50,000

Direct Labour 30,00
Direct Expenses 20,000
Plant 80,000
From the following additional information prepare a Contract Account for the year ended
31st March, 2019. Also show the amount in Work-in-Progress which will be shown in the Balance
Sheet of the Contractor as on that date.

Value of Plant as on 31sT March, 2019 60,000

Stock of material on hand at site 10,000
Materials returned to storehouse 2,000
Value of Work Certified 1,50,000
Cost of Work Uncertified 8,000
Cash Received 1,40,000
SOLUTION
Working Notes:
i) Calculation of amount of Notional Profits to be credited to Profit and Loss Account :
As the value of Work Certified (R 1,50,000) is less than "/4 of the Contract Price ( 8,00,000),
nothing out of notional profits will be transferred to Profit and Loss Account, but everything will
be transferred to Reserve Account.
Basics of COst Accounting 4.27 Methods of Costing

i) Calculation of amount of Work-in-Progress

= Total Expenses Asset in hand + Profits transterred to Profit and Loss Account.
-

Expenses ...
lotal 1,80,000
(Direct Materials Direct Labour Direct Expenses Plant
50,000 30,000 7 20,000 80,000
Less: Assets in hand . 2.000
1,08,000
Add: Profits transferred to Profit and Loss Account NIL
. Work-in-Progress 1,08,000
In the books of Ramesh Builders, Raipur
Dr. Contract Account for the year ended 31st March, 2019 Cr
Particulars Particulars
To Direct Materials 50,000 By Stock of Materials on hand at site 10,00
To Direct Labour 30,000 By Materials returned to storehouse 2,000
To Direct Expenses 20,000 By Value of Work Certified 1,50,000
To Depreciation on Plant 20,000 By Value of Work Uncertified 8,000
(Opening Closing
R80,000 60,000)
lo Notional Profits C/D* 50,000|
1,70,000 1,70,000
To Profit and Loss By Notional Profits B/D 50,000
To Reserve 50,000
50,000 50,000
LLUSTRATION 4
Bharat Constructions, Baroda undertook a Contract No. 54 for 4,00,000 on 1st April, 2018.
They incurred the tollowing expenses during the year 2018-2019.

Materials issued from stores 36,600

Materials transferred from Contract No. 45 3,400
Materials directly purchased for the Contract 10,000
Materials in hand on site 2,500
Plant issued for contract 20,000
Wages paid directly 70,000
Architect's Fees 3,000
Wages due but not paid ,000
Direct expenses outstandings 600
Cash received from contractee 1,44,000
Work Certified 1,80,000
Cost of Work uncertified 1,500
Of the Plant and Materials charged to contract, Plant costing 4,000 and Materials costing
3,000 were lost. On 31t March, 2019 Plant costing 3,000 was returned to stores. Charge
depreciation on Plant@15% p.a. as per written down value method.
Prepare Contract Account for the year ended 31t March, 2019.
Basics of Cost AccOunting 4.28 Methods of Costing

SOLUTION
Working Notes:
i) Calculation of amount of Notional Profits to be credited to Profit and Loss Account :
As the value of Work Certified 1,80,000) is more than /4 but less than /2 of the contract
price ( 4,00,000), the following formula is to be applied to find out the amount of notional profits
to be credited to Profit and Loss Account.
Cash Received
x Notional Protits x Work Certified
1,4 00
3x 60,000
1,80,000
16,000
In the books of Bharat Constructions, Baroda
Dr. Contract Account for Contract No. 54 for the year ended 31st March, 2019
Particulars ParticularS
r
To Materials issued from stores 36,600 By Materials in hand on site 2,500
To Materials transferred to Contract 3,400 By Work Certified 1,80,000
No. 45
To Materials directly purchased for 10,000 By Cost of Work Uncertified 1,500
the Contract
To Plant issued for contract 20,000 By Costing Protit and Loss Account
To Wages paid directly 70,000 () Plant lost 4,000
To Architect's Fees 3,000 Materials lost
(i) 3,000
To Wages due but not paid 1,000 By Plant returned to stores:
|

To Direct Expenses Outstandings 600 Original Cost 3,000

Less: Dep. ®15% p.a. -450 2,550
|

By Plant in Hand:
Original Cost 13,000
Less: Dep. 15% p.a. 91950 11,050
To Notional Profits C/D 60,000
2,04,600 2,04,600
To Profit and Loss 16,000 By Notional Profits B/D 60,000
To Reserve" 44,000
60,000 60,000
LLUSTRATION 5
Cooper Constructions Pvt. Ltd., Chennai undertook a contract for construction of a library
buildings. The following is the information relating to the contract during the year 2018-2019.

Materials sent to site 1,00,000

Materials purchased and issued 70,698
Matertais
on 31st
Materials at site on 31t March,
March, 2019
1,096
3,766
Labour engaged on site 1,40,000
Wages accrued and due but not paid 8,750
Engineer's Fees 6,334
irect Expenses Payable 580
General Overheads 8,252
Basics of Cost Accounting 4.29 Methods of Costing

Overheads Outstanding 9,250

Plant Installed at site at cost 500
Erection Charges on site for Plant 1,250
Scrap Value of plant after its life of five years 2,750
Work Certified 3,90,000
Cost of Work not Certified 9,000
Cash received from Contractee 3,60,000
Prepare Contract Account and Contractee's Account. Also show the amount of profit which
you consider might be fairly taken on the Contract and how you have calculated the same.
SOLUTION
Working Notes:
i) Calculation of depreciation on Plant:
Purchase Price + Erection charges- Scrap Value
Estimated Life of Plant
41,500 +R 1,250-R 2,750
years
40,000
5years
8,000
ii) Calculation of amount of Notional Profits to be credited to Profit and Loss Account:
In the absence of Contract Price, it is assumed that the value of Work certified R 3,90,000)
must be more than /2 of the Contract Price, the following formula is to be applied to find out the
amount of notional profits to be credited to Profit and Loss Account.
Cash Received
x Notional Profits x Work Certified

x 52,000
3,60,000
90,000
= 32,000
In the books of Cooper Construction Pvt. Ltd. Chennai,
DI. Contract Account for the year ended 31st March, 2019 C
Particulars Particulars
To Materials sent to site 1,00,000 By Materials returned to stores 1,098
To Materials purchased and issued 70,698 By Materials at site on 31-3-2019 3,766
To Labour engaged on site 1,40,000 By Work Certified 3,90,000
To Wages accrued and due but not paid | ,750
To Engineers Fees 6,334 By Cost of Work not Certified 9,000
To Direct Expenses payable S80
To General Overheads 8,252
To Overheads Outstandings 9,250
To Depreciation on Plant 8,000
To Notional Profits C/DD 52,000
4,03,864 4,03,864
To Profit and Loss 32,000 By Notional Profits B/D 52,000
To Reserve* 20,000
52,000 52,000
Basics of Cost Accounting 4.30 Methods of Costing

Dr. Contractee Account Cr.

Particulars Particulars
To Work Certified 3,90,000 By Bank ,60,000
By Balance C/D* 30,000
(Balancing figure i.e. Retention
money)
3,90,000 3,90,000
ILLUSTRATION 6
Reliable Constructions Ltd., Raipur undertooka contract of 8,00,000 for the construction of
a sports Gymkhana on 1st April, 2018. The following information is taken up from the contract
ledger as on 51a Ma in respect of the above.

Materials directly issued from stores 1,30,000

Materials purchased 70,000
Scrap materials sold 8,000
Materials transferred to other contract 10,000
Materials in hand on site 11,000
Materials returned to stores 5,0D00
Direct Wages paid and payable 85,000
Direct Charges 45,000
Overheads charged to contract 40,000
Sub-contract cost 9,000
Cost of additional work 3,400
Outstanding Direct Expenses 1,600
lant purchased on 1st April, 2018 and issued directly 80,000
Annual depreciation on Plant 8,000
Plant transferred on 1st April, 2018 to other contract 40,000
Cash received being 90% of Work Certified 3,60,000
Uncertified Work being 8% of ce ed
You are required to prepare: i) Contract Account and i) Contractee's Account
SOLUTION
Working Notes:
i) Calculation of value of Work Certified :
Work Certified = Cash Received + Retention Money
100
= R3,60,000
90 + 10

If 90 CR = 100 WC
7 3,60,000 CR = ?
5,60,000 x 100
90
4,00,000
ii) Calculation of cost of Work uncertified
=8% of Work Certified i.e. T 4,00,000
32,000
Basics of Cost Accountin9 4.31 Methods
of Costing

ii) Calculation of amount of Notional Profits to be credited to Profit and Loss Account :
As the value of Work Certified (R 4,00,000) is exactly half of the contract price (R 8,00,000) the
following formula is to be applied to find out the amount of notional profits to be credited to
Profit and Loss Account.
x Cash Received
Notional Profits x Work
Certified

x 3,60,000
75,000xT
4,00,000
745,000
In the books of Reliable Constructions Ltd., Raipur
Dr. Contract Account for the year ended 31st March, 20119 Cr.
Particulars Particulars
To Materials directly issued from 1,30,000 By Scrap materials sold 8,000
stores
To Materials purchased 70,000 By Materials transferred to other 10,000
contract
lo Direct wages paid and payable 85,000 By Materials in hand on site 11,000
To Direct charges 45,000 By Materials returned to stores 6,000
To Overheads charged to contract 0,000 By Plant at Site on hand 40,000
To Sub-Contract cost 9,000 Less: Depreciation 8.000 32,000
To Cost of additional work 3,400 | By Plant transterred to other 40,000
To outstanding direct expenses 1,600 contract on 1st April, 2018
To Plant purchased and issued 80,000 By Value of Work certified 4,00,000
directly
By Cost of Work Uncertified 32,000
To Notional Profits C/D* 75,000
5,39,000 5,39,000
To Profit and Loss 45,000 By Notional Profits B/D 75,000
To Reserve 30,000
75,000 75,000
Dr. Contractee Account Cr.
Particulars Particulars
To Work Certified 4,00,000 By Bank ,60,00
By Balance C/D* 40,000
(Balancing Figure i.e. Retention
money)
40,000 40,000
LLUSTRATION 7
Porwal Builders, Patna undertook several large contracts. The following are the particulars
relating to Contract No. 22 tor the year ended 31st March, 2019.

Materials issued from storehouse 90,000

Materials purchasedd 40,000
Materials transferred from Contract No. 27 25,000
Materials returned to storehouse 500
Materials at site on 31st March, 2019 1,000
Basics of Cost Accounting 4.32 Methods of Costing

Plant purchased and installed at site 72,000

Freight and installation charges of plant 8,000
Operating Wages 1,22,000
Process Labour outstandings 5,000
Other Direct Expenses 12,000
Operating Expenses payable 2,000
Establishment on Cost 27,000
Office Expenses acerued 1,500
Work Uncertified 6,000
Contract Price 16,00,000
Cash Received from Contractee 3,20,000
(represented the full amount of Work Certified less 20% as retention money).
Provide depreciation on Plant @ 10% p.a as per Reducing Balance Method.
You are required to prepare, Contract Account and Contractee's Account.
SOLUTION
Working Notes:
i) Calculation of value of Work Certified:
Work Certified = Cash Received + Retention Money
100 30 20
? 3,20,000
If 80 CR = 100 WC
3,20,000 CR =?
3,20,000 x 100
=

= 4,00,000.
ii) Calculation of amount of Notional Profits to be credited to Profit and Loss Account.
As the value of Work Certified ( 4,00,000) is exactly 1/4 of the Contract Price ( 16,00,000) the
following formula is to be applied to find out the amount of notional profits to be credited to
Profit and Loss Account.
Cash Received
=
xNotional ProtitS X Work Certified

=
x 5 oM 320,000
75,000x4,00,000
= R20,000
i) Calculation of depreciation on Plant @ 10% p.a. as per Reducing Balance Method:

Add:
Plant purchased and installed
Freight and installation charges
000
(+) 8,000
80,000
Less: Depreciation@ 10% p.a. ( 8.000
Z000
Basics of Cost Accounting 4.33 Methods of Costing

Dr. Contract Account for Contract No. 22 for the year ended 31st March, 2019 Cr.
Particulars Particulars
To Materials issued from storehouse 90,000 By Materials returned to storehouse
|
500
To Materials purchased 40,000 | By Materials at site on 31-3-2019 1,000
To Materials transterred from 25,000 By Work Certified 4,00,000
Contract No. 27
To Depreciation on Plant 8,000 By Work Uncertified 6,000
To Operating Wages 1,22,000
To Process Labour Outstandin8s 5 oo
To Other Direct Expenses
ToOperating Expenses Payable 2,000
To Estabishment on cost 27,000
To Office Expenses Accrued
To Notional Profits C/D
1,500
75,000
4,07,500 4,07,500
To Profit and Loss 20,000 By Notional Profits B/D 75,000
To Reserve* 55,000
75,000 75,000
Dr. Contractee's Account Cr.
_
Particulars Particulars
To Work Certified 4,00,000 By Bank 3,20,000D
By Balance C/D* 80,000
(Balancing Figure i.e. Retention
money)
4,00,000 | 4,00,000
LLUSTRATION 8
Gharkul Builders, Goregaon took a Contract No. 51 for construction of a school buildings on
1s April, 2018. The Contract price is fixed at R 15,00,000 subject to a retention of 20% of work
certified. The tollowing are the details of expenses made by the contractor on this contract during
the year 2018-2019.

Productive Labour Charges 4,00,000

Unproductive Labour Charges 5,000
Outstanding Wages 7,800
Materials lssued torm store-room 4,20,0000
Materials Purchased directly 81,2200
Stock of Materials in hand on site 300
Materials Transferred to Contract No. 52 6,000
Materials Transferred from Contract No. 50 1,600
Direct Expenses 23,,000
(Inclusive of unpaid chargeable expenses 3,000)
Establishment Overheads 37,200
Plant Installed at site on 30th September, 20188 58,000
Installation Charges for Plant 2,000
Work Certified 11,00,000
Work Uncertified 16,500
Cash Received upto 31st March, 2019 S,80,000
Basics of CostAccounting 4,34 Methods of Costing
Provide depreciation on Plant @ 40% p.a. as per Straight Line Method.
Prepare, Contract Account for Contract No. 51 and Contractee's Account
SOLUTIONN
Working Notes
i) Calculation of depreciation on Plant @ 40% p.a. as per Straight Line Method:

Plant installed at site on 30th September, 2018 58,000

Add: Installation charges (+) 2.000
Original Cost 60,000
Less: Dep. 40% of R60,000 for 6 months 12.000
Value of Plant at site on 31st March, 2019 48,.000
ii) Calculation of amount of Notional Profits to be credited to Profit and Loss Account.
As the value of Work Certified * 11,00,000) is more than /2 of the Contract Price
15,00,000), the following formula is to be applied to find out the amount of notional profits to
be credited to Profit and Loss Account.

=x Cash Received
Notional Profits Work Certified
R8,80,000
x1,35,000x 11,00,000
72,000
Dr Contract Account for Contract No. 51 for the year ended 31st March, 2019 Cr.
Particulars Particulars
To Productive Labour charges 4,00,000 By Materials transterred to 6,000
Contract No. 52
To Unproductive Labour charges 5,000 By Work Certified 11,00,000
To Outstanding Wages 7,800 By Work Uncertified 500
To Materials issued from store-room 4,20,000 By Stock of Materials in hand on |
300
site
To Materials purchased directly 61,200
To Materials transferred from 1,600
Contract No. 50
To Direct expenses 23,000
including unpaid chargeable
expenses)
To Establishment Overheads 37,200
To Depreciation on Plant 12,000
To Notional Profits C/D* 35,000
11,22,800o 11,22,800
To Profit and Loss 72,000 By Notional Profits B/DD 1,35,000
lo Reserve" 63,000
1,35,000 1,35,000
Dr. ontractee's Account
Particulars Particulars
To Work Certified 11,00,000 By Bank 8,80,000
By Balance C/D 2,20,000
(Balancing Figure i.e. Retention
money)
|
|11,00,000 11,00,000
Basics of Cost Accounting 4.J8 Methods of Costing

ILLUSTRATION 9
The following information is relating to building contract of R 50,00,000 undertaken by
Niwara Builders, Nanded. The contractee has agreed to pay 90% of the work certified in cash.
Particulars 2016-17 2017-18 2018-19

Materials ,00,000 8,00,00 4,00,000

Labour 3,20,000 4,80,000 5,00,000
Expenses -Direct 20,000 30,000 10,000
Expenses-Indirect 10,000 7,000 3,00
Work Certified 10,00,000 30,00,000 50,00000
Work Uncertified 40,000
Plant issued 2,00,000
Value of Plant on Closing Date_ 1,80,000 1,60,000 1,30,000
Prepare Contract Account for the year 2016-17, 2017-18 and 2018-19 separately.
SOLUTION
Working Notes:
2016-1
The entire amount of loss suffered during the year 2016-17 is to be transferred to Profit and
LOss ACcount
ii) 2017-18:
As the value of Work Certified ( 30,00,000) is more than /2 of Contract Price (R 50,00,000),
the following formula is to be applied to find out the amount of Notional Protits to be credited to
Profit and Loss Account.
Cash Received
x Notional Protits X Work Certified

x 27,00,000
7,03,000 x 7 30,00,000
4,21,800
ii) 2018-19:
As entire contract is completed during the year 2018-19, the total amount of profit is to be
transferred to Profit and Loss Account
In the books of Niwara Builders, Nanded
DE. Contract Account for the year ended 31st March, 2017 r.
Particulars Particulars
To Materials 7,00,000 By Work-in-Progress:
To Labour 3,20,000 i) Work Certified 10,00,000
To Expenses- Direct 20,000 i) Work Uncertified
To Expenses - Indirect 10,000 ii) Plant in hand 1,80,00
To Plant issued 2,00,000| (Closing Balance C/D.)
By Profit and Loss 70,000
(Balancing figure i.e. Actual loss)
12,50,000 12,50,000
Basics of Cost Accounting Methods of Costing

Dr. Contract Account for the year ended 31st March, 2018 Cr.
Particulars Particulars
To Work-in-Progress : By Work-in-Progress:
Work Certified 10,00,000 Work Certified 30,00,000
ii) Work Uncertified ii) Work Uncertified 40,000
i) Plant in hand 1,80,000 ii) Plant in hand 1,60,000
(Opening Balance B/D.) (Closing Balance C/D.)
To Materials 8,00,000
fo Labour 4,80,000
To Expenses-Direct 30,000
To Expenses- Indirect 7,000
To Notional Profits C/D* 7,03,000
(Balancing Figure i.e. Notional
Profits)
32,00,000 32,00,000
To Profit and Loss 4,21,800 By Notional Profits B/D 7,03,000
To Work-in-Progress 2,81,200
(Reserve C/D)
7,03,000 7,03,000
Dr. Contract Account for the year ended 31st March, 2019 Cr.
Particulars Particulars
ToWork-in-Progress ByWork-in-Progress:
1) Work Certified ,00,000 (Reserve B/D) 2,81,200
Work Uncertified 40,000 By Contractee's A/c 50,00,000
Plant in hand 1,60,000 (Work Certified)
(Opening Balance B/D.) By Plant in hand 1,30,000
To Materials 4,00,000 (Closing Balance C/D)
To Labour 5,00,000
To Expenses - Direct 10,000
lo Expenses- Indirect 3,000
To Profit and Loss 12,98,200
(Balancing Figure i.e. Actual Profit)
54,11,200 54,11,200
Working Notes:
Particulars 2016-17 2017-18 2018-19

Contract Price 50,00,000 50,00,000 50,00,000

Work Certified 100%| 10,00,00030,00,000| 50,00,000
Work Uncertified 40,000
Cash Received 90% 9,00,000 27,00,000
Retention Money 10% 1,00,000 3,00,000
Actual Loss/Notional Profits/Actual Profit 70,000 7,03,000 12,98,200
(AL) (NP) (AP)
Basics of Cost Accounting 437 Methods of Costing

ILLUSTRATION 10
The following information relates to Aditya Builders, Amravati for 10,00,000.
2018 2019

Materials issued 3,00,00 84,000

Direct Wages 2,30,000 1,05,000
Direct Expenses 22,000 10,000
Work Certified 7,50,000 10,00,000
Work Uncertified 8,000
Materials at site 5,000 7,000
Plant issued 14,000 2,000
Cash received from Contractee 6,00,000
10,00,000
The value of plant at the end of 2018 and 2019 was 7,000 and 5,000 respectively.
Prepare, Contract Account and Contractee's Account for two years 2018 and 2019 taking into
consideration such profit for transter to Profit and Loss Account as you think proper.
SOLUTION
In the books of Aditya Builders, Amravati
Dr. Contract Account for 2018 Cr.
Particulars Particulars
To Materials issued 3,00,000 By Materials at site C/D 5,000
To Direct Wages 2,30,000 By Plant at site C/D 7,000
To Direct Expenses 22,000 By Work-in-Progress C/D
To Indirect Expenses 6,000 Work Certified 7,50,000
To Plant Issued 14,000 Work Uncertified (+) 8000 7,58,000
To Notional Profits C/D* ,000
1,98,0

7,70,000 7,70,000
To Profit and Loss 1,05.600 By Notional Profits B/D 1,98,000
To Work-in-Progress 92,400
1,98,000 1,98,000
Working Note:
Profit taken to Profit and Loss Account:
= Notional Profit x2Cash Received
3*Work Certified
1,98,000 2 6,00,000
x3x7.50.000-1,05,600
Dr. Contract Accountfor 2019_
Particulars Particulars
To Materials at site B/D 5,000 By Materials at site 00n
To Plant at site B/D ,000 By Plant at site
lo Work-in-Progress B/D 6,65,600 By Contractee's Account 10,00,000
R7,58,000-92,400)
To Materials issuedd 84,000
To Direct Wages 1,05,000
To Direct Expenses 10,000
To Indirect Expenses 1,400
To Plant issued 2,000
To Profit and Loss A/c 1,32,000
10,12,000 10,12,000
Basics of Cost Accounting 4.38 Methods of Costing
Dr. Contractee's Account Cr.
Particulars Particulars
2018 To Work Certified 7,50,000 2018 By Bank 6,00,000D
2018 By Balance C/D 1,50,000
7,50,000 7,50,000

2019| To Balance B/D 1,50,000 2019 By Bank 10,00,000

2019 To Work Certified 10,00,000 2019 By Balance C/D 1,50,000
(Balancing igure
ie. Retention Money)
11,50,000 11,50,000

QUESTIONS FOR SELF-STUDY

I. Theory Questions:
i)What is 'Contract Costing ? State the important features of Contract Costing.
ii) State the costing procedure involved in Contract Costing
i) Define the term Contract Costing. Name the industries where contract costing is
applied.
iv) What is 'Contract Costing ? State the accounting treatment of material cost in contract
costing.
vWhat is 'work certified' ? How work certified differentiate from work uncertified ?
vi) Explain the term "Contract Costing. State the method of ascertaining cost of work
certified and cost of work uncertified.
vil) "Both job costing and contract costing are the forms of specific order costing. Discuss.
vii) What is "Escalation Clause ? State the importance of escalation clause to the contractor.
ix) What is 'Cost Plus Contracts' ? State the clauses in which Cost Plus Contract Method is
applied.
X)State the advarntages and disadvantages of Cost Plus Contract Method to the contractor.
xi) What is 'work-in-progress ? State the method of valuation of work-in-progress in ?
Contract Costing.
xii) What do you understand by the term 'Cost-Plus-Contract ? State the implications of
Cost-Plus-Contract from the point of view of manufacturer and customer.
xii) What is Escalation Clause ? State the relevance of the escalation clause provided in a
contract.
XIv) What is incomplete contract?State the various methods of calculating profit on
incomplete contracts.
xv) State clearly the similarities and dissimilarities between the job costing and contract
costing
xvi) What is "Profit on Incomplete Contracts ? State the need for calculating the profit on
incomplete contracts.
xvii) What is Work-in-Progress ? State the accounting treatment of work-in-progress in
contract costing.
Basics of Cost Accounting 4.39 Methods of Costing

xvii) Write short notes on :

a) Features of Contract Costing, b) Applicability of Contract Costing, c) Sub-contract

Cost, d) Architect's Certificate, e) Objectives of Retention Money, ) Notional Profit,
g) Work Certified, h) Work Uncertified, i) Escalation Clause, j) Cost Plus Contract,
k) Advantages of Cost Plus Contract to the Contractor and Contractee, 1) Profit on
Incomplete Contract
xix) Differentiate between:
i) Job Costing and Contract Costing, i) Actual Profit and Notional Profit, ii) Work
Certified and Work Uncertified, iv) Escalation Clause and De-escalation Clause.
II. Practical Problems:
i)Suyash Corporation Ltd. Mumbai is engaged on two contracts A and B during the year,
2019. The following particulars are available on 31st December, 2019 in respect of
Contract 'A'.

Contract price 6,00,00

Materials issued Contract A/C - Dr 1,60,000
Materials returned Contract A/C - Cr 4,000
Materials on site 31st December, 2019 Contract A/C - Cr 22,000
Direct labour Contract A/C - Dr 1,50,000
Direct expenses Contract A/C - Dr 66,000
Establishnment expenses Contract A/C - Dr 25,000
Plant installed at site at cost Dep Info 80,000
Value of plant on 31s December, 2019 Dep Info 65,000
Cost of corntract not yet certified Contract A/C - Cr 23,000
Value of Work Certified Contract A/C - Cr 4,20,000
Cash received from contractee Information to compute part of profit to be trf to P/L A/C 3,78,000
Architects fees Contract A/C - Dr 2,000
Material transterred to contract 'B Contract A/C - Cr 9,000
You are required to prepare Contract 'A" Account for the year ended 31t December, 2019
ii) Niwara Builders, Pune undertook a contract No. 354, for 4,00,000 on 1st January, 2019.
They incurred the following expenses during the year:

Materials issued from stores 40,000

Materials purchased for the contract 10,000
Plant issued tor contract 20,000
Wages paid 71,000
Other expenses paid 3,000
Other expenses payable and due on 31st December, 2019 600
Cash received on account at the end of the year i.e. on 31st December, 2019 amounted to
1,44,000. The work certified was 1,80,000. Of the plant and materials charged to
contract, Plant costing4,000 and Materials costing 3,000 were lost. On 31s December,
2019, Plant costing 3,000 was returned to stores. The cost of work uncertified was
1,500. Materials in hand on site were R 2,500. Charge depreciation on plant @ 15%% p.a.
Prepare Contract Account for the year ended 31st December, 2019.
Basics of Cost Accounting 440 Methods of Costing

ii) Gharkul Builders, Nasik, undertook a contract for 5,00,000 for construction of a library
building. The following is the information relating to the contract during the year 2019.

Materials sent to site 1,00,000

Materials directly purchased 70,698
Labour engaged on Site 1,40,000
Wages accured 750
Plant installed at site 30,000
Depreciation on plant 8,000
Direct expenses 6,334
Direct expenses outstanding 580
Overhead charges 8,252
Materials returned to stores 1,098
Work Certified 3,90,000
Cost of work not certified 9,000
Materials at site on 31st December, 2019 3,766
Overhead charges payable 9,250
Cash received from contractee 60,0
Prepare Contract Account and Contractee's Account in the books of Gharkul Builders,
Nasik.
iv) The following balances have been extracted from the books of Home Constructions,
Haridwar on 31st March, 2019.

Materials Issued from stores 60,000

Materials Purchased 3,100
Wages paid 73,000
Outstanding Wages 150
Plant and Machinery purchased and installed at site on 1st July, 2018 16,000
Direct expenses 2,500
Direct Expenses accrued 650
Administration on Cost 6,000
Value of Work Certified 1,60,000
Cost of Work Uncertified 5,600
Material returned to stores 7,200
Cash received from contractee 1,44,000
Depreciation on plant and machinery @ 20% p.a.
Prepare Contract Account and Contractee Account for the year ended 31st March, 2019
in the books of a contractor
v) Gemini Constructions, Ghatkopar took a contract No. 49 for the construction of a college
building on 1t January 2019. The contract price is fixed at * 15,00,000 subject to a
retention of 20% ot work certified. The following are the details of expenditure made by
the contractor during the year.

Direct labour charges 4,05,000

Materials issued from store house ,20,000
Materials directly purchased 81,200
Basics of Cost Accounting 4.41 Methods of Costing

Plant instalied at site on 30th June, 2019 60,000

Direct expenses 23,000
(inclusive of direct expenses due but not paid 3,000)
Management overheads 37,200
Materials transferred to contract No. 51 6,300
Outstanding wages 7,800
Material transferred from contract No. 48 1,600
Work certified 11,00,000
Work uncertified 16,500
Cash received from contractee upto 31st December, 2019 8,80,000
Provide depreciation on plant @ 40% p.a. on the original cost.
Prepare, Contract Account and Contractee Account
vi) Shaini Construction, Bhusawal undertook several large contracts. The following are the
particulars relating to contract No. 17 for the year ended 31st December, 2019.

Materials issued from stores 90,000

Materials purchased 40,000
Materials transferred to contract No. 15 25,000
Plant purchased and installed at site
i) Plant cost 72,000
ii) Installation cost 8,000
Direct waEes paid 1,22,000
Wages due but not paid as on 31st December, 2019 5,000
Chargeable expenses 12,000
Direct expenses payable 2,000
Establishment on cost 27,000
Administrative expenses accrued 1,500
Contract price 5,60,000
Cash received from contractee upto 31st December, 2019 was 3,20,000 which
represented the full amount of work certified less 20% as retention money. The materials
at site were 7,500. Depreciate plant @ 10% p.a. on the original cost.
You are required to prepare Contract Account, Contractee Account.
vii) The following balances have been extracted from the books of Shanti Construction,
Sholapur as on 31st December, 2019.

Materials issued to contract 81,000

Plant issued for contract 25,000
Wages paid 1,29,600
Wages accurred on 31* December, 2019 10,400
Direct charged paid 4,800
Direct charges accrued on 31st December, 2019 2,200
The work was commenced on 1st January, 2019. Cash received on account on
31t December, 2019 amounted to 2,00,000. The cost of Work certified was 2,50,000.
Of the Plant and materials charged to the contract plant costing 5,000 and materials
costing4,000 were lost in accident.
Basics of Cost Accounting 442 Methods of Costing

On 31st December, 2019, Plant costing 5,000 was returned to stores. The cost of work
certified was2,000. Materials costing 4,000 were in hand on site. Charge depreciation
@ 10% p.a. on the plant.

Prepare Contract Account for the year ended 31st December, 2019.
vii) Siddhartha Construction, Surat is engaged on two contracts M and N during the year
2019. The following particulars are obtained at the end of the year on
31st December, 2019 in respect f contract M.

Cash received 2,80,000

Contract price 16,00,000
Direct material purchased 40,000
Materials issued from stores 60,000
Materials transterred from contract'N 10,000
Direct wages 60,000
Plant installed at site 1,60,000
Direct chargeable expenses 40,000
Stock of materials in hand on site 20,,000
Materials returned to stores 4,000
Work certified 3,00,000
Cost of work not certified 16,000
Depreciate plant @ 25% p.a. on the original cost.
Prepare a Contract Account for the year 2019.
ix) The following balances have been extracted from the books of Amit Construction,
Ahmedabad on 31st December, 2019.

Materials issued 81,000

Wages paid 1,29,600
Direct labour charges payable 10,400
Direct expenses 4,800
Direct expenses due but not paid 2,200
Cost of work certified 2,000
Cost of work uncertified 2,50,000
Cash received on account upto 31st December, 2019 2,00,000
Plant issued for contract 25,000
The work was commenced on 1st January, 2019. Of the plant and materials charged to
contract, plant costing 5,000 and materials costing 4000 were lost in accidernt. On 31st
December, 2019, Plant costing 5,000 was returned to stores. Materials costing 4,000
were in hand on site. Charge depreciation @ 10% p.a. on the plant.
You are required to prepare Contract Account and Contractee Account for the year.
Basics of Cost Accounting 443 Methods of Costing

x)M/s Janhavi Construction, Jaipur undertood several contracts. The following are the
particulars of contract for the year ended 31st March, 2019.

Materials 1,15,0
Plant issued on 30th September, 2018 80,000
Wages 1,22,000
Wages payable 33,500
Direct expenses 2,000
Establishment overheads 27,000
Contract price 6,00,000
Cash received on account 3,60,000
Work certified 4,00,000
Materials at site 7,500
Depreciation on plant ® 20% p.a.
Prepare Contract Account and Contractee Account for the year ended 31st March, 2019.
xi) Sunny Contractors, Shahapur commences operations on 1st January, 2019 and during the
year 2019 they were engaged on a contract of which contract price was fixed at
4,00,000. The following particulars relating to the contract are available on
31st December, 2019.

Materials issued 75,000

Direct wages 95,700
Chargeable expenses 5,000
Cash received on account (being 80% of work certified) 1,60,000
Work uncertified 2,000
Of the plant and material charged to the contract, plant costing 3,000 and materials
costing 2,400 were destroyed by fire. On 31st December, 2019 plant costing4,000 was
returned to stores and materials on hand at site were R 3000. Depreciate plant @ 10%% p.a.
on the original cost.
You are required to prepare Contract Account and Contractee Account.

4.2 PROCESS COSTING

Process Costing is probably the most widely used costing system. Process Costing is a
method of costing under which all costs are accumulated for each stage of production and the
cost per unit of product is ascertained at each stage of production by dividing the total cost of
each process by the normal output of that process. It represents a type of costing procedure for
mass production industries producing standard products. Typically, in such industries all goods
produced are tor stock, units produced are identical, goods move down the production line ina
continuous stream, and all factory procedures are standardised, costs are compiled for each
process or department by preparing a separate account for each process. Thus, it is a method of
costing used to ascertain the cost of product at each stage of manufacturing.
Basics of Cost Accounting 4.44 Methods of Costing

4.2.1 MEANING
Process Costing refers to a method of accumulating cost of production by process. lt
represents a method of cost procedure applicable to continuous or mass production industries
producing standard products. Costs are compiled for each process or department by preparing a
Separate account for each process.
DEFINITIONS
Process Costing as a method of ascertaining the cost has been defined by ditterent experts
and professional institutions in the manner stated below.
i) According to I.CM.A., London, Process Costing is,
"that form of operating costing which applies wvhere standardised goods are produced".
ii) Kohler defines Process Costing as,
a method of cost accounting wiereby costs are charged to processes or operations and averaged over
units produced.
iii) The terminology of CIMA defines Process Costing as,
the costing method applicable where goods or services result from a sequence of continuous or
repetitive operations or processes. Costs are arranged over the units produced during the period".
Like unit costing, Process Costing is also a form of operation costing as distinguished from
specific order costing. In case of unit costing, production of a single product is brought about by
setting up a separate plant. In the case ot Process Costing, however, production follows a series of
sequential processes for either a single product or a limited range of product. The aim of Process
Costing is to determine the total cost of each operation and to apply this cost to the product at
each state ot process. It will then be possible to ascertain cost per unit for each operation or
process and in total.
APPLICABILITY
Process Costin8 should be used by firms which are engaged in the manufacture of
standardised products on a continuous basis. It is suitable for a large number of industries like
paint works, mines and standard quarries, cotton, wool and jute textile mills, chemical plants,
soap-making, paper plastics, distilleries, oil refining, screws, bolts and revets, food processing,
dairy, breweries, sugar works, contectionaries, cement, flour mill or gas etc.
In short, Process Costing is easily applicable in those industries using continuous sequential
processes, discontinuous processes, parallel processes and selective processes.
4.2.2 FEATURES
Following are the important features of Process Costing.
i) Each plant is divided into a number of process cost centres or departments and each
Such division is a stage of production or a process.
ii) The finished products are uniform in all respects such as shape, size, weight, quality,
colour, chemical content etc. so unit cost is calculated by dividing the total cost by the
number of units produced.
iil) Output ot one process is the input of the next process.
iv) t is not possible to distinguish finished products while they are in the stage of
processing.
v) Costs follow the flow of production ie. costs incurred in the earlier process are
transterred to the later process alongwith the output.
vi) Total cost of the finished product in the last process is cumulative i.e. it comprises of
costs of all processes.
Basics of CostAccounting 4.45 Methods of Costing

vii) The cost of any particular unit is the average cost of manutacture over a period.
vii) Production of one article may give rise to two or more by-products.
ix) Occurrence of process losses e.g. evaporation, shrinkage, chemical reaction etc.
x)The semi-finished products are expressed în terms of complete products. This is
technically termed as equivalent production.
x1) Production accumulated and reported by process.
xii) Production process is predetermined and a definite sequence of production is followed.
xii) The unit of cost is the "Process" under this method of costing.
xiv) The production is continuous and on large scale basis in anticipation of demand.
xv) The entire production is divided in clearly defined processes.
xvi) The number of units produced in a particular process are identical.
xV11) Eacn process is treated as a separate cOst centre.

Difference between Job Costing and Process Costing

The important difference between Job Costing and Process Costing can be summarised as
follows
Job Costing ProcessCosting
i) Production is against specific orders and i) Production is in continuous flow and is for
instructions from the customers. cks.
ii) Cost are determined separately for each ii) Costs are compiled for each process or
unit or job. department and unit cost is the average
cOst.
ii) Jobs are independent of each other. ii) Products lose their individual identity
Decause of continuous tloW.
iv) Unit cost of a job is calculated by dividing iv)
The unit of cost of a process is computed
the total costs incurred into the units by dividing the total cost for the period
produced in the lot or batch. into the output of the process durin8 that
period.
v)Costs are ascertained when a job is v) Costs are calculated at the end of the cost
complete. period.
vi) Cost of a job is not transferred to another. vi) The cost of process is transferred o the
next process.
vii) There may or may not be work-in- vii) Due to continuous production, work-in-
Progress at the beginning or at the end of progress 1s a regular teature.
the accounting period.
vii) Cost control is comparatively difficult vii) Production is standardised making it
and needs more attention. comparatively easier to exercise cost
control.
1X) t requires more forms and documents. 1x) t requires less paper work
x)Diversification is possible in Job Costing. x) Diversification is not possible under
process coOsting unless altogether a new set
of machineries are installed.
xi) n Job Costing reporting is ater xi) In Process Costing eporting IS
Completion ot job. progresswise and in respect of time.
X1) Investment of capital is less. X11) Investment of capital
is more.
Job Costing is considered as a labour-intensive process, whereas Process Costing is
considered as a capital-intensive process.
Basics of Cost Accounting 4.46 Methods of Costing

ADVANTAGES
Following are the important advantages of Process Costing
i) It helps in computation of costs of the process as well as of the end product at short
intervals.
ii) Average costs of homogeneous products can easily be computed.
ii) Allocation of expenses can be easily made and this results into a more accurate costing.
iv) It involves less clerical labour because of the simplicity of cost records.
v)Quotation can be submitted more promptly with standardisation of processes
vi) Managerial control is possible by evaluating the performance of each cess and by
ascertaining the abnormal losses.
vii) It is easier to establish the standards in case of continuous production, hence, Standard
costing system can be tollowed easily in process costing
vii) As cost of production is ascertained periodically, management is in a position to receive
various reports periodically and review the progress and efficiency of the production
process.
ix) The method of cost ascertainment is simple and economical than that in job costing.

DISADVANTAGES
Following are the disadvantages of Process Costing.
i) The average cost ascertained under this method is not true cost per unit, as such, it
conceals eaknesses and inetticiencies in processing
ii) Since, it is based on historical costs, it has all the weaknesses of historical costing.
in) The valuation of work-in-progress on the basis of the degree of completion may
sometimes, be a more guess work.
iv) The emergence of joint products may present the problem of apportionment of joint cost
and it apportionment is not properly done cost results may not be accurate.
v)It may not always be possible to indicate the suitable units for showing quantity figures
in procesS Cost statements.
vi) It is very difficult to estimate the normal quantity loss in process.
vii) The method does not permit evaluation of efforts of individual workers or supervisors.
vii) It involves difficulty in ascertaining closing stock value when output of one process is
transferred to another process at transter price or market price.

4.2.3 PROCESS LOsSES OR GAINS

In many of the industries which employ Process Costing a certain amount of loss or wastage
Occurs at various stages or production. 1his lOSs may be due to evaporation, chemical change,
change in moisture content, carelessness, accident or any other reason. It is therefore, necessary to
keep accurate records tor both input and output of each process. Where loSs Occurs at a last stage
of manuacture, it Is apparent that financial loss 15 greater than the mere cost of raw materials.
This is because more and more labour and overheads are expanded in process as the products
move towards completion stage.
Basics of Cost Accounting 447 Methods of Costing
The term "Process Loss" may be defined as,
"the ditference between the input quantity of raw materinl and the output quantity".
The I.C.M.A. defines waste and scrap' from the recovery value point of view as follows:
Waste: "Discarded substances having no value"
Scrap: "Discarded material having some recovery value which is ustually disposed of without
further treatment or re-1ntroduced mto the production process tn the place of raw materal.
Process losses and wastages are usually of two types viz. Normal Process Loss and Abnormal
Process LoSS.

4.2.3.1 NORMAL LOSs

Meaning
Normal Process Loss represents the loss which is expected under normal conditions. This
type of loSS is unavoidable and is inherent in the process of manutacture. It is otten caused by
such factors as evaporation, chemical change, withdrawals for test or sampling, unavoidable
spoilage quantities or other physical reasons. It often includes scrap and waste. This type of losses
can be estimated from the nature of materials, nature of operation, previous experience or
technical data. Normal loss is generally calculated at a certain percentage of the input of units
introduced in the respective process.

Accounting Treatment
The normal process cost is borne by the good units produced. The unit cost is calculated as
under

Unit Cost
ost- otal rocessGood
CostValue of Normal Wastage
Units Produced

The units of normal wastage are recorded on the credit side of a process account in quantity
column only. The value of normal wastage, if any, should be included in the amount column on
the credit side as saleable value. This reduces the cOst of normal output. Process loss is shared by
saleable units.
The Accounting Entries in respect of Normal Loss may be passed as follows:
i) For Arising Normal Loss:
Normal Loss A/c .. Dr.
To Process A/c
ii) For adjustment of the deficiency in the sale of normal loss:
Abnormal Gain A/c .. Dr.
To Normal Loss A/c
ii) For sale of scrap, if any :
Cash/Bank A/c .. Dr.
To Normal Loss A/c
Basics of Cost Accounting 447 Methods of Costing
The term "Process Loss" may be defined as,
"the ditference between the input quantity of raw materinl and the output quantity".
The I.C.M.A. defines waste and scrap' from the recovery value point of view as follows:
Waste: "Discarded substances having no value"
Scrap: "Discarded material having some recovery value which is ustually disposed of without
further treatment or re-1ntroduced mto the production process tn the place of raw materal.
Process losses and wastages are usually of two types viz. Normal Process Loss and Abnormal
Process LoSS.

4.2.3.1 NORMAL LOSs

Meaning
Normal Process Loss represents the loss which is expected under normal conditions. This
type of loSS is unavoidable and is inherent in the process of manutacture. It is otten caused by
such factors as evaporation, chemical change, withdrawals for test or sampling, unavoidable
spoilage quantities or other physical reasons. It often includes scrap and waste. This type of losses
can be estimated from the nature of materials, nature of operation, previous experience or
technical data. Normal loss is generally calculated at a certain percentage of the input of units
introduced in the respective process.

Accounting Treatment
The normal process cost is borne by the good units produced. The unit cost is calculated as
under

Unit Cost
ost- otal rocessGood
CostValue of Normal Wastage
Units Produced

The units of normal wastage are recorded on the credit side of a process account in quantity
column only. The value of normal wastage, if any, should be included in the amount column on
the credit side as saleable value. This reduces the cOst of normal output. Process loss is shared by
saleable units.
The Accounting Entries in respect of Normal Loss may be passed as follows:
i) For Arising Normal Loss:
Normal Loss A/c .. Dr.
To Process A/c
ii) For adjustment of the deficiency in the sale of normal loss:
Abnormal Gain A/c .. Dr.
To Normal Loss A/c
ii) For sale of scrap, if any :
Cash/Bank A/c .. Dr.
To Normal Loss A/c
Basics of Cost Accounting 4.48 Methods
of Costing
4.2.3.2 ABNORMAL LOSS

Meaning
Where the loss is caused by unexpected or abnornmal conditions and if it is beyornd limit, it is
called "Abnormal Loss or unplanned loss. In other words, any wastage arising in excess of the
normal wastage is known as "Abnormal Wastage". It arises due to abnormal causes or unforseen
tactors. Use of detective materials, carelessness, fire, machine breakdown, power failure, strike
etc. may give rise to abnormal process losses. Abnormal loss is avoidable. It can be controlled by
the management by taking proper care. Units of Abnormal Loss is calculated as follows:
Units Introduced (entered
Less: Normal Loss in units
Normal Output *****

Less: Actual Output

Units of Abnormal Loss
(Normal Output= Units Entered-Normal Loss in units)
Thus, in short, the difference between the nomal output and the actual output is termed as
abnormal loss.

Accounting Treatment
Accounting procedure for Abnormal Loss is different. Abnormal loss i.e. wastage is valued at
the end at which the good units would be valued if there were only normal loss i.e. wastage. The
amount of abnormal loss is credited to a process concerned. A separate Abrnormal Loss Account is
opened and the scrap value, if any is credited to Abnormal LoSs Account and the balance on it
ultimately transferred to Costing Profit and Loss Account. The value of Abnormal Loss is
calculated as under:
Normal Cost of Normal Output Units of
Value of Abnormal Loss or wastage Normal Output Abnormal Loss
[where, i) Normal Cost Total Process Cost-Value of normal loss, if any
ii) Normal Output = Units entered Normal Loss in units
-

The Accounting Entries in respect of Abnormal Loss may be passed as follows:

i) For the value of Abnormal Loss:
Abnormal LOss A/e Dr.
To Concerned Process A/c
ii) If any amount is received from sale of scrap:
Cash/Bank A/c .L Dr.

To Abnormal Loss A/c

ii) For Closing Abnormal Loss Ac
Costing Profit and Loss A/c . Dr.
To Abnormal Loss A/c
Basics of Cost Accounting 49 Methods ofCosting

Distinction between Normal Loss and Abnormal Loss

The distinction between Normal Loss and Abnormal Loss can be shown as tollows
Normal Loss Abnormal Loss
i) Normal loss represents the loss under i)Abnormal loss represents the loss which
normal conditions. unexpected or under abnormal
is
conditions.
ii) Normal loss is unavoidable. ii) Abnormal loss is avoidable.
ii) Normal loss is often caused by the factors ii) Abnormal loss arises due to abnormal
like evaporation, chemical change, causes or untorseen factors such as use of
withdrawals for test or sampling defective materials, carelessness, fire,
unavoidable spoilage, etc. machine breakdown, power failure,
strike-lockouts, etc.
iv) Normal loss can be estimated in advance on iv) Abnormal loss cannot be estimated in
the basis of past experience or technical advance.
specification.
)The normal process cost is borne by the V) The abnormal process loss is valued at
good units produced. In other words it is the end at which the good units would be
shared by saleable units. valued it there were only normal loss.
vi) The normal process cost is calculated as Vi) The abnormal process cost is calculated
follows : as follows
Total Process Cost -) Value of Normal Loss Normal Cost of Normal Units of
GOods Units Produced Oupul(x) Abnormal
Normal Output
LOSS

4.2.3.3 ABNORMAL GAIN

Meaningg
The normal loss is an estimated figure. The actual loss may be more or less than the normal
loss. If the actual loss is more than the normal loss, it is treated as Abnormal Loss. But if the
actual loss is less than the normal loss, it is known as Abnormal Gain or Abnormal Effectives.
The abnormal gain is calculated in a similar manner as an abnormal loss. Units of Abnormal Gain
is to be calculated as under:
Actual Output
Less: Normal Output )*****

Units of Abnormal Gain *****

(Normal Output = Units Entered - Normal Loss in Units

Accounting Treatment
Like Abnormal loss, Abnormal Gain also does not affect the cost of normal output as this is
also valued in the same manner as abnormal loss. The process account is debited with the
quantity and value of Abnormal Gain and Abnormal Gain Account is credited. Finally, the
Process account is credited with the quantity and value of normal scrap, but the actual quantity is
less, the difference is credited to Normal Loss Account by debiting the Abnormal Gain Account.
Basics of Cost Accounting 4.50 Methods of Costing

Finally, the balance to the credit of Abnormal Gain Account is transferred to Costing Profit and
Loss Account as Abnormal Gairn. The value of Abnormal Gain is calculated as tollows
Value of Total Process Cost () Value of Normal Wastage Units of
Abnormal Gain Normal Units P'roduced ADnormal Gain

The Accounting Entries in respect of Abnormal Gain may be passed as follows:

i) For the value of Abnormal Gain:
Concerned Process A/C . Dr.
To Abnormal Gain
ii) For adjustment of scrap value of Abnormal Gain
Abnormal Gain A/c . Dr.
To Normal Loss A/c
iii) For Closing Abnormal Gain Account:
Abnormal Gain A/c Dr.
To Costing Profit and Loss A/c

Distinction between Abnormal Loss and Abnormal Gain

The distinction between Abnormal Loss and Abnormal Gain can be shown as follows:

Abnormal Loss Abnormal Gain

If the actual loss is more than the normal i) If the actual loss is less than the normal
loss, it is treated as abnormal loss. oss, it is treated as abnormal gain.

ii) Abnormal loss does not attect the cost of ii) Abnormal gain also does not aftect the
normal output. cost of normal output
ii) The amount of abnormal loss is credited to ii) The amount of abnormal gain is debited
the process concerned. o the process concerned.

iv) The balance of abnormal loss account is iv) The balance of abnormal gain account is
transterred to the debit of Costing Profit transferred to the credit of Costing Profit
and Loss Account. and Loss Account.
Value of abnormal loss is calculated as v) The value ot abnormal gain is caleulated
follows as follows:
Normal Costof Normal Output Units of Total Process Cost (-) Value of Normal Loss
Normal output AbnormalLoss Normal Units Produced

)Units of Abnormal Gain

Basics of Cost Accounting 4.51 Methods of Costing

4.2.4 JOINT PRODUCTS AND BY-PRODUCTS

4.2.4.1 JOINT PRODUCTS
Meaning
When two or more products of equal importance are simultaneously produced from same
basic raw materials from a common process, they are known as Joint Products. These are
distinctly different major products which are inevitably produced simultaneously from common
inputs or by common processing.
Definitions
According to) M.A. London,
Joint Products means two or more products separated in the course of processing ench having a
suficientiy high value to merit recognition as a main prodiuct".
ii) According to the Cost Accountants Hand-Book,
Joint Products represent two or more products separated in the course of the same processing
operations USually requiring further processin8, each product beng n such proportion that no single
product can be designated as a major product
ii) Charles T. Horugree has defined Joint Products as,
"w'ten a group of individual products is simultameously produced with ench having a siguificant
relative sale value, the outputs are usually called }oint Products
iv) According to Matz, Curry-Frank,
Joint Products are produced sinultaneously by a common process or series of processes wvith each
product possessing more than a nominal value in the forn in which it is produced.
Features
From the above definitions, the features of joint products may be summarized as follows
i)Joint Products are produced simultaneously with respect to common raw material and
common manutacturing process.
11) Eachproduct has a significantly relative sales value.
iii) The "Jointness" may be associated with the complete transformation from raw materials
into finished goods or it may be characteristic ot only part of the complete
transtormation in process.
iv) There exists a direct quantitative relationship among various Joint Products such that an
increase in the output of one increases the output of others, although not necessarily in
the same ratio.

Examples
Following are some of the examples of Joint Products
Oil Refining: Petrol, Diesel, Lubricant, Paraftin, Kerosene, Naptha, Gasoline etc.
Mining: Copper, Silver etc. from the same ore.
Coal Gas :
Coke, tar, benzol, sulphate of ammonia etc.
Dairy: Milk, butter, cream, cheese etc.
Floor milling: Difterent grades of flour.
Leather: Hides, skins, meat, etc.
It must be remembered that joint products do not emerge incidentally. On the contrary, their
production is the result of deliberate intention on the part of management. The intention may be
either to produce two or more products by processing basic raw materials or to produce two
different grades of the same product.
Basics of Cost Accounting 4.52 Methods of Costing

Need for Apportionment of Joint Costs

Joint costs are those costs which are incurred betore that stage in manufacture when the
products become separated. The object of joint cost accounting is to assign portion of the total
joint costs to each product. The need for apPportionment of joint costs may be as followS:
i)to determine the unit costs of products.
i)to help in inventory valuation.
iii) to determine the profit or loss on each line of product.
iv) to determine and appraise the efficiency of various Joint products.
vto help in fixing selling price ot Joint products and
vi) to set-up standard output in advance of production.
When costs are incurred after the point of separation i.e. split-off point, it can easily be
ascertained and accounted for. Ditficulty arises only in regard to apportionment of Joint costs as
Joint costs cannot be traced to individual products. Inspite of this problem, proper
apportionment of Joint costs becomes most important. But the basis of apportionment must be
rational and reasonable. There are various methods for apportionment of Joint costs. While
selecting a particular method, it should be kept in mind that the method should be logical,
appropriate and reliable and should be consistently followed.
Joint products are produced simultaneously from the same material and in the same process.
These are produced in natural proportions and they are of almost equal importance. Figure 4.2
indicated below shows Joint Process Cost.

Common
Raw Material Joint Product "A"
Cost

JOINTPROCESS
Joint Product "B"
COST

Common
Processing Joint Product "C
Wages and
Overheads

Fig. 4.2: Joint Process Cost

Methods of Apportionment of Joint Products Costs
i)Physical Unit Method:
According to this method, joint cost are apportioned on some physical base such as weight or
units of measurement expressed in tonnes, gallons, kgs etc. Ihus, the basis of apportionment is
the physical volume of materials found in the joint products at the point of separation. Any loss
arising during processing is also apportioned on the same basis. This method is suitable only
where the products are capable of being expressed in the same physical unit. This method cannot
be applied it the units of measurement of he Joint products are different.
Basics of Cost Accounting 4.53 Methods of Costing

ii) Average Unit Cost Method:

This method is based on the assumption that, the total cost of the process should be borne
equally by all the products, as all the products are produced in the same process. Accordingly,
under this method, an average cost is arrived at for all the products without calculating
separately the cost of each joint product. In other words, the joint processing cost incurred upto
the point of separation is divided by the number of units produced to get the average coOst per
unit. This method is Suitable where the production is in a common measurable unit such as litre
kg, etc. arnd is suitable in tobacco and paint industries. However, this method cannot be adopted
if the products cannot be expressed in the same unit owing to their dissimilarity.
iii) Survey Method:
Under this method, all the important factors such as volume, selling price, technical side,
marketing process etc. affecting costs are ascertained by means of extensive survey. Information
is collected from engineering, production, planning departments. Points value or percentages are
given to individual products according to their relative importance and costs are apportioned on
the basis of total points. These ratios should be revised from time to time depending upon the
factors affecting production and sales. This method is also known as Weighted Average Unit Cost
Method.
iv) Market Value Method:
This method of apportioning joint costs to products on the basis of relative market value is
the most popular and convenient method. The joint costs are split in the ratio of selling prices of
individual products. Under this method, the number of units of each product manufactured is
multipliecd by the products selling price to obtain the sales value of production. Joint costs are
apportioned in the ratio of sales value of individual products. The various market value methods
are: Market value at the point of separation, Market value after further processing and Net
realisable value method.
v Contribution or Gross Margin Method
Under this method, the marginal cost of the joint cost is apportioned on the basis of weight or
quantity of each product and fixed cost on the basis of marginal contribution made by each of the
products. This method provides useful information for taking a decision on maximisation of
profit by rearrangement of products and sales mix.
4.2.4.2 BY-PRODUCTs
Meaning
By-products are products of relatively small value which are incidentally produced in the
course of manufacturing the main product. lt is secondary in nature.
Definitions
i) Kohler defines a By-product as,
a secondary product obtained during the course of manufacture, having relatively small importance
as compared to that of the chief product or products
ii) According to Goodman and Reece,
"By-product is a term uwhich is applied to products produced simultaneotusly that have a very minor
sales value as conmpared to main product".
ii) Theodore Long defines By-product as,
"having any saleable or usable value incidentally produced in addition to the main product".
iv) According to Schlatter,
"By-product split of from the original material in process and thus do not become part of the main
product
Basics of COst Accounting 4.54 Methods of Costing

v)According to CIMA, London, By-product is,

a product which is recovered incidentally fronn the material used in the manufacture of recognized
main product, having either a net-realisable value or usable value being unimportant in comparison
with the saleable value of the main product".
Thus, by-products are secondary results of operations and their economic importance is not
Such as to rank them as joint products, nor is their value so insignificant as to classify them as
Waste or scrap.

Features
i) By-products are obtained simultaneously alongwith main product.
i) The quantity of by-product obtained is less than the main product
ii) By-products yield only minor sales value when compared to main product.
iv) By-products cannot be used as such and therefore require further processing to make it
more acceptable by customer.
v Only limited control can be exercised over by-products.
Examples
Examples of By-products are as follows:
Main Product By-Product
Meat Packing Meat Bones, fats, hides, hairs etc.
Sugar Industry Sugar Baggassee, Molasses etc.
Cotton Ginning Cotton fibre Cotton seeds
Coke-Making Coke Ammonia, coal tar, benzol, gas etc.
.Soap-Making Soap Glycerin
Accounting Treatment
Accounting of by-product depends upon two main consideration viz. the by-product is of
little value and the by-product is of considerable value.
i) Where the By-Product is of little value :
In this type of treatment, there are two difficulties viz.
It is uneconomical to incur expenses in determining the price of each unit of by-product
produced.
It is also equally difficult to ascertain the cost of producing a by-product upto the point
of separation. The amount realised on the sale of by-product is treated as profit and
recorded in the Profit and Loss Account. If the amount realised is too small, the amount
so realised may be credited to the main product, thereby reducing the cost of the main
product.
ii) Where By-Product is of considerable value :
Here, the cost of by-product is ascertained accurately on account of increased cOsts incurred.
A separate account is opened for each by-product to which is debited the estimated cost upto the
split off point. The main product account is credited with the amount realised on transfer of by-
product.
ii) Where By-Product requires further processing
In this case any cost of further processing the by-product will be debited to the by-product
account. Then the by-product account will be credited with the sale proceeds of the by-product
and any profit or losS on this account will be transterred to the Costing Protit and Loss Account.
Basics of Cost Accounting 4.03 Methods of Costing

Accounting Methods
There are two methods which are generally used in accounting of by-products which are as
follows.
a) Non Cost or Sales Value Method
i) Other Income Method:
Under this method, the sale value of by-product is credited to Profit and Loss A/c as
"Other Income". The circumstances in which this method is followed are as follows:
Where the value of by-product is very less.
Where the use of other method is expensive than the benefits obtained.
Where the carrying of by-product with the main product does not entail any
appreciable ditterence in the cost of the main product.
ii) Sale of by-product included in the main product sales:
Under this method all costs incurred on the Joint products and the by-products are
accumulated and their sum is deducted from the sales value of all the products.
i) Sales value of by-product deducted from the total cost:
Under this method, the sale value of by-products are deducted either from production
costs or from the cost of sales.
iv) Credit of by-product at sales less selling and distribution costs:
Under this method, selling and distribution costs incurred for selling the by-products
are deducted from the sales value of the by-products and net amount Is either credited
to the process account or is deducted from total cost.
Credit of by-product at sales value less cost incurred after split off point and selling
and distribution cost:
Under this method, selling and distribution costs and costs incurred on further
processing the by-products are deducted from the sales value of the by-products and
net amount is credited to the process account.
vi Reverse Cost Method:
Under this method, an estimated profit from the sale of by-products, selling and
distribution expenses and further processing cost after the split off points are deducted
from the sales value of by-products and the net amount is credited to the main-product.
b) Cost Method :
i) Opportunity Cost Method (Replacement Cost Method):
This method is used whereby products are utilised in the same undertaking as material
for some other process. The by-products are valued at cost of replacing them. The term
OPportunity cost is used because it represents the cost which would have been incurred
had the by-products been bought from external source. This value, which is the current
replacement or market value, is credited to the main product account. By-product
revenue in this method, does not appear in the Profit and Loss Account.
i) Standard Cost Method:
Under this method, a standard cost is estimated for each type of by-product based
upon past experience. The main product account is credited with this standard cost of
by-products. This enables to judge efficiency of main product because the standard cost
of by-products is a constant figure.
Basics of COst Accountrng 4.56 Methods of Costing

ii) Joint Cost Method:

This method is used where the value of by-product is comparatively of a higher value.
So the cost incurred upto the point of split-off is apportioned among the main product
and all by-products using any method of treating Joint cost.

Distinction between Joint-Products and By-Products

Thedistinction between Joint-Products and By-Products can be shown as follows:
Joint Products By-Products
i) Obtaining the joint product is the main i) Obtaining by-product is secondary
objective. objective.
ii) There exists a direct quantitative ii)There is no direct relationship in case of
relationship among joint products. Dy-products.
ii) Value of joint product is significant. ii) Value of by-product is negligible.
iv) To exercise control on joint products is iv) To exercise control on by-product is not
possible. possible.
V) APportionment of total jont cost to each V APportionment of by-product c0st to each
product is necessary. product is not necessary.
vi) Some examples of joint products are vi) Some examples of by-products with joint
Oil Refining: Petrol, diesel, lubricant, etc. products are:
Mining: Copper, silver from the same ore. Meat: Bones, fats, hides, hairs.
Dairy : Milk, butter, cream, cheese, etc. Sugar: Baggassee, molasses.
Leather: Hides and skin, meat, etc. Soap: Glycerin.
Cotton: Cotton seeds.
Coke: Ammonia, coal tar, benzol, gas, etc.
vii) Joint products are produced from same vi) By-products are produced trom wastages,
input and process. SCrap or discarded material of the main
Process.
vii)Joint product are not produced vii) By-products emerge incidentally also.
incidentally.
ix) Joint products have significant impact on ix) By-products have little impact on total
totalcost at the point of separation. cost.
The main purpose of accurate accounting of joint products and by-products is to
ascertain profit or loss on each product line.
PROCESS coSTING PROCEDURE
The whole manufacturing unit is divided into distinct processes to which all items ot direct
material, direct labour, direct expenses and overheads are debited.
1)Direct Materials:
With the help of material requisition, cOsts of raw materials are debited to the process
concerned.
ii) Direct Labour:
Wages paid to the labourers and other staff engaged in particular process are charged to the
concerned process. Sometimes, many workers are engaged in more than one process, the
spent.
8ross wages paid are to be allocated on the basis of time
Basics of Cost Accountin9 .5 Methods of Costing

ii) Direct Expenses:

There are certain expenses chargeable to the process concerned which are treated as direct
expenses e-g. electricity bill, depreciation etc.
vi) Overheads:
There are many expenses which are incurred for more than two processes, the total of such
expenses may be apportioned either on suitable basis or at predetermined rate based on
direct labour charges or prime cost etc.
4.2.5 PREPARATION OF PROCESS ACCOUNTS
The accounting procedure of Process Costing is as follows:
a) For the purpose of cost accounting, process industries are divided into departments,
each department representing a particular process. A process may consist of a separate
operation or series of operations. A foreman or supervisor 1s appointed for each
department. He is responsible for efficient functioning of his department.
b) A separate account is maintained for each process and it is debited with the value of
raw material, labour and overheads relating to the process.
c)Output is recorded in terms of units e.g. tons, litres, kg, etc. on daily, weekly or suitable
periodical basis depending upon processing time.
d) Items of Debit Side of Process Account:
Each Process Account is debited with:
Cost of Materials used in that process.
Cost of labour incurred in that process.
Direct expenses incurred in that process.
Overhead charged to that process on some pre-determined basis.
Cost of Rectification of Normal Defectives.
Cost of Abnormal Gain (1f any arises in the process).
e) Items of Credit Side of Process Account:
Each Process Account is credited with,
Scrap Value of Normal Loss (if any occurs in that process).
Cost of Abnormal LoSs (if any occurs in that process).
Sale of By-product (if any).
Finished Stock Account (in case of last process).
Loss in weight (if any).
f)Equivalent Production Units: For incomplete physical units in progress at the end of a
period, equivalent production units (i.e. notional quantity of completed units substituted
for an actual quantity of incomplete units) are calculated on the basis of percentage
estimate of degree oft completion. eg, if 200 units are in progress and it is estimated that
they are complete only to the extent of 20o, then 200 incomplete units are considered as
equivalernt to 40 completed urnits.
g) Calculation of Average Cost Per Unit : Average cost per unit is found out by dividing
the total cost of each process by total production of that process. In arriving at average
unit costs, normal loss in production and incomplete units, in the beginning and at the
end ot the period, are taken into consideration. An average cost per unit produced in
each process is ascertained as follows
Total Cost (OScrap Value of Normal Loss (if any)
Average cost per unit = Input () Units of Normal Loss (if any)
h) Transfer of the Cost of output: The cost of output of each process may be transferred
either directly to next Process Account or to a Process Stock Account from where it will
be transterred to the next process as and when required. Products remaining untinished
Basics of CostAccounting +.00 Methods of Costing

in the process at the close of the period are to be assessed in terms of equivalent
completed units on the basis of percentage or degree of completion.
In making process accounts, columns are generally provided on both debit side and credit
side for total cost, per unit cost and for material quantities.
Notable Calculations:
The calculation of various items to be recorded in process account may be made as follows:
i)Number of Units of Expected Normal Loss
Input() Expected Percentage of Normal Loss
ii) Realizable Value of Units of Normal Scrap
= Units of Normal Scrap () Scrap Value per unit
(Note: Units of Normal Wastage have no recoverable value)
iii) Number of Units of Abnormal Loss
= Expected Output (i.e. Input (-) Normal Loss (-) Actual Output
iv) Cost of Abnormal Loss :
Total Cost incurred () Scrap Value of Normal
Input (-) Units ot Normal Loss
xUnits of Abnormal Loss
(Total Cost = Basic Raw Material Cost + Direct Material Cost + Direct Wages + Direct
Expenses + Production Overheads + Cost of Rectification of Normal Defectives)
Cost of Output transterred to next process:
Total Cost incurred OScrap Value of Normal Loss Units of Output transferred to
Input (-) Units of Normal Loss Next Process Account
vi) Cost of Output transferred to Process Stock Account:
Total Cost Incurred (OScrap Value of Normal Loss, Units of Output transferred
-

Input (Units of Normal LosS to Process Stock Account

vii) Cost of Output sold :
Total Cost incurred (OScrap Value or vo
Input (-) Units of Normal Loss Lx
Units of Output Sold
viii) Number of Units of Abnormal Gain:
Actual Output () Expected Output (i.e. Input Normal Loss)
-

ix) Cost of Abnormal Gain:

Total Cost incurred OScrap Value of Normal Loss
Units of Abnormal Gain
Input (-) Units of Normal Loss
Preparation of Process Accounts (where there is no work-in-progress)
The following steps are required to be taken for accurate ascertainment of the cost per unit of
output of each process and finally the finished goods.
i) For the purpose of cost accounting, process industries are divided into departments,
each department is representing a particular process. A process may consist ot a
separate operation or series of operations. A toreman or supervisor is appointed for each
department. He is responsible for etficient functioning of his department
ii) A separate account is maintained for each process and it is debited with the value of
raw material, labour and overheads relating to the process.
11) Output is recorded in terms of units (e.g. tons, itres, kg, etc.) on daily, weekly or
Suitable periodical basis depending upon processing time.
iv) Average cost per unit is found out by dividing the total cost of each process by total
production of that process. In arriving at average unit costs, normal loss in production
and incomplete units, in the beginning and at the end of the period, are taken into
consideration.
Basics of Cost Accounting Methods of Costing

v) Cost of previous process 15 PROCESs COST FLOw

transterred to the subsequent
process so that the total cost and "P
unit cost of products are "P By-product
ain
accumulated.
Products remaining unfinished
vi)
in the process at the close of the
period are to be assessed in
Workcin process
terms of equivalent completed PrOcED
oSs9du
units on the basis of percentage/
degree ot completion.
While preparing Process Accounts,
columns are generally provided on both Proce FrOcesS By-product
debit side and credit side for total cost, sig
per unit cost and for material quantities.
The Figure 4.3 indicated below shows the
Process Cost Flow. Finished Output Work-in process
Fig 4.3: Process Cost Flow

Specimen of Various Accounts in Process Costing

The following are the specimen of various accounts prepared in process costing.
In the books of a Manufacturing Company
Dr. Process Account Cr.
Particulars QuantityCost perAmount Particulars Quantity Cost per Amount
unit unit
Units Units
To Earlier Process 5y Norma LOSS
on ne case of later Process
ACCoung Dy LOSs in Weight
1o Kaw Materials By Scrap Value
To Direct Labour By Sale of By-product
To Direct Expenses ByAbnormal Loss
To Indirect Expenses By Next Process or
To Abnormal Gain Finished Stock
(incase of last process)

Dr. Normal Loss Account Cr.

Particulars Quantity Amount Particulars Quantity Amount
Units
Units
fo Process By Abnormal Gain
By Cash/Bank
(Sale)

Dr. Abnormal Loss Account Cr.

Particulars Quantity Amount| Particulars Quantity Amount
Units Units
lo Process By Cash/Bank
(Sale)
By Costing Profit and
Loss
Basics of Cost Accounting 4.60 Methods of Costing

Dr. Abnormal Gain Account Cr.

Particulars Quantity Amount Particulars Quantity Amount
Units_ Units
To Normal Loss *** *******
by Frocess ******

To Costing Profit and

Loss
******

ILLUSTRATIONS

1LLUSTRATION 1
In the course of a manufacture relating to Asmita Ltd.; Akola a particular product passes
through three distinct processes viz. A, B and C. During a monthly period 1,000 units are
produced with which the following additional information is available.
ParticularsS Frocess A_ Process B_ Process C
Direct Materials 1,000 1,000
Direct Labour 1,500 800
Direct Expenses 300 100 TOU
Indirect expenses amounted to 4,500 and they are to be apPportioned to the processes on the
basis of Direct Labour.
Prepare Process Account showing the total cost and cost per unit at each process.
SOLUTION In the books of Asmita Ltd.; Akola
D Process'AAccount (Units Produced: 1,000) Cr.
Total Cost per Total Cost per
Particulars Cost Unit Particulars cost Unit
To Direct Materials 2,000 2.00 By Process B' A/c* 6,050 6.05
To Direct Labour I,500 I.50
To Direct Expenses 3U0 U.DU
To Indirect Expenses ,250
(4,500 x 15/30)
6,050 6.05 6,050 6.05
rocess 'B Account (UnitsProduced:1,000) C
Total Cost per Total Cost per
Particulars Ost Unit Particulars COst
To Process 'A' A//c 6,050 6.05 By Process C A/c* 8,900 8.90
To Direct Materials ,000
To Direct Labour
ToDirect Expenses 100
o indirectExpenses
4,500 X 7/30)
1,USU 1.05

8,900 8.90 8,900 8.90

FTocess 'CACcount (UnitsProduced: 1,000) Cr.
Total Cost per Total Cost per
Particulars COst Unit Particulars Cost Unit
To Process B A/c 8,900 8.90 By Finished Stock A/c*12,000 12.00
To Direct Materials 1,000 1.00
To Direct Labour 800 0.80
To Direct Expenses 100 0.10
lo Indirect Expenses ,200 1.20
(4,500 x 8/30)
12,000 12.00 | 12,000 12.00
Basics of Cost Accountin9 4.61 Methods of Costing

ILLUSTRATION 2
The product of Bright Ltd., Baroda passes through two processes viz. A and B. It is
ascertained that in each process 10% of the total weight is lost and 20o 1s scrap. The realisation
from scrap amounts to 160 per ton and 400 per ton from Process A and Process 'B
respectively. The cost figures relating to processes are as follows:
Process ProcessS
Particulars
Materials Consumed Tons 2,000 140
Cost of Materials per ton 250 400
Direct Wages ,000 ,000
Chargeable Expenses 11,000 12,960
Prepare Process Account showing the cost per ton of output in each process.
SOLUTION
In the books of Bright Ltd. Baroda
Pr. Process 'A Account
Particulars Quantity Amount Particulars Quantity Amount

To Materials Consumed
To
2,000 5,00,000 By Loss in Weight
Ton:
200
2,000 Tons. x 250) (10% of 2,000 Tons.)
To Direct Wages 36,000 By Scrap 400 64,000
To Chargeable Expenses 11,000 (20% of 2,000 Tons.)
R 160 x 400 Tons.)
By Process B A/cC 1,400 483,000
(@R 345 per ton)
2,000 5,47,000| 2,000 5,47,000
Process 'B Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
Tons. Tons.
To Process A A/C 1,400 4,83,000 By Loss in Weight 154
To Materials Consumed 140 56,000 (10%% of 1,540 Tons.)
(140 Tons. x*400) y
Crap 308 1,23,200
To Direct Wages 24,000 (20% of 1,540 Tons.)
To Chargeable Expenses 12,960 R 400 x 308 Tons.)
By Finished Stock A/c* 1,078 4,52,760
(@R 420
per ton)
1,540 5,75,960 1,540 5,75,960
Working Notes :
i) Calculation of cost per ton of output:
Total Production Cost
Actual Output
Process'A' Account:
4,83,000
Tons.1,400
345 per ton
Process 'B Acount
4,52,760
Tons. 1,078
R 420 per ton
Basics of Cost Accounting 4.62 Methods of Costing

1LLUSTRATION 3
Cansas Ltd., Chennai produces a patent material used in building Construction in three
consecutive grades v1Z. Soft, medium, and hard.
Particulars Process 'A' Process 'B' Process 'C_
Raw Materials used Tons 1,000
Costper ton 200
Manufacturing Wages 7 500 9 500 10,710
Weight Lost o 10% 0
% of input of the process)
Cap Ions 50 30
Value of Scrap per ton 50
SellingP'rice per ton 350 500 800
Management overheads and selling on cost were R 8,500 and R 10,740 respectively. 2/3tard of
the output of Process A and '/2 of the output of Process 'B are passed on to the next process and
the balances are sold. The entire output of Process 'C' is sold. Approximation should be made
wherever necessary
Prepare Process 'A Account, Process 'B Account, Process C Account separately. Also
prepare a statement showing profit or loss.
SOLUTION
Working Notes:
i) Calculation of cost of production per ton of output:
Total Cost-Scrap Value
Units Introduced Units Lost -

Process 'A' Account

*2,87,500-R 2,500
Tons. 1,000- 1ons. 100
2,85,000
900 Tons.
316.667
Process 'B Account
2,29,50- 1,500
lons. 600-Tons. 90
2,28,00
510 Tons.
447.058
In the books of Cansas Ltd, Chennai
Dr. rocess A ACCOunt Cr
Particulars Quantity Amount Particulars Quantity Amount
On5. Tons.
To Raw Materials 1,000 2,00,000 By Loss in Weight 50
(1,000 Tons. x 200) (5% of 1,000 1ons.)
To Manufacturing Wages 87,500 By Scrap 50 2,500
1o Costing Profit and LoSs Alc 10,000 (50 Tons. x 50)
Balancing figure i.e. Profit in By Sales 1,05,000
Process A' Alc) V3 of output i.e.
900 Tons.)
(300 TONS. x 350)
5y Process 'B' Ac* 1,90,000
of output i.e. 900 Tons)
(600Tons. x? 316.667)
1,000 2,97,500 1,000 2,97,5000
Basics of Cost ACCOunung 4.63 Methods of Costing

Dr. Process"B Account_ Cr

Particulars Quantity Amount Particulars Quantity Amount
Tons.
To Process 'A' Alc 600 1,90,000 By Loss in Weight
To Manufacturing Wages 39,500 (10% of 600 Tons)
To Costing Profit and Loss A/C 13,500 By Scrap 30 1,500
(Balancing figure i.e. Profit in
Process 'B Ac) dies 255 1,2/,500
(2 of output ie. 510 Tons.)
(255 Tons. x 500)
By ProcessCAC 55 ,14,000
('2) of output i.e. 510 Tons.)
(255 Tons. xR 447.058)
600 2,43,000 600 2,43,000
Process'C Account
Particulars Quantity Amount Particulars QuantityAmount
Tons. Tons.
To Process 'B AC 255 1,14,000 By Loss in Weight 51
To Manufacturing Wages 10,710 20% of 255 Tons.)
To Costing Profit and Loss AC 240 By SCrap 51 2,550
(Balancing figure i.e. Proit in (1 1ons, x 50)
Process NC) BySales 153 1,22,400
(entire Output
(153 Tons. x R 800)
255 124,950
Statement showing Profit or Loss for the period ended . 55 1,24,950

Particulars Amount Amount

Total Profits earned at Processes 23,740

Profits at Process 'A' Account 10,000
ii) Profits at Process B Account 13,500
ii) Profits at Process'C' Account 240
Less T'otal Expenses incurred 19,240
1)
Management Overheads 8,500
ii) Selling on Cost (+)10,740
Net Profit 4,500
ILLUSTRATION 4
Doxy Ltd., Durgapur produced three types ot chemicals during the month of August, 2019
by three consecutive processes. In each process 20 of the total weight put in is lost and 10% is
scrap. In Process T' and Process TI" the sCrap realises 100 a ton and from Process IIT 20 a ton.
Particulars rocess 'T Process '1 Process '
Materials Used Tons 1,000 40 1,348
Raw Materials consumed 1,20,000 28,000 2,83,620
Manufacturing Wages 20,500
18,520 15,000
General Overheads 10,300 7,240 3,100
he product of three processes are as
dealt with follows
Passed to next process o
Sent to warehouse for sale % 25 100
Prepare PTOcess ost Accounts showing cOst per ton of each process.
Basics of Cost Accounting 4.04 Methods of Costing

SOLUTION
In the books of Doxy Ltd., Durgapur
Dr.
Rate perQuanay
TocessT Account
Amount Rate per Quantity Amount
r.
Particulars ons. Particulars Ton TOns.

To Raw Materials Consumed 1,000 By Loss in Weight

1,20,000 20
To Manufacturing Wages 20,500 (2% of1,000 Tons)
To General Overheads 10,300 By Scrap 100 100 10,000
(10% of 1,000 Tons.)
(100 Tons. x 100)
Transfer to Warehouse
By 160 220 35,200
(25% of 880 Tons.)
By Process 'T Alc T60 50 1,05,600
(75% of 880 Tons.)
1,000 1,50.800 1,000 1.50,800
Dr. Process 'I' Account
Rate per Quantity Amount Rate per Quantity Amount
Particulars Tons. Particulars on

1,05,600 By Loss in Weight

ToProcessTAC 16
o Kaw Matenals Consumed * 28.000(2% of 800 Tons)
To Manufactunng Wages
1o Generai overneaus
18,5205y
240
a
(07% Or 800 TOns.
100 8,000

y Iranster to Warehouse Z10 75,680

(507% of r04 1ons.)
By Process AC 215 2 75,680
(50% of 704 Tons.)

B00 - 189560 800 1,59,360

DI. Process I' Account Cr.

Rate per Quanity Amount Rate per Quantity Amount
articulars On Tons. Particulars Ton Tons.

To Process 'T AC 215 352 75,680 By Loss in Weght 4

To Raw Materials Consumed 13J40 2,83,620 (2% of 1,700 Tons.)
To Manufacturing Wages 15,000 By Scrap 20 3,400
To General Overhead 3,100 (10% of 1,700 Tons.)
By Transfer to Warehouse

(100% of 1,496 Tons.)

50 1,496
.000
1700 3,77,400
Working Notes:
i) Calculation of cost per ton in Process 'T' Account:
If 880 tones = 1,40,800
I ton i
1xR1,40,800
880 Tons.
=160 per ton
ii) Calculation of cost per ton in Process l' Account:
If704 Tons.
I ton
=1,51,360

1xR 1,51,360
704 Tons.
=215 per ton
Basics of Cost Accounting 4.65 Methods of Costing

iii) Calculation of cost per ton in Process 'III' Account:

If 1,496 Tons. = *3,74,000
1 ton=
1xR3,74,000
,496 Tons.
250 per ton
ILLUSTATION 5
Elpro Chemicals Ltd., Edalabad manufacture and sell their chemical product by consecutive
processes. The products of these processes are dealt with as under :
Process1 Process 2 Frocess 3
Transferred to next process % 66-/3 6
Transferred to warehouse for sale o 33 '/3 00
Raw Materials Tons. ,400 160 1,260
Raw Materials-rate per ton 10 17
Wages and Other Expenses 5,152 3,140 8,928
In each process 4% of the total weight put in is lost and 6% is scrap which from Process I
realises at R 3 per ton, from Process 2 at R5 per ton and from Process 3 at R 6 per ton.
Prepare Process Cost Account showing cost per ton of each process.
SOLUTIONN
In the books of Elpro Chemicals Ltd, Edalabad
Dr. Process '1 Account Cr.
Rate per Quantity Amount Rateper Quantity Amount
ParticularsS Ton Tons. Particulars Ton Tons.

To Raw Materials 1,400 14,000 By Loss in Welght

To Wages and dter 4% of 1,400 1ons
Expenses 5,152 84
(6% of 1,400 Tons.)

(84 TONS. xT 3)
By Transfer to Warehouse 15 2 D,J00

(33 g% of 1,260 Tons)

15 840 12,600
By Process 2 AC*
(66% of 1,260 Tons.)
1,400 19,152 1,400 19,752
Dr. Process 2' Account Cr.
articuiars Rate per Quantity Amount Particulars Rate per QuantityAmount
Tons. TOn ons.

To Process1' Alc 15 840 By Loss in Weight

12.600 0
To Raw Malernals 160 2,5604%of 1,800 Tons.)
To Wages and Other ByScrap 300
Expenses 3,140 (60 Tons. x 5)
(i.e.6% of 1000 Tons. x R 5)
20 7,200
By Transfer to Warehouse
4076 O1 900 1ons 10,800
By Process 3' Alc" 540
(60% of 900 Tons.)
1,000 18,300 18,300
00
Basics of Cost Accounting 4.66 Methods of Costing

Dr. Frocess 3 Account Cr.

Rate per Quantity unt Rate per Quantity mount
Particulars Ton Tons. Particulars Ton Tons.

To Process 2 Ac 540 10,800 By Loss in Weight

ToRaw Materials ,260 21,420 4% of 1,800 Tons)
To Wages and Other By Scrap 548
Expenses 8.928 (6% of 1,800 Tons)
By Transter to Warehouse 5 ADU 40,500
(100% of 1,620 Tons.)
41,148 1,800 41,148
600
Working Notes:
i) Calculation of cost per ton in Process T Account:

If1,260 Tons. = 18,900

1 ton = ?

1x 18,90
1,260 Tons.
15 per ton
ii) Calculation of cost per ton in Process 2 Account:
If900 Tons. = 18,000
1 ton =
?
1 x*I8,000
900Tons.
20 per ton
ii) Calculation of cost per ton in Process 3 Account :

If 1,620 Tons. = 40,500

1 ton =

1x 40,500
1,620 1ons.
25 per ton
LLUSTRATION 6
A product in Femina Ltd., Fattepur passes through two distinct processes A and B. From the
following information you are required to prepare Process A Account, Process 'B Account,
Abnormal Loss Account and Abnormal Gain Account.
Process Process
Particulars
A B
Materials (introduced 20,000 units in Process 'A) 30,000 3,000
Labour 10,000 12,000
Overheads 7,000 9,850
Normal Loss 10% 40
Scrap value of Normal Loss per unit 2 per unit
Output Units| 17/500 17,000
There is no stock or work in progress in any process.
Basics of Cost Accounting 4.67 Methods of Costing

SOLUTION
In the books of Femina Ltd., Fattepur
r. Quantity
Process 'A Account
Particulars
Cr.
Particulars Amount Quantity Amount
Units Units
To Materials 20,000 30,000 By Normal Loss 2,000 2,0000
TO Labour 10,000 (10% of 20,000 units)
10 Overheads 7.000 (2,000 units xR 1)
By Abnormal Loss 1,250
(Balancing Figure)
By Process 'B' Alc 17,500 43,750
20,000 47,000 20,000 47,000
FrocessB ACCOUnt
Particulars Quantity Amount Particulars Quantity Amount
Units Units
ProcesS A AC 17,500 43,750 By Normal Loss 1,400
O

To Materials
00
3,000 4% of 17,500 units)
12,000 700 units x 2)
lo
To
Labour
17,000
Overheads 9,850 By Finished Stock AC 68,000
ToAbnormal Gain 200
(Balancing Figure)
17,700 69,400 17,700 69,400
Dr.
Particulars Quantity
Units
Abnormal Loss Account
mount Particulars Quantity
Onits
r.
Amount

To Process 'A' Alc 500 ,250 By Bank 500 00

(500 unitsx R1)
By Costing Profit and Loss Ac"
(Balancing Figure) 750
500 1,250 500 1,250
Abnormal Gain Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
Units
200
Units
Nomal Loss
To 400 By Process 'B Alc 200 800
CU0 unitsx7 2)
o Costing Profit and Loss A/c
(Balancing Figure)
200 800
Working Notes:
Calculation of cost of Abnormal Loss in Process 'A' Account:
Dr. Cr 5alance
Quantity: Units 20,000-2,000 Units 18,000 Units: Normal Outuput
Amount: 47,000- 2,000 = 45,000 Normal Cost
If 18,000 Units = 45,000
S00 Units
500 units x? 45,000
18,000 units
1,250
ii) Calculation of cost of Abnormal Gain in Process 'B' Account:
Cr. Balance
Quantity: 17,500 Units-700 Units 16,800 units: Normal Output
Amount 68,600-R 1400 =R67,200: Normal Cost
Basics of Cost Accounting 4.68 Methods of Costing

If16,800 Units = R67,200

200Units
=200 units x 67,200
16,800 ts
unts
800
ILLUSTRATION Z
The product of Glaxo India Ltd., Goregaon passes through two processes A andB and then to
finished stock. It is ascertained that in each process normally 5% of the total weight is lost and
10% is scrap which from process A and B realises R 80 per ton and ? 200 per ton respectively. The
tollowing are the figures relating to both the process.
Particulars Process 'A' Frocess "B'
Materials Ions 1,000 0
Cost of materials per ton 125 200
Wages 28,000 10,000
Manufacturing Expenses 8,000 5,250
Output Tons 830 780
Prepare Process Cost Account showing cOst per ton of each process. There was no stock or
work-in-progress in any process.
SOLUTION
In the books of Glaxo India Ltd., Goregaon
Dr. Process 'A' Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
Tons. Tons.
To Cost of Materials 00 1,25,000 By Loss in Weight 50
(1,000 Tons. x 125) (5% of 1,000 Tons.)
To Wages 28,000 By Normal Scrap 100 8,000

To Manutacturing (10% of 1,000 Tons.)

Expenses 8,000 (100 Tons. x R 80)
By Abnormal Loss " 3,600
(Balancing Figure)
By Process 'B A/c 830 1,49,4
1,000 1,61,000 1,000 1,61,000
Dr. Process'B' Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
1Ons. Tons.
To Process 'A' A/c 830 1,49,400 By Loss in Weight 45
To Cost of Materials 14,000 (5% of 900 Tons.)
(70 Tons. x 200) By Normal Scrap 90 18,000
To Wages 10,000 (10% of 900 Tons.)
ToManufacturing (90 Tons. xT 200)
Expenses 5,250
To Abnormal Gain "
15 3,150 By Finished Stock A/c 780 1,63,800
(Balancing Figure)
915 1,800 915 1,81,800
Basics of Cost Accounting 4.69 Methods of Costing

Abnormal Loss Account Cr.

Particulars Quantity Amount Particulars Quantity Amount
Tons. Tons.
To Process 'A' A/c 20 ,600 By Bank 20 1,600
(20 Tons.xR 80)
By Costing Profit
and Loss A/c* 2,000
(Balancing Figure)
20 3,600 3,600
Dr. Abnormal Gain Account Cr
Particulars Quantity Amount Particulars Quantity Amount
Tons. Tons.
To Normal Loss 15 3,000 By Process 'B A/c 15 3,150
(15 Tons. x 200)
To Costing Profit and
Loss A/c 50
(Balancing Figure)
15 3,150 15 3,150
Working Notes
i) Calculation of cost of Abnormal Loss in Process 'A' Account:
Dr. Cr. = Balance
Quantity : 1,000 Tons.-150 Tons. 850 Tons. : Normal Output
Amount 1,61,000- 8,000 =1,53,000 : Normal Cost
If850 Tons. =1,53,000
20Tons.
20Tons.x R1,53,000
50 Tons.
= 3,600
ii) Calculation of cost of Abnormal Gain in Process B' Account
Dr. Balance
Cr.=
Quantity: 900 Tons. -135 Tons. = 765 Tons. : Normal Output
Amount: R1,78,650-R 18,000 = T1,60,650 : Normal Cost
If765 Tons. = 1,60,650
15 Tons.

1ons XTonsS.
L,60,050
765
= T3,150
ii) Calculation of cost per ton in Process 'A' Account:

If830 Tons. =R1,49,A00

1 Tonne
1 Ton x 1,49,400
830 tons.
= R180 per ton
Basics of Cost Accountin9 4.70 Methods of Costing

iv) Calculation of cost per ton in Process 'B' Account:

If 780 Tons. 1,63,8000
?
TTon =

1 Ton. x 1,63,800
780 Tons
210 per ton
ILLUSTRATION 8
A product 'Bee' produced in Himani Ltd.; Himmatpur passes through three processes A, B
and C. 10000 units were issued to Process A in the beginning at cost of 10 per unit.
.Prepare Process Account assuming that there was no opening or closing stock. The following
intormation is made available.
Tarticulars Process "A' Process B Process "C
Sundry Materials 10,000 00 ,000
Wages 50,000 80,000 65,000
Direct Expenses 15,300 18,100 30,828
Normal crap 8
Value of Scrap per unit 2.50 5.00 8.50
Actual Output Units 500 9,100 8,100
SOLUTION
In the books of Himani Ltd.; Himmatpur
Dr.
Particulars Quantity
Process 'A' Account
Particulars Quantity
Cr
Amount Amoun
Units Units
To Cost of Units Issued 10,000 1,00,000 By Normal Scrap 300 750
(10,000 units x 10)
57o of 10,000 units)
lo Sundry Materials 10,000 (300 units X2.50)
To Wages 0,0U0By Abnormal Loss 200 3,599
To Direct Expenses 15,300 (Balancing Figure)
By Process 'B' A/c 9,500 1,70,951
10,000 1,75,300 10,000 1,75,300
Dr Process"B" Account Cr.
Particulars Quantity Amount articulars Quantity Amount
Units Units
To Process "A
A/c 9,500 1,70,951 By Normal Scrap
To Sundry Materials 15,000 5 of 9500 units)
Wages 80,000(475 units XR 5)
To Direct Expenses 18,100
ToAbnormal Gain 5 2,341 By Process C A/c 9,100 2,84,017
(Balancing Figure)
9,575 2,86,392 ,5/5 2,86,392
Dr. Process'C Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
Units its
To Process 'B' A/c 9,100 2,84,017 By Normal Scrap 6,188
To Sundry Materials 5,000 (8% of 9,100 units)
lo Wages 65,000 (728 units x R 8.50)
To Direct Expenses 30,828 By Abnormal Loss 72 12,302
(Balancing Figure)
By Finished Stock A/c 8,100 3,66,355
9,100 3,84,845 9,100 3,84,845
Basics of Cost Accounting 4.71 Methods ofCosting

Dr. Abnormal Loss Acount Cr.

Particulars Quantity Amount Particulars Quantity Amount
Units Units R
To Process 'A'A/c 200 3,599 By Bank 200 500
(200 units x 7 2.50)
By Costing Profit
and Loss A/c* 3,099
(Balancing figure)
200 3,599 3,599
Dr. Abnormal Gain Account Cr
Particulars Quantity Amount Particulars Quantity Amount
unitsS units
ToNormal Loss 75 375 By Process 'B' A/c 75 2,341
(75 units x? 5)
To Costing Profit and
Loss A/c* 1,966
(Balancing Figure)
75 2,341 75 2,3*1
Dr. Abnormal Loss Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
units units
To Process 'C' A/c 272 12,302 By Bank 2/2 2,312
(272 units x 8.50)
By Costing Profit
and Loss A/c* 9,990
(Balancing Figure)
272 12,302 272 12,302
Working Notes:
i) Calculation of cost of Abnormal Loss in Process 'A' Account:
r. Cr.=Balance
Quantity 10,000 Units - 300 Units = 9,700 Units : Normal Outuput
Amount: 1,75,300 -R750 = R1,74,550 : Normal Cost
If 9,700 Units *1,74,550
200 Units
200 units xR1,74,550
9,700 units
R 3,599
ii) Calculation of cost of Abnormal Gain in Process 'B' Account:
Dr. Cr. Balance
Quantity: 9,500 Units-475 Units = 9,025 Units :Normal Output
Amount: 2,84,051-?2,375 2,81,676 Normal Cost:
If
9,025 Units=2,81,676
75 Units
75 units x 2,81,676
9,025 units
2,341
Basics of Cost Accounting 4.72 Methods of Costing

iii) Calculation of cost of Abnormal Loss in Process 'C' Account:

Dr Cr. Balance
Quantity 9,100 Units - 728 Units= 8,372 Units :
Normal Output
Amount 3,84,845 -6,188 = 73,78,657 :Normal Cost
If 8,372 Units 3,78,657
* LIZUnits
272 units >x 3,78,657
8,372 units
12,302
ILLUSTRATION 9
The finished product of Indiana Ltd.; lgatpuri has to pass through three process 1, 2 and 3.
During August 2019 data relating to this product was as shown below:
Particulars Process Process Process Total
1- 2 3
Basic Raw Materials (10,000 Unit) 6,000 6,000
Direct Materials added 9.500 5,500 23,500
Direct Wages 4,000 6,000 12,000 22,000
Direct Expenses 1,200 930 1,340 3,470
Production Overheads 16,500
absorbed as a percentage of direct wages)
Output units 9,200 8,700 7,900
Normal Loss 10
Scrap Value of Normal Loss per unit 0.20 0.50 1.00
1

here was no at
stock the beginning or at the end ot any process. ou are required to prepare-
i) Process '1 Account, i) Process 2 Account ii) Process '3' Account iv) Abnormal Loss
Account and v) Abnormal Gain Account.
SOLUTION In the books of Indiana Ltd.; Igatpuri

Dr. Process '1' Account Cr.

Particulars Quantity Amount Particulars Quantity Amount
Units Units
To Cost of Basic Raw By Normal Loss 1,000 200
Materials 10,000 6,000 (10%% of 10,000 units)
lo Direct Materials 8,500 x
(,000 units Ke. 0.20)
To Direct wages 4,000
To Direct EXpenses 1,200
To Production Overheads 3,000
K 16,500 x
2/ 11)
To Abnormal Gain* 200
(Balancing Figure) By Process 2 A/C 9,200 23,000
10,200 23,200 10,200 25,200
DI. ProcessZ Account Cr
Particulars Quantity Amount Particulars QuantityAmount
Units Units
To Process A A/C 9,200 23,000By Normal Loss
To Direct Materials 9,500 (5% of 9,200 units)
To Direct Wages 6,000 (460 units x x 0.50)
To Direct EXpenses 930 By Abnormal Loss 200
To Production Overheads 4,500 (Balancing Figure)
(R 16,500 x 3/11) By Process 3 A/c 8,700 43,500
9,200 43,930 9,200 43,930
Basics of Cost Accounting 4.73 Methods of Costing

Cr.
Dr. Particulars
Process '3 Account
Quantity Amount Particulars Quantity Amount
Units Units
To Process 2' A/c 8,700 43,500 By Normal Loss 870 870
To Direct Materials 5,500 (10% of 8,700 units)
To Direct wages 12,000 (870 units x*)
To Direct xpe nses
To Production Overheads
Overneads 9,000
R16,500x6/11)
To Abnormal Gain 70 30
(Balancing Figure) By Finished Stock A/c 7,900 71,100
S,770 71,970 8,770 71970
Dr Abnormal Gain Account Cr.
Particulars Quantity Amount Particulars Quantity Amount
Units Units
To Normal Loss 200 40 By Process T' A/c 200
(200 units x0.20)
To Costing Profit and
Loss A/cC 460
(Balancing Figure)
200 500 200 50
Dr Abnormal Loss Account Cr.
Particulars Quantity Amount articulars Quantity Amount
Units Units
lo Process 2' A/c 200 By Bank 20
(40 units X R0.50)
By Costing Profit
and Loss A/C 180
(Balancing Figure)
40 200 0 200
Dr. Abnormal Gain Account Cr.
P'articulars Quantity Amount Particulars Quantity Amount
units units
To Normal Loss 70 By Process 3 A/c 70 630
(70 units X* 1)
lo Costing Profit and
Loss A/c* 60
(Balancing Figure)

Working Notes
70 630 70 630

i) Calculation of cost of Abnormal Gain in Process Account: 1'

Dr. Cr. = Balance
Quantity: 10,000 Units 1,000 Units=
-
9,000 Units : Normal Output
Amount 22,700 -T 200= T 22,500 : Normal Cost
If 9,000 Units = 22,500
200 Units
200 units xR 22,500
9,000 units
F 500
Basics of Cost Accounting 4.74 Methods of Costing
ii) Calculation of cost of Abnormal Loss in Process "2" Account:
r. Balance
Quantity 9,200 Units-460 Units 8,740 Units: Normal Output
Amount : R43,930-7230 =R43,700 Normal Cost
If8,740 Units= 43,700
40 Units
40units x { 45,70
6,/40 units
200
ii) Calculation of cost of Abnormal Gain in Process '3 Account:
Balance
Quantity: 8,700 Units- 870 Units 7,830 Units : Normal Output
Amount: 71,340- 870 70,470 : Normal Cost
If 7,830 Units = 70,470
70 Units = ?

70units x *70,470
7,830 units
630
ILLUSTRATION 10
Product X 1s obtained atter it passes through three distinct processes arranged in Jonson Ltd,
Jaipur.You are required to prepare Process Account from the following înformation.
Total Frocess
iculars

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

Direct Wages ,000 4,000 6,000 8,000
Production Overheads 18,000
Actual Output units 950 340 50
Normal Loss 15
Value of Scrap per unit 81
1,000 units @6 per unit were introduced in Process T Account. Production Overheads to be
distributed as 100o ot Direct Wages.
SOLUTION In the books of Jonson Ltd., Jaipur
Process T ACCOunt T.
Particulars Quantity Amount Particulars Quantity Amount
Units Units
To Cost of Units Introduced 1,000 6,000 By Normal Loss 50 200
(1,000 units x 6) (5a of 1,000 units)

o Ware
5,200
4,000
(50 units X T4)

To Production Overheads 4,000

950 19,000
4,000x 100o) By Process 'l' A/c
1,000 19,200 1,000 19,200
Process 'l' Account
Particulas Quantity Amount Particulars Quantity Amount
Units Units
To Process T A/c 50 19.00 By Normal Loss 5

o aera
To Production Overheads 6,000
Ahnormal Loss 15
R 6,000 x 100%) Balancing Figure)
By Process TIl' A/e 840 3,600
950 34,96b0 950 34,960
Basics of Cost Accounting 4.75 Methods of Costing

Process 'Tm' Account Cr.

Particulars Quantity Amount Particulars Quantity Amount
Units
Units
To Process 'I' A/c 33,600 By Normal Loss 126 1,260
To Materials 5,924 (15% of 840 units)
O Direct Wages (126 units xR 10)
To Production Overheads 8,00
R 8,000 x 100%)
To Abnormal Gain 2,736
(Balancing Figure) By Finished Stock A/c 750 57,000
876 58,260 8/6 58,260
Dr. AbnormalLoss Account Cr.
Particulars QuantityAmount Particulars Quantity Amount
Units Units
To Process
T'A/c 15 600 By Bank
(15 units x8)
120

By Costing Profit
and Loss A/c* 480
(Balancing Figure)
15 15 600
Dr. Abnormal GainAccount Cr.
Particulars Quantity Amount Particulars Quantity Amount
units units
To Normal Loss 360 By Process 'I'A/c 2,736
(36 units x* 10)
To Costing P'rofit and
Loss A/c* 2,376
(Balancing Figure)
36 2,736 36 2,736
Working Notes:
i) Calculation of cost of Abnormal Loss in Process 'Il' Account:
Dr. Cr. Balance
Quantity: 950 Units-95 Units= 855 Units :
Normal Output
Amount: 34,960 R760
If 855 Units R 34,200
=
* 34,200 :
Normal Cost

15 Units
15units xR 34,200
855 units
600
ii) Calculation of cost of Abnormal Gain in Process 'I"' Account
Dr. r. 5alance
Quantity: 840 Units-126 Units 714 Units: Normal Output
Amount: 55,524-R1,260 T54,264: Normal Cost
If714 Units=54,264
?
36 Units =

36units x 54,264
714 units
2,736
Basics of Cost Accounting 4.76 Methods of Costing

ILLUSTRATION 11
In Koton Queen Ltd., Kalyan, the product passes through two processes A and B. A loss of
5% is allowed in Process A and 2% in Process 'B, nothing being realised by disposal of wastage.
During April 2019, 10,000 units of materials costing R6 per unit were introduced in Process 'A.
The other costs are as tollows
ParticularsS Process 'A' Process 'B'
Materials 6,140
Labour 10,000 6,000
Overheads 6,000 4,600
The output was 9,300 units from Process A. 9,200 units were produced by Process 'B which
were transferred to the finished stock. 8,000 units of the finished product was sold at 15 per
unit, the selling and distribution expenses were 2 per unit. Prepare, i) Process Account,
i) Statement of Profit or Loss for the month of April 2019, assuming that there were no opening
stocks of any type.
SOLUTION
In the books of Koton Queen Ltd., Kalyan
Dr. Process 'A" Account Cr
Particulars Quantity Amount Particulars Quantity Amount
Units Units
To Cost of Materials Introduced 10,000 60,000 By Normal Loss 500
(10,000 units x R 6) (5%% of 10,000 units)

To Labour 10,000 By Abnormal Loss 200 1,600

To Overheads 6,000 (Balancing Figure)
By Process B A/c 9,300 74,400
10,000 76,000 10,000 76,000
Dr. Process'B' Account Cr.
Particulars QuantityAmount Particulars Quantity Amount
Units Units
To Process A' A/c 9,300 74400 By Normal Loss 186
To Materials 6,140 (2 of 9,300 units)
To Labour 6,000

ToOverheads 4,600
To Abnormal Gain 860 By inished Stock A/e 9,200 92,000
(Balancing Figure) (i.e. @ 10 per unit)
9,386 92,000 ,386 92,000
Dr. Abnormal Loss Account Cr
Particulars Quantity Amount Particulars Quantity Amoun
Units Units
To Process 'A A/C 200 1,600 By Bank 200
(200 unitsx NIL)
By Costing Profit
and Loss A/c* 1,600
(Balancing igure)
200 1,600 200 1,600
Basics of Cost Accountin 4.77 Methods of Costing

Dr. Abnormal Gain Accouunt Cr.

Particulars Quantity | Amount Particulars Quantity Amount

Units Units
To Normal Loss 86 By Process BA/c 86 860
(86 units x NIL)
To Costing Profit and
Loss A/c* S6U

(Balancing Figure)
860 86 S60

Working Notes:
i) Calculation of cost of Abnormal Loss in Process A" Account:
Dr. Cr. Balance
Quantity: 10,000 Units 500 Units = 9,500 Units :
Normal Outuput
Amount: 76,000 NIL = 76,000 : Normal Cost
If 9,500 Units = 76,000
200 Units =

200 units x R76,000

9,500 units
I,600
ii) Calculation of cost of Abnormal Gain in Process 'B' Account:
r. Cr.=Balance
Quantity : 9,300 Units- 186 Units = 9,114 Units: Normal Output
Amount T91,140-NIL = 791,140 Normal Cost
If 9,114 Units = T91,140
S6 Units
86units x 91,1400
9,114 units
860
In the books of Koton Queen Ltd., Kalyan
Statement showing Profit or Loss for the month ended 30th April, 2015
Particulars Amount Amount

Sale of Finished product 1,20,000

8,000 Units x15)
Less (1) Production Cost of Finished Product (8,000 Units x T 10) 80,000
(2) Selling and Distribution Expenses (8,000 Units x*2) 16,000
3) Balance of Loss trom Costing Profit and LOSS AC 40
(Abnormal Loss Abnomal Gain Balance of Loss
1,600 R 860 740
NetProfit 96,740
(Subject to Net Profit adjustment of Abnormal Loss Account and Abnormal Gain 23,260
Account)
Basics of Cost Accounting 4.78 Methods of Costing

QUESTIONS FOR SELF-STUDY

I. Theory Questions:
i) What is Process Costing ?State the important features of "Process Costing8
ii) Define the term Process Costing. Name the industries where Process Costing can be
aPplied suitably.
ii) What is 'Normal Loss' ? How do you treat normal process loss in process costing ?
iv) What is "Abnormal Loss' ? Explain briefly how it should be treated in cost accounts.
VWhat is 'Abnormal Gain' ? How do you treat abnormal gain in process costing?
vi) What is 'Process Cost ? State the features of process costing
vii) State the important differences between and the similarities in Job Costing and Process
Costing
vii) What is "Abnormal Loss? Explain the possible causes and accounting treatment of
Abnormal Loss.
ix) Job Costing is more accurate than Process Costing. Comment.
x)Write short notes on:
a) Process Costing, b) Features of Process Costing, c) Normal Loss, d) Abnormal LSs,
e) Abnormal Gain, ) Accounting treatment of Abnormal Loss and Gain g) Joint
Products, h) By-Products.
xi) Distinguish between:
a) Job Costing and Process Costing, b) Normal Los and Abnormal Loss, c) Abnormal
LOss andAbnormal Gain.
II. Practical Problems
i) An article passed through three processes. From the figures shown the cost of each of the
threeprocesses during the month of January 2019. Prepare Process Account.
ParticularS Process I Process II Process IlI
Materials Used 1,500 5,000 2,000
Labour 8,000 20,000 6,000
Direct expenses 2,600 7,200 2,500
The indirect expenses amounting to 1,5O0 may be apportioned on the basis of wages.
The number of articles produced during the month are 240.
ii) A product passes through two distinct processes A and B and then to finished stock. The
output of A passes direct to B and that of B to finished stock. From the following
information you are required to prepare the process accounts.
Particulars Process A ProcessB
Materials Consumed 12,000 6,000
Direct Labour 14,000 8,000
Manufacturing Expenses 4,000 4,000
Output Units 9,400 8,300
Input in Process A Units 10,000
Input in Process A Value in 10,000
Normal Wastage (o of input) 5% 10%
Value of normal wastage per 100 units) | 8 10
No opening or closing stock is held in process.
Basics of Cost Accounting 4.79 Methods of Costing

ii) A product passes through three processes X, Y and Z betore its completion. From past
experience it is realised that wastage is incurred in each process as under:
X-2%, Y-5% and Z-10% of the units introduced in the process.
Scrap value: X* 10 for 100 units

Y15for 150 units

Z 40 for 100 units
Other details are
Particulars
Materials 6,000 3,000 500
Direct Wages 9,000 6,000 ,500
Manufacturing Expenses 1,500 1,500 2,200

30,000 units are issued to Process X at a cost of 15,000. The output of

Process X-29,200 units, "Y' - 28,200 units and Z-24,000 units.
Show the Process Accounts.
iv) A product passes through three processes to completion in January 2019, the cost of
production were given as below:
Particulars Process I
Process Process I

Direct Materials 2,000 3,020 2,462

Wages 3,500 4,226 5,000
Production Overheads 1,500 2,000 2,500
1000 units were issued to Process I at 5 each
Particulars
Normal Los 10% 5% 10%

Wastages Realised unit 5 6

Actual production units 920 870 800
Prepare the necessary process accounts.
v The product X is obtained after it is produced through three distinct processes. The
followingcost information is available for the operation:
Particulars Total ProcessI Process III Process III
Materials 5,625 500 2,000 1,025

Direct Wages 7,330 3,500 4,226 5,000

Production Overheads 7,330
500 units at 4 per unit were introduced in Process I. Production overheads are
absorbed at 100% of direct wages. The actual output and normal loss of the respective
processes are:
Basics of Cost Accountin9 4.80 Methods of Costing

Particulars Output Units Normal Loss on Input Value of Scrap per

Yo unit

Process I 450 10%

Process III 340 20%

Process III 270 25%

There is no stock of work-in-progress in any process.

Show the three process accounts and abnormal loss and abnormal gain account
vi) n a manufacturing concern the output of A' Process is transferred to B Process. It has
been the experience that normal wastage in Process A is 5% and in case of B 10% of the
units entering the process. The scrap value of normal wastage * 50 per hundred units in
Process A and R 80 per hundred units in Process B.
Particulars Process A Process B

Materials 10,000 6,000

Wages 8,000 4,000
Manufacturing Expenses 2,000 2,000
In Process A and thousand units were entered at a cost of 5,000. The output of Process
A is 900 units and Process B 750 units.

Prepare Process "A' Account and Process "B' Account.

 GLOSSARY
(BASIC COST ACCOUNTING TERMS WITH SIMPLIFIED EXPLANATIONS)
Abnormal Costs:A cost which is normally incurred at a given level of output in the
conditions in which that level of output is normally attained.
Abnormal Gain: It is a result of the excess of actual output over normal output due to
excellent climatic conditions for production, exceptionally good material, new equipments,
etc.

Abnormal Loss : It is the loss caused by abnormal conditions which is excess of actual loss
over normal loss which may arise due to poor quality of raw materials, defects in machines,
carelessness on the part of workers, etc.

Abnormal Overheads: These are the overhead costs which are not expected to occurin
producing a given output e.g, abnormal idle time, abnormal wastage etc.
Absorption of Overheads: It is the process of charging of overheads of a cost centre to
difterent cots units in such a way that each cost unit bears an aPpropriate portion of its share
of overheads.

Actual Overhead Rate : It is the rate calculated by dividing the actual overhead expenses
incurred by the actual quantity or value of selected base for the corresponding period.
AdministrationCosts : The sum of these costs of general and management, and of secretarial,
accounting and administrative services which cannot be directly related to production,
marketing research and development function of the enterprise.
Allocation of Overheads : It is the process of allotment of an entire cost to a particular cost
centre or cost unit.
Apportionment of Overheads : It is the process of distribution of overheads to cost centres
on an equitable basis.

Architects Certificate: is the certificate issued by the contractees architect specifying

It
clearly as to the value of work so far performed.
Batch Costing: It is that form of specific order costing, which applies where similar articles
are manufactured in batches either for sale or use, within the undertaking.

Capital Costs: A cost which is intended to benefit in fuure period.

Class-Cost Method: It is the method of job costing where the costing of goods is done by
classes instead of the unit or a piece.

Classification of Overheads: lt is the process of grouping of overhead costs on the basis of

common characteristics and clear objectives.

(G.1)
Basics of Cost Accounting G.2 Glossary

Codification of Overheads: It is a method of identifying and describing various overhead

expenses in numbers or letters or in a combination of both so that cost data can easily be
collected.

Composite Cost Unit: It is a unit which measures two characteristics simultaneously. For
e-gper tonne-mile, per passenger-kilometre, kilowat-hour etc.
Contract Costing: It is that form of specific order costing, which applies where work is
undertaken regarding customers special requirements and each order is of long duration.
Controllable Costs: A cost chargeable to a cost centre, which can be influenced by the
actions of the person in whom control ot the centre is vested.

Controllable Overheads: These are the overhead costs which can be controlled by executive
action at the point of their incurrance e-g. advertisement, delivery-van running expenses etc.

Cost: It is the amount of expenditure (actual or notional) incurred on or attributable to a

specified thing or activity.
Cost Account Numbers: These are the code numbers given to an item of administration
Overheadsor selling and distribution overheads.
Cost Accountancy: It is the application of costing and cost accounting principles, methods
and techniques to the science, art and practice of cost control and the ascertainment of
profitability.
Cost Accounting: It is that branch of accounting dealing with the classification, recording,
allocation, summarisation and reporting of current and prospective costs.
Cost Centre: It is a location, person or item of equipment for which costs may be ascertained
and used for the purpose of control.
Cost Classification :lt is a grouping of cost according to their common characteristics.

Cost Plus Contracts: It is that type of account, where a contractor is paid with actual cost of
direct materials, direct labour, direct factory expenses and a stipulated amount or percentage
of cost to cover overheads and profits.
Cost Sheet : It is a statement which shows the details regarding total cost of the job or a
product.
Cost Unit: It is a unit of a quantity of product, service or time in relation to which costs may
be ascertained or expressed.
Costing: 1t is the technique and process of ascertaining costs.

De-escalation Clause : It is the clause which provides for a decrease in the contract price due
to a decrease in the price of inputs, so that the benefit of price decrease is passed on to the
contractee.
Basics of Cost Accounting G.3 Glossary

Departmentalisation of Overheads : It is the process of allocation and apportionment of

overheads to different departments or other costs centres.

Development Costs: The cost of process which begins with the implementation of the
decision to produce or new or improved methods and ends with the commencement of
formal production of that product or by that method.
Direct Expenses: Costs other than materials or wages which are incurred for a specific
product ora saleable service.
Direct Labour Costs: The cost of remuneration for employee's efforts and skills applied
directly toa product or saleable service.

Direct Material Costs: The cost of materials entering into and becoming constituent elemernt
of a product or saleable service.
Distribution Costs : These are the costs incurred for despatching the products which are
ready after packing.
Escalation Clause: It is the clause which aims at safeguarding the interests of the contractor
against unforeseen rise in cOst.

Expenses: The cost of services provided to an undertaking.

Factory Costs: These are certain indirect expenses incurred by a concern right from the
receipt of an order to the final delivery of goods to the customer, or for storing the finished
goods in the godowns.
Financial Accounting: It is concerned with recording, classifying analysing and
summarising financial transactions and preparing financial statements with a view to
showing profitability and financial state of the affairs of the business.
Fixed Cost: A cost which accrues in relation to the passage of time and which, within certain
output and turnover limits, tends to remain unaffected by the fluctuations in the level of
activity (of the output or turnover) for eg, rent, rates, insurance etc.
Fixed Overheads These are the overhead costs which tend to be unaffected by the
variations in the volume of output e.g. office rent and taxes, depreciation on factory premises
etc.
Historical Costs: The costs which are ascertained after these have beern incurred.
Impersonal Cost Centre: It is a cost centre which consists of a location or item of equipment.
Indirect Expenses : The expenses other than direct expenses.
Indirect Labour Costs: The Labour Cost other than Direct Labour Cost.
Indirect Material Costs: The Material Cost other than Direct Material Cost.
Basics of Cost Accounting G.4 Glossary

Job Cost Sheet: It is a cost statement prepared to analyse and ascertain the actual cost
incurred with respect to the individual jobs.
Job Costing: It is that form of specific order costing, which applies where work is undertaken
regarding customer's special requirements.
Labour Costs: The sum total of all payments made by the employer to the work-force for
performing production activity and the cost to the employer of all benefits granted to the
work-force for the same.
Maintenance Charges: 'These are certain semi-variable expenses which are to be incurred on
the maintenance of the vehicles to keep them in proper conditions eg repairs and
maintenance, painting etc.
Material Costs: The cost of commodities, other than Fixed Assets, introduced in products or
consumed in the operation of an organisatiorn.
Methods of Costing: It indicates a systematic procedure established for ascertaining cost of
product, job, process or services by using the principles of costing.
Multiple Costing: It is an application of more than one method of cost ascertainment in
respect of the same product.
Non-cost Items: These are certain items of financial nature, which are excluded from the
ascertainment of cost.

Normal Costs: A cost which is normally incurred to a given level of output in the condition
in which that level of output is normally attained.

Normal Loss: It is the loss of materials under normal conditions, which is unavoidable, as a
result normally expected quantity of output is less than the input
Normal Overheads: These are the overhead costs which are expected to be incurred in
producing a given output e.g. catalogues and price-lists, salary and commission to traveling
salesmen etc.
Notional Profit :It is the difference between the value of work certified and cost of work
certified.
Office Overheads: These are the cost of formulating the policy, directing the organisation
and controlling the operations of an undertaking which is not related directly to research,
development, production, selling or distribution activity function e.g. printing and stationery,
office rent and taxes etc.
Operating Cost: It is the cost incurred in providing a service.
Operating Cost Centre : It is a cost centre which consists of those machines and persons
which carry out the same operations.
Basics of Cost Accounting G.5 Glossary

Operating Costing: It is that form of operation costing, which applies where standardised
services are provided either by an undertaking or by a service cost centre within an
undertaking
Operation Costing: The category of basic costing methods applicable where standardised
80ods or services result from a sequence of repetitive and more or less continuous operations
or process to which costs are charged, betore being averaged over the units produced during
the period.
Output Costing: It is that form of operation costing where large number of identical units
are produced.
Over-Absorption of Overheads: It is the excess of absorbed overheads over actual
Overheads.
Overhead Absorption Rate: These are the rates determined for the purpose of absorption of
overheads.
Overheads : It is the aggregate of indirect material, indirect labour and indirect expenses.
Partly Producing Department:lt is one that is normally treated as service department, but
sometime they are also required to undertake direct production work.
Period Costs: These are the costs which are associated with a particular accounting period.
Personal Cost Centre: It is a cost centre which consists of a person or group of persons.
Process Cost Centre: It is a cost centre which consists of a continuous sequence of operations.

Process Costing: It is that form of operation costing which applies where the standardised
goods are produced.
Process Loss: It is the difference between the input quantity of raw materials and the output
quantity.
Product Costs: These are the costs which are directly associated with the product.
Production Cost Centre: It is a cost centre where actual production takes place for
eg, welding, mechanical, electrical, assembly etc.
Research Costs: The cost of seeking new or improved products, applications of material or
methods.
Retention Money : It is the money which serves as a security with the contractee and also
acts as a deterrent against leaving the work incomplete by the contractor.
Revenue Costs: A cost which is incurred to benefit the current period.
Scrap: These are the discarded material having some recovery value, which is usually
disposed ott without further treatment or re-introduced into the production process in place
of raw materials.
Basics of Cost Accounting .b Glossary

Selling Cost or Selling Overheads: These are the costs incurred for attracting the potential
Customers and retaning the exIsting customers.

Semi-variable Cost: A cost which has an element of fixity and also of variability for e.g
telephone charges, electricity charges etc.
: It is a cost centre which renders services to
Service Cost Centre production department for
e-g, power generation plant, repair shop, personnel department etc.
Simple Cost Unit: It is a unit which measure one characteristics such as length or volume or
area or weight for eg- per metre, per kilogram etc
Source Document : It 1S an original record that supports journal entries in an accounting
system.
Specific Order Costing: The category of basic costing methods applicable where the work
consists of separate contracts, jobs or batches each of which is authorised by a special order or
contract.
Sub-Contract Cost: These are the cost incurred for a sub-contract, where the contractor has
entrusted some special work to some expertise sub-contractor for e.8, electrification, sanitary
work, welding, digging, installation of lifts, painting work, etc.
Uncontrollable Costs: A cost chargeable to a cost centre which cannot be influenced by the
actions of the person in whom control of the centre is vested.
Variable Cost: A cost which in aggregate, tends to vary in the direct proportion with the
changes in the volume of production or turnover for e.g, direct material cost, direct labour
direct expenses etc.
cost,

Waste: These are the discarded substances having no value.

Work Certified: It is the cost of that part of work-in-progress, which is being completed
successfully by the contractor and has been approved by the certifier.
Work Uncertified: It is the cost of that part of work-in-progress which is being completed by
the contractor, but not approved by the certifier because of the faulty work or the work not
according to the specifications.
****
 OBJECTIVE QUESTIONS
TRUE/FALSE STATEMENTS
State with reasons whether the following statements are True or False:
1. Financial Accounting has been developed out of the limitations of Cost Accounting
2. Cost is an increase in assets or decrease in liabilities made to secure an economic benetit.
3.Costing is simply the technique and process of ascertaining costs.
4. Cost Accounting can replace Financial Accounting
5. Cost Accounting is concerned with cost ascertainment, cost presentation and cost control.
6. Cost Accountancy is the application of costing and COst Accounting principles.
7. A cost unit is a unit of measurement of efficiency.
8. A cost centre is a location, person or item of equipment, for which costs may be ascertained
and used tor the purposes of control.
9. A service cost centre renders services to production departments.
10. Per passenger-kilometre 1s an example of composite cost unit in passenger transport
company.
1. A process cost centre is that which consists of a specific process or a continuous sequence of
Operations.
12. Cost + Profit = Sales' is the equation of costing.
13. The classification of costs into fixed costs and variable costs helps the management to take
vital decisions.
14. Prime Costs are identifiable.
15. Depreciation on Fixed Assets is always a Marginal Cost.
16. Semi-fixed costs are partly controllable and partly uncontrollable.
17. Fixed Cost decisions, once implemented are irreversible.
18. Motive power is an example ot administration overheads.
19. Total Fixed Cost always increases in proportion to output.
20. Period costs are not to
assigned products.
21. Cost-Sheet is a statement which shows only the indirect components ot the total cost.
22. Works Cost is the difference between Gross Cost and Management Cost.
25. Hire charges of a special machinery is an example ot unproductive expenses.
24. Clay used in bricks manufacturing is an example of indirect material.
25. rime osts are aggregate of indirect materials, indirect labour and indirect expenses.
26. The difference between cost of sales and value of sales is known as a loss.
27. Leather used in shoe making business is an example of indirect material.
28. Underwriting commission is a non-cost item.
29. Material Cost is the cost of commodities supplied to an undertaking
30. All overheads are costs, but all costs may not be overheads.
31. Cleaning materials used to maintain the machine in factory workshop is an example of Prime
Cost Material.
32. Carriage on Sales is a Prime Cost expense.
83. Wages paid to watchman is an item of productive labour.
34. Selling Overheads are the cost of promoting sales and retaining customers.
35. Salary paid to computer operator increases direct labour cost in software industries.
36. All variable costs are direct and indirect costs.
37. Per unit fixed cost is always constant.
38. All costs are variable in the long run.
39. All costs are controllable.

(T.1)
Basics of Cost Accountung 2 Objective Questions

40. All costs are relevant for some decisions or the other.
41. Methods of Costing refers to the process of collecting, arranging, processing and presenting
costs.
42. Methods of Costing are introduced for controlling the cost.
43. Job Costing is applicable to cases, where the work is done according to customers
specification.
44. Contract Costing is a method used in civil engineering works, plant installations, etc.
45. A clause providing for reduction in the contract price, in case of falling prices to protect the
interest of the contractee is termed as Escalation clause.
46. Retention money is the amount paid to the contractor after the satisfactory completion of the
Work.
47. Each contract is treated as a separate cost unit.
48. Work certitied in a subsequent year is always greater than in the preceding year.
49. Cost-plus-contracts are entered into when the cost of contract can be determined in advance.
50. Process Costing is a method of operation costing.
bl. n process manufacturing industries, there is a flow of materials from one operation to the
next operation.
52. Each process is treated asa separate cost centre.
53. Normal losses are not charged to the product in Process Costing.
54. Excess of actual loss over normal loss is termed as abnormal loss.
55. The loss inherent in the production process is treated as a normal loss.
56. Process Costing is applicable to those industries, where manutacture of product is of uniform
standards.
57. Operating Costing is a part of specific order costing.
58. Operating Costing deals with costing of services.
59. Operating Costing method can suitably be applied in transport undertakings.
60. Operating Costing is used for evaluating alternatives.
61. A standard method of costing cannot be used for all types of industries.
62. Job Costing and Contract Costing are the forms of operation costing.
63. Difterence between a job and a contract is that of time involved and cost.
64. Most of the costs in case of contracts are direct costs.
65. Work uncertified does not contain a profit element.
66. Cost of additional work is to be recovered from the contractee.
67. Supplementary costs are also termed as 'Overheads.
68. Abnormal overheads are charged to Production Account.
69. Direct costs can not be conveniently identified with a particular cost unit.
70. Overhead costs changes in proportion to changes in output.
71. All overheads are the costs, but all costs are not the overheads.
72. Behavioural classification of overheads is highly helpful to the management for the efficient
working of the production shop.
73. Increase in overhead costs due to higher level of mechanisation result in reducing the labour
cost.
74. Secondary packing costs are treated as prime cost.
75. Kigid overheads are generally uncontrollable.
76. Fixed overheads are influenced by policy decisions of top management, hence they are
termed as Policy costs.
77. Office overheads are controllable at lower level of management.
78. Marginal costs are always fixed in total.
Basics of Cost Accounting .3 Objective Questions

79. Depreciation on plant and machinery changes only witha change in capacity.
80. Per unit semi-fixed overheads decline with decrease in output.
81. Lubricants are the indirect materials which can be ascertained from stores requisitions.
82. Certain direct costs of very small value though identifiable with specific cost units may be
reated as overhead costs.
83. Some cost may be direct in one situation and indirect in other situation.
84. If no payment of rent of owned premises by the owner, the notional rent may be charged as
verhead.
85. The overheads incurred for procuring, promoting and effecting sales are termed as
distribution overheads.
86. Fixed, variable and semi variable overheads is the classification of overheads as per
variability.
87. Cost of power used by a speciic department can be better controllable by the shop
supervisor.
88. Due to improvement of technology, overheads are becoming more or less equal to direct
cOsts.
89. Fixed overhead cost is a committed cost.
90. Variable overhead is a period cost.
91. Factory rent is a direct cost to the tactory as a whole but indirect to the departmernts.
92. Fixed costs vary with the volume rather than time.
93. Variable overheads vary with the volume of output.
94. Packing cost is usually treated as distribution overhead.
95. After sales service cost is the part of distribution on cost.
96. Cost of unsuccessful research should be charged to costing Profit and Loss Account.
97. An increase in output reduces per unit overhead cost and increases profits at higher rate.
98. Direct costs are also termed as overheads.
99. High overhead cost increases the risk profile of the busines.
100. Sales commission is an example of direct overheads.
101. Costs which do not change with change in output upto given capacity, are marginal costs.
102. What is controllable now may not remain controllable in future.
103. Allocation of overheads refers to the process of charging full amount of overheads to a
pardcular cost centre.
104. The code number given to an item of factory overhead is termed as factory order number.
105. The process of assigning service department overheads to production departments is called
as secondary distribution.
106.
107.
Departmentalisation overheads is the process of assigning overheads to
various departments.
Secondary distribution of overheads is impossible after completion of primary distribution.
108. Codification of overheads facilitates appropriate accounting and systematic analysis of
indirect costs.
109. Absorption of overheads is nothing but charging of overheads to cost units.
110. Office overheads are recovered as a percentage of prime cost materials.
T. ApPportionment is nothing but charging of overheads to cost centres.
112. When actual overheads are in excess of absorbed overheads, it is a case of over absorption.
113. When absorbed overheads are in excess of actual overheads, it is the case of under
absorpuon.
114. Allocation of cost is always direct.
115. Under or over absorption due to cyclical fluctuations is generally carried over to the next
year.
116. All overheads are fixed costs.
117. The overhead rate should be simple to understand and easy to operate.
Basics of Cost Accountingg Objective Questions

ANSWERSs
True
3,5, 6, 8,9, 10, 11, 12, 13, 14, 16, 17, 20, 22, 26, 28, 29, 30, 34, 35, 36, 38, 40, 41, 43, 44, 46, 47, 48
50, 51, 52, 54, 55, 56, 58, 59, 60, 61, 63, 64, 65, 66, 67, 71, 72, 73, 75, 76, 79, S1, 82, 83, 84, 86, 88,
89,91,93, 94, 96, 97, 99, 100, 102, 103, 105, 106, 108, 109, 111, 114, 115, 117.
False:

1- Cost Accounting has been developed out of the limitations of Financial Accounting
2- A decrease in assets or an increase in liabilities, 4- Both are necessary, 7 A unit of
measurement of cost, 15 can be a Fixed Cost, 18 Factory Overheads, 19 Total Variable
-

Cost, 21 - Shows direct and indirect components of the 1otal Cost, 23 - Productive expenses,
24 Direct Material, 25 are aggregate of direct materials, direct labour and direct expenses,
-

27 Direct Material, 31 - Indirect Material, 32 Distribution overhead, 33 unproductive

labour, 37 always variable, 39 are not controllable, 42 for ascertaining the cost,
- -

45- De-escalation clause, 49 Cannot be determined in advance, 53 are charged to the

product, 57- operation costing, 62- forms a specific order costing, 68. are changed to costing
Profit and Loss Account, 69. indirect costs, 70. direct costs, 74. overhead costs,
77. uncontrollable, 78. variable in total, 80. decline with increase in output, 85. selling
overheads, 87. departmental manager, 90. product cost, 92. vary with time rather than
volume, 95. selling on cost, 98. indirect costs, 101. fixed costs, 104. standing order number,
107. possible, 110. percentage of works cost. 112. under absorption, 113. over absorption,
116. fixed or variable costs.
***
 FILLIN THE BLANKS
1.
2.
The amount of expenditure incurred on a given thing is terms as
Costing is the technique and process of .costs,
.
3. Cost Accounting is based on ..
System.
4. Cost Accounting helps in . appraisal.
is the application of costing and cost accounting principles, methods and
techniques.
D. Cost Accounting focusses on ... and not on ..
Cost Accounting is a system of
.. and not a postmortem examination.
...
8.
9.
The basic object of cost accounting is to
Need for cost accounting arises because of limitations of ..
aCcounting
..
10. Larger the number of alternative techniques ot production, greater is the need tor
11.
12.
13.
Cost Accounting begins where. ends.
Both financial accounting and cost accounting are basically the branches of
Financial Accounting generally discloses the profitability of the
.
.
organisation.
14. Financial Accounting record ..costs, whereas Cost Accounting record .
osts.

..
15. The main function of financial accounting is. reporting.
16. The basic needs of the majority of the users of accounting information can be satisfied
by ccounting
17. is the price paid for something
18. Opportunity cost means the
.. made for not utilising the other alternatives.
19. Cost Accounting is concerned with...of cost.
20. Cost includes costing and cost accounting
21.
.Accounting shows only the overall performance of the business.
22.
25.
24.
Cost Accounting has become an essential
Cost Accounting helps the management in
Cost unit a unit of measurement or
making.
...
...
f marnagement.

is

...
25.
26.
27.
Cost unit should be neither too nor too.
In cement industries, the cost unit is per
..
.
refers to an outflow of resources without any commensurate benefit.
28. .. COst centre is that which consists of a location or item of equipment.
29. Direct cost is ...
to cost unit or cost centre, whereas indirect cost is ..
30. A cost unit for measuring products is mostly
.. cost unit.
31. Cost unit is a Unit or a product or Service or time in relation to which costs are
ascertained.
32. In passenger ransport company, per passenger is a .... COSt unit.
35. In goods transport company, per tonne per kilometer isa..COst unit.

(F.1)
Basics of Cost Accounting9 F.2 Objective Questions

34. A cost .. is a sub unit of the organisation for which costs may be collected
separately for cost ascertainment and cost control.
35. cOst units are mostly applicable in case of services rendered.
36. Repair shop is an example ot .cost centre
37.
38.
..
. COsts remain constarnt with changes in volume of output.
COsts benefit the current period only, whereas
particular period.
COsts benefit more than one

39. . 1S a statement which provides tor the assembly of the detailed cost of a cost
centre ora cost unit.
. is the physical or mental eftort expended in production.
40.
41. Abnormal costs are charged to ..
42. .. COsts are based on recorded facts.
43. Pre-determined cost ascertained on scientific basis becomes... COst.
44. . costs are the costs directly associated with the product.
45. Primary packing charges is an example of direct ...cOst.
46. The marginal cost per unit of product remains ...
47. Direct expenses are also known as ... eXpense
48.
. COst is the cost of seeking new or improved products, aPplications of material or
methods.
49. The sum total of .. cOst, production and administration overheads is known as cost
of production.
50. Direct cost plus variable overheads is known as. COst.
51. If profits are 20% of value of turnover and the cost of turnover is ? 80,000, the profits
will be..
52. Prime cost and overhead cost makes the ..
cost.
53. Milk used in dairy products is the example of ...materials.
54. t is more appropriate to treat threads in dress making businesses as materíals.
55. Lubricants used in factory workshop is the example of .... materials.
56. Direct materials torm the part of .... products.
57. .. cost is the cost of remuneration of the employees of an undertaking.
58. Wages paid for factory supervision is the example of ..
abour.
59. Expenses which can be identified with and allocated to cost centres and cost units are
termed as...
60. Royalty payable in mining business is to be treated as..
61. .
COsts are the operating expenses of a business enterprise.
62. The costs incurred in promoting sales and retaining customers is treated as ..
63. Carriage on purchases is the part of direct..cost.
64. Bad debts recovery is a .cost item.
65. The. Of cost of a product are material, labour and expenses.
Basics of Cost Accounting Objective Questions

66. .. 1s the physical or mental ettort expended in production.

67. Fixed cost can be controlled mostly by .level management.
68. All costs are. n long run.
the
69. Electricity charges is the most suitable example of ... Cost.
70. .. COsts are objective in nature.
Product costs are torm a part

. COsts
71. because they of value of inventories of
finished stock.
72. COsts are non-inventoriable costs, as they are not included in the value of finished
stocks.
73. Revenue costs are incurred for maintainin8 capacity ot the business.
74. .. is a document which provides for the assembly of the estimated detailed cost in
respect of a cost centre or cost unit.
Underwriting commission should not be incorporated in the cost sheets because these
75.
are expenses of ... nature.
76. Overheads are the ... costs of a business enterprise which can not be traced directlyy
to a particular unit of output.
77. The aggregate of indirect material cost, indirect wages and indirect expenses is termed

78.
79. .
1s.

Wages of store-keeper is an example of ..

Overheads.
Overheads are related to the periods, hence they are termed as period costs.
80. .classification of overheads, is the grouping of overheads with reference to the
major activity of an organisation.
81. Variable overheads .. in direct proportion to the volume of output.
82. Normal bad debts is an example of ..Overheads.
.
83. An increase in efficiency per unit overhead cost.
84. Generally items of manutacturing overheads are to be apportioned to various
departmernts on the basis of ... hours.
85. Training expenses would be abnormally . in case of high labour turnover.
..
86.
87.
Normal rent of shop supervisor is to be charged as
Technical directors travelling expenses form a part of .... Overheads.
88. . means the allotment of whole items of cost to cost cerntres or cost units.
89 .. is the allotment of proportionate items of cost to cost centres or cost units.
90. In telephone charges, telephone rent is. whereas charges tor telephone calls are

91, The overhead is the process of charging of overheads to cOst units on an

estimated basis.
92. Under absorption of overheads signifies ... financial profit compared with cost
profit.
Basics of Cost Accounting_ F4 Objective Questions

93. .. absorption of overheads signifies higher financial profit compared with cost

94.
pront.
When actual overheads are 21,500 and overhead absorbed are 20,600, there is .
absorption of R 900.
95. The absorption of machine overheads would indicate the extent to which the
machines have been idle.
96. If under absorption of overheads arises due to defective planning, it may be transferred
to.
97. Under absorption of overhead results in .
statement of cost.
98. Absorption ot overhead takes place only atter the and apportionment of
Overheads
99. Contract costing is a variant of .. cOsting.
100. The contracts undertaken are always completed from the premises. ..
101. The difference between the value of work certified and the cost of work certified is
KnownasS
102. In contract accounting, the total loss if any, is transterred to .. account.
103. Under
.. the value of contract is determined by adding a fixed margin of profit to
the total cost of contract.
104. Under the ... clause the contract price is increased for a given increase in the prices
ofinputs.
105. Materials issued to the sub-contractor free of charge, should be charged to
account
106. contract is generally of a . duration.
.
107.
108.
EScalation clause 1s generaly
Cost-plus-contracts are undertaken
included in case of
tor production of ..Contract agreement
products.
109. Work certified is always valued at contract. whereas work uncertified is always
valued at.. ..
110. Work certified ina year is always higher than in the .. year.
111.
112.
113.
Work certified in a subsequent year is always
Cost plus contract is mainly used in
In contract costing, usualy work
. than that in the preceding year.

form the basis of protit computation.

..Should
114. The .certificate forms the basis of release of payments to the contractor
115. ketention money serves asa.. ith the contractee.
..

..
116. An escalation clause usually relates to the change in prices of
117. When the completion of the contract is less than 50o, profit to be credited to profit and
loss account will be equal to
118. When cash ratio is.. retention money is 13%.
119. A bigger job is referred to as a
Basics of Cost Accounting F.5 Objective Questions

120. In a particular building construction company the estimated profit is 90,000 and the

121. Process costing represents one extreme of

....
contract is almost two-third complete. If the cash ratio is 90%, the profit to be
transterred to profit and loss account is
cOsting
122. In process costing, as the product passes from one process to another, the ... ost of
previous process is transferred to the next process.
123. In oil and petroleum refineries,... costing may be adopted more suitably.
124. The is a material residue from certain manufacturing operations that has
relatively minor value.
125. In process industries there 1s a continuous tlow of .....
from orne operation to the next

126.
127.
operation.
Make or buy decisions are involved before and after different
In process industries materials move down the production line in a
.stream.
128. In process costing each process is treated as a separate ...
..
129.
130.
In process industries the output is generally tor
All normal losses in process costing are charges directly to the ..
131. Cost per unit remains. in case of abnormal loss as well as abnormal gain.
132. loss is what which arises under efficient operating conditions.
..
133.
134.
Abnormal
Generally normal loss is .
gain may be the result due to the errors in

135. Balance in abnormal loss account is transferred to .... account.

136. Normal wastage is credited to process account and debited
137. If the actual loss is
. to.
account.
than normal lo5s, it is termed as abnormal loss.
138. Frocess costing manuracturing
15
...Suitable for industries colour television.
139. The cost finding method is more simple and less expensive in .... Costing than that of
* COsting
140. In process costing the output of one process becomes the .. of another process.
141. The cost of abnormal gain is computed on the basis of
.
production.
142 Operating cost is the cost incurred for providing...

ANSWERS
1.cost, 2. ascertaining, 3. double entry, 4. pertormance, 5. Cost Accountancy, 6. cost-revenues,
7. foresight, 8. control the costs, 9. financial, 10. costing, 11. costing, 12. accounting, 13. entire,

14. historical-projected, 15. external, 16. Financial, 17. Cost, 18. sacrifice, 19. recording
20. accountancy, 21. Financial, 22. tool, 23. decision, 24. cost, 25. big-small, 26. tonne, 27. Loss,
28. Impersonal, 29. allocated-apportioned, 30. single, 31. quantitative, 32. single, 33. composite,
34. centre, 35. Composite, 36. service, 37. Fixed, 38. Revenue-capital, 39. Cost sheet, 40. labour,
41. costing profit and loss, 42. Historical, 43. standard, 44. Direct, 45. material, 46. fixed,
Basics of Cost Accounting .b Objective Questions

17. chargeable, 48. Research, 49. prime cost, 50. marginal, 51. 20,000, 52. total, 53. direct,
54. indirect, 55. indirect, 56. finished, 57. Labour, 58. indirect, 59. direct, 60. direct expense,
61. Overhead, 62. selling, 63. material, 64. non, 65. elements, 66. Labour, 67. toP, 68. variable,
69. semi-variable, 70. Historical, 71. inventoriable, 72. Period, 73. earning, 74. Cost sheet,
75. financial, 76. operating, 77. overheads, 78. factory, 79. Fixed, 80. Functional, 81. changes,
82. selling, 83. reduces, 84. machine/labour, 85. high, 86. factory overheads, 87. works,
88. Allocation, 89. Apportionment, 90. fixed /variable, 91. absorption, 92. labour, 93. over,
94. under, 95. under, 96. costing profit and loss account, 97. under, 98. allocation, 99. job,
100. contractors, 101. notional profit, 102. costing profit and loss, 103. cost plus contract,
104. escalation, 105. contract, 106. long, 107. fixed price, 108. highly specialised, 109. price-cost,
110. subsequent-preceding, 111. higher, 112. government, 113. certified, 114. architects,
Cash Received
115. security, 116. inputs, 117. 1/3 x Notional Profit x Work Certified
erti
118. 87%, 119. contract,

120. * 54,000, 121. product, 122. accumulated 123.

process, 124. scrap, 125. material,
126. processes, 127. continuous, 128. cost centre, 129. stock, 130. product, 131. same, 132. Normal,
133. estimate, 134. unavoidable, 135. costing profit and loss, 136. normal wastage, 137. greater,
138. not, 139. process-job, 140. input, 141. normal, 142. services.
 BIBLIOGRAPHY

Sr. Title of the Book Author/s Publication Place

No.

1. Cost Accounting ana M. Y. Khan, P. K. Jain McGraw Hill New Delhi

Financial Management

2.Cost Accounting Theory Bhabatosh Banerjee, PHL Learning Pvt. New Delhi
and Practice Jawahar Lalseema Ltd., McGraw Hill
Srivastav

Cost Accounting Dr.P.C. Tulsian S. Chand New Delhi

Costing Adviser P.V. Rathnam, Kitab Mahal Allahabad

P. Lalitha
5.Cost Accounting - Charles T. Horngreen, Pearson New Delhi
A Managerial Emphasis Srikant M. Datar,
Madhav V. Rajan

6. Advanced Cost and V.K. Saxena, C. D. Sultan Chand and New Delhi
Management Vashist Sons
Accounting

(B.1)