JAY SHREE KRISHNA PRADIPTA SARKAR

BASICS
Classification of Costs

Nature of Element
Material: Cost of Material used in production. Cost of Raw Material
Labour: Cost of Workers. Wages and Salary
Expenses: Costs other than Material and Labour. Power, Office Maintenance

Traceability to Object
Direct Costs: Which can be allocated directly to the product. Wood in case of Furniture
Indirect Costs: Which cannot be directly allocated to the product.Nails used in Furniture

Functions
Production Costs Cost of whole process of Production. Direct Materials and Conversion Cost.
Selling Costs: Cost for creating demand of the product produced. Advertising Expenses
Distribution Costs: Costs starting from packing of the product till reconditioning of empty products. Freight and
Transportation
Administrative Costs: Cost of formulating policy, controlling the organisation, costs not directly related to
production. Salary of Office Staff
Development Costs: Development Costs for trial Run. Research Costs
Pre- Production Costs: Costs starting with implementation of decisions and ending with the commencement of the
production process. Direct Labour and Factory Overheads
Conversion Costs: Cost of transforming direct material into Finished Products
Product Costs: Costs necessary for production.

Variability
Fixed Costs: Cost which remains constant in total
Variable Costs: Costs which changes with production
Semi- Variable Costs: Costs which are partly fixed and partly variable

Controllability
Controllable Costs: Costs which can be influenced by the action of a specific member of an undertaking
Uncontrollable Costs: Costs which can not be influenced by the action of a specific member. Fixed Costs- Rent

Normality
Normal Costs: Costs which are expected to be incurred in normal routine. Raw Material Costs
Abnormal Costs: Costs which are over and above normal costs Cost of Wastes

Decision
Relevant Costs (Marginal Costs, Cost of Best Possible Use Making Differential Costs, Opportunity Costs, Out of
Pocket): Costs which are relevant and useful for decision making
Irrelevant Costs (Sunk costs, Committed costs, Fixed costs): Costs which are not relevant or useful to decision
making Costs incurred in the past - Advance Payment

Cash Outflow
Explicit Costs: Costs involving immediate payment of cash
Implicit Costs: Costs not involving immediate cash payment

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Q. What is Cost accounting? Enumerate its important objectives.

Cost Accounting is defined as "the process of accounting for cost which begins with the recording of income and
expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and
reports for ascertaining and controlling costs."
The main objectives of the cost accounting are as follows:
(a) Ascertainment of cost: There are two methods of ascertaining costs, viz., Post Costing and Continuous Costing.
Post Costing means, analysis of actual information as recorded in financial books. Continuous Costing, aims at
collecting information about cost as and when the activity takes place so that as soon as a job is completed the cost
of completion would be known.
(b) Determination of selling price: Business enterprises run on a profit making basis. It is thus necessary that the
revenue should be greater than the costs incurred. Cost accounting provides the information regarding the cost to
make and sell the product or services produced.
(c) Cost control and cost reduction: To exercise cost control, the following steps should be observed:
(i) Determine clearly the objective.
(ii) Measure the actual performance.
(iii) Investigate into the causes of failure to perform according to plan;
(iv) Institute corrective action.
(d) Cost Reduction may be defined “as the achievement of real and permanent reduction in the unit cost of goods
manufactured or services rendered without impairing their suitability for the use intended or diminution in the
quality of the product.”
(e) Ascertaining the profit of each activity: The profit of any activity can be ascertained by matching cost with the
revenue of that activity. The purpose under this step is to determine costing profit or loss of any activity on an
objective basis.
(f) Assisting management in decision making: Decision making is defined as a process of selecting a course of action
out of two or more alternative courses. For making a choice between different courses of action, it is necessary to
make a comparison of the outcomes, which may be arrived under different alternatives.

Q. Write short note on essential factors for installing a Cost Accounting system.

Essential Factors for installing a Cost Accounting System

Before setting up a system of cost accounting following factors should be studied:

(a) Objective : The objective of costing system, for example whether it is being introduced for fixing prices or for
insisting a system of cost control.

(b) Type of Business: The areas of operation of business wherein the managements’ action will be most beneficial.
For instance, in a concern, which is anxious to expand its operations, increase in production would require maximum
attention. On the other hand for a concern, which is not able, to sell the whole of its production the selling effort
would require greater attention. The system of costing in each case should be designed to highlight, in significant
areas, factors considered important for improving the efficiency of operations in that area.

(c) General organisation: The business, with a view of finding out the manner in which the system of cost control
could be introduced without altering or extending the organisation appreciably.

(d) The Technical Details: Technical aspects of the concern and the attitude and behaviour that will be successful in
winning sympathetic assistance or support of the supervisory staff and workmen.

(e) Change in operations: The manner in which different variable expenses would be affected with expansion or
cessation of different operations

(f) Method of maintenance of cost records: The manner in which Cost and Financial accounts could be inter-locked
into a single integral accounting system and in which results of separate sets of accounts, cost and financial, could be
reconciled by means of control accounts.

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(g) Information: The maximum amount of information that would be sufficient and how the same should be secured
without too much clerical labour, especially the possibility of collection of data on a separate printed form designed
for each process; also the possibility of instruction as regards filling up of the forms in writing to ensure that these
would be faithfully carried out.

(h) Accuracy: How the accuracy of the data collected can be verified? Who should be made responsible for making
such verification in regard to each operation and the form of certificate that he should give to indicate the
verification that he has carried out?

(i) Informative and Simple: The manner in which the benefits of introducing Cost Accounting could be explained to
various persons in the concern, especially those in charge of production department and awareness created for the
necessity of promptitude, frequency and regularity in collection of costing data.

(j) Support: Support of top management and employees are essential for installing a Cost Accounting System in any
organisation.

Q. Difference between Cost Accounting and Management Accounting

Nature It records the quantitative aspect only It records both qualitative and
quantitative aspect

Objective It records the cost of producing a product Provides information to management for
and providing a service planning and co-ordination

Area It only deals with cost Ascertainment. It is wider in scope as it includes F.A.,
budgeting, Tax, Planning.

Recording of It uses both past and present figures. It is focused with the projection of
data figures for future.

Development It’s development is related to industrial It develops in accordance to the need of

revolution modern business world.

Rules and It follows certain principles and procedures for It does not follow any specific rules and
Regulation recording costs of different products regulation

Q. Essentials of a Good Cost Accounting System

The essential features, which a good Cost Accounting System should possess, are as follows:
(a) Informative and Simple: Cost Accounting System should be tailor-made, practical, simple and capable of meeting
the requirements of a business concern. The system of costing should not sacrifice the utility by introducing
meticulous and unnecessary details.

(b) Accuracy: The data to be used by the Cost Accounting System should be accurate; otherwise it may distort the
output of the system and a wrong decision may be taken.

(c) Support from Management and subordinates: Necessary cooperation and participation of executives from
various departments of the concern is essential for developing a good system of Cost Accounting.

(d) Cost-Benefit: The Cost of installing and operating the system should justify the results.

(e) Procedure: A carefully phased programme should be prepared by using network analysis for the introduction of
the system.

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(f) Trust: Management should have faith in the Costing System and should also provide a helping hand for its
development and success

SHORT NOTES:

(i) Conversion cost: It is the cost incurred to convert raw materials into finished goods. It is the sum of direct wages,
direct expenses and manufacturing overheads.

(ii) Sunk cost: These are historical costs which are incurred in the past. These costs were incurred for a decision made
in the past and cannot be changed by any decision that will be made in future. In other words, these costs play no
role in decision making, in the current period. While considering the replacement of a plant, the depreciated book
value of the old plant is irrelevant, as the amount is a sunk cost which is to be written off at the
time of replacement. Again for example, in the case of a decision relating to the replacement of a machine, the
written down value of the existing machine is a sunk cost, and therefore, not considered.

(iii) Opportunity cost: It refers to the value of sacrifice made or benefit of opportunity foregone in accepting an
alternative course of action. For example, a firm financing its expansion plan by withdrawing money from its bank
deposits. In such a case the loss of interest on the bank deposit is the opportunity cost for carrying out the expansion
plan.

(iii) Research and Development Costs: Research costs are the costs incurred for the discovery of new ideas or
processes by experiment or otherwise and for using the results of such experimentation on a commercial basis.
Research costs are defined as the costs of searching for new or improved products, new applications of materials, or
improved methods, processes, systems or services.
Development costs are the costs of the process which begins with the implementation of the decision to produce a
new or improved product or to employ a new or improved method and ends with the commencement of formal
production of that product by that method.

(iv) Training Costs: These costs comprises of – wages and salaries of the trainees or learners, pay and allowances of
the training and teaching staff, payment of fees etc, for training or for attending courses of studies sponsored by
outside agencies and cost of materials, tools and equipments used for training. Costs incurred for running the
training department, the losses arising due to the initial lower production, extra spoilage etc. occurring while
providing training facilities to the new recruits.
All these costs are booked under separate standing order numbers for the various functions. Usually there is a
service cost centre, known as the Training Section, to which all the training costs are allocated. The total cost of
training section is thereafter apportioned to production centers.

Q. Define Explicit costs. How is it different from implicit costs?

Explicit costs: These costs are also known as out of pocket costs. They refer to those costs which involves immediate
payment of cash. Salaries, wages, postage and telegram, interest on loan etc. are some examples of explicit costs
because they involve immediate cash payment. These payments are recorded in the books of account and can be
easily measured.
Main points of difference: The following are the main points of difference between explicit and implicit costs.
(i) Implicit costs do not involve any immediate cash payment. As such they are also known as imputed costs or
economic costs.
(ii) Implicit costs are not recorded in the books of account but yet, they are important for certain types of managerial
decisions such as equipment replacement and relative profitability of two alternative courses of action.

Q. Period and Discretionary costs

There are the costs, which are not assigned to the products but are charged as expenses against the revenue of the
period in which they are incurred. All non-manufacturing costs such as general and administrative expenses, selling
and distribution expenses are period costs.

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Such costs are not tied to a clear cause and effect relationship between inputs and outputs. They arise from periodic
decisions regarding the maximum outlay to be incurred. Examples are – advertising, public relations, training etc.

Q. Distinguish between product cost and period cost.

Product Cost vis-à-vis Period cost

Product costs are associated with the purchase and sale of goods. In the production scenario, such costs are
associated with the acquisition and conversion of materials and all other manufacturing inputs into finished product
for sale. Hence under absorption cost, total manufacturing costs constitute inventoriable or product cost.
Periods costs are the costs, which are not assigned to the products but are charged as expense against revenue of
the period in which they are incurred. General Administration, marketing, sales and distributor overheads are
recognized as period costs.

Imputed Cost:
These costs are notional costs which do not involve any cash outlay. Interest on capital, the payment for which is not
actually made, is an example of Imputed Cost. These costs are similar to opportunity costs.

Captialised Cost: These are costs which are initially recorded as assets and subsequently treated as expenses.

Q. State the unit of cost for the following industries

(a) Transport (b) Power (c) Hotel (d) Hospital

Industry Unit of Cost

(a) Transport – Per passenger k.m. or per tonne. k.m.
(b) Power – Per Kilo – watt (kw) hour
(c) Hotel – Per room day / or per meal
(d) Hospital – Per patient – day

Q. State the types of cost in the following cases:

(i) Interest paid on own capital not involving any cash outflow.
(ii) Withdrawing money from bank deposit for the purpose of purchasing new machine for expansion purpose.
(iii) Rent paid for the factory building which is temporarily closed
(iv) Cost associated with the acquisition and conversion of material into finished

Type of costs
(i) Imputed Cost
(ii) Opportunity Cost
(iii) Shut Down Cost
(iv) Product Cost

Q. Cost Units

It is a unit of product, service or time (or combination of these) in relation to which costs may be ascertained or
expressed.
We may for instance determine the cost per tonne of steel, per tonne kilometre of a transport service or cost per
machine hour. Sometime, a single order or a contract constitutes a cost unit. A batch which consists of a group of
identical items and maintains its identity through one or more stages of production may also be considered as a cost
unit.
Cost units are usually the units of physical measurement like number, weight, area, volume, length, time and value.
A few typical examples of cost units are given below:
Industry or Product Cost Unit Basis
Automobile Number
Cement Tonne/ per bag etc.
Chemicals Litre, gallon, kilogram, tonne etc.
Power Kilo-watt hour
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Steel Tonne
Transport Passenger kilometer

Q. Cost Centre : It is the smallest area of responsibility or segment of activity for which costs are accumulated. It can
be defined as a location; person or an item of equipment or a group of these for which costs are ascertained and
used for the purpose of cost control. Cost centres are of two types viz.., personal and impersonal.

Personal cost centre: It is a cost centre which consists of a person or a group of persons.

Impersonal cost centre: It is a cost centre which consists of a location or an item of equipment or a group of these.

Cost Centres in a manufacturing concern:

Two main types of Cost Centres are indicated as below:

Production Cost Centre: It is a cost centre where raw material is handled for conversion into finished product. Here
both direct and indirect expenses are incurred.
Machine shops, welding shops and assembly shops etc. are examples of production Cost Centres.
Service Cost Centre: It is a cost centre which serves as an ancillary unit to a production cost centre. Payroll
processing department, HRD, Power house, gas production shop, material service centres, plant maintenance
centres etc. are examples of service cost centres.

Q. Cost Objects

Cost object is anything for which a separate measurement of cost is required. Cost object may be a product, a
service, a project, a customer, a brand category, an activity, a department or a programme etc.

Examples of Cost Object are:

Product Smart phone, Tablet computer, SUV Car, Book etc.
Services An airline flight from Delhi to Mumbai, Concurrent audit assignment, Utility bill payment facility etc.
Project Metro Rail project of DMRC, Road projects of NHAI etc.
Activity Quality inspection of materials, Placing of orders etc.
Process Refinement of crudes in oil refineries, melting of billets or ingots in rolling mills etc.
Department Production department, Finance & Accounts, Safety etc

Q. Difference between Cost Control and Cost Reduction

Cost Control Cost Reduction
1. Cost control aims at maintaining the costs in accordance with the established standards.
Cost reduction is concerned with reducing costs. It challenges all standards and endeavours to better them
continuously

2. Cost control seeks to attain lowest possible cost under existing conditions.
Cost reduction recognises no condition as permanent, since a change will result in lower cost.

3. In case of Cost Control, emphasis is on past and present

In case of cost reduction it is on present and future.

4. Cost Control is a preventive function.

Cost reduction is a corrective function. It operates even when an efficient cost control system exists.

5. Cost control ends when targets are achieved

Cost reduction has no visible end.

Q. Discuss cost classification based on variability and controllability.

Cost classification based on variability

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Fixed cost – These are costs, which do not change in total despite changes of a cost driver. A fixed cost is fixed only in
relation to a given relevant range of the cost driver and a given time span. Rent, insurance, depreciation of factory
building and equipment are examples of fixed costs where the final product produced is the cost object.

Variable costs – These are costs which change in total in proportion to changes of cost driver. Direct material, direct
labour are examples of variable costs, in cases where the final product produced is the cost object.

Semi-variable costs – These are partly fixed and partly variable in relation to output e.g. telephone and electricity bill.

Q. Cost classification based on controllability

Controllable costs – Are incurred in a particular responsibility center and relate to a defined time span. They can be
influenced by the action of the executive heading the responsibility center e.g. direct costs.

Uncontrollable costs – Are costs are influenced by the action of the responsibility center manager e.g. expenditure
incurred by the tool room are controllable by the foreman in charge of that section, but the share of tool room
expenditure which are apportioned to the machine shop are not controllable by machine shop foreman.

Q. Different industries follow different methods of costing because of the differences in the nature of their work.
The various methods of costing are as follows:
Methods Description
Job Costing In this method of costing, cost of each job is ascertained separately. It is suitable in all cases where work
is undertaken on receiving a customer’s order like a printing press, motor workshop, etc.

Batch Costing It is the extension of job costing. A batch may represent a number of small orders passed through the
factory in batch. Each batch here is treated as a unit of cost and thus separately costed. Here cost per unit is
determined by dividing the cost of the batch by the number of units produced in the batch.

Contract Costing Here the cost of each contract is ascertained separately. It is suitable for firms engaged in the
construction of bridges, roads, buildings etc.

Single or Output Costing

Here the cost of a product is ascertained, the product being the only one produced like bricks, coals, etc.

Process Costing Here the cost of completing each stage of work is ascertained, like cost of making pulp and cost of
making paper from pulp. In mechanical operations, the cost of each operation may be ascertained separately; the
name given is operation costing.

Operating Costing
It is used in the case of concerns rendering services like transport, supply of water, retail trade etc.

Multiple Costing It is a combination of two or more methods of costing outlined above. Suppose a firm manufactures
bicycles including its components; the parts will be costed by the system of job or batch costing but the cost of
assembling the bicycle will be computed by the Single or output costing method. The whole system of costing is
known as multiple costing

For ascertaining cost, following types of costing are usually used.

Techniques Description
Uniform Costing When a number of firms in an industry agree among themselves to follow the same system of
costing in detail, adopting common terminology for various items and processes they are said to follow a system of
uniform costing.
Advantages of such a system are that
i. A comparison of the performance of each of the firms can be made with that of another, or with the average
performance in the industry.
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ii. Under such a system it is also possible to determine the cost of production of goods which is true for the industry
as a whole. It is found useful when tax-relief or protection is sought from the Government.

Marginal Costing It is defined as the ascertainment of marginal cost by differentiating between fixed and variable
costs. It is used to ascertain effect of changes in volume or type of output on profit.

Standard Costing and Variance Analysis

It is the name given to the technique whereby standard costs are predetermined and subsequently compared with
the recorded actual costs. It is thus a technique of cost ascertainment and cost control.
This technique may be used in conjunction with any method of costing. However, it is especially suitable where the
manufacturing method involves production of standardised goods of repetitive nature.

Historical Costing It is the ascertainment of costs after they have been incurred. This type of costing has limited
utility.
Post Costing: It means ascertainment of cost after production is completed.
Continuous costing: Cost is ascertained as soon as the job is completed or even when the job is in progress.

Direct Costing It is the practice of charging all direct costs to operations, processes or products leaving all indirect
costs to be written off against profits in which they arise.

Absorption Costing It is the practice of charging all costs, both variable and fixed to operations, processes or
products. This differs from marginal costing where fixed costs are excluded.

Q. Indicating giving reasons, whether the following items are to be dealt with in cost accounts mentioning whether
and how any of these items are to be included in the total cost:
i. Surplus realised on sale of factory Plant & Machinery.
ii. Royalties paid on patents of other party used in own manufacturing process.
iii. Royalties received for allowing other to use own patents.
iv. Carriage and freight inwards in respect of raw materials purchased.
v. Carriage and freight outwards in respect of finished products sold.
vi. Advertising expenses for selling goods.
vii. Cash discount received from suppliers of raw materials.
viii. Packing materials required for making a product saleable.

Ans.
i. Surplus realised (or loss sustained) on sale of Factory Plant & Machinery is not an item of cost it
is purely a financial matter, therefore, it is to be kept outside the purview of total cost.
ii. Royalties paid on patents is an item of Direct expenses, therefore it is to be charged to prime
cost or may be shown as an item of factory overhead.
iii. Royalties received from others is a financial matter, therefore it is to be excluded from costs.
Alternatively it can be deducted from the research/ development cost so that depreciation is
written off on such reduced cost and charged to prime cost/ factory overhead.
iv. Such expenses are to be added to cost of material i.e., charged to prime cost.
v. Such expenses are the items of distribution overhead and charged to costs accordingly.
vi. This is an item of selling overhead.
vii. This is a financial matter, therefore it is to be excluded from costs.
viii. This is an item of distribution overhead, and charged to costs accordingly.

Q. a)Classify costs according to “element” and ‘function” and give three examples of each.
b) “Direct costs and controllable costs are not necessarily the same” – Discuss.

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Ans. (a)Costs can be classified into various categories depending upon different bases, such as natural
characteristics, changes in activity, relation to the product, traceability to the product, function and decision
making purposes.
Costs can be classified into four categories according to elements.
For Example:
i. Material Costs.
ii. Labour Cost.
iii. Direct / chargeable expenses.
On the basis of functions costs can be classified as follows:
i. Production or manufacturing cost.
ii. Administration cost.
iii. Selling cost.
iv. Distribution cost.

(b)Direct Cost:Direct Cost means that which can be conveniently identified with and allocated to particular
unit of cost i.e., job, product or process. On the contrary the term indirect means that which is of general
character and that cannot be identified with a particular unit of cost. It has to be distributed or shared.
Costs which can be directly identified with cost centres, processes or production units are direct costs.
Examples are: the cost of cloth in the readymade shirt, wages payable to a worker who is directly involved in
production etc.

Controllable Costs: The costs which are influenced by the activities of the managers in various levels are
known as controllable costs. Such costs can be controlled / reduced by adopting various control measures by
the managers. In other words such costs increase unnecessarily in undue proportion due to exercise of
control measures. Direct materials used in production, direct wages paid to workers engaged in production,
other direct expenses and some of the indirect costs are also controllable.
Therefore it is seen that all direct costs are controllable, but there are some costs which are
controllable nut not direct. Hence it follows that direct costs and controllable costs are not necessarily the
same.

Q. Define Management Accounting.

Ans. Management Accounting is the branch of accounting that deals with presenting and providing accounting
information to the management in such a systematic way so that it can perform its managerial functions of
planning controlling and decision-making in an effective and efficient manner. It acts as a “decision-making
support system” to the management.
Many distinguished accountants and accounting institutions have defined the term Management Accounting
in different languages, some of those are enumerated below:
According to Robert N. Anthony, “Management accounting is concerned with accounting information which
is useful to the management”.
According to J. Batty, “Management accounting is the term used to describe the accounting methods, system
and techniques which, coupled with special knowledge and ability, assists management in its task of maximizing
profits or minimizing losses”.
It can be concluded that management accounting is concerned with collection of data from both internal and
external sources and communicates relevant information to the management, after processing, analysing and
interpreting those, to perform its managerial functions of planning, controlling and decision-making in an
effective and efficient manner.

Q. What are the role and functions of Management Accounting?

Ans. The function of management accounting is to assist the management to perform its functions of planning,
organising, directing, controlling and decision making. Major functions of management accounting are as given
below:

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i. Collection of Data: Management accounting does not maintain records of financial and cost data; rather,
it collects basic financial data mainly from the records as maintained by financial and cost accounting for
the purpose of preparing plans and actions of the management.
ii. Supply of Modified Data: Management accounting modifies collected raw data by classifying and
compiling them for making them suitable for the purpose of their analysis and interpretation.
iii. Analysis and Interpretation of Data: Management accounting analyses and interprets those modified
data and extracts necessary and effective information for making them understandable and useable to
the management in the process of its planning, controlling and decision making.
iv. Planning and Forecasting: Management accounting formulates some definite plans for implementing
policies of the management.
v. Communication: Management accounting provides a means of communicating plans and actions of the
management over all areas of activities of the organization. It provides necessary and relevant
information to all levels of management.
vi. Ensures Control: Management accounting ensures control over the performance of different sections of
an enterprise. It uses various techniques such as budgetary control, standard costing and responsibility
accounting to identify weaker areas of performance of activity and can suggest appropriate remedial
measures to overcome the prevailing problems.
vii. Helps in Decision-making: Management accounting helps the management in the process of its effective
decision-making by providing necessary and relevant information in relation thereto.
viii. Performance Evaluation: Management accounting evaluates performance of activities of different
divisions as well as the business as a whole of an enterprise by using its various tools and techniques.
ix. Preparation of Reports: Management accounting prepares reports of performances of different activities
of the enterprise and provides to the management on regular intervals. These managerial reports are
prepared as per the requirement of the management.

Differentiate between Management Accounting and Financial Accounting.

Management Accounting Financial Accounting

i. Management Accounting is primarily based on the i. Financial accounting is based on the monetary
data as obtained from financial accounting. transactions of the enterprise.

ii. Its main function is to assist the management in ii. Its main functions are recording and classifying
their process of planning, control, performance monetary transactions in the books of accounts
evaluation, and decision-making by proving and preparation of financial statements at the
necessary information to the management. end of every accounting year.
iii. Reports as prepared in management accounting iii. Reports as prepared in financial accounting
may contain both objective and subjective figures. should always be supported by relevant figures.
It lays emphasis on objectivity of data.
iv. Reports as prepared in management accounting iv. Reports as prepared in financial accounting are
are exclusively meant for the management of the meant for the management as well as for
concern. shareholders and creditors of the concern.
v. Reports are prepared as per requirement of the v. Reports are prepared at the end of every
management. accounting period.
vi. Reports are prepared in management accounting vi. Reports as prepared in financial accounting are
are not subject to statutory audit. always subject to statutory audit.
vii. It evaluates sectional as well as whole vii. It ascertains results and exhibits financial
performance of the business. strength of the business as a whole.
viii. Its success depends on existence of a sound viii. Its success does not depend, in any way, on
financial accounting system. existence of management accounting system.

Q. What are the objectives of Management Accounting?

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Ans. The prime objective of management accounting is to provide necessary information to the management for
effective and efficient execution of managerial functions. Various objectives of management accounting are
enumerated as below:

i. Analysis and Interpretation of Financial Statements: Management Accounting collects, analyses and
interprets necessary data from the results shown by financial and cost accounting system and provides
necessary and relevant information to the management in a systematic and useful manner, which are to
be applied by the management in the process of its planning, controlling and decision-making.

ii. Planning and Policy Making: Management accounting provides necessary and relevant information to
the management in the process of its planning and policy making to achieve organizational goals. Various
statistical forecasting techniques, such as time series analysis and regression analysis are used in
management accounting to guide proper planning and policy making.

iii. Decision Making: Management accounting provides necessary and relevant information to the
management in the process of its decision-making. Success of the management highly depends upon
perfect decision-making.

iv. Controlling: management accounting applies various useful techniques such as standard costing,
budgetary control, responsibility accounting and management audit to ensure effective managerial
control over the use of resources of the enterprise.

v. Communicating: Proper communication of the performance of various sections of an enterprise to

different levels of management is essentially required for planning, control and decision-making.
Management accounting does such communication by preparing reports of performance of various
sections of the enterprise with the help of management information system.

vi. Coordinating: Management accounting helps in coordinating various business activities of an enterprise.
Its techniques of planning make a very good coordination between various activities of a concern.

vii. Tax Planning: Determination of tax liability of the enterprise after availing various tax rebates and reliefs
falls within the purview of management accounting system. Management accounting helps the
management in the process of tax planning by availing various tax rebates and reliefs and, thus, reduces
the burden of tax of the enterprise.

viii. Advisory Service: Management accounting renders valuable advice to the management for resolving any
financial and other problem of the enterprise. To overcome any existing financial and other problem,
various management accounting techniques are applied according to the nature of the problem.
Management accounting also plays a very important role as an advisor to the management.

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MATERIALS
Cost Accounts treatment of normal and abnormal loss of material arising during storage.

The difference between the book balance and actual physical stock, which may either be gain or loss, should be
transferred to Inventory Adjustment Account pending scrutiny to ascertain the reason for the difference.
If on scrutiny, the difference arrived at is considered as normal, then such a difference should be transferred to
overhead control account and if abnormal, it should be debited to costing profit and loss account.
In the case of normal losses, an alternative method may be used. Under this method the price of the material issued
to production may be inflated so as to cover the normal loss.

ABC Analysis: It is a system of selective inventory control whereby the measure of control over an item of inventory
varies with its usage value. It exercises discriminatory control over different items of stores grouped on the basis of
the investment involved,. Usually the items of material are grouped into three categories viz; A, B and C according to
their use value during a period. In other words, the high use value items are controlled more closely than the items
of low use value.

(i) 'A' Category of items consists of only a small percentage i.e., about 10 % of the total items of material handled by
the stores but require heavy investment i.e., about 70% of inventory value, because of their high prices and heavy
requirement.
(ii) 'B' Category of items comprises of about 20% of the total items of material handled by stores. The percentage of
investment required is about 20% of the total investment in inventories.
(iii) 'C category of items does not require much investment. It may be about 10% of total inventory value but they are
nearly 70% of the total items handled by stores.

'A' category of items can be controlled effectively by using a regular system, which ensures neither over- stocking nor
shortage of materials for production. Such a system plans its total material requirements by making budgets. The
stocks of materials are controlled by fixing certain levels like maximum level, minimum level and re-order level. A
reduction in inventory management costs is achieved by determining economic order quantities after taking into
account ordering cost and carrying cost. To avoid shortages and to minimize heavy investment of funds in
inventories, the techniques of value analysis, variety reduction, standardization etc. are used along with aforesaid
techniques.
In the case of 'B' category of items, as the sum involved is moderate, therefore, the same degree of control as
applied in 'A' category of items is not warranted. The order for the items, belonging to this category may be placed
after reviewing their situation periodically. This category of items can be controlled by routine control measures.
For 'C' category of items, there is no need of exercising constant control. Orders for items in this group may be
placed either after six months or once in a year, after ascertaining consumption requirements.

Q. What is material handling cost? How will you deal it in cost account?

Material handling cost: It refers to the expenses involved in receiving, storing, issuing and handling materials. To deal
with this cost in cost accounts there are two prevalent approaches as under:
First approach suggests the inclusion of these costs as part of the cost of materials by establishing a separate
material handling rate e.g., at the rate of percentage of the cost of material issued or by using a separate material
handling rate which may be established on the basis of weight of materials issued.
Under another approach these costs may be included along with those of manufacturing overhead and be charged
over the products on the basis of direct labour or machine hours.

Q. Perpetual Inventory:

It represents a system of records maintained by the stores in department. It in fact comprises of:
(i) Bin Cards, and
(ii) Stores Ledger

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Bin Card maintains a quantitative record of receipts, issues and closing balances of each item of stores. Separate bin
cards are maintained for each item. Each card is filled up with the physical movement of goods i.e. on its receipt and
issue.
Like bin cards, the Stores Ledger is maintained to record all receipt and issue transactions in respect of materials. It is
filled up with the help of goods received note and material requisitions.
A perpetual inventory is usually checked by a programme of continuous stock taking.
Continuous stock taking means the physical checking of those records (which are maintained under perpetual
inventory) with actual stock. Perpetual inventory is essentially necessary for material control. It incidentally helps
continuous stock taking.

The main advantages of perpetual inventory are as follows :

(1) Physical stocks can be counted and book balances adjusted as and when desired without waiting for the entire
stock-taking to be done.
(2) Quick compilation of Profit and Loss Accounts (for interim period) due to prompt availability of stock figures.
(3) Discrepancies are easily located and thus corrective action can be promptly taken to avoid their recurrence.
(4) A systematic review of the perpetual inventory reveals the existence of surplus, dormant, obsolete and slow-
moving materials, so that remedial measures may be taken in time.
(5) Fixation of the various levels and check of actual balances in hand with these levels assist the Storekeeper in
maintaining stocks within limits and in initiating purchase requisitions for correct quantity at the proper time.

Q. Explain why the Last in First out (LIFO) has an edge over First in First out (FIFO) or any other method of pricing
material issues.

LIFO has following advantages:

(a) The cost of the material issued will be reflecting the current market price.
(b) The use of the method during the period of rising prices does not reflect undue high profit in the income
statement.
(c) In the case of falling price, profit tend to rise due to lower material cost, yet the finished goods appear to be more
competitive and are at market price.
(d) During the period of inflation, LIFO will tend to show the correct profit.

Q. Economic Order Quantity (EOQ)

The size of the order for which both ordering and carrying cost are minimum is known as economic order
quantity or EOQ.

Factors-
Ordering Cost: The costs which are associated with the purchasing or ordering of material. It includes costs of tender
invitation, preparation of purchase orders, staff posted for ordering of goods, expenses incurred on transportation of
goods purchased, inspection cost of incoming material etc.

Carrying Cost: The costs for holding the inventories. It includes the cost of capital invested in inventories, cost of
storage, insurance cost etc.

Q. Bin Cards: Bin refers to a box/ container/ space where materials are kept. Card is placed with each of the bin
(space) to record the details of material like receipt, issue and return. The first two forms are records of quantities
received, issued and those in balance, but in the third record i.e. store ledger, value of receipts, issues and closing
balance is also maintained.
Usually, records of quantities i.e. Bin cards and Store Control Cards are kept by the store keeper in store department
while record of both quantity and value is maintained by cost accounting department

Q. Bill of Materials: It is also known as Materials Specification List or simply Materials List. It is a schedule of standard
quantities of materials required for any job or other unit of production. A comprehensive Materials List should rigidly
lay down the exact description and specifications of all materials required for a job or other unit of production and
also required quantities so that if there is any deviation from the standard list, it can easily be detected. The
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materials specification list is prepared by the Engineering or Planning Department in a standard form. The numbers
of copies prepared vary according to the requirement of each business. Generally Bill of Material is sent to
Production control department, Store department, Cost/ Accounting department and a copy retained with
engineering or planning department.

The advantages of using “bill of materials”, by the concerned departments may be summed up as follows:—

Stores Department :
1. A bill of material serves as an important basis of preparing material purchase requisitions by stores department.
2. It acts as an authorisation for issuing total material requirement.
3. The clerical activity is reduced as the stores clerk issues the entire/part of the material requirement to the users if
the details of material asked are present in the bill of materials.

Cost Accounts Department:

1. Bill of material, is used by Cost Accounts department for preparing an estimate/budget of material cost for the
job/process/operation, it is meant.
2. It may be used as a device for controlling the excess cost of material used. This is done after determining material
variances and ascertaining the reasons for their occurrence.

Production Control Department:

1. Bill of material may be used by this department for controlling usage of materials.
2. Its usage saves time which otherwise would have been wasted for preparing separate requisitions of material.

Material Requisition Note: It is also known as material requisition slip, It is the voucher of the authority regarding
issue of materials for use in the factory or in any of its departments. Generally it is prepared by the production
department and materials are withdrawn on the basis of material requisition list or bill of materials. If no material list
has been prepared, it is desirable that the task of the preparation of material requisition notes be left to the planning
department or by the department requires the materials. Usually, a foreman’s authority is enough but, in the case of
costly materials, it would be desirable to have such requisitions duly approved by some higher authority, like the
superintendent or works manager before these are presented to Stores. Apart from sending a material requisition to
store a copy is sent to cost accounting department and one copy is retained as office copy.

Q. What is Just in Time (JIT) purchases? What are the advantages of such purchases?

Just in time (JIT) purchases means the purchase of goods or materials such that delivery immediately precedes their
use.
Advantages of JIT purchases:
Main advantages of JIT purchases are as follows:
1. The suppliers of goods or materials co-operates with the company and supply requisite quantity of goods or
materials for which order is placed before the start of production.
2. JIT purchases results in cost savings for example, the costs of stock out, inventory carrying, materials handling and
breakage are reduced.
3. Due to frequent purchases of raw materials, its issue price is likely to be very close to the replacement price.
Consequently the method of pricing to be followed for valuing material issues becomes less important for companies
using JIT purchasing.
4. JIT purchasing are now attempting to extend daily deliveries to as many areas as possible so that the goods spend
less time in warehouses or on store shelves before they are exhausted.

Q. Discuss the accounting treatment of defectives in cost accounts

Accounting treatment of defectives in cost accounts:

Defectives refers to those units or portions of production, which do not meet the prescribed specifications. Such
units can be reworked or re-conditioned by the use of additional material, labour and /or processing and brought to
the point of either standard or sub-standard units. The possible way of treating defectives in cost accounts are as
below:
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1. When defectives are normal and it is not beneficial to identity them job-wise, then the following methods may be
used.
(a) Charged to good products: The cost of rectification of normal defectives is charged to good units. This method is
used when defectives rectified are normal.
(b) Charged to general overheads. If the department responsible for defectives cannot be identified, the rework costs
are charged to general overheads.
(c) Charged to departmental overheads: If the department responsible for defectives can be correctly identified, the
rectification costs should be charged to that department.
2. When normal defectives are easily identifiable with specific job the rework costs are debited to the identified job.
3. When defectives are abnormal and are due to causes within the control of the organisation, the rework cost
should be charged to the Costing Profit and Loss Account.

Important Terms
CIF = Cost Insurance and Freight (This consignment is inclusive of prepaid insurance and freight)

FOB = Free on Board (Materials moving by sea – insurance premium is not paid)

FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid by the company or purchase)

For each receipt of goods = Goods Receipt note

For each issue of goods = Materials Requisition note (or) Material Issue note

Accounting Treatment :-

1) Normal Wastage = It should be distributed over goods output increasing per unit cost

2) Abnormal Wastage= It will be charged to costing profit and loss a/c

3) Sale value of scrap is credited to costing profit and loss a/c as an abnormal gain.

4) Sale proceeds of the scrap can be deducted from material cost or factory overheads.

5) Sale proceeds of scrap may be credited to particular job.

6) Normal Defectives = cost of rectification of defectives should be charged to specific

7) Abnormal Defectives = This should be charged to costing profit and loss a/c

8) Cost of Normal spoilage is to borne by good units

9) Abnormal spoilage should be charged to costing profit and loss a/c

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LABOUR

Idle Time: The time for which the employer pays but obtains no direct benefit or for no productive purpose.
Normal Idle Time: Time which can not be avoided or reduced in the normal course of business. The cost of normal
idle time should be charged to the cost of production.
Abnormal Idle Time: It arises on account of abnormal causes and should be charged to Costing Profit and Loss
account.
Time Keeping: It refers to correct recording of the employee’s attendance time
Time Booking: It is basically recording the details of work done and the time spent by workers on each job or
process.

Q. Discuss the accounting treatment of Idle time and overtime wages

Accounting treatment of idle time wages & overtime wages in cost accounts: Normal idle time is treated as a part
of the cost of production. Thus, in the case of direct workers, an allowance for normal idle time is built into the
labour cost rates. In the case of indirect workers, normal idle time is spread over all the products or jobs through the
process of absorption of factory overheads.

Under Cost Accounting, the overtime premium is treated as follows:

- If overtime is resorted to at the desire of the customer, then the overtime premium may be charged to the job
directly.
- If overtime is required to cope with general production programme or for meeting urgent orders, the overtime
premium should be treated as overhead cost of particular department or cost center which works overtime.
- Overtime worked on account of abnormal conditions should be charged to costing Profit & Loss Account.
- If overtime is worked in a department due to the fault of another department the overtime premium should be
charged to the latter department.

Q. State the circumstances in which time rate system of wage payment can be preferred in a factory.

Circumstances in which time rate system of wage payment can be preferred:

In the following circumstances the time rate system of wage payment is preferred in a factory.
1. Persons whose services cannot be directly or tangibly measured, e.g., general helpers, supervisory and clerical staff
etc.
2. Workers engaged on highly skilled jobs or rendering skilled services, e.g., tool making, inspection and testing.
3. Where the pace of output is independent of the operator, e.g., automatic chemical plants.

Q. Explain the meaning of and the reasons for Idle time and discuss its treatment in cost

Idle time refers to the labour time paid for but not utilized on production. It, in fact, represents the time for which
wages are paid, but during which no output is given out by the workers. This is the period during which workers
remain idle.
Reasons for idle time: According to reasons, idle time can be classified into normal idle time and abnormal idle time.
Normal idle time is the time which cannot be avoided or reduced in the normal course of business.

The main reasons for the occurrence of normal idle time are as follows:
1. Time taken by workers to travel the distance between the main gate of factory and the place of their work.
2. Time lost between the finish of one job and starting of next job.
3. Time spent to overcome fatigue.
4. Time spent to meet their personal needs like taking lunch, tea etc.

The main reasons for the occurrence of abnormal idle time are:
1. Due to machine break downs, power failure, non-availability of raw materials, tools or waiting for jobs due to
defective planning.
2. Due to conscious management policy decision to stop work for some time.

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3. In the case of seasonal goods producing units, it may not be possible for them to produce evenly throughout the
year. Such a factor too results in the generation of abnormal idle time.
Treatment in Cost Accounting: Idle time may be normal or abnormal.
Normal idle time: It is inherent in any job situation and thus it cannot be eliminated or reduced.
For example:- time gap between the finishing of one job and the starting of another; time lost due to fatigue etc.
The cost of normal idle time should be charged to the cost of production. This may be done by inflating the labour
rate. It may be transferred to factory overheads for absorption, by adopting a factory overhead absorption rate.
Abnormal idle time: It is defined as the idle time which arises on account of abnormal causes;
e.g. strikes; lockouts; floods; major breakdown of machinery; fire etc. Such an idle time is uncontrollable.
The cost of abnormal idle time due to any reason should be charged to Costing Profit & Loss Account.

Q. Discuss the treatment of overtime premium in Cost accounting.

Treatment of Overtime Premium in Cost Accounting

- If overtime is resorted to at the desire of the customer, then overtime premium may be charged to the job directly.
- If overtime is required to cope with general production programme or for meeting urgent orders, the overtime
premium should be treated as overhead cost of the particular department or cost center, which works overtime.
- If overtime is worked in a department, due to the fault of another department, the overtime premium should be
charged to the latter department.
- Overtime worked on account of abnormal conditions such as flood, earthquake etc., should not be charged to cost
but to costing P/L A/c.

Q. What do you understand by labour turnover? How is it measured?

Labour turnover in an organization is the rate of change in the composition of labour force during a specified period
measured against a suitable index. The standard of usual labour turnover in the industry or labour turnover rate for a
past period may be taken as the index or norm against which actual turnover rate should be compared.
The methods for measuring labour turnover are:

Labour Turnover Rate

a. Separation Method = Number of separations during the period x 100
Average number of workers during the same period

b. Replacement Method = Number of workers replace during the period x 100

Average number of workers during the same period

c. Flux Method = Number of separations + No of replacements x 100

Average number of workers during the same period

Enumerate the causes of labour turnover.

Causes of Labour Turnover: The main causes of labour turnover in an organisation/ industry can be broadly classified
under the following three heads:
(a) Personal Causes;
(b) Unavoidable Causes; and
(c) Avoidable Causes.

Personal causes are those which induce or compel workers to leave their jobs; such causes include the following :
(i) Change of jobs for betterment.
(ii) Premature retirement due to ill health or old age.
(iii) Domestic problems and family responsibilities.
(iv) Discontent over the jobs and working environment.

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Unavoidable causes are those under which it becomes obligatory on the part of management to ask one or more of
their employees to leave the organisation; such causes are summed up as listed below:
(i) Seasonal nature of the business;
(ii) Shortage of raw material, power, slack market for the product etc.;
(iii) Change in the plant location;
(iv) Disability, making a worker unfit for work;
(v) Disciplinary measures;
(vi) Marriage (generally in the case of women).

Avoidable causes are those which require the attention of management on a continuous basis so as to keep the
labour turnover ratio as low as possible. The main causes under this case are indicated below
(i) Dissatisfaction with job, remuneration, hours of work, working conditions, etc.,
(ii) Strained relationship with management, supervisors or fellow workers;
(iii) Lack of training facilities and promotional avenues;
(iv) Lack of recreational and medical facilities;
(v) Low wages and allowances.

Enumerate the remedial steps to be taken to minimize the labour turnover.

The following steps are useful for minimizing labour turnover:

(a) Exit interview: An interview be arranged with each outgoing employee to ascertain the reasons of his leaving the
organization.
(b) Job analysis and evaluation: to ascertain the requirement of each job.
(c) Organisation should make use of a scientific system of recruitment, placement and promotion for employees.
(d) Organisation should create healthy atmosphere, providing education, medical and housing facilities for workers.
(e) Committee for settling workers grievances.

Q. Discuss the various advantages and disadvantages of remunerating labour under time rate system or piece-
work rate system.

There are many methods of payment of wages to the workers. Out of which time wages and piece wages are the
two main methods of remunerating workers. Both the methods have their own advantages and disadvantages.

Time Wages: In this method wages is paid to the workers according to their time taken for a job/ time spent
in the factory irrespective of the volume of production.

Advantages:
i. It is easy to understand and calculate. Even an ordinary worker can calculate wages of his own.
ii. It assures a guaranteed wages to every worker specially to those who are inefficient, because a minimum
amount is available regardless of production.
iii. It is accepted by trade unions, therefore maintains better industrial relations.
iv. Since wages calculation is easy it involves less clerical job, hence reduces costs.
v. It ensures good quality of products.

Disadvantages:
i. Efficient workers are penalised. Because this method does not provide incentives to produce more.
ii. It necessitates high degree of supervision, otherwise workers will sit idle due to guaranteed minimum
wages.
iii. Since it encourages the inefficient workers productively will decrease hereby increasing cost of
production.
iv. It becomes difficult to finish a job within scheduled time due to progress of work at slow pace.

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Piece Rate Method: In this method workers are paid at a pre-determined rate on number of units produced/
volume of work.

Advantages:
i. It encourages the efficient workers because this method provides reward for them.
ii. It reduces supervision costs.
iii. Since large volume of production is available in less time, factory overhead reduces, thereby reducing
cost per unit.
iv. There is increase in productivity due to direct relationship between efficiency and earnings.
v. Like time wages this method is also simple and easy to calculate.
vi. Suitable for industries where quality is not a prime concern.

Disadvantages:
i. Productivity is achieved at the expense of quality.
ii. Not suitable for industries producing high quality goods.
iii. It results in high degree of breakdown of machine and production of defective articles.
iv. Not patronised by inefficient workers.

OVERHEADS

Q. Distinguish between Allocation and Apportionment.

Ans.
i. Allocation of overheads is the process of charging whole amount of a particular overhead to a particular
department or cost centre; whereas, apportionment of overheads is the process of charging the
proportionate amount of a particular overhead to two or more cost centres on some suitable basis.

ii. Allocation refers to direct process of charging overheads to a department or cost centre; whereas
apportionment refers to distribution of proportionate share of overheads between several departments
or cost centres on some suitable basis.

iii. Allocation refers to distribution of overheads to departments; whereas apportionment refers to method
of distribution of overheads of one department to other department.

iv. “Allocation” is a much wider term than apportionment.

Q. Define Machine Hour rate.

Ans. Machine hour rate refers to overhead cost (actual or pre-determined) per machine hour worked or
expected to be worked. Under this method, machine hours worked/ or expected to be worked in a production
department is taken as the basis for consumption of overhead absorption rate. In this case, actual production
overhead incurred (for calculating pre-determined overhead absorption rate) during a certain period in a
production department is absorbed by the machine hours worked (actual or expected) in the production
department during that period. Such overhead absorption rate is calculated as follows:
Overhead absorption rate = Production overhead actually incurred or expected to be incurred/ machine
hours worked (actual or expected).

Q. Distinguish between over-absorption and under-absorption of overheads.

Ans. Over or under absorption/recovery of overheads may arise in case where pre-determined overhead rate is
used to charge overheads to the various departments or cost centres. Pre-determined overhead rate is
calculated on the basis of estimated figures before the production process actually starts and this rate is applied
to the units produced from the concerned department during the period. Accordingly, there is likely to be some
differences between the amount of overhead absorption on the basis of pre-determined overhead rate and the
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amount of overhead actually incurred after the production. Such difference between the amount of overhead
absorbed and the amount of overhead actually incurred is called over or under-absorption of overhead.
When the amount of overhead absorbed on the basis of pre-determined overhead rate exceeds the amount
of overhead actually incurred, such excess amount of overhead absorption/recovery is identified
overabsorption/recovery of overheads.
Over absorption/recovery of overheads = Overhead absorbed on the basis of pre-determined overhead
rate- Overhead actually incurred.
When the amount of overhead absorbed on the basis of pre-determined overhead rate is less than the
amount of overhead actually incurred, such shortage amount of overhead absorption/recovery is identified as
under absorption/recovery of overheads.
Under absorption/recovery of overheads = Overhead actually incurred – Overhead absorbed on the basis of
pre-determined overhead rate.

Q. What are the causes of Over-absorption and Under-Absorption of Overheads?

Ans. Over or under absorption of overhead arises due to the following reasons:
i. Wrong estimation of output.
ii. Wrong estimation of overheads.
iii. Over or under-utilization of production capacity.
iv. Wrong estimation of machine hours or labour hours to be worked.
v. Unforeseeable change in method of production.
vi. Seasonal fluctuation in overhead costs.

Q. What does Idle capacity mean?

Ans. Idle capacity represents that part of the plant capacity of a manufacturing concern which cannot
be effectively utilized in production of goods. It refers to the time spent in the manufacturing plant
where no production occurs. This is the difference between theoretical capacity and actual production.
During periods of idle capacity, the concern gains no benefit from owning the plant or hiring the
employees. Instead, the company absorbs the expenses incurred during the time of idle capacity. Idle
capacity is classified into two parts, viz. abnormal idle capacity and normal idle capacity. Abnormal idle
capacity is the difference between normal capacity and actual capacity utilization, provided the actual
capacity is lower than the normal capacity; whereas, normal idle capacity is the difference between
installed capacity and the normal capacity. Cost of normal idle capacity shall be assigned to cost
objects; whereas cost of abnormal idle capacity shall not be assigned to cost objects.

Q. Distinguish between cost allocation and cost absorption

Cost allocation and Cost absorption:

Cost allocation is the allotment of whole item of cost to a cost centre or a cost unit. In other words, it is the process
of identifying, assigning or allowing cost to a cost centre or a cost, unit.
Cost absorption is the process of absorbing all indirect costs or overhead costs allocated to apportioned over
particular cost center or production department by the units produced.

Q. Indicate the base or bases that you would recommend to apportion overhead costs to production department:
(i) Supplies (ii) Repairs (iii) Maintenance of building (iv) Executive salaries (v) Rent (vi) Power and light
(vii) Fire insurance (vii) Indirect labour.

Item Bases of apportionment

(i) Supplies Actual supplies made to different departments
(ii) Repair Direct labour hours; Machine hours; Direct labour wages; Plant value.
(iii) Maintenance of building Floor area occupied by each department
(iv) Executive salaries Actual basis; Number of workers.
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(v) Rent Floor area

(vi) Power and light K W hours or H P (power)
Number of light points; Floor space; Meter readings (light)
(vii) Fire insurance Capital cost of plant and building; Value of stock
(viii) Indirect labour Direct labour cost.

Q. Explain the treatment of over and under absorption of Overheads in Cost accounting.

Treatment of over and under absorption of overheads are:-

(i) Writing off to costing P&L A/c:– Small difference between the actual and absorbed amount should simply be
transferred to costing P&L A/c, if difference is large then investigate the causes and after that abnormal loss shall be
transferred to costing P&L A/c.
(ii) Use of supplementary Rate: Under this method the balance of under and over absorbed overheads may be
charged to cost of W.I.P. , finished stock and cost of sales proportionately with the help of supplementary rate of
overhead.
(iii) Carry Forward to Subsequent Year: Difference should be carried forward in the expectation that next year the
position will be automatically corrected. This would really mean that costing data of two years would be wrong.

ABC

1) Key terms in ABC.

a) Cost Objects: Cost Object is an item in respect of which a separate measurement of cost is required. For
example, a product, a customer, a service, a location and a job. Under ABC, cost is measured in respect
of these cost objects.

b) Cost Drivers: Cost driver is an activity that generates cost. It is a link between the activity and cost. It is a
factor that causes a change in cost of an activity. According to CIMA, UK, “Cost driver is any factor that
causes a change in the cost of an activity; for example,the quality of parts received by an activity is a
determining factor in the work required by that activity and therefore affects the resources required. An
activity may have multiple cost drivers associated with it”.
ABC identifies the activity that cause cost to be incurred and searches prime cost drivers
responsible for incurring those activities. Once the activities and their cost drivers are identified, it is
used to attach overheads to those cost objects, such as products, that have actually caused the cost to
be incurred. Therefore, a cost driver is a factor that influences cost of an activity.

c) Activity Cost Drivers: It is a yardstick of measuring the frequency of demand placed by cost objects on
activities. It is used to assign activity costs to cost objects consuming activities.

d) Cost Pools: Cost pool is defined as a location, function, items of equipment in respect of which costs may
be ascertained and related to cost units for cost purpose. A cost pool is basically the cost centre. It is
nothing but grouping of individual cost items.

2) Activities and their related cost drivers

A. Relating to production/setting up of machines:

Production/machine set-up No. of production runs
No. of machine set-ups
No. of machine hours

B. Relating of materials:
Purchase of materials No. of purchase orders placed
Receipt of materials No. of receipts of materials

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Store delivery No. of store deliveries

Inspection No. of inspections
Materials handling No. of orders executed
No. of materials move

C. Relating to finished goods:

Warehousing No. of items in stock
Packing No. of packing orders
Quality testing No. of hours of test time

D. Relating to customer service:

Customer service No. of service cells
No. of product serviced
No. of hours spent on servicing

Q. What are the benefits of implementing ABC?

Ans. Following are the benefits of implementing ABC in an organization:

i. Approach of ABC system in distributing overhead costs is objective as it is based on respective activities.
ii. ABC system of distributing overhead costs is more realistic as it gives emphasis on activities responsible
for incurring overhead costs than the traditional system.
iii. It is more accurate and reliable basis of allocating indirect costs as it assigns indirect costs to activities
and then assigns the costs to products based on the product’s usage of the activities.
iv. ABC provides more reliable and realistic information regarding overhead costs, which enables the
management to control over those overhead costs.
v. Overhead costs can be easily traced by the use of ABC system in the organization.
vi. It identifies effective as well as necessary activities of an organization.
vii. It helps the management in accurate pricing decision as this system of distributing overhead costs
overcomes the problem of over-costing and under-costing.

Q. What are the reasons responsible for difference between the profit as per cost accounts and that under
financial accounts?

Ans. Reasons for difference between profit or losses as per cost accounts & financial accounts:
Purely Financial Charges and Appropriations Not Considered in Cost Accounts:
i. Interest on capital.
ii. Interest on loan, debenture and so on.
iii. Loss on sale of fixed assets and investments.
iv. Writing off discount on issue of shares and debentures.
v. Writing off goodwill, preliminary expenses.
vi. Payment of demurrage, fines and penalty.
vii. Payment of legal charges.
viii. Provision for income tax.
ix. Bad debt, discount allowed.
x. Transfer to general reserve or any other reserves.
xi. Payment of dividend.
xii. Payment of charity and donation.

Purely Financial Incomes Not Considered in Cost Accounts.

i. Profit on sale of fixed assets and investments.
ii. Interest and dividend received from investments.
iii. Recovery of bad debts.

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iv. Brokerage and commission received.

v. Rent received from let out property.
vi. Cash discount received.
vii. Claim received against damages.
viii. Refund of income tax.
ix. Discount received.

Purely Costing Expenses Not Considered in Financial Accounts.

i. Notional interest on capital.
ii. Notional rent payable on property used.
iii. Notional salary payable to proprietor or partner.

JOB & BATCH COSTING

Concept of Job Costing

As per CIMA official terminology, job order costing is defined as “that form of specific order costing which
applies when work is undertaken according to customer’s specifications”. Therefore, job order costing is a form of
specific order costing. This method of costing is applied by organizations whose production is carried out against
specific order costing. This method of costing is applied by organizations whose production is carried out against
specific orders from customers. Under this costing method, each job is considered to be a distinctively and separately
identifiable cost unit.
Job costing is applied in those industries where goods are produced and services are rendered against
specific orders as per customer’s specifications for example, construction industries, printing press, etc.

Features of Job Costing

Job Costing is having the following distinguished features:
i. Every job is treated as a separate cost unit.
ii. Every job has been undertaken as per customer’s order and specification.
iii. The job is distinctively identifiable by a production order throughout the production stage, that is, at each
stage of production.
iv. A separate job card is used for each job.
v. A separate job cost sheet is prepared for each job to ascertain its cost and profit and to fix up selling price.
vi. A separate work-in-progress ledger is maintained for each job.

Concept of Batch costing

According to CIMA official terminology, batch costing is defined as “that form of specific order costing which
applied where similar articles are manufactured in batches either for sale or use within the undertaking”.
Therefore, batch costing is a form of specific order costing and it is applied to those industries whose
products are manufactured in batches. This method of costing is generally applied to spare parts and components
manufacturing industries, pharmaceutical/drug industries, toys manufacturing industries, readymade garments
manufacturing industries and so on.

Features of Batch Costing

Batch Costing is having the following distinguished features:
i. Every batch is treated as separate cost unit.
ii. A separate batch cost sheet is prepared for every batch.
iii. This method of costing is applied by organisations when a certain quantity of identical products are produced
in batches.
iv. All costs are accumulated and ascertained for each batch.
v. Cost per unit of the product produced in batch is ascertained by dividing total cost of a batch by the number
of units produced in that batch.
Batch costing is applied in following cases:
Electronic industry like manufacturing of radio, tape recorder, T.V., VCR, Camera, Mobile Phones etc.
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Manufacture of Toys, Biscuits, Cars, Medicines, Ready-made garments etc.

CONTRACT COST

Q. Write notes on Escalation Clause

Escalation Clause: This clause is usually provided in the contracts as a safeguard against
any likely changes in the price or utilization of material and labour. If during the period of
execution of a contract, the prices of materials or labour rise beyond a certain limit, the
contract price will be increased by an agreed amount. Inclusion of such a term in a contract
deed is known as an 'escalation clause'
An escalation clause usually relates to change in price of inputs, it may also be extended to
increased consumption or utilization of quantities of materials, labour etc. In such a situation
the contractor has to satisfy the contractee that the increased utilization is not due to his
inefficiency.

Q. What is cost plus contract? State its advantages.

Answer
Cost plus contract: Under cost plus contract, the contract price is ascertained by adding a percentage of profit to the
total cost of the work. Such types of contracts are entered into when it is not possible to estimate the contract cost
with reasonable accuracy due to unstable condition of material, labour services etc.
Following are the advantages of cost plus contract:
(i) The contractor is assured of a fixed percentage of profit. There is no risk of incurring any loss on the contract.
(ii) It is useful specially when the work to be done is not definitely fixed at the time of making the estimate.
(iii) Contractee can ensure himself about the ‘cost of contract’ as he is empowered to examine the books and
documents of the contractor to ascertain the veracity of the cost of contract.

Q. Discuss the process of estimating profit/loss on incomplete contracts

Process of estimating profit / loss on incomplete contracts

(i) If completion of contract is less than 25% no profit should be taken to profit and loss account.
(ii) If completion of contract is upto 25% or more but less than 50% then

1/3 × Notional Profit × Cash received

Work certified

may be taken to profit and loss account.

(iii) If completion of contract is 50% or more but less than 90% then

2//3 × Notional Profit × Cash received

Work certified

may be taken to profit and loss account

(iv) If completion of contract is greater than or equal to 90% then one of the following formulas may be used for
taking the profit to profit and loss account.

1. Estimated Profit × Work certified

Contract price

2. Estimated Profit × Work certified x Cash received

Contract price Work certified

3. Estimated Profit × Cost of the work to date

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Estimated total cost

4. Estimated Profit × Cost of the work to date x Cash received

Estimated total cost Work certified

5. Notional Profit × Work certified

Contract price

MARGINAL COSTING

Q. Write short notes on Angle of Incidence

This angle is formed by the intersection of sales line and total cost line at the breakeven point. This angle shows the
rate at which profits are being earned once the breakeven point has been reached. The wider the angle the greater is
the rate of earning profits. A large angle of incidence with a high margin of safety indicates extremely favourable
position.

Q. Profit-volume Ratio (P/V ratio)

Profit-Volume (P/V) ratio is the ratio of contribution and sales. It is generally expressed in percentage. It
exhibits the percentage of contribution included in sales. It indicates the effect on the profit for a given
change in sales. Mathematically, P/V ratio can be expressed as follows:
C
P/V ratio = × 100
S
Mathematically, P/V ratio may be expressed in different forms as shown in the following:

S−V
P/V ratio = × 100 [As C = S – V]
S
F +P
P/V ratio = × 100 [As C = F + P]
S
Change∈Profit
P/V ratio = × 100
Change∈Sales

Features of P/V ratio

P/V ratio is an indicator of the rate at which the profit is being earned by a concern. It can be
improved either by increasing the selling price per unit or by reducing the variable cost per unit. It
possesses the following distinguished features:
i. It exhibits the percentage of contribution included in sales.
ii. It shows the rate of profit that can be earned by a concern after achieving its BEP.
iii. Higher P/V ratio indicates a higher profitability rate of the concern.
iv. It does not change with the change in the output level.
v. It changes either due to the change in the selling price per unit or variable cost per unit or both.
vi. It is useful to calculate the BEP.
vii. It is useful to calculate profit at the given level of sales.
viii. It is useful to calculate the sales that is required to earn a given profit.

Q. Margin of Safety
Margin of Safety (MS) is the level of sales made above the BEP. In other words, MS is the excess of actual
sales over BEPS. As the total fixed cost for the actual sales has already been recovered at BEP, no further

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fixed cost is to borne at the MS level of sales. Generally, at any point of sales, the contribution from sales is
available towards the fixed cost and profit. But as the total fixed cost has already been recovered at BEP,
the contribution from sales at MS is available towards profit only, that is, at MS, C = P. At the MS level of
sales, the excess of sales over Variable cost only represents the profit. Mathematically, MS can be
expressed as follows:

∴MS = S – BEPS
Margin of Safety (MS) = Actual Sales (S) – BEPS

Generally, at any point of sales other than BEP;

C=F+P
At BEP, the total fixed cost has been recovered from sales. As MS is that level of sales achieved above BEP,

∴At MS, Contribution = Profit [as at MS, no further fixed cost is incurred]
no further fixed cost is to be borne at the MS level of sales.

∴At MS, C = P

Q. What do you mean by Breakeven Chart? How is it drawn?

Breakeven point of a business is the level of production at which a firm earns no profit no loss i.e., its
total cost equals to total revenue, Break even chart is the graphical representation of this situation. It
shows the relationship among cost, volume and profits at different levels of activity.
Breakeven chart is drawn as follows:
i. In x-axis level of production is shown.
ii. In y-axis variable cost, fixed cost, sales (hence profit/loss) are shown.
iii. Since selling price per unit remains constant sales revenue is shown by a straight line having a
45° angle starting from the origin.
iv. Total fixed cost curve remains constant over a certain level of production, therefore it is shown
by straight line parallel to x-axis.
v. Total variable cost curve is shown by a straight line with positive slope starting from the origin.
vi. Total cost curve is drawn by combining the Total Fixed Cost curve and Total variable cost curve.
vii. The intersection point of Total cost curve and sales revenue line is the breakeven point.

Q. What are the limitation of Breakeven Chart?

i. It is true for an individual product.

ii. Fixed cost may change after certain level of production.
iii. It is difficult to segregate semi variable cost into fixed part and variable part.
iv. Sales price per unit may change for selling large volume.
v. Variable cost per unit may change due to many factors.
vi. It has limited application in the long range planning.

Q. What types of information are disclosed by a Break-even chart?

Following information are available from a break-even chart:

i. The point where the firm will start earning profit. How much units to be sold to recover all costs,
and what will be sale value at the point.
ii. The angle of incidence, which shows the rate of profit earned per unit of sales.

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iii. Margin of Safety which shows by how much unit volume the firm is operating beyond the Break-
even point.

Distinction between marginal costing and absorption costing

1. In Marginal, only variable costs are considered for product costing and inventory valuation.
Both fixed and variable costs are considered for product costing and inventory valuation in absorption.

2. Fixed costs are regarded as period costs. The Profitability of different products is judged by their P/V ratio.
Fixed costs are charged to the cost of production. Each product bears a reasonable share of fixed cost and thus the
profitability of a product is influenced by the apportionment of fixed costs.

3. Cost data presented highlight the total contribution of each product.

Cost data are presented in conventional pattern. Net profit of each product is determined after subtracting fixed cost
along with their variable costs.

4. The difference in the magnitude of opening stock and closing stock does not affect the unit cost of
production.
The difference in the magnitude of opening stock and closing stock affects the unit cost of production due to the
impact of related fixed cost.

5. In case of marginal costing the cost per unit remains the same, irrespective of the production as it is
valued at variable cost.
In case of absorption costing the cost per unit reduces, as the production increases as it is fixed cost which reduces,
whereas, the variable cost remains the same per unit

BUDGET

CIMA official terminology has defined the terms ‘budget’ as “Quantitative expression of a plan for a defined period of
time. It may include planned sales volumes and revenues; resource quantities, costs and expenses; assets, liabilities
and cash flows.”

Budgeting: It is a means of coordinating the combined intelligence of an entire organisation into a plan of action
based on past performance and governed by rational judgment of factors that will influence the course of business in
the future.

CIMA has defined the terms ‘budgetary control’ as “Budgetary control is the establishment of budgets relating to the
responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted results,
either to secure by individual action the objective of the policy or to provide a basis for its revision.” It is the system
of management control and accounting in which all the operations are forecasted and planned in advance to the
extent possible and the actual results compared with the forecasted and planned ones.

Budgetary Control Involves:

1. Establishment of budgets
2. Continuous comparison of actual with budgets for achievement of targets
3. Revision of budgets after considering changed circumstances
4. Placing the responsibility for failure to achieve the budget targets.

Advantages of Budgetary Control System:

Points Description
1. Efficiency The use of budgetary control system enables the management of a business concern to conduct its
business activities in the efficient manner.
2. Control on expenditure It is a powerful instrument used by business houses for the control of their expenditure. It
in fact provides a yardstick for measuring and evaluating the performance of individuals and their departments.

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3. Finding deviations It reveals the deviations to management, from the budgeted figures after making a comparison
with actual figures.
4. Effective utilisation of resources
Effective utilisation of various resources like—men, material, machinery and money—is made possible, as the
production is planned after taking them into account.
5. Revision of plans It helps in the review of current trends and framing of future policies.
6. Implementation of Standard Costing system- It creates suitable conditions for the implementation of standard
costing system in a business organisation.
7. Cost Consciousness Budgets are studied by outside fund providers also such as banking and financial institutions,
realising that management encourages cost consciousness and maximum utilisation of available resources.
8. Credit Rating Management which have developed a well ordered budget plans and which operate accordingly,
receive greater favour from credit agencies.

Fixed budget : According to CIMA, “a fixed budget, is a budget designed to remain unchanged irrespective of the
level of activity actually attained”.
A fixed budget shows the expected results of a responsibility center for only one activity level. Once the budget has
been determined, it is not changed, even if the activity changes. Fixed budgeting is used by many service companies
and for some administrative functions of manufacturing companies, such as purchasing, engineering, and accounting.
Fixed Budget is used as an effective tool of cost control. In case, the level of activity attained is different from the
level of activity for budgeting purposes, the fixed budget becomes ineffective. Such a budget is quite suitable for
fixed expenses. It is also known as a static budget.

Flexible Budget: A flexible budget is defined as “a budget which, by recognizing the difference between fixed, semi-
variable and variable cost is designed to change in relation to the level of activity attained”. A fixed budget, on the
other hand is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. In
a fixed budgetary control, budgets are prepared for one level of activity whereas in a flexibility budgetary control
system, a series of budgets are prepared one for the each of a number of alternative production levels or volumes.
Flexible budgets represent the amount of expense that is reasonably necessary to achieve each level of output
specified. In other words, the allowances given under flexibility budgetary control system serve as standards of what
costs should be at each level of output.

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