Cost accountancy mcom part1 sem 2

Question 01. With help of two suitable example, Explain following concept under operating

costing in case of a transporter (Hotel / Hospital)

Solution:-

1. Fixed Cost / Standing Cost

Fixed costs are those costs that do not change based on production levels, while variable

costs increase or decrease based on production.

Fixed costs can be assets like buildings and equipment. For example, a beverage company

that bottles water is going to need a physical building and an assembly line that includes

specialized equipment. If we assume the building and equipment are leased, there is a

monthly payment for each of them. The company is responsible for paying 100% of the

monthly payments whether they produce one case of bottled water or 10,000 cases of

bottled water.

It is important to note that fixed costs are NOT always the same. Like the price of

anything, they can change - sometimes unpredictably and sometimes on a regular

schedule, but they do so based on some other factor, NOT the level of production.

Fixed costs are one part of the total cost formula. The formula used to calculate costs is

FC + VC(Q) = TC, where FC is fixed costs, VC is variable costs, Q is quantity, and TC is

total cost

It is important to understand that variable costs, as opposed to fixed costs, are those costs

that change based on the amount of product being produced. For example, our bottled

water company has a variable cost in bottles. The more bottled water they produce, the

higher their cost associated with bottles will be.

2. Variable Cost/ Running Cost:

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Variable costs are expenses that fluctuate proportionally with the quantity of output.

Variable costs are directly tied to the activities of producing volume, which rises when

these activities increase and falls when activities decrease. This effect can be related to

materials, labor, and sales commissions.

For example, if you produce spark plugs, the copper used in production is a variable cost.

This means if you stop producing spark plugs, you would no longer have the cost of

copper. Additionally, regardless of how many spark plugs you produce, the price of

copper for one spark plug remains unchanged.

Formula - Variable Cost

The formula to calculate variable cost is:

Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output.

Example :- HOSPITAL COSTING:

A concern of most countries is health sector resources: the sources of finance for health

services, the ability to maintain past funding levels, resource allocation patterns, and the

efficiency of health services delivery. In aggregate terms,

• hospitals utilize nearly half of the total national expenditure for the health sector;

• hospitals commonly account for 50 to 80 percent of government recurrent health sector

expenditure:

• hospitals use a large proportion of the most highly trained health personnel

A hospital is engaged in providing various types of medical services to the patients.

Hospital costing is applied to decide the cost of these services. A hospital may have following

departments for providing various types of services:

1

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. Outdoor Patient Dept. (O.P.D)

2. Indoor Patient Department (Medical Wards).

3. Medical Services Department:

• X – Ray Department,

• Scanning Centre,

• Pathology Laboratory,

• Sonography Department.

4. General Services Departments:

• Bolier House,

• Power House,

• Catering department,

• Laundry Room,

• Administrative Department,

5. Miscellaneous Services Departments:

• Transport Department,

• Dispensary Department,

• General Porting Department.

UNIT OF COST:

The common units of costs of various departments in a hospital are as follows:

Department Unit of Cost

1. Outdoor Patient Department Per out-patient

2. Indoor Patient Department per Room-day

3. X – Ray Department Per 100 units

4. Scanning centre Per case

5. Pathology Laboratory Per 100 Requests

6. Laundry Department Per 100 items laundered

7. Catering Department Per Patient per week

The cost of hospital is divided into fixed and variable costs. Fixed costs include

staff salaries, depreciations of building, rent of building whereas variable cost

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include light and power, water, laundry charges, food supplied to patients etc.

COST SHEET FOR MONTH/YEAR

A.

B

C.D.E.

FIXED STANDING COSTSSalaries to staff ………….Premises Rent ………….Repairs and maintenance ………….General administration Expenses .…………Cost of Oxygen, X-Ray, etc. .…………Depreciation .……….. RUNNING OR VARIABLE COSTSDoctor’s fees …………Food …………Medicines …………Diagnostic Services …………Laundry .………..Hire charges for Extra Beds .……….TOTAL OPERATING COSTNO. OF PATIENTS DAYSCOST PER PATIENT DAY (C)+(D)

xxxxxxxxxxxx

xxxxxxxxxxxx

XX

XXXXXXXX

Illustration 1:

Apollo Hospital runs an Intensive Care Unit in a hired building at a rent of Rs.

7500 p.m. The Hospital has undertaken to bear the cost of repairs and

maintenance.

The Intensive Care Unit consists of 35 beds and 5 more beds can be conveniently

accommodated whenever required. The permanent staff attached to the unit is as

follows:

2 Supervisors, each at a salary of Rs. 2500 p.m., 4 Nurses each at a salary of Rs.

2000 p.m., 4 Ward boys each at a salary of Rs.500 p.m.

Though the unit was open for the patients all the 365 days in a year but it was

found that only 150 days in a year, the unit has the full capacity of 35 patients

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per day and for another 80 days it had on an average 25 beds only occupied per

day. But there were occasions when the beds were full, extra beds were hired

from outside at a charge of Rs. 10 per bed per day. This did not come to more

than 5 beds extra above the normal capacity any one day. The total hire charges

for the extra beds incurred for the whole year amounted to Rs. 7500.

The unit engaged expert doctors from outside to attend on the patients and fees

were paid on the basis of the number of patients attended and time spent by them

on an average worked out to Rs.25000 per month in the year 2013.

The other expenses for the year were as under:

Repairs and Maintenance (Fixed) Rs. 8100

Food supplied to patients (Variable) Rs. 88000

Janitor and Others Services for patients (Variable) Rs. 30000

Laundry Charges for their bed linen (Variable) Rs.60000

Medicines supplied (Variable) Rs. 75000

Cost Oxygen, X – Ray, etc., other

Then directly borne for treatment of patients (Fixed) Rs. 108000.

General Administration Charges allocated

To the unit (Fixed) Rs. 100000

1. Calculate the profit per patient day made by the unit in the year 2003 if the

unit recovered on the overall amount of Rs. 200 per day on an average from each

patient.

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2. The unit wants to work on a budget for the year 2004, but the number of

patients requiring intensive care is a very uncertain factory.

Solutions:

Calculation of No. of Patients days:

35 beds * 150 days = 525025 beds * 80 days = 2000Extra bed days 7500 / 10 = 750 8000

STATEMENT OF COST

Particulars Rs Rs

1. Income Received (Rs. 200 * 8000 Patient days)1600000

2. Variable Costs (Marginal Costs) Per Annum:

Food 88000

Janitor charges 30000

Laundry Charges 60000

Medicines supplied 75000

Doctors Fees (25000 *12) 300000

Hire Charges for extra beds 7500 560500

Contribution 1039500

3. Fixed costsa. Salaries:

Supervisors (2 * 2500 * 12) Nurses (4 * 2000 *12) Ward Boys (4 * 500 * 12)

600009600024000

b. Rent (7500 *12) 90000

c. Repairs and Maintenance 8100

d. Cost and oxygen etc. 108000

e. General Administration 100000 486100

553400

Profit per Patient-day = 553400 / 8000 patients’ days

= Rs. 69.175

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Illustration:

Care Hospital operates a fitness center to provide counseling on nutrition,

exercise and health care for major surgery patients after their release from the

hospital. Average patient will make three visits to the center. Each visit lasts 40

minutes.

The hospital has estimated the following costs of operating the center:

Particulars Amt

Occupancy costs per monthClerical costs per month Other costs per monthMedication charges per patientRecords charge per patientStaffing cost per visitComputer record update per visit

18000120004000441693

Hospital expects to have an average of 500 visits per month. What should be the

amount charged to each patient in order to cover the above costs?

Solution:

Particulars Amt

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Indirect cost per month

Occupancy

Clerical

Other costs

A. Indirect costs per visit ( 34000/500)

Staffing cost per visit

Computer record update per visit

Total costs per visit

Visits per patient

B. Total cost per patient

Records charge per patient

Medication change per patient

C. Total average cost per patient

C. Or per patient (60+80) per visit

18000

12000

4000

3400

68

9

3____

80

3____

240

16

44____

300

3. Absolute Tonne – Km.

Absolute ton-kms is standard unit of measuring absolute units. Absolute

(weighted average) units are calculated by the total of tone-kms (or

quintal-kms, tone-mile etc), arrived by multiplying the distance with the

respective weight carried.

Absolute tone-km = Distance x Respective weight

4. Commercial Tonne – Km.

Commercial ton-kms is standard unit of measuring Commercial units.

Commercial (simple average) units are calculated by multiplying average

weight carried with the total distance travelled.

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Commercial tone-km = Average weight x Total distance

Example:

A truck starts with a load of 10 tonnes of goods from station P. It unloads 4

tonnes at station Q and rest of the goods at station R. It reaches back directly

to station P after getting reloaded with 8 tonnes of goods at station R. The

distance between P to Q to R and then R to P is 40 Kms, 60 Kms and 80

Kms respectively. Compute Absolute Tonnes-Kilometers and Commercial

Tonnes- Kilometer.

Absolute Tonnes-Kilometers

= (10 tonnes*40km) + (6 tonnes*60km) + (8

tonnes*80 kms)

= 1400

Commercial Tonnes-Kms = Average Load × Total Kms Travelled

= 10+6+8/3 Tonnes×180 Kms.

= 1,440 Tonnes-Kms

Example

A lorry starts with a load of 20 tonnes of goods from station A. It unloads 8

tonnes at station B and rest of goods at station C. It reaches back directly to

station A after getting reloaded with 16 tonnes of goods at station C. The

distance between A to B, B to C and then from C to A are 80 kms, 120 kms.,

and 160 kms., respectively. Compute ‘Absolute tonnes-kms.,’ and

‘Commercial tonnes-kms.

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Solution:

Absolute tonnes-kms. = 20 tonnes × 80 kms + 12 tonnes × 120 kms +16

tonnes × 160 kms.

= 5,600 tonnes-kms.

Commercial Tonnes-kms. = Average load × total kilometres travelled16

tonnes

=(20+12+16)/3) × 360 kms.

= 5,760 tonnes-kms.

5. Effective Passengers Kms:

Effective Kms = Run × Load = (One way trip (Km.) × Trip per day × Days

operated) × (Carriage capacity × Usage rate)

In case of passenger transport, Carriage capacity is in terms of seats; and

Cost unit is Effective Kilometers Per Passenger.

In case of goods transport, Carriage capacity is in terms of Tonnes; and Cost unit

is Effective Kilometers Per Tonne.

6. Cost Per Passenger Kms:

Cost Per Passenger Kms = Operating Cost ÷ Effective Kilometres

Example

From the following information calculate total kms and total passengers

Kms

No. of Buses=6

Days Operated in the month=25

Trips mage by each bus = 4

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Distance of route 20 Kms (one way)

Capacity of Bus = 40 passengers

Normal passenger travelling 90% of capacity.

Solution:

Total Kms covered = Run

Distance * Two ways * No. of trips * No. of days * No. of buses

20 Kms * 2 * 4 *25 * 6 = 24000 Kms

Total passenger-Kms. Covered = Run * Load

Load = Maximum capacity* Used capacity = 40 * 90% = 36

Total Passenger Kms Covered = 24000*36

= 864000

Question 02. We help of suitable example. Explain how the decisions are

made by management under following situation.

1. Decision regarding optimum product mix.

When a factory manufactures more than one product, a problem is faced

by management as to which product mix will give maximum profits. The

best product mix is that which yields the maximum contribution. The

products which give the maximum contribution are to be retained and

their production should be increased. The products, which give

comparatively less contribution, should be reduced or closed down

altogether. The effect of sales mix can also be seen by comparing the P/V

ratio and breakeven point. The new sales mix will be favourable if it

increases P/V ratio and reduced the breakeven point.

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Illustration: A manufacturer with an overall capacity of one lakh machine

hours (interchangeable among products) has so far been producing a

standard mix of 15,000 units of product A, 10,000 units of Product B and

C each. The total expenditure exclusive of fixed charges is Rs. 2.09 lakhs

and variable cost ratio among the products approximates

1:1.5:1.75respectively per unit. The fixed charges came to Rs. 2.00 per

unit. When the unit selling prices are Rs. 6.25 for A, Rs 7.50 for B and

Rs. 10.50 for C, he incurs a loss. He desires to change the product mix as

under:

Mix 1 Mix 2 Mix 3

A 18,000 15,000 22,000

B 12,000 6,000 8,000

C 7,000 13,000 8,000

As an accountant what mix will you recommend ?

Solution:

(i) Computation of variable cost per unit

Total variable cost of Rs. 2,09,000 will be apportioned among the three

products in the following ratio:

A 15,000 x 1= Rs.15000: B 10,000 x 1.5 = Rs. 15000 C 10,000 x 1.75 =

Rs. 17,500

or 6:6:7

Hence, total variable cost of each product will be

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A: 2,09,000 x 6/19 = Rs.66,000

B: 2,09,000 x 6/19 = Rs.66,000

C: 2,09,000 x 7/19 = Rs.77,000

And per unit variable cost of each product:

A: 66,000/15000= Rs. 4.40 per unit

B: 66,000/10,000 = Rs.6.60 per unit

C: 77,000/ 10,000 = Rs. 7.70 per unit

(ii) Computation of contribution per unit of each product:

Product A Product B Product C

Selling Price6.25 7.50 10.50

Variable Cost 4.40 6.60 7.70

Contribution 1.85 0.90 7.80

(iii) It is assumed that the fixed cost of Rs. 70,000 (35,000 unit of present

mix at Rs. 2) remains constant for all proposed mixes.

Comparative profitability statement to evaluate here product mixes.

Product Contribution rate per unit Mix 1 Mix 2 Mix 3

Units Total Contribution Units Total Contribution

Units Total Contribution

A

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B

C 1.85

0.90

2.80 18000

12000

7000 33300

10800

19600 15000

6000

13000 27750

5400

36400 22000

8000

8000 40700

7200

22400

Contribution 63700 69550 70300

Less: Fixed

Charges 70000 70000 70000

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Profit/(Loss) (6300) (450) 300

Note: It is evident from the above statement that Mix 3 gives the

maximum total contribution and gives a net profit of Rs.300 after

recovering fixed cost hence Mix 3 is recommended.

2. Decision regarding Make or Buy

Make-or-Buy Business Decision or Make or buy decisions arise in

business when a company must decide whether to produce goods

internally or to purchase them externally. This typically is an issue when

a company has the ability to manufacture material inputs required for its

production operations that are also available for purchase in the

marketplace. For example, a computer company may need to decide

whether to manufacture circuit boards internally or purchase them from a

supplier.

When analyzing a make or buy business decision, it is necessary to look

at several factors. The analysis must examine thoroughly all of the costs

related to manufacturing the product as well as all the costs related to

purchasing the product.Such analysis must include quantitative factors

and qualitative factors. The analysis must also separate relevant costs

from irrelevant costs and look only at the relevant costs. The analysis

must also consider the availability of the product and the quality of the

product under each of the two scenarios.

A concern can utilize its idle capacity by making component parts instead

of buying them from market. In arriving at such a make or buy decision,

the price asked by the outside suppliers should be compared with the

marginal cost of producing the component parts. If the marginal cost is

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lower than the price demanded by the outside suppliers, the component

parts should be manufactured in the factory itself to utilize unused

capacity. Fixed expenses are not taken in the cost of manufacturing

component parts on the assumption that have been already incurred, the

additional cost involved is only variable cost.

Factors that influence Make or Buy Decision

In make or buy decision the following cost and non‐cost factors must be

considered:

1. Cost Factors:

(1) Availability of plant facility

(2) The space required for production of item.

(3) Any special machinery or equipment required.

(4) Cost of acquiring special know how required for the item

(5) Any transportation involved due to location of production

(6) As to labour factors like availability of required labour, sheet required

and other must be kept in view.

(7) As to overhead expenses, adoption of lease for apportioning them

must be taken into consideration including other factors.

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2. Non‐Cost Factors:

(1) In favour of making, the factors like:

Secrecy of company production

Ideal facility available

Tax considerations

Quality and stability of market supply

(2) In favour of buying factors:

Lack of capital required

Wide selection

Passing know how to suppliers or not

Uneven production of end product.

(3) The outside supplier should not be competitor.

(4) In case there are large fluctuation in demand, it is better to purchase

from outside, but if demand is likely to increase substantially own

production may lead to lower cost latter.

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Illustration: (Make or Buy Decision) Auto Parts Ltd. has an annual

production of 90,000 units for a motor component. The component cost

structure is as below:

Materials Rs. 270 per unit

Labour (25% fixed) 180 per unit

Expenses:

Variable 90 per unit

Fixed 135 per unit

Total 675 per unit

(a) The purchase manager has an offer from a supplier who is willing to

supply the component at Rs.540. Should the component be purchased and

production stopped?

(b) Assume the resources now used for this component's manufacture are

to be used to produce another new product for which the selling price is

Rs.485.In the latter case the material price will be Rs.200 per unit. 90,000

units of this product can be produced at the same cost basis as above for

labour and expenses. Discuss whether it would be advisable to divert the

resources to manufacture that new product, on the footing that the

component presently being produced would, instead of being produced,

be purchased from the market.

Solution: Rs.

Material 270

Labour (75% of Rs.180) 135

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Variable expenses 90 .

Total variable cost when component is produced 495

Suppliers price 540

Excess of purchase price over variable cost = 540 – 495 = Rs.45 (a)

Fixed expenses are not affected whether the component is made or

purchased. Thus company should make the component itself because if

purchased from outside it will have to pay Rs.45 per unit more and on

90,000 units @ Rs.45 it comes to Rs.40,50,000.

(b) Cost implications of proposal to divert available production facilities

for a new product:

Rs.

Selling price of per unit of new product 485

Less: Variable costs

Material 200

Labour 135

Expenses 90 425

Contribution per unit 60

Loss if present component is purchased = 540 – 495 = Rs.45.

If company diverts the resources for the production of a new product, it

will benefit by Rs.15 (i.e. Rs.60 – 45) per unit. On 90,000 units it will

save @ Rs.15 i.e. Rs.13,50,000. Thus, it is advisable to divert the

production facilities in the manufacture of the new product and the

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component presently being manufactured should be bought from outside.

This will result in additional profit of Rs.13,50,000.

1. Decision regarding accept/reject a special order

One issue likely to be appropriate to all managers at some time in their

careers is whether to accept what we will refer to as a special order. By

this we mean, ‘Are there circumstances in which it might make sense in

financial terms to sell products or services at a lower price than normal,

or alternatively, to provide a service internally at less than its full cost?’

In considering such decisions, it is most important to be quite clear about

the meaning of the term full cost. In many organisations external and

internal prices for products and services are generated with reference to

the full or total cost of its provision plus a percentage margin, a practice

known as cost-plus pricing. Within the full cost, there will usually be

allocated and apportioned fixed overheads required to be covered,

irrespective of whether a special order is accepted. Such non-relevant

costs must be ignored since the criteria for accepting a special order must

only consider whether the direct benefits which result, exceed those costs

that could be avoided by not taking it.

Such evidence, as exists from surveys of pricing, reveals that some

organisations do accept special orders using some form of the

contribution analysis, although the bias towards its use is not as

significant as many textbooks would imply.

You should be aware that the acceptance of a special order with reference

to direct costs and benefits can be problematic if it generates a special

order ‘culture’. If all orders are priced as special, how will fixed

overheads ever be recovered!

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There are also other considerations to be taken into account that may

have financial consequences. For example, if it became widely known

that special orders were negotiable then the subsequent marketing and

selling of products, or services, may be far more difficult, and require a

good deal more effort to be expended than currently.

Generally speaking, a special contract should not be accepted if it will

affect consumer behavior adversely within the same marketplace.

General knowledge of the availability of special orders may well lead to

"consumer games" with the supplier. Special orders might relate to

Government contracts or customers in a separate market segment;

possibly in an overseas market.

2. Decisions regarding Key or Limiting Factor – Raw Material

A key factor is that factor which puts a limit on production and profit of a

business. Usually the limiting factor is sales. A concern may not be able

to sell as much as it can produce. But sometimes a concern can sell all it

produces but production is limited due to shortage of materials, labour,

plant capacity or capital. In such a case, a decision has to be taken

regarding the choice of the product whose production is to be increased,

reduced or stopped. When there is no limiting factor the choice of the

product will be on the basis of the highest P/V ratio. But when there are

scarce or limited resources, selection of the product will be on the basis

of contribution per unit of scarce factor of production.

Illustration:

A company manufactures and markets three products A, B and C. All the

three products are made from the same set of machines. Production is

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limited by machine capacity. From data given below indicate priorities

for products A, B and C with a view to maximizing profits.

Product A Product B Product C

Raw Material Cost per unit Rs.2.25 Rs.3.25 Rs. 4.25

Direct Labour cost per unit Re.0.50 Re.0.50 Re 0.50

Other variable cost per unit Re. 0.30 Re.0.45 Re.0.71

Selling price per unit Rs.5.00 Rs.6.00 Rs.7.00

Standard machine time required per unit 39 minutes 20 minutes 28

minutes

In the following year the company faces extreme shortage of raw

materials. It is noted

that 3kg, 4kg and 5 kg of raw materials are required to produce one unit

of A, B and C respectively. How would products priorities change?

Solution

Products

Current Year A B C

Selling price per unit 5.00 6.00 7.00

Less Marginal cost per unit

Raw materials cost 2.25 3.25 4.25

Direct labour cost 0.50 0.50 0.50

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Other variable cost 0.30 3.05 0.45 4.20 0.71

5.46

Contribution per unit 1.95 1.80 1.54

Standard machine time

required per unit (minutes) 39 20 28

Contribution per machine Minute 5 paise 9 paise 5 ½ paise

Priorities for products III I II

Following year

Raw materials required to produce one unit 3 kg 4 kg 5 kg

Contribution per kg of raw Material 65 paise 45 paise 30.80 paise

Priorities for products I II III

3. Decisions regarding Limiting factor and key factor- Labour

Example:

Sausage makes two products, the Mash and the Sauce. Unit variable costs

are as follows.

Mash Sauce

Rs. Rs.

Direct materials 1 3

Direct labour (Rs.3 per hour) 6 3

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Variable overhead 1 1

8 7

The sales price per unit is Rs.14 per Mash and Rs.11 per Sauce. During

July the available direct labour is limited to 8,000 hours. Sales demand in

July is expected to be as follows.

Mash 3,000 units

Sauce 5,000 units

Required:

Determine the production budget that will maximize profit, assuming that

fixed costs per month are Rs.20,000 and that there is no opening

inventory of finished goods or work in progress.

Solution:

1. Determine the limiting factor

Mash Sauces Total

Labour hours per unit 2 hrs 1 hr

Sales demand 3,000 units 5,000 units

Labour hours needed 6,000 hrs 5,000 hrs 11,000

hrs

Labour hours available 8,000 hrs

Shortfall 3,000 hrs

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Labour is the limiting factor on production.

2. Identify the contribution earned by each product per unit of scarce

resource, that is, per labour hour worked.

Mash Sauce

Rs. Rs.

Sales price 14 11

Variable cost 8 7

Unit contribution 6 4

Labour hour per unit 2 hrs 1 hr

Contribution per labour hour (= per unit of limiting factor) Rs.3

Rs.4

Ranking 2 1

3. Determine the budgeted production and sales.

Product Units Hours needed Contribution per unit

Total

Rs. Rs.

Sauces 5,000 5,000 4 20,000

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Mashes (Bal.) 1,500 3,000 6

9,000

8,000 29,000

Less: fixed costs 20,000

Profit 9,000

Conclusion:

(1) Unit contribution is not the correct way to decide priorities.

(2) Labour hours are the scarce resource, therefore contribution per

labour hour is the correct way to decide priorities.

(3) The Sauce earns Rs.4 contribution per labour hour, and the Mash

earns Rs.3 contribution per labour hour. Sauces therefore make more

profitable use of the scarce resource, and should be manufactured first.

4. Decisions regarding Limiting factor and key factor- Machine Hours

In the examples which we have examined so far, the selection of

alternative courses of action has been made on the basis of seeking the

most profitable result. Business enterprises are limited in the pursuit of

profit by the fact that they have limited resources at their disposal, so that

quite apart from the limitation on the quantities of any product which the

market will buy at a given price, the firm has its own constraints on the

volume of output. Hence at a given price, which may be well above costs

of production, the firm may be unable to increase its overall profit simply

due to its inability to increase its output.

The limiting factors which affect the level of production may arise out of

shortages of labour, material, equipment and factory space to mention but

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a few obvious examples. Faced with limiting factors of whatever nature,

the firm will wish to obtain the maximum profit from the use of the

resources available, and in making decisions about the allocation of its

resources between competing alternatives, management will be guided by

the relative contribution margins which they offer. Since the firm will be

faced with limiting factors, however, the contribution margins must be

calculated not in terms of units of product sold which fail to reflect

constraints on the total volume of output, but should be related to the unit

of quantity of the most limited factor. A simple example will serve to

explain this point.

Example

Multiproduct Ltd manufactures three products about which is derived the

following data:

Product Machine hours required per unit - Margin per unit - Margin

per mac. hour

A 3 hours Rs.9.0 Rs.3.0

B 2 hours Rs.7.00 Rs.3.5

C 1 hour Rs.5.00 Rs.5.0

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The three products can be made by the same machine, and on the basis of

this information, it is evident that product C is the most profitable

product yielding a contribution of Rs.5 per machine hour, as against

product A, which shows the smallest contribution per machine hour.

Hence, in deciding how to use the limiting factor the firm should

concentrate on the production of product C, rather than products A and B.

If there were no limits to the market demand for product C, there would

be no problem in deciding which product to produce-it would be product

C alone.

Firms undertake the manufacture of different products because the

market demand for any one product is limited, so that firms seek to find

that product-mix which will be the most profitable. Let us assume that

the maximum weekly demand for the three products and the total

machine capacity necessary to meet this demand is as follows:

Product Maximum demand in Machine hours - Product units

equivalents

A 100 300

B 100 200

C 100 100

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This product-mix reflects the order of priority in allocating machine use

to the products with the highest contribution margin per hour. Product C

receives the highest priority, then product B, and lastly product A. If

machine hours were further limited to 300 hours, the firm would cease to

make product A.

For example, if raw material is the limiting factor, the profitability of

each product is determined by contribution per Kg of raw material. If

machine capacity is a limiting factor then contribution per machine hour

is calculated. It electricity is the limiting factor, then contribution per unit

of electricity of each product is calculated.

Question 03. Differentiate between Non- integral accounting system and

Integral accounting system on the basis of following points-

a) Nature and Features

b) Advantages of each system of Accounts

c) Books to be maintained in each system of accounts.

Solution:-

I. Nature and Features

A. Non-Integrated Accounting System

It is a system of accounting under which separate ledgers are maintained

for cost and financial accounts by Accountants. This system is also

referred to as cost ledger accounting system. Under such a system the

cost accounts restricts itself to recording only those transactions which

relate to the product or service being provided. Hence items of expenses

which have a bearing with sales or, production or for that matter any

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other items which are under the factory management are the ones dealt

with in such accounts. This leads to the exclusion of certain expenses like

interest, bad debts and revenue/income from ‘other than the sale of

product or service’.

A special feature of the non-integrated system of accounts is its ability to

deal with notional expenses like rent or interest on capital tied up in the

stock. The accounting of notional rent facilitates comparisons amongst

factories (some owned and some rented).

Non-Integrated Accounting Systems contain fewer accounts when

compared with financial accounting because of the exclusion of

purchases, expenses and also Balance Sheet items like fixed assets,

debtors and creditors. Items of accounts which are excluded are

represented by an account known as Cost ledger control account.

B. Integrated (or Integral) Accounting System

Integrated Accounts is the name given to a system of accounting,

whereby cost and financial accounts are kept in the same set of books.

Obviously, then there will be no separate sets of books for Costing and

Financial records. Integrated accounts provide or meet out fully the

information requirement for Costing as well as for Financial Accounts.

For Costing it provides information useful for ascertaining the Cost of

each product, job, process, operation of any other identifiable activity and

for carrying necessary analysis. Integrated accounts provide relevant

information which is necessary for preparing profit and loss account and

the balance sheets as per the requirement of law and also helps in

exercising effective control over the liabilities and assets of its business.

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The following are the essential features of an integral an accounting

system:

1. This system records financial transitions not normally required for cost

accounting be sided recording internal costing transaction prepayments

and accruals are opened.

2. Stores transactions are recorded in the stores control account.

This account is debited with the cost of stores purchased corresponding

credit being given to cash or sundry creditors depending whether the

purchase is made for cash or on credit.

3. Wages control account is debited with the wages paid, contra credit is

taken in cash or bank account

4. Overhead expenses are debited to the overhead control account,

corresponding credit being given to cash or band account or the sundry

creditors.

5. Transactions relating to material, labour cost overheads are posted in

the stores wages and overhead control account after making suitable cost

analysis and tat the end of the period transfer of the totals is made to the

work in progress accounts by crediting various control accounts. The day

to day cost analysis made for this purpose is known as making third etc.

These entries do not mean entries in the same sense a entry of transaction

in the ledger but such entries are simply a sort of cash analysis.

6. All advance payments are credited and accruals debited to the

respective control account by contra entries in the prepayments and

accrual accounts.

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7. Capital asset account is debited and respective control accounts are

credited in the process of cost analysis of capital expenditure.

II. Advantages of each system of Accounts


The following are some of the advantages of interlocking accounting

system:

a) When separate set of costing books are maintained it facilitates ready

accomplishment of its objectives’ If avoids the complications or

recording the entries if it is integrated with financial accounts.

b) It can be maintained according to convenience as it need not be

statutorily maintained

The following are some of the limitations

a) When cost accounts are independently maintained, it amounts to

duplication of expenses along with financial accounts.

b) The profit shown by cost books may vary with that shown by financial

accounts. This requires reconciliation which involves time and effort.

B. Integrated Accounting System

The following are the main advantages of integral accounting:

a. There is no need to reconcile the profit ascertained by the cost accounts

with that of financial accounts since only one profit and loss account is

prepared from the information recorded in the cost accounts.

b. There is no duplication of recording and effort as in non integral

system and as such this system is simple and economical.

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c. This system tends to coordinate the functions of different selections of

the accounts department since all efforts are integrated and directed

towards achievement of one aim that is providing a high level of

efficiency.

d. The accounting procedures can be simplified and the system can be

centralised with the object of achieving a greater control over the

organization.

e. The system creates conditions which are eminently suitable for the

introduction of mechanized accounting.

f. There is no possibility of overlooking any expense under the system .

g. As cost accounts are posted straight from the books of original entry,

there is no delay in obtaining the data.

h. There is automatic check on the correctness of the cost data. It ensures

that all legitimate expenditure is included in Cost accounts and reliable

and proved data is provided to the management for its decisions’.

i. Integrated accounting widens the outlook of the accountant and his

staff ad they can take broader view of things.

III. Books to be maintained


Subsidiary books maintained under interlocking system of accounting:

The following are some of the subsidiary books maintained under

interlocking system of accounting:

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1) Stores ledger; this ledger is used to record both the quantity and

amount of receipts, issues and balance of materials and supplies. The

basis for recording the transactions are (a)

Materials received note (b) Material transfer note, and (d) Material

returned note.

2) Payroll and wage analysis book; this ledger is used to record the

wages. The basis for recording the transactions are (a) clock cards,

(b)time tickets, and (c)piece work tickets

3) Job ledger: this ledger is used to record the material cost, wages, and

overheads incurred in respect of a job.

4) Finished goods stock ledger: This ledger is used to record the receipt

of finished goods from production department, the sale and stock of

finished goods both in terms of quantity and value.

The basis for recording the transactions is delivery note issued by the

production departments, sales returns note and sales order requisitions.

5) Standing order ledger: This ledger is used to record overheads

incurred.

Accounts Maintained Under Cost Books

The following important accounts are maintained under cost books:

1) General ledger adjustment account: This ledger is also known as cost

ledger control account or nominal ledger control account. In this accounts

transactions with only one entry is recorded and contra appears in

financial book. On the credit side of this account are recorded

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(a) Opening Balance of materials, work in progress and finished stock,

(b) expenses of material, wages and overheads on the credit side, (c) on

the debit side returns of materials to the supplier, (d) sales income: and

(e) on the debit side balancing entries of P&L accountant closing stock.

2) Stores ledger control account: the total of stores ledger is entered in

this account.

3) Wages control account: In this account the wages accrued and paid and

allocation of wages in this account are recorded.

4) Work in progress control account: This account represents cost ledger

in summary form.

5) Finished goods stock ledger control account: This account represents

finished goods stock ledger transactions in total form.

6) Selling, distribution, and administration overhead control

account:”This account represents selling, distribution and administration

overheads

B. Integrated Accounting System

In non-integral system, a cost control account or general ledger

adjustment account is used in cost ledger. In this system, general ledger

adjustment account is eliminated and detailed accounts for assets and

liabilities are maintained. In other words, following accounts are used for

“General Ledger Adjustment Account” of non-integrated system:

(a) Bank account

(b) Debtors account

(c) Creditors account

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(d) Provision for depreciation account etc.

In integrated system, all accounts necessary for showing classification of

cost will be used but the general ledger adjustment account of non-

integrated accounting is replaced by use of following accounts:

(a) Bank account

(b) Debtors account

(c) Creditors account

(d) Provision for depreciation account

(e) Fixed assets account

(f) Share capital account

Accounts to be opened in the Integral Accounting System are as follows:-

1. Store ledger control account

2. Wages control account

3. Factory Overheads Control Account

4. Work in Progress Control Account

5. Office and Administrative Overheads Control Account

6. Finished Goods Control Account

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7. Selling and Distribution Overheads Control Account

8. Cost of Sales Account

9. Sales Account

10. Costing Profit and Loss Account

11. All remaining accounts.

Question 04 :- With the help of example, prepare journal and various

ledger accounts under Integral Accounting System and Non- Integral

Accounting System.

Solution:-

I. Integral Accounting System

Following transactions took place in Lovely & Co. during the month of

March, 2013 :

1. Raw material purchased on credit 40,000

2. Direct material issued to production 30,000

3. Wage paid (30% indirect) 24,000

4. Manufacturing expenses incurred (cash) 16,800

5. Manufacturing overhead charged to production 16,000

6. Selling and distribution cost (cash) 4,000

7. Finished goods at cost 40,000

8. Sales 58,000

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9. Receipts from debtors 13,800

10. Payments to creditors 22,000

You are required to journalise the above transactions.

Solution:-

Lovely & Co.

Journal (Integral Accounting System)

Dr. Cr.

1. Stores Control A/c Dr. 40,000

To Creditors A/c 40,000

(Being the raw material purchased on credit)

2. Work-in-progress A/c Dr. 30,000

To Stores Control A/c 30,000

(Being the material issued to jobs)

3. (a) Wages Control A/c Dr. 24,000

To Cash 24,000

(Being the entry for direct and indirect wages paid)

3. (b) Work-in-progress A/c Dr. 16,800

Production overhead A/c Dr. 7,200

To Wages Control A/c 24,000

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(Being the entry for direct and indirect wages)

4. Production overhead A/c Dr. 16,800

To Cash 16,800

(Being the production overhead incurred)

5. Work-in-progress A/c Dr. 16,000

To Production overhead A/c 16,000

(Being the overhead charged to production)

6. Selling and Distribution overhead A/c Dr. 4,000

To Cash 4,000

(Being the selling and distribution expenses Incurred)

7. Finished goods A/c Dr. 40,000

To work-in-progress A/c 40,000

(Being the cost of production of finished goods)

8. Debtors A/c Dr. 58,000

To Sale A/c 58,000

(Being the amount of sale)

9. Bank A/c Dr. 13,800

To Debtors A/c 13,800

(Being the receipt from debtors)

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10. Sundry Creditors A/c Dr. 22,000

To Cash 22,000

(Being the amount paid to creditors)

II. Non- Integral Accounting System or Cost Ledger Accounting System

From the following balances and transactions extracted from the books of

East-West Company Ltd., journalize and write up the accounts in the cost

ledger and prepare a trial balance as at 31st December 2014. Also show

the profit or loss for the month:

Dr. Cr.

Balances as on 1.12.2014:

Work-in-progress a/c 5,200

Finished goods a/c 2,300

Factory overhead suspense a/c 50

Office overhead suspense a/c 30

Stores ledger control a/c 1,150

General ledger adjustment a/c 8,730

8,730 8,730

Transactions for the month were: Rs.

Direct wages 7,500

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Indirect wages 500

Works overhead absorbed in production 2,200

Office overhead absorbed in production 1,200

Stores issued to production 4,900

Goods finished during the month 18,000

Finished goods sold 21,000

Stores purchased 5,000

Stores issued to factory repair orders 200

Carriage inwards on stores issued for production

80

Factory expenses 1,450

Office expenses 1,170

Solution:

JOURNAL ENTRIES

1. Work-in-progress ledger control a/c Dr. 5,200

Finished goods ledger control a/c Dr. 2,300

Factory overhead suspense a/c Dr. 50

Office overhead suspense a/c Dr. 30

Stores ledger control a/c Dr. 1,150

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To general ledger adjustment a/c 8,730

(Being the opening entries for the balances)

2. Stores ledger control a/c Dr. 5,000


(Being stores purchased)


To stores ledger control a/c 4,980

(Being the stores issued to production Rs. 4,900 and

carriage inward on stores issued Rs. 80)

4. Factory overhead control a/c Dr. 200

To stores ledger control a/c 200

(Being stores issued to factory repairs)


To wages control a/c 7,500

(Being direct wages charged to production)


To wages control a/c 500

(Being indirect wages charged to factory overhead)

7. Wages control a/c Dr. 8,000

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(Being the total wages brought into costing book from

financial books)


To factory overhead suspense a/c 50

(Being the latter transferred to former a/c)

9. Factory overhead control a/c Dr. 1,450


(Being the actual factory expenses brought into costing books)


To factory overhead control a/c 2,200

(Being the overheads charged to production)

11. Office overhead control a/c Dr. 30

To office overhead suspense a/c 30

(Being suspense a/c transferred to former a/c

12. Office overhead control a/c Dr. 1,170


(Being the actual office overheads brought into costing

books)

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To office overhead control a/c 1,200

(Being the office overheads charged to production)

14. Finished goods control a/c Dr. 18,000

To work-in-progress ledger control a/c 18,000

(Being the work-in-progress transferred to former a/c)

15. Cost of sales a/c Dr. 20,300

To finished goods control a/c 20,300

(Being the finished stock transferred to former a/c)

16. Costing profit & loss a/c Dr. 20,300

To cost of sales a/c 20,300

(Being cost of sales transferred to profit & loss a/c)

17. General ledger adjustment a/c Dr. 21,000

To costing profit & loss a/c 21,000

(Being the amount of sales brought into costing

profit & loss a/c)

18. Costing profit & loss a/c Dr. 700

To general ledger adjustment a/c 700

(Being the amount of profit)

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COST LEDGER

GENERAL LEDGER ADJUSTMENT A/C

To costing P & L a/c 21,000 By balance b/d 8,730

To balance c/d 4,050 By stores ledger control a/c

5,000

By wages control a/c 8,000

By factory overhead control a/c 1,450

By office overhead control a/c 1,170

By costing P & L a/c 700

25,050 25,050

STORES LEDGER CONTROL ACCOUNT

To balance b/d 1,150 By WIP ledger control a/c

4,980

To general ledger adjustment a/c 5,000 By factory overhead

control a/c 200

By balance c/d 970

6,150 6,150

WAGES CONTROL ACCOUNT

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To general ledger adjustment a/c 8,000 By WIP ledger control

a/c 7,500

By factory overhead control a/c 500

8,000 8,000

FACTORY OVERHEAD CONTROL ACCOUNT

To stores ledger control a/c 200 By WIP ledger control

a/c 2,200

To wages control a/c 500

To factory overhead suspense a/c 50


2,200 2,200

OFFICE OVERHEAD CONTROL ACCOUNT

To office overhead suspense a/c 30 By WIP ledger control

a/c 1,200


1,200 1,200

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WORK-IN-PROGRESS LEDGER CONTROL ACCOUNT

To balance b/d 5,200 By finished goods control a/c

18,000

To stores ledger control a/c 4,900 By balance c/d

3,080

To wages control a/c 7,500

To factory overhead control a/c 2,200

To office overhead control a/c 1,200

21,080 21,080

FINISHED GOODS CONTROL ACCOUNT

To balance b/d 2,300 By cost of sales a/c

20,300

To WIP ledger control a/c 18,000

20,300 20,300

COST OF SALES ACCOUNT

To finished goods control a/c 20,300 By costing P & L a/c

20,300

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COSTING PROFIT & LOSS ACCOUNT

To cost of sales a/c 20,300 By general ledger adjustment

To general ledger adjustment a/c a/c (sales)

21,000

(profit) 700

21,000 21,000

TRIAL BALANCE AS ON 31.12.2014

Dr. Cr.

General ledger control a/c 4,050

Stores ledger control a/c 970

WIP ledger control a/c 3,080

4,050 4,050

Reference/ Bibliography

• © 20142015 e Notes MBA

• http://icmai.in/

• ICAI Institute

• Advanced Cost Accounting MCom Sem II

Sheth Publishers Pvt. Ltd.

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L. N. Chopde

• Advanced Cost Accounting – Manan Prakashan

• Search Engine – www.google.com

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Cost accountancy mcom part1 sem 2

Economy & Finance

Transcript of Cost accountancy mcom part1 sem 2