Cost Theory - Professional Course

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BIEE Cost Accounting Theory - CA PCC [email protected] TERMS

1. Define cost object and give three examples

Cost object is defined as Anything for which a separate measurement of cost is desired. Theterm cost object and cost objective is synonymous. Cost object may refer to a process, a cost centre,and cost units.

Cost unit is a quantitative unit of product or service in relation to which cost are ascertained.

Cost centre is a location, function or item of equipment in respect of which cost areascertained.

2. Define cost accumulation and cost assignment

Cost accumulation refers to the process of collecting cost data through an accounting system.Usually costs are collected under general ledger accounting headings, which follow naturalclassifications, such as materials, labour, power, electricity, fuel etc.

Cost assignment is a general term used to cover 1. Tracing of costs to cost objects, 2.Apportionment of costs to cost objects, and 3. Application of costs to cost objects often termed as costabsorption.

3. Define Cost apportionment and Cost absorption.

Cost apportionment is The allotment to two or more cost centres of proportions of thecommon items of cost on the estimated basis of benefit received.

Cost Absorption is a method of assigning cost to cost units. Cost which cannot be allocatedto cost units are assigned to them on some equitable basis. Normally it shall be assigned at apredetermined basis like machine hour rate, labour cost etc.

4. How the cost is classified?

The costs are classified according to the basis of relationship to the production unit as direct

cost and indirect cost. The cost incurred direct in manufacture of a product in respect of each andevery unit is called direct costs. These include direct material cost; direct labour cost and directchargeable expenses. The expenses that are normally incurred to a production centres irrespective ofproduction are called indirect costs. These include indirect materials, indirect labour and other indirectexpenses.

Based on the variability of the costs they are classified as fixed costs, Variable cost and semi-variable cost. The expenses, which are constant for a particular period or for a particular level ofproductivity, are fixed costs. These costs have no-direct relationship to the actual production andincurred irrespective of actual production. Semi-variable costs include an element, which is directlyproportionate to the production, and other element, which has no relation to the production. Normallythese expenses assumes the function y = a+bx or y= a + bx + cx2.

Based on the financial accounting principle these can be classified as capital costs or revenuecost. Capital cost is those expenses that result in increase in productivity. E.g. purchase of machinery.The cost incurred in producing or aids in such production are the revenue costs. E.g. Materials, rent,power, electricity etc.

5. Define the term cost driver.A cost driver is a factor, which influences the cost of a cost object. It is often used to describe

the factors, events of forces that are the significant determinants of the cost object. For example, costof issuing materials is determined by the number of times materials being issued to production costcentres and also by the size of the and the weights of materials. Similarly the cost of operating the

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-37255

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BIEE Cost Accounting Theory - CA PCC [email protected] department is determined by the variety of materials being used and also the number ofpurchased orders being issued.6. What do you mean by step costs?

Step costs are those which increase in steps. These costs remain constant over various levels

of small ranges of output. These cost increase by discrete amounts as activity moves from one range to

next. Example: the amount of depreciation will remain constant till 100% productivity is achieved and

will increase considerably where the output increases above 100%.

7. Define notional cost.

Notional cost is one, which is not actually incurred but ascertained and allocated on somebasis. For example the rent for one premise can be charged which is not actually incurred butascertained based on actual rental value etc. These costs will not result in outflow of cash.

8. Define imputed cost, sunk cost and relevant cost.

Imputed cost It is a historical cost and does not involve actual cash outlay, and, as aconsequence does not appear in the financial records. Imputed cost is similar to the notional cost and isconsidered only in cost accounts in ascertaining the cost of a product.

Sunk cost It represents historical cost which is irrecoverable in a given situation. Forexample, while considering the replacement of asset the capital loss or depreciated book value of theexisting asset may not be taken into account on the ground that this portion of the cost having beenalready incurred in the past and has no relevance to the present decision.

Relevant cost Costs appropriate to aiding the making of specific management decisions arecalled relevant cost. These are expected future costs that will differ under alternatives. Future variablecosts generally become relevant in a decision context while fixed costs may be irrelevant if they do notchange in total. However the fixed cost will also be relevant if there is a change in value immediately orin future.

9. Define controllable cost and policy cost.

Controllable cost- costs which can be influenced by the action of an individual enterprise within a given time of span. But few costs are clearly under the influence of one person in any organisationand few items of cost are susceptible to control at all levels. Another major aspect in controllability isthe time factor. With enough time virtually all cost are controllable by somebody or by some means inan organisation.

Policy cost- the costs incurred as a result of policy decisions is called policy cost. Forexample, purchase of assets will create a charge for depreciation.

10. What are the essentials of a good costing system?

An ideal system of cost accounting must posses some characteristics, which will bring theadvantages to the business. He main features of an ideal costing system are:

a. Simplicity - It must be simple, flexible and adaptable to the changing conditions. Theinformation must be provided in proper order, at the right time and to the right persons so as to beutilised fully.

b. Flexibility and adaptability The costing system must be flexible to adjust to the changingconditions and circumstances. The expansion, contraction or changes must be adopted in the existingsystem with minimum changes.


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BIEE Cost Accounting Theory - CA PCC [email protected]. Economy The costing system must suit the availability of finance. The expenditure must

be less than the benefits derived from the system adopted.

d. Comparability The management must be able to compare the facts and figures with pastfigures, figures of other concerns or other departments of the same concern.

e. Suitability to the firms Before accepting a costing system, the nature, requirements, size,conditions of business etc. must be carefully studied. The system must be capable of prompt andaccurate reporting to different levels of management according to their requirements.

f. Minimum change in the existing set up When introducing a costing system, it mustcause minimum disturbance to the existing system of business.

g. Uniformity of forms- Forms of different colours can be used to distinguish them forms mustbe uniform in size and quality. Forms should contain instructions to fill, to use and for disposal.

h. Less clerical work Printed forms will involve less labour to fill in, as the workers may be alittle educated.

i. Effective material control and wage system There must be a proper procedure forrecording the time spent on different jobs, by workers for the purpose of payment of wages. Asystematic method of wage system will help in control of labour cost. Since the cost of materials forms

a greater part of the total cost there must be an efficient system of stores control.

j. Sound plan There must be proper and sound plan to collect, allocate and absorption ofoverhead expenses on each job or each product in order to find out the cost accurately.

k. Reconciliation The system of costing and financial accounting must facilitate reconciliationin an easy manner.

l. Overall efficiency of cost accountant The work of the cost accountant under a goodsystem of costing must be clearly defined as his duties and responsibilities to the firm are very essential

11. You have been asked to design a system of cost accounting in a factory. Describe thevarious points that should be considered before you design a system. (Installation of a costing

system)

It is very difficult to prepare a uniform method of cost applicable to each and every kind ofindustry. The basic principles are fairly definite, but practical application varies from industry to industrybecause of the basic nature of industries. The installation of a costing system requires carefulconsideration of the following:

a. Objectives of a costing system The expectation of the management from the costingsystem should be carefully understood for a smooth adoption of costing system. One must decide theobjectives to be achieved. The system must suit the general nature of the business. The system mustbe well understood to the management and the personnel.

b. Product and the business The nature of the product and business determines themethod of costing system to be adopted. E.g. Engineering industries adopt job costing, chemicalindustries process or batch costing, etc. Some industries may require more labour than more materials;many industries may require more materials than labour, etc. Hence the cost components of theproducts are to be analysed into its various constituents and their relative importance must be studiedcarefully.

c. The organisation When a new system of costing is introduced, the existing organisationalset up has to be modified. There should be minimum dislocation of existing set up. The size of theorganisation, levels of management, authority of each executive, sources of cost information, thereports to be sent to various managerial authorities, etc. should be studied carefully. The whole


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BIEE Cost Accounting Theory - CA PCC [email protected] must be geared to have full co-ordination and control and of course without overlappingand overlooking all functions.

d. Technical aspects A careful study of manufacturing operations and process, materialcontrol, labour control, system of wage payment, factory layout, etc. are of immense significance.These will enable to remove inefficiencies of labour, wastage of materials, etc.

e. Standardisation The forms to be used must be standardised so that clerical work can bereduced to the minimum. The method of filling, the forms to be used etc. should be simple andguidelines may be provided whenever necessary.

f. Communication Emphasis should be put on the system of communication. A propersystem must be drawn to ensure complete and reliable cost information in the field of collection,transmission, report making and reaching the appropriate levels of management.

g. Accounting system Determination of unit of cost, classification of operating expenses,coding systems of material, developing the measures of inventory control, stores accounting system,preparation of charts, budgetary control, reconciliation of cost with financial accounts, preparation ofcost reports to managerial levels for making decisions are the general problems to be dealt with. Whenall these are adopted in an existing industry the personnel may give raise to problems because of thefact that the existing inefficiencies may be brought to light. The personnel should be convinced aboutthe system and their co-operation is ensured. Only then the system will be successful. Instead of rapid

introduction, gradual introduction of the cost system will reap the desired goal.

h. Elasticity and economy The system to be adopted must be capable of being flexible andadaptive to the changing circumstances. Care should be taken that the utility be more than the costpaid. The system should not be complicated and expensive.

i. Regularity- Cost data and costing information must reach the person concerned regularlyand promptly. Otherwise significance of the costing system will be lost and expensive. A good systemof communication will render the communication process attainable the objective.

12. What do you mean by cost centre and what are its subdivisions?

A cost centre is a location, person or item of equipment or group of these for which cost may be

ascertained and used for the purpose of control. The cost centre may be a department or a machine ora plant or a salesman or a particular work, etc. In certain cases the cost unit and cost centre may bethe same. Each cost centre is given charge under a personnel for controlling the cost, accumulation ofcost and its allocation. The sub divisions of cost centre are:

a. The personal cost centre It consists of a person or group of persons; cost like salary ofworks manager, storekeeper, sales manager and others may be accumulated.

b. Impersonal cost centre It consists of a location or items of equipment.

c. Process cost centre- It consists of a specific process or a continuous sequence ofoperations. The cost accumulated by each of these categories of department is a production or aservice, which can be considered as a cost centre.

13. What do you mean by cost control and cost Reduction. Distinguish between them.

Cost control is defined as The guidance and regulation by executive action, by costs ofoperating an undertaking. Cost control plays its part at the discretion of the management, who wish tomaintain the cost within a specific limit. It aims at improving performance efficiency to achieve thetarget. Cost control can be secured through:

a. Setting up standards for expenses and production.b. Finding out differences of actual against standards.c. Analysing the differences with reasons.d. Taking up corrective measures to eliminate variances.


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BIEE Cost Accounting Theory - CA PCC [email protected]

Cost reduction is concerned with reducing costs. It is concerned with reduction program,which is a continuous process. It strives to achieve permanent reduction which starts where costcontrol ends; cost can be reduced on account of saving in cost.Distinction between cost control and cost reduction

s.no cost control cost reduction

1. Aims at maintaining the cost in accordance It aims at reducing costwith standard cost

2. Seeks to attain the lowest possible cost Brings profit by challengingunder existing conditions through research standard.

3. The function is static. The function is dynamic.

4. Emphasis is on the past and present Emphasis is on the present andfuture

5. It is a preventive function It is a corrective function.

14. List out various methods of costing and explain their practical applications.The following are the various methods of costing. a. Single or output costing, b. Process

costing, c. Multiple costing, d. Terminal costing, e. marginal costing, e. Operating costing f. Job costing,g. Batch costing and Standard costing.

a. single or output costing This costing system is applied where a single product ismanufactured. It requires no allocation of overheads between products. A costing per unit of product isascertained for a product in respect of a period. E.g. Brick-making

b. Process costing Process costing is designed to show the cost of each process throughwhich raw materials pass through in their conversion into saleable products. This system is appliedwhere the plants are laid out in process layout. E.g. Textile industries.

c. Multiple costing It is a system adopted in a business producing a variety of productseach of which differs from the others as to material, manufacturing process etc. the principlecharacteristic of multiple costing is that a separate method of costing may be employed in respect ofeach article.

d. Terminal costing terminal costing is also called as contract costing and is used by anundertaking which carries substantial contract the completion of which generally takes more than ayear. Under this method a major part of the expenditure is charged direct to contracts and only theoffice expenses need to be allocated. The amount of such expenditure will be very less whencompared to the direct expenses charged to production, a more precise scientific method of allocationof such expenditure is not needed. E.g. Construction of building.

e. Marginal costing Marginal costing is a method of costing in which the allocation of

expenditure to production is restricted to those expenses which arise as a result of production. Fixedoverheads are not allocated on the ground that frequently the apportionment to cost centres or jobscannot be made on any scientific basis. Marginal costing is useful in manufacturing industries withvarious levels of output. This system of differentiates between fixed costs and variable costs. This typeof costing is useful in taking important policy decisions such as price fixing during competition, make orbuy decisions, product mix etc.

f. Operating costing- Operating costing is a system of costing applicable to industries in whichend product is service. e.g. Transport service, power generation etc. the system is also applicable toutility services such as canteen, hospitals, distribution services such as supply of electricity, petrol, gasetc.BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

37255

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BIEE Cost Accounting Theory - CA PCC [email protected]. Job costing Job order costing or specific order costing means ascertainment of cost of

each job, work order or project separately. It is adopted by many undertakings both manufacturing andnon-manufacturing concerns. Manufacturing concerns adopting this method are printing press, machinetool manufacturing units etc. Non-manufacturing units such as general engineering work shops,automobile repair shops etc. The main objective of this type of costing is to determine profit or loss foreach job. Before accepting a job an estimation of cost is made.

h. Batch costing- batch costing is a system of costing where the production facilities arearranged in such a way that a particular batch of production is carried out. This system is best adoptedwhere the products manufactured cannot be manufactured as one piece and the cost also cannot beallocable per piece. The best example adopting this system is pharmaceuticals, biscuits and otherconfectioneries.

i. Standard costing- This system is a pre-determination of how must costs be incurred undercertain specific conditions. It is built up from an assessment of the values of cost elements andcorrelates technical specifications and quantification of various elements of cost to the prices and ratesexpected to apply during the period in which the standard cost is intended to be used. Standardcosting, thus involves: i. Ascertainment and use of standard cost; ii. Measurement of actual costs; iii.Comparison of standard costs and actual costs to develop variances; and iv. Analysis of variances andtaking the appropriate action where necessary.

15. Define uniform costing and when can it be applied? what are the causes for differences in

cost?

Uniform costing is not a separate method of costing. It implies the use by several undertakings ofthe same costing systems i.e. the same basic costing methods, principles and techniques. It is aset of principles and in some cases of accounting methods, which when incorporated in theaccounting systems of individual members of an industry, will result in obtaining all cost figures bythe individual members of the industry on a comparable basis.

Application of uniform costing Uniform costing may be applied in two differentcircumstances, viz. i. When an undertaking controls a number of factories firms etc. a. producingsimilar products, or b. performing similar operations. When a number of firms or business are membersof a Trade Association.

Causes of differences in cost Costs differ between firms or factories of the sameundertaking or members of an industry or Trade Association because of a. Difference in size; b.differences in attitude of management; c. Differences in degree of mechanisation; d. The possibility ofproduction in more than one way and e. Differences between costing principles and proceduresadopted by different units.


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MAERIALS1. Explain the various types of costs involved in connection with materials management?

There are five types of cost, which are relevant for materials management. They are purchase cost,ordering cost, carrying cost , stock-out cost and quality cost.

1.Purchase cost Purchase cost consists of price paid to suppliers and all expenses forbringing the materials to stores including freight, insurance and transportation cost. In case ofMODVAT credit (Central Excise Law) is available, the same is deducted from the price paid to thesupplier.

2.Ordering cost This includes expenses incurred on requisitioning, preparing purchaseorder, following up with suppliers for early delivery, transportation, receiving supplies and placing thesame in stores.

3.Carrying cost This includes opportunity cost of funds locked up in stock, storage cost,expenses on handling, insurance, rent and rates and losses due to obsolescence. Opportunity cost in

this context refers to contribution from alternative use of fund, which the firm has foregone by investingthe same in stock.

4.Stock-out cost (Shortage cost)- When stock falls short of demand, it results in higher costinvolved in crash procurement, less efficient and uneconomic production schedule, customerdissatisfaction and loss of sales.

5.Quality cost Cost of quality can be classified into two i. Prevention costs which are incurredto avoid the purchase of sub-quality of material, e.g. , the cost of vendor development; ii. Appraisalcosts which are incurred to detect sub-quality material, e.g., inspection cost; iii. Internal failure costswhich arise when defects are detected before shipment of the product to the customers, e.g., cost ofdefective parts; iv. External failure costs which occur when defects are detected after shipment, e.g.,cost of replacing the products.

2. What are the objectives and functions of purchase department?

The most important objective of purchasing department is to ensure continuity of supplies at the lowestcost commensurate with acceptable standards of quality and delivery. It is the responsibility ofpurchase department to procure, right type of material in the right quantity, and at the right price and toprovide the materials, at the right time and right place.

3. What are the advantages of a. centralised purchasing; and b. decentralised purchasing?

Advantages of centralised purchasing a. avoids duplication of errors, b. Provides betternegotiating Power and consequently ensures better prices, terms and conditions, c. Ensures uniformityin purchasing policies, practices and procedures, d . Develops expert purchase staffs, and e. Helps

standardisation and substitution.

Advantages of de-centralised purchasing a. provides full liberty to the plant manager andthus avoids problems in co-ordination and dilution of responsibility, b. Cuts down unnecessary paperwork, c. Helps to develop local vendors and develop a personal touch with the vendors, and d. Helpspurchase department staff to familiarise with the materials which are in use.

4. What are the responsibilities of a storekeeper ?The responsibilities of a storekeeper are: i. To maintain stores in a tidy manner. 2. To prevent

entry of unauthorised persons. 3. To maintain up-to-date records of receipts, issue and balance of each


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BIEE Cost Accounting Theory - CA PCC [email protected] of material. 4. To accept materials after proper verification of documents. 5. To issue materialsagainst Material requisition note signed by an authorised official only and after checking the materialrequisition with Bill of materials. 6. To periodically reconcile bin-card balance with physical balances.7. To ensure good turnover of stock i.e., he must not allow to stock to be left at the bottom of the binand deteriorate.

5. Write a note on Goods received note.

Goods received note is prepared by the receiving section, which forms the basis of entries in thestores ledger. The note is serially numbered and prepared in multiple copies. The receiving sectionretains one copy. Goods along with three copies of goods received note be passed on to the Inspectiondepartment. It inspects the goods and enters in appropriate columns in the note, the quantitiesaccepted and the quantities rejected. Goods are passed on to the stores along with one copy of dulyendorsed goods received note. The other copy is forwarded to the accounts department and theinspection department retain the third copy. Following is the proforma of a goods received note.

X&Y Ltd.Goods Received Note

Supplier Serial No.Currior Purchase order No.Date of delivery Advice note No.

Description

Code Quantity Packages Gross weight

Inspection report Received by

Quantity passed Rejected Remarks Required andaccepted by

Inspector. . Date

6. Write notes on various documents used in stores.

a. Material Requisition Note - This is an authorisation to the store keeper to issue materials.

This is used as users acknowledgement for receipts of materials and forms the basis for materialaccounting. This should clearly specify the job for which materials are required and the departmentwhich gets the materials issued. Store keeper must ensure that material requisition is signed by anauthorised official and that the columns are filled in properly and legibly as any mistake will result inwrong accounting of material issued. The material requisition note should be pre numbered. Followingis the proforma of material requisition note.

b. Material Transfer note This document is used to record the transfer of materials from onedepartment to another department or job to another. This document should be prepared correctly,otherwise the cost would be accounted for wrongly:

c. Bin card This refers to a card which shows quantitative details of receipt, issue andbalance. Entries are made immediately on receipt or issue of materials. This card also shows the

maximum level, minimum level and reordering level of material and thus helps the storekeeper tocontrol material. This is known as Bin card as the cards are usually kept attached to the bins in whichmaterials are kept.

d. Material Return Note This note is an authorisation to return the materials issued in excessof the requirement or the material being defective. It is also pre numbered and be prepared to avoidwrong accounting.


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X& Y Ltd.Material Requisition note

Job No. Serial No.Department Dateshop

S.no Description

Code No. Quantity Rate Value Remarks

Authorised by Stores Ledger Folio.. Bin no.. Store keeper.

Cost office reference

X& Y Ltd.

Material Teransfer noteIssuing department Serial No.Receiving department. date

Description

Code No. Quantity Rate Value Remarks

Transferred by: Dept. Received by : Depot.. Cost office reference

X& Y Ltd.Material Return note

Serial NoIssuing department.. Date:

Number Description Code No. Quantity Rate Value Remarks

Transferred by: Dept. Stores Dept. Bin No.. Cost office reference

e. Store Material Control Record Production planning and control department alsomaintains quantitative record of materials. These are kept in loose-leaf forms similar to bin cards. Inthis form additional columns are provided to enter details of materials in pipeline.


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BIEE Cost Accounting Theory - CA PCC [email protected] f. Bill of Materials Bill of material is a comprehensive list of all materials required for aparticular job, process or service. It shows the exact specifications of materials and quantity requiredagainst each item. In engineering industry this document is issued by the Designs department and inother industries by Production planning department. It is used for the following purposes: 1. As anadvance information to all concerned. 2. As an authorisation to Production department for drawingmaterials. 3. As an additional check by the accounts department for material control.

7. In stores control there are four critical quantities: a. Re- order level, b. Minimum level , c.Maximum level and d. danger level. Define these levels and what factors should be consideredin determining them?

a. Re-order level This is the level at which storekeeper initiates purchase requisition forfresh supplies of materials. This level takes into account the maximum usage and unexpected delay inreceiving such supplies. If it is assumed that the stock out cost is prohibitive, the firm protects itselffrom any stock out situation by providing for the maximum usage and maximum lead-time. The level issuch that even with maximum usage during lead time and with unusual delay , stock does not reachZero level.

ROL = Max. re order period X Maximum usage.

b. Minimum level This represents that level which the stock of a particular material will touchjust before receipt of the fresh lot provided the same is received in normal re-order period and undernormal usage. Stock level is normally not allowed to fall below this level, which is considered as buffer

stock for using during emergency. Fall in stock level below the minimum level will indicate potentialdanger leading to stock-out position. Stock will fall below minimum level if consumption exceeds thenormal consumption or re-order period exceeds the normal re-order period or both of these happen. Ifstock falls below this level extra effort have to be taken to expedite the supply.

Stock levels

Quantity Max. stock level

Re-order level

Minimum level

Danger level

periodc. Maximum level- maximum level is that level above which no stock is allowed to rise. l. Stocknormally touches this level immediately on receipt of the fresh lot. This will happen only minimumusage is occurred and delivery is received in the minimum re-order period . This level is a controlIndicator. The factors need to be considered in fixing this limit are: 1. Storage facilities available.2. Carrying cost. For costly or bulky materials the maximum level is generally low. 3. Nature andproperties of materials. . 4. Economy in prices. 5. Availability of funds. 6. Forecasted futuremovements of prices. 7. Government restrictions on import procurements. The maximum level isfixed as follows

Maximum Level = ROL + Re-order quantity (Min.consumption X min.Re-order period)

d. Danger level This level is fixed somewhere below the minimum level. Emergentpurchase actions are taken if stock falls below this level.


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8. Define Economic ordering Quantity. What are its determinants?

Economic Ordering Quantity (EOQ) is the quantity to be ordered when the stock reaches theminimum level. It is also called as Re-ordering Quantity. It is the quantity when it is added tominimum

stock shall not exceed maximum stick level. It focuses on trading off between ordering cost and cost ofcarrying and is based on the following assumptions: 1. Demand and purchase order lead time is knownwith certainty. 2. Cost per unit is unaffected by order size and, therefore, cost per unit is irrelevant indetermining EOQ.

AC

CostCC

CO

EOQ Quantity

3. The cost of stock out is prohibitively high and therefore stock is replenished before a stock-outoccurs. 4. Ordering cost is constant irrespective of the size of the order.EOQ can be calculated by using the formula:

EOQ = 2AO / C

Where A = Annual consumption; O = Ordering cost per order and C = Cost of carrying per unit

The main factors to be considered while deciding reorder quantity are as follows: 1.Consumption pattern . 2. Re-order period. 3. Availability of resources. 4. Nature of materials . 5. Riskof price fluctuations. 6. Risk of obsolescence . 7. Storage space available. 8. Seasonal conditions asto the availability and price. 9. Quantity discount and 10. Carrying cost and ordering cost.

9. Explain a. Input-output ratio and b. Inventory turnover ratio

a. Input-output ratio is the ratio of raw materials put in production and the output derived. Itenables in determining whether the usage of materials is favourable or adverse. For example, if 100kg. Of material is put in process and the final product contained is 80 kgs, the input-output ratio is100/80 =1.25 or 125%. This can also be ascertained by comparing the standard cost of actual outputand standard cost of standard output as :Standard cost of actual output/standard cost of standardoutput. The comparison actual and standard facilitates to ascertain the performance of the firm and todecide about the favourable or adverse usage of materials.

b. Inventory turnover ratio - It is the ratio which is useful to measure the performance ofinventory. It is the ratio of the value of materials consumed during a period to the average value of

inventory during the period. A high ratio is an indicator of fast moving stock. A low ratio indicates thatlocking up of working capital in undesirable stock. The ratio is calculated as follows.

Inventory turnover = Cost of materials used / Average value of stock.Material turnover in days = Days during the period / Inventory turnover ratio.

10. Explain the system of a. ABC analysis and b. Two-bin system.

a. ABC Analysis- This analysis is also known as Proportional Parts Value Analysis. Under thismethod (Always Better Control) efficient control of store is required to give more care on costlier items.

As such, on the basis of the value of different materials, items are grouped into three categories: 1.High


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BIEE Cost Accounting Theory - CA PCC [email protected] material (A) ; 2. Medium priced materials (B); 3. Low priced materials (C). The materials,which are costly and form a small part of total inventory, can be grouped under A. Greater degree ofcare should be taken in storing and in the use of such items marked A. For these category ofmaterials, high price has to be paid and the number of items is small. On the other hand, certainmaterials do not require much investment but occupies a higher proportion of physical quantity aregrouped and marked C. The materials that have moderate value and represented by proportionatestock compared to its value are grouped under B. The following is an example:

Stock item % of total items % of value

A 10 70

B 20 20

C 70 10

ABC analysis facilitates 1. Closer control on the basis of investment; 2. Development ofscientific inventory control; 3. Saving the time of management, as attention is given to high valuematerials; 4. Ensures minimum cost.

b. Two bin system- The two bin system of inventory controls has many variations of the basicprocedure. Under this system, for each item two bins are maintained. In cases where materials are not

kept in the bins, two separate piles are made for each material. One of the two bins contains enoughstock for usage during the period between receipt of the fresh supply of the materials to the date ofplacing the next order. The other bin contains quantity to cover normal usage during re-order periodplus Safety stock. Purchase requisition is issued immediately when the bin is tapped. The system issimple and in addition to being helpful in inventory control, facilitates easy handling, physical countingand control of the materials.

11. Explain the systems: a. VED analysis; b. XYZ analysis ; c. Ageing schedule of inventoriesand d. Kartex system

a. VED analysis- This analysis is of the nature of ABC analysis and it is generally used in caseof spare parts. The parts are classified into three categories Vital(V), Essential(E) and Desirable(D),depending upon their requirements.

Vital spare parts are kept in stock in sufficient quantity to ensure uninterrupted operation of theplant. They are vital because their non-availability at the required time may cause stoppage inproduction. Essential spare parts are also kept in stock in adequate quantities. But the firm may takereasonable risk with regard to these parts. There should be sufficient arrangement for replenishment ofthese stock at short notice. Desirable spare parts are those which are readily available in the marketand hence the firm need not keep in stock such items except to provide for the lead time.

b. XYZ analysisThis analysis based on the value of stock. It is different from ABC analysiswhich is based on value of materials consumed and VED analysis which is based on relativeimportance of inventory in stock. X items are those whose inventory value is high while z items arethose inventory the value of which is less. Y items fall in between these two extremes. Items ofcategory X need greater attention as compared to items of Y items. Similarly items of category Y are

given greater importance as compared to items of category Z while taking inventory.

c. Ageing schedule of inventories Classification of the inventories according to age helps inidentifying inventories which are moving slowly into production or sales. Based on the date of purchaseon which the inventories are purchased they will be chronologically entered and the value of stockpurchased during a period will be represented as a percentage on the total stock holding. Following isan example.

Ageing schedule of inventories as on Dec,31

Ageclassification(days)

Date of purchase Amount (Rs.) Percentage to thetotal


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0 -15 Dec 16 8,000 20

16 30 Dec11 4,000 10

31-45 Nov26 2,000 5

46-60 Nov10 20,000 50

61 and above Oct25 6,000 15

Total 40,000 100

The above table shows that 50% of the inventories are of age group of 40 to 60 days, while

15% is older than 60 days. In case steps are not taken to clear the inventories, it is possible that morethan 50% inventories to suffer deterioration in its value or may even become obsolete.

d. Kartex system- This technique is of recent origin. In this system a card is maintained foreach item of materials. The cards are arranged in a metallic tray and kept in Kartex cabinet, especiallymanufactured for the purpose. The cards used in this system are generally of the size 21cm X 5cm or28cm X13cm. The cards may contain columns like stores ledger for both quantity and value ofmaterials , receipts ,issues and balance. Colour signals may also be developed in this card to showdifferent levels.

12. Write about various systems of inventory systems.

There are two types of inventory systems. 1. Periodic inventory system and 2. Perpetualinventory system.

1. Periodic inventory system - in this system, quantity and value of inventory is found out onlyat the end of the accounting period after having a physical verification. The system does not providethe information regarding the quantity and value of materials in hand on a continuous basis. The cost ofmaterial used is obtained by adding the total value of inventory in hand in the beginning to the totalvalue of purchases made during the period and subtracting the value of inventory at the end of period.Under this method no accounting is made done for losses, theft and wastage.

2. Perpetual inventory system- This system is called as automatic inventory system. I t is asystem of records maintained by the controlling department, which reflects the physical movement ofstocks and their current balance. It is a method of recording stores balances after every receipt andissue, to facilitate regular checking and to obviate closing down for stock taking. The basic objectives ofthis system is to make available details about the quantity and value of stock of each item at all times.

This system thus provides a rigid control over stock of materials as physical stock can regularly beverified with the stock records kept in the stores and the cost office.

Perpetual inventory system requires: 1. Maintenance of both bin cards as well as stores ledgeron perpetual inventory system. Bin cards provide quantitative perpetual inventory while stores ledgerprovides quantitative-cum-value of the inventory. 2. Adoption of continuous stock taking.

Advantages of perpetual inventory system 1. The system serves as a morale check on thestores staff. They keep the stores record up-to- date and discourage committing fraud. 2. Interimfinancial accounts can be prepared with greater convenience because the long and costly work ofactual stock taking is avoided. 3. Over investment in stock can be avoided because quantity and valueof materials in stock is always known. 4. In case of destruction of stock by fire, the system helps insatisfactorily settling the insurance claim as correct stock figures can be readily be obtained. 5. Loss of

stock due to pilferage or obsolescence etc., is detected at an early stage and suitable steps can betaken to prevent its recurrence. 6. Timely replenishment of stock is facilitated as the management maybe informed daily of the number of units and the value of each kind of material on hand. This tends toeliminate delays and shutdown in plant activities.

Continuous stock-taking -An essential part of perpetual inventory system is continuousphysical stock verification. This is done by an independent internal audit staff who compares thephysical quantity with the quantities shown in the bin card and the store ledger. The system has thefollowing advantages. 1. It does not require a shut down of business operations. It serves as a moralcheck on the stores staff as they keep their records up-to-date at all times in anticipation of theunexpected arrival of the audit staff.


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13. what are the essentials of material control policy?

The following are the essentials of a materials control policy.

1. Co-ordination There has to be a proper co-ordination between the various departmentsconcerned with material control, viz., purchasing, receiving, inspection, storage and accountsdepartment, etc.

2. Centralised purchasing- All materials purchases should be centralised. This will result inmaking bulk purchases at competitive purchases and skilled purchasing. Of course, for smallpurchases the departmental heads should be given the necessary authority in order to avoid delay.

3. Classification and codification There should be proper classification and codification ofmaterials to avoid delay in locating them and convenience in accounting.

4. Proper scheduling The material requirements should be properly scheduled. Schedulinginvolves a wide range of activities Viz., receiving, moving, packaging, storing and issuing of materials.

5. Inspection In order to prevent and check purchasing of sub-standard materials, pilferageor deterioration of materials, it is necessary to have a proper inspection of materials at appropriate timeintervals.

6. Standard forms- standard forms of purchase orders, material requisitions, issue ofmaterials, transfer of materials, etc., should be used. This will facilitate movement and accounting ofmaterials.

7. Effective internal control- materials constitute a significant part of the total cost of theproduct. It is therefore necessary that the organisation follows an appropriate system of internal controlfor prevention of fraud in purchase, issue or storage of materials.

8. Proper storage There should be proper arrangement for storage of materials withadequate shelves, racks, safeguards followed by effective supervision

9. Proper issue procedure -Materials should be issued in a manner that every job or process

gets the right time.

10. Stock-taking Physical stock-taking should be done from time to time. This will greatlyfacilitate if the organisation follows perpetual inventory system, which gives the information regardingboth quantity and value of materials on a continuing basis.

11. Levels of materials- Maximum, minimum, re-ordering and danger levels of each materialsshould be fixed in order to ensure that neither there is a shortage nor there is excess of materials in thestore. Similarly, the economic ordering quantity should be fixed up in respect of each materials to havemaximum economy in purchasing of materials.

12. Valuation of materials- Both in coming and out-going materials should be properlyvalued. The adoption of a suitable method for pricing the materials issue is all the more important sinceit affects the cost of a job, order or process.

13.Properinventory records- proper inventory records have to be kept in the as well as thecosting office to have effective control of materials.

14. Effective MIS-The organisation should have an effective management information systemregarding materials in order to ensure continuous flow of information about the position of materials tothe concerned managerial personnel.

14. Enumerate and explain the main bases used in cost accounting for pricing materials issuedto jobs.


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a. Where the materials can be identified with a particular purchase, it can be charged to theproduction either at actual cost or market price.

Actual cost The method ensures that each job is charged with the actual cost of materialsused in it. It is suitable where materials are specially purchased for a particular job.

Market price - This method whereby materials are charged to a job at the prices ruling at thetime of issue is appropriate where it is desired to disclose results of good or bad buying.

b. Where materials issued cannot be identified with a particular purchase, it can be charged indifferent methods . The following are the methods in which it can be charged.

1. Last in first out In this method materials received last by the stores will be issued first.This method is advantageous in a time of rising prices as it ensures that production is charged at theprice of the latest purchase and hence the stock of material is carried forward at a mere conservativevalue. It tends to prevent the overstatement of profits. Advantages- 1. Material cost representscurrent price. 2. It facilitates complete recovery of material cost. 3. It is most suitable when prices arerising. 4. There is better matching of cost and revenue. Disadvantages : 1. It involves considerableclerical work. 2. Due to variation in prices comparison of cost of similar jobs is non-comparable. 3.Stock of materials shown in the Balance Sheet will not reflect market prices. 4. This system is notacceptable to income tax authorities.

2.First in first out Under this system, materials are issued in the order in which they arereceived in the stores. The materials received first will be issued first. In other words, old stocks areissued first and latest arrivals will be issued later. As a result of this system, the closing stock ofmaterials will always reflect the current prices. Advantages - 1. This method is simple and easy tooperate. 2. Closing value of materials will reflect the current market prices. 3. This system is good forslow moving materials. 4. The system is a logical system. 5. When prices are falling, this methodgives better results. 6. Deterioration and obsolescence can be avoided. Disadvantages when pricefluctuate, calculation becomes complicated. 2. Complicated calculations will invite clerical errors. 3.Under fluctuating prices , materials charged with higher price of earlier materials; the quotations areless competitive. 5. When materials are returned to stores, they are treated as new purchases, for thepurpose of next issue.

3. Next in first out - The method attempts to value material issues at an actual price which isas near as possible to the market price. Under this method the issues are made at the next price, i.e.,the price of materials which has been ordered but not yet received. In other words, issues are at thelatest price at which the company has been committed even though materials have not yet beenphysically received. This method is better than market price method under which every time whenmaterials are issued, their market price will have to be ascertained. In case of this method materials willbe issued at price at which a new order has been placed and this price will continue for all future issuestill a next order is placed. The value of inventory on a particular date is ascertained by deducting thecost of material issued from the total value of materials in stock. Calculations under this method arecomplicated and therefore the method is not widely used. The method may be used in case ofmaterials, which are not much in demand, and hence only a minimum stock is kept and simultaneouslya new order is placed for the quantity issued.

4. Base stock method In almost all concerns, a minimum quantity of stock is always kept instores. A fixed minimum stock of the material is always maintained and is known as safety or basestock. This stock is always valued at a price at which the first lot of materials is received. This stockwill not be issued until emergency arises. The quantity in excess of this base stock may be valuedeither on LIFO or FIFO basis. Since the system operates in conjunction with FIFO or LIFO method, theadvantages and disadvantages relating to those methods are equally applicable to this method also.

5. Highest in first out Under this method materials of highest price are issued first.According to this method the closing stock will be of the minimum price or as low as possible. In short,materials purchased at highest price will be first issued, irrespective of the order of purchase; when the


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BIEE Cost Accounting Theory - CA PCC [email protected] lot of the highest price is exhausted, materials purchased at the next higher price are issued.This method is suitable for cost plus contracts.

6. Simple average method-Under this method the price is calculated by dividing the total ofunit prices of different purchase lots that are in stock by the number of such prices included in the total.Unit prices of the latest consignment also is taken. The simple average price method is very easy tooperate. It gives satisfactory results in cases when the prices of purchases do not show markedfluctuations. The method suffers from various disadvantages. It does not charge actual cost ofmaterials to production and, therefore, a profit or loss may arise because of this type of valuation. Themethod is also unscientific as it does not take into account the quantity of materials purchased atdifferent prices. Clerical work is also considerably increased because the average price will have to becalculated on the occasion of each issue.

7. Periodic simple average method- The method is similar to the simple average pricemethod with the advantage that average price is calculated periodically and not at the time of eachissue. The work of pricing materials issued is done only at the end of the period and only the quantity ofmaterial issued be entered in the stores ledger at the time of issue. The average price is calculated byadding the prices at which different consignments were purchased during the period (excluding theprice of opening stock) and dividing the same of these prices by the number of prices taken intoconsideration for calculation of average price. The method is simple to operate and morerepresentative than the simple average price method. It suffers from the same disadvantages as insimple average price method, except that tedious clerical work at the end of the period in calculating the

issue rates.

8. Weighted average price method- Under this method the issue price is calculated bydividing the value of materials in hand by the number of units in hand. The average price to be chargedto issues will continue to be the same till a new purchase is made which will necessitate computation ofa new average. The method is more scientific than the simple average method. It also reduces thenumber of calculations to be made s the old average price will continue till fresh supply of material isobtained. Under this system on account of approximations being used while calculating the averageprice a profit or loss on issue of materials may be incurred.

9. Periodic weighted average price method This method is similar to the weighted averageprice method with an advantage that average price is not calculated at the time of every new receipt ofmaterials but only periodically. The average price is calculated by dividing the total value of materials

purchased during the period by the total quantity purchased during the same period. The value ofopening stock and its quantity be ignored because it was purchased during the previous period. Themethod is more scientific than the periodic simple average method and more simpler than the weightedaverage method. In this method also since actual cost is not charged to production it may result insome profit of loss on issue of materials. This method throws considerable burden on clerical staff atthe end of the year.

10. Moving simple average price method The moving simple average price is the averageof the periodic simple average prices for a given number of periods. The period for which the materialissues are to be valued will be the last period. The issues are valued at the average price socalculated. This pricing method is suitable where there are seasonal fluctuations in prices and themonthly purchase do not vary much.

11. Moving weighted average price method - Under this method materials issues for aperiod are valued at a price which is the average of the periodic weighted average prices of a givennumber of periods. The price calculated under this method is more representative as it takes intoaccount the quantities purchased and the amount paid for each consignment over a number of periods.

12. Standard price method - This is a method of valuing the issues at a pre-determined priceof the materials taking into account the quantity purchased, market conditions, future trend of the pricesand all others matters concerned with materials. Under such circumstances, the cost of the issue ofmaterials will neither be at cost price nor at market price. There are two standards such as basicstandard price which remains unaltered or for a longer period, the other being current standard pricewhich is related to current market conditions over a shorter period. Under this method, issues had been


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BIEE Cost Accounting Theory - CA PCC [email protected] at standard price. Purchase of materials have been made at the actual price and issue prices,at the standard price, fixed in advance. There arises a difference between the actual cost of thematerials and standard cost of the materials. The difference is known as variance and it indicates theefficiency of purchases, usage etc.,.

advantages - 1. It is simple to work. 2. Materials cost can be fixed in advance. 3.Comparison of the job becomes easy. 4. Control over purchases is possible.

12. Inflated price When purchases are made looking at invoices, one is able to understandthat the seller charges the cost of materials and expenses like packing, forwarding, freight, etc. Thenafter additional expenses- storing, preservation, issuing, etc., are there. Apart from this , there may beunavoidable losses like evaporation, deterioration in quality, shrinkage, loss of weight etc. Thereforewhen issues are made, the price is to be inflated to cover the expenses and losses. The price socalculated and charged to materials is called inflated price.

13. Market price method This is based on the principle that materials issued to any job on aparticular day, should be charged at the rate prevalent in the market. In other words,materials issued are valued at a price at which they can be replaced. After the issue, theclosing stock is adjusted to the net value. Advantages 1. Latest prices are reflected incharging the production in respect of materials. 2. Comparison between jobs in respect ofmaterial cost is possible. Disadvantages- 1. Cost of production varies with the markettrends. 2. It is not easy to know the latest prices. 3. Difference in value arises and needsadjustment. 4. Profit or loss may arise because of rise and fall in prices of raw materials.

15. what are the salient features of International Accounting Standard 2 (IAS-) ?

The following are the salient features of IAS-2.

1. inventories should be valued at the lower of the historical cost and the net realisable cost.Net realisable value is the actual or estimated selling price in the ordinary course of business, less costof completion and cost necessarily to be incurred in order to make the sale.

2. Historical and net realisable values should be compared for each item of the inventoryseparately or for each group of similar items separately. For example, there are four groups A,B,C andD with the following particulars:

If aggregate of historical cost is compared with aggregate net realisable value Rs.20,000 being

the historical cost of the inventory, will be shown in the balance sheet as the value of inventory. Thestandard does not recognise this method and requires that only Rs. 19,800 be taken as stock value forbalance sheet purpose. In cost records, the value of Rs.20,000, will be shown as the historical cost ofthe inventory.

GROUP HISTORICAL COST(Rs)

REALISABLEVALUE(Rs)

VALUE FORBALANCESHEET(Rs)

A 5,000 4,800 4,800

B 5,000 5,300 5,000

C 4,000 4,000 4,000

D 6,000 6,200 6,000

TOTAL 20,000 20,300 19,800

3. The standard recognises FIFO and weighted average cost methods for pricing materialissues. Specific identification method should be used for items that are not ordinarily interchangeable.

4. The Standard cost method may be used if the result consistently approximates the resultthat would be obtained in accordance with (3) above.

5. If the LIFO or base stock method is used the fact should be disclosed as required underthis standard.


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6. Product cost, i.e., the cost of manufactured inventories is to be determined on absorptioncosting principle. Fixed cost are to be allocated on the basis of normal level of production. Overheadsother than production overheads should be included in the value of finished goods or work -in- progress, only if they clearly relate to putting those goods in their present location and condition.

7.Normal quantities of materials and supplies held for incorporating in the production of goodsshould not be written down below historical cost if the finished goods in which they will be incorporatedare expected to be realised at or above historical cost. If historical cost of finished product exceeds thenet realisable value, such materials and supplies should be written down below cost. In that case,replacement cost may be available measure of the net realisable value of those materials.

16. Write a note on Just-In-Time (JIT) production and JIT purchasing.

It is a management philosophy which aims at eliminating waste from every aspect ofmanufacturing and its related activities. The term JIT refers to producing only what is needed. JIT isdefined as A technique for the organisation of work-flows, to allow rapid, high quality, flexibleproduction whilst minimising manufacturing waste and stock levels. (CIMA official terminology)

There are two aspects to JIT just- in-time production and just- in-purchasing. JIT productionis defined as A system which is driven by demand for finished products, whereby each component on aproduction line is produced only when needed for the next stage.

JIT philosophy aims at reducing waste, which is defined by Fujio Cho of Toyota as any thingother than the minimum amount of equipment, materials, parts, space and workers time, which areabsolutely required to add value to the product. Thus waste is any resource used in excess of theminimum amount required to add value to the product. More specifically JIT seeks to achieve thefollowing goals. 1. Estimation of non-value added activities. 2. Zero inventory. 3. Batch size of one.4. A 100% on time delivery service.

The following are the key features of JIT production.

1. The production line is run on a demand pull basis, so that activity of each work station isauthorised by the demand of downstream work stations. Thus, parts move through production systembased on end unit demand, focusing on maintaining a constant flow of parts rather than batches of

WIP.

2. Set-up time and manufacturing lead time are minimised. Demand-led production mayrequire manufacturing small quantities of the product and producing small batches is economical only ifset up time are small.

3. The production line is stopped if parts are absent or defective work is discovered. Inabsence of buffer stock emphasis is placed on doing the job right the first time. The focus is oneliminating the root causes of defect, waste or re-work. JIT goes hand in hand with total quality.

In a JIT environment: 1. Absence of large amount of materials and work-in-progress inventoryenables to control inventory through personal observation; b. work-in-progress constitutes, a lowerpercentage of total cost of production; c. there is no need for an elaborate cost accounting system ofstores requisition, material transfer notes, rework accounting and so forth. All the above providetremendous cost advantage to firms adopting JIT production.

Just- in- time purchasing demands working in close co-operation with vendors. Usually firmswork with a few vendors and develop a kind of partnership with them. Firms enter into long termcontracts with them and make them aware of the premium placed for on time delivery of high qualitygoods in the exact quantity required. Thus the responsibility for checking quality and quantity is placedon vendors. The shift from the policy of placing individual purchase orders up to entering into long termcontracts makes it possible for suppliers to be paid either monthly or per batch delivered rather thanagainst each delivery. The advocates of JIT purchasing argue that firms following conventionalpurchasing policy overestimate ordering cost and underestimate holding cost of inventories. The


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BIEE Cost Accounting Theory - CA PCC [email protected] seems to be correct if cost of quality (e.g., inspection cost of incoming materials, cost ofreturning defective materials, scrap cost, rework cost, cost of idle capacity arising due to defectivematerials ), cost of delayed delivery (e.g., expediting cost, contribution of lost sales, cost of idlecapacity) and cost of early delivery (e.g., incremental carrying cost) are considered. All these costs areto be treated as derived holding cost. Operating cost has come down significantly for firms, which areusing computer, aided integrated system for production and material planning.

In a JIT environment, EOQ model has lost its relevance because the focus is on synchronisingdelivery and usage. Such synchronisation requires no stock be purchased in large and kept in stores.Should a firm adopt JIT purchasing depends on reduction in cost of quality, cost of delayed delivery,cost of early delivery, and ordering costs. All these cost be compared with premium payable tosuppliers (by way of increase in cost of quality products for just in time supply). Firms using JITpurchasing have reported significant saving in cost.

17. Define wastage. Distinguish between normal and abnormal wastage. How is it treated incost accounts?.

Wastage is that portion of basic raw material lost in processing, having no value to berecovered. Wastage is different from scrap. Wastage is a complete loss. It is a portion of the rawmaterials left behind at the time of processing or operation that has no reuse value. The waste is of twotypes- normal waste and abnormal waste.

Normal waste is that which is unavoidable and is bound to arise because of the nature ofmaterials. It may happen as a result of evaporation, shrinkage or breaking the bulk, etc. Consideringthe nature of materials and type of operations, through a careful study, the amount of normal loss canbe determined. For example, a manufacturing operation needs 10 kg .of material , but when the outputis only say9.5 kg., the difference of 0.5 kg .is the normal wastage. The value of normal wastage beborne by the balance of the products. Normal waste is unavoidable and generally uncontrollable.

Abnormal waste is avoidable and controllable. Wastages occur on account of pilferage, fire,theft, careless handling, etc. this loss cannot be part of manufacturing cost. Such losses will betransferred to costing profit and loss account.

18. Define scrap. How is it treated in cost accounts.

Scrap is the incidental residue from certain types of manufacture usually of small quantity andlow value recoverable without further processing. ICMA (London) defines it as: it is discarded materialhaving some value which is usually either disposed of with or without further treatment, i.e., other thanreclamation and handling or is introduced into the production process in the place of raw materials. It isthe incidental residue from a certain method of manufacture, recoverable without further processing.Example of scrap are: metal from stamping operations, filing, turning, boring etc. left after completion ofmanufacturing operations. These scrap materials may be sold away or reused. Scrap occurs becauseof:1. Faulty planning process. 2. Poor manufacturing methods. 3. Raw materials of low quality. 4.Unconditional or inadequate machines and tools . 5. Defective inspection system.

Scrap are of three types. 1. Legitimate scrap this type of scrap is unavoidable. Such lossesare bound to arise. These losses in almost all the cases are pre-determined or anticipated. 2.

Administrative scrap- This type of scrap arises because of administrative defects; for example, scraparising from obsolescence design, inferior quality of materials, poor workmanship, unsuited machinesand equipment etc. Such type of scrap is treated as abnormal and be transferred to costing profit andloss account. 3. Defective scrap- This is because of inferior quality of machine or bad workmanship.

Accounting treatment 1. When the value of the scrap is negligible, the realised value iscredited to profit and loss account. 2. If it is too large, the value of scrap may be debited to scrapaccount and credited to material account or factory overheads account. The realised value be creditedto scrap account Control of scrap may be made effective through setting up standard, keepingproper records of scrap and fixing proper responsibility.


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BIEE Cost Accounting Theory - CA PCC [email protected]. Define defectives. How are they treated in cost accounting.

Defectives are that portion of a product which in the process of manufacture developed someimperfection and which can be rectified at an extra cost of operating on it. Defective work must bedistinguished from spoiled work. Defectives are the imperfections which by further processing berectified and attains saleable value. But the spoiled work cannot be reconditioned and the spoiledproducts be sold at scrap or seconds or third grade products.

Accounting treatment- 1. The cost of rectification work, if identified, can be charged to theparticular job or product. 2. If the rectification work is not identifiable, the cost be charged to factoryoverheads. 3. If the cost of rectification is due to abnormal reasons, it is to be transferred to costingprofit and loss account.

Defectives arise because of: 1. Poor quality of raw materials. 2. Poor workmanship. 3.Improper maintenance of machines, tools and equipment. 4. Faulty design of products. 5. Wrongsetting of tools. 6. Lack of supervision. 7. Lapse of time. 8. Unsound working conditions. 9. Poormanufacturing conditions. 10. Management failure, etc.

20. Define spoilage. How is it treated in cost accounts.

ICMA defines spoilage as units of output which fail to reach the required standard quality andspecifications. Such faulty units may be capable of rectification; and they may be so corrected that the

cost of doing so is more than the loss in value from allowing the fault to remain uncorrected. When it isuneconomic to rectify the fault, the article may be sold as sub-standard if it still functioning sound;otherwise it may be disposed of as scrap; spoilage occurs when goods so damaged in the course ofmanufacturing process. Generally spoilage is irreparable or un-rectifiable. It is also of two kinds- normaland abnormal. If it is a normal spoilage the cost of it is borne by the balance of the products. If it isabnormal the amount of such spoilage be debited to costing profit and loss account.

21. what are obsolete materials and how such losses can be minimised?

Obsolete materials are those, which are no longer required for production due to change offashion, technology, change of design, etc., and are not able to be pushed through sales. It happensbecause of ; 1. Lack of co-operation between production department and purchase department. 2. Noreport from store keeper. 3. Absence of standardisation.

The loss on account of obsolescence can be minimised by recourse to the following steps. 1.Whenever there is a change in design, it must be made known to all the people concerned. 2. Thestore keeper should send reports of slow moving items. 3. A separate register for obsolete materialsbe kept. 4. The obsolete materials may be substituted to other productions. 5. If possible,modifications may be done to create demand.6. If the scrap is of no value, be discarded.

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LABOUR COST

1. Distinguish between direct labour and in-direct labour.

According to ICMA Direct labour cost is that cost which can be identified with and allocated tocost centres or cost units. Again , the cost of remuneration for employees efforts and skills is applieddirectly to a product or a saleable service. The labour spent in altering the construction, composition orcondition of the product is known as Direct labour. The direct labour cost can easily be identified and

allocated to cost units. It varies directly with production, thus creating closeness to production.

Indirect labour, on the other hand, cannot be conveniently identified with cost unit or costcentre. ICMA defines indirect wages as cost other than direct wages cost. Therefore indirect labourcost is the amount of wages paid to workmen, engaged in other than production of goods and services,at the same time indirect labour helps the direct labour in accomplishing their goal. Examples ofindirect labour cost are wages paid to supervisors, inspectors, foremen, watchmen, timekeepers,repairers, cleaners etc. the direct labour cost forms part of prime cost and indirect wages becomes thepart of overheads.

2. What is meant by control of labour cost control? What are the objectives and importance oflabour cost control?

The control of labour cost is very important. Engaging unfit persons in the factory results inpoor output at high cost of production; in -turn the product finds no place in the market or fetches lessprice and less profits and a time arises when the factory has to be shut down. Therefore managementtakes measures for effective control on the labour. Labour cost control deserves special attention inthose organisations where labour cost forms a significant portion of the total product cost. Improvementof labour productivity results in the reduction of fixed overheads per unit. Labour cost per unit is alsoreduced if increase in wages is proportionately less than the increase in output.

Importance of labour cost control Labour cost requires constant measurement, control andanalysis because: 1. It represents human contribution to production. 2. Labour is different from otherfactors of production in the sense that it is not subject to any technical limitations, which restrictproductivity. 3. In view of present labour laws, labour cost is a committed cost than discretionary cost.Labour is now a days no more a variable overhead based on production. 4. Labour productivitysignificantly influence cost per unit.

Accounting and control of labour cost requires: 1. Strict control on labour requirements. 2.Correct time keeping , i.e., recording of the total actual time spent in the factory. 3. Time booking i.e., analysis of time in terms of departments, operations and production orders or jobs. 4. Generationof adequate and effective manpower performance reports indicating productivity and efficiency oflabour. 5. Constant endeavour to improve productivity and efficiency through improvement in themethods of remuneration, conversion of indirect labour into direct labour etc.

3. Which are the various departments involved in labour cost control?


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BIEE Cost Accounting Theory - CA PCC [email protected] following departments are involved in exercising effective labour control

1. The personnel department - this department is responsible for manpower planning, hiringand firing of personnel on the recommendations of other functional heads. It is also responsible formanagement of human resources including training and development of personnel.

2. The engineering department- This department is responsible for preparation of productionplans and specification for each job, supervision of all the production activities, time and motion studies,

job analysis etc.

3. Time keeping department This department is primarily responsible for collecting data inrespect of total and specified time worked on a job, product, process or in a department.

4. Pay roll department - This department is responsible for computing total and net earningsof each worker, preparation of pay rolls and maintenance of records.

5. cost accounting department This department collects and classifies all cost data ofwhich labour cost is one of the most important elements. It charges jobs, products, processes ordepartments with the relevant cost as evidenced by various factory documents.

4. Describe the tools under scientific management in control of labour.

Under scientific management through a careful study, determine a standard task for everyworker. The standard is the quantity of work to be done by an average worker, under standardcondition. The fixation of standard can be done by a careful analysis of job called Work-study.

Work-study means the application of systematic analysis to the work of men and machines soas to improve methods and establish time values for that work. It is an analysis of work processes andwork methods to improve productivity. Work study helps to increase productivity throughstandardisation and simplification of work. Work study seeks to achieve the following objectives: 1.Optimum utilisation of plant and equipment. 2. Most effective use of human effort. 3. Reasonablework load for the workers. Work study includes method study, motion study and time study.

Method study - It involves critical examination and systematic recording of existing andproposed ways of doing a job so as to find better and more efficient methods: method study covers the

following activities. 1. Factory layout. 2. Factory automation. 3. Material handling. 4. Motion study-how people work. The main objectives of method study are as follows: 1. To eliminate wasteful andinefficient motions, thereby improving production flow. 2. To remove duplication of effort. 3. Toeliminate unnecessary fatigue and thereby effect economy in human effort. 4. To improve work designand plant layout. 5. To standardise work processes, work conditions and machinery or equipment. 6.To optimise use of manpower, materials, machinery and other facilities. Method study helps to improveproductivity by 1. Eliminating unnecessary task. 2. Reducing the number of operations. 3. Combininginterrelated tasks. 4. Re-arranging the tasks. 5. Simplifying the process.

Motion study Motion study is a systematic and critical analysis of the movements of men andmachines involved in the performance of a job so as to eliminate wasteful and unnecessarymovements. According to Frank Gilbreth motion study is the science of eliminating wastefulnessresulting from using unnecessary, ill directed and inefficient motions. Its aim is to find out andperpetuate the least waste methods of doing work'. It covers all aspects of work, e.g., equipment,layout, procedures, methods etc. It helps to improve productivity and to reduce industrial fatigue.

Motion study has the following advantages and limitations: Advantages: 1. It helps faster andbetter working. 2. It helps in better distribution of work, and better arrangement of work place andtools. 3. It helps in planning the operations in a scientific manner. 4. It ultimately results in increasedproductivity and reduced costs. The limitations are: 1. It is costly and time consuming. 2. It is likely tobe misunderstood by workers and may put strain worker-management relationship.

Time study Time study involves the technique of establishing an allowed time standard toperform a given task, based upon measurement of the work content of the prescribed method, with due


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BIEE Cost Accounting Theory - CA PCC [email protected] for fatigue and for personal and unavoidable delay. It endeavours to find out the timetaken by average worker, posing average skill, working under average conditions, exerting averageeffort, and maintaining this effort with average consistency. In short, time study aims at thedetermination of standard time required by a worker of average ability, under normal conditions toperform a task. The main advantages of time study are: 1. It helps in establishing an incentive wagepayment scheme. 2. To set production quotas for hourly rated workers. 3. To calculate cost ofproduction. 4. Sets standard labour cost under a system of standard costing. 5. Helps in the process ofproduction scheduling, sequencing, budgeting and staffing. The limitations of time study are : 1. It lacksmathematical accuracy because of complexity in breaking up a task into various elements and alsobecause of subjective element that is present in levelling or performance rating. 2. It fails to provide foradequate measurement for jobs and tasks where quality is of prime importance. 3. Trade unions andassociations generally consider time study as an infringement on workers freedom of action. It is notapplicable to jobs, which are casual and not repetitive.

5. What is Job Evaluation and what are its advantages?

Job evaluation is to determine by studying and assessing, the relative worth of each job in orderto ascertain its comparative labour worth. It is studied on the basis of job description and job analysiscomparing one job with another. The labour value of each job is calculated by considering skill,educational qualifications, responsibilities, risk involved etc. All these characteristics are given point

value and the total of these points is the relative value of the job. It is the basis on which wages arefixed and paid. In job evaluation it is the job and not the incumbent is rated. The advantages of jobevaluation are: 1. It helps in job classification and work simplification. 2. Helps in bringing uniformity inwage structure. 3. Facilitates cost control. 4. Simplifies wage administration by bringing out uniformityin wage rates. 5. There develops good relationship between the employee and employer as no scopeis left for personal bias of the employer. 6. It helps in avoiding anomalies, confusion, unrest etc.

6. Write a short notes on Merit Rating and what are its merits?

Merit rating may be defined as systematic evaluation of an employees performance on the jobin terms of the requirements of the job. It aims at evaluating the performance of employee. The mainobjective of merit rating is that an employee is to be rewarded suitably, on the basis of merit. It alsoacts as a record for punishments. Merit rating is subjective and rates the people than the jobs.

Following are the advantages of merit rating. 1. Promotions and wage rates are based on merit rating ofindividuals. 2. The employees are encouraged through a good system of reward and effort; thusfurther improvement is aimed at. 3. It simplifies wages structure. 4. Labour turnover is reduced. 5 . Asense of healthy competition in the minds of workers is developed. 6. Promotions, demotions,transfers and punishments are justified.

7. What are the different methods of recording attendance of a worker in a factory?

Every factory maintains a Time-Keeping Department. The major function of this department isto keep a record of workers arrival and departure time in the factory, and duration of engagement in thefactory. To be clearer the department has to keep records of employees attendance in and out of thefactory, in and out of the production department and the actual time spent on the job. The record oftimes for two purposes- time keeping and time booking.

Time keeping means the recording of the time of workers arrival and departure from the factoryfor the purpose of attendance and preparation of wage records. There are two methods of timekeeping. They are manual methods and mechanical methods.

Manual methods - The following are the methods generally used for recording the attendance.

a. Muster Roll (Attendance Register) - an attendance register is kept under the custody ofthe time keeper. In it, the names of the workers, the number if any are written. As soon as the workersarrive and when they leave they have to sign the register. The late commerce may even be asked tosign after noting the time of their arrival. This system is an orthodox system. It is good for small firms,


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BIEE Cost Accounting Theory - CA PCC [email protected] large firms cannot adopt the system as at the arrival time there will be a crowd. Moreover fellowworkers may sign by proxy.

b. Disc Method (Check token) All the workers are allotted some numbers, known as tokennumbers and each worker is provided with a metal disc bearing this number. These discs are allowedto hang on a board at the entrance of the factory. On arrival, the worker takes their respective discsand place them in a tray or box, kept inside the factory. When the schedule time is over, the tray or boxis removed and another tray meant for late comers is placed. This tray shall also be removed aftersome time. This system is also defective since a fellow worker can drop an absentees disc in the tray.

Mechanical devices - to overcome the defects of manual methods mechanical devices aregenerally adopted by large concerns for recording the time of the workers. They are as follows:

a. Time Recording Clocks The use of time recording clocks ensures greater accuracy andavoids all types of disputes. The clock is a mechanical device and it automatically records the time ofthe workers. Under this system, each worker is given a time card for a week or fortnight, whichcontains all relevant information about the worker. These cards are serially arranged in a tray and keptat the entrance of the factory. Workers arrive, take their respective cards and insert them in the slit ofthe clock and the clock prints the time of arrival of the worker in appropriate column. The clock mayalso be devised in such a way to print the late arrivals in red. The same process is repeated at the endof the day to enter the departure time of the workers. In this method, mischief has no place, clericallabour in recording time is reduced and wage preparation is rendered easy.

b. Dial Time Recorder- The Dial Time Recorder has a number of holes, about 160 , each of,which bears a number corresponding to the token number. There is a radial arm mounted at the centre.Each worker, when entering the gate, has to turn the arm and press the same into the hole bearing hisnumber. this automatically imprints the arrival and departure time on a paper roll mounted inside themachine. This can be used as a pay roll also. This devise is of two types- Dial time recorder and cardtime recorder

8. What is tim

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