The margin of safety can be defined as the difference between the expected level of sale
and the breakeven sales. The larger the margin of safety , the higher are the chances of
making profits. In the above example if the forecast sale is 1,700 units per month, the
margin of safety can be calculated as follows,
Margin of safety = Projected sales – Breakeven sales
= 1,700 units – 1,000 units
= 700 units or 41 % of sales.
The Margin of Safety can also be calculated by identifying the difference between the
projected sales and breakeven sales in units multiplied by the contribution per unit. This is
possible because, at the breakeven point all the fixed costs are recovered and any further
contribution goes into the making of profits.
Tuesday, March 17, 2009
THE BREAKEVEN POINT
The word contribution has been given its name because of the fact that it literally
contributes towards the recovery of fixed costs and the making of profits. The contribution
grows along with the sales revenue till the time it just covers the fixed cost. This point
where neither profits nor losses have been made is known as a break-even point. This
implies that in order to break even the amount of contribution generated should be exactly
equal to the fixed costs incurred.
contributes towards the recovery of fixed costs and the making of profits. The contribution
grows along with the sales revenue till the time it just covers the fixed cost. This point
where neither profits nor losses have been made is known as a break-even point. This
implies that in order to break even the amount of contribution generated should be exactly
equal to the fixed costs incurred.
COST-VOLUME-PROFIT ANALYSIS
cost, volume and profit. Such an analysis explores the relationship between costs,
revenue, activity levels and the resulting profit. It aims at measuring variations in cost and
volume.
CVP analysis is based on the following assumptions:
1. Changes in the levels of revenues and costs arise only because of changes in the
number of product (or service) units produced and old – for example, the number of
television sets produced and sold by Sony Corporation or the number of packages
delivered by Overnight Express. The number of output units is the only revenue driverand the only cost driver. Just as a cost driver is any factor that affects costs, a revenue
driver is a variable, such as volume, that causally affects revenues.
2. Total costs can be separated into two components; a fixed component that does not vary
with output level and a variable component that changes with respect to output level.
Furthermore, variable costs include both direct variable costs and indirect variable costs
of a product. Similarly, fixed costs include both direct fixed costs and indirect fixed costs
of a product.
revenue, activity levels and the resulting profit. It aims at measuring variations in cost and
volume.
CVP analysis is based on the following assumptions:
1. Changes in the levels of revenues and costs arise only because of changes in the
number of product (or service) units produced and old – for example, the number of
television sets produced and sold by Sony Corporation or the number of packages
delivered by Overnight Express. The number of output units is the only revenue driverand the only cost driver. Just as a cost driver is any factor that affects costs, a revenue
driver is a variable, such as volume, that causally affects revenues.
2. Total costs can be separated into two components; a fixed component that does not vary
with output level and a variable component that changes with respect to output level.
Furthermore, variable costs include both direct variable costs and indirect variable costs
of a product. Similarly, fixed costs include both direct fixed costs and indirect fixed costs
of a product.
MARGINAL COST EQUATION
The contribution theory explains the relationship between the variable cost and selling price. It
tells us that selling price minus variable cost of the units sold is the contribution towards fixed
expenses and profit. If the contribution is equal to fixed expenses, there will be no profit or
loss and if it is less than fixed expenses, loss is incurred. Since the variable cost varies in
direct proportion to output, therefore if the firm does not produce any unit, the loss will be
there to the extent of fixed expenses. These points can be described with the help of following
marginal cost equation: S × U – V × U = F + P
Where,
S = Selling price per unit
V = Variable cost per unit
U = Units
F = Fixed expenses
P = Profit
tells us that selling price minus variable cost of the units sold is the contribution towards fixed
expenses and profit. If the contribution is equal to fixed expenses, there will be no profit or
loss and if it is less than fixed expenses, loss is incurred. Since the variable cost varies in
direct proportion to output, therefore if the firm does not produce any unit, the loss will be
there to the extent of fixed expenses. These points can be described with the help of following
marginal cost equation: S × U – V × U = F + P
Where,
S = Selling price per unit
V = Variable cost per unit
U = Units
F = Fixed expenses
P = Profit
Limitations of Marginal Costing
1. It is difficult to classify exactly the expenses into fixed and variable category. Most of the
expenses are neither totally variable nor wholly fixed. For example, various amenities
provided to workers may have no relation either to volume of production or time factor.
2. Contribution of a product itself is not a guide for optimum profitability unless it is linked
with the key factor.
3. Sales staff may mistake marginal cost for total cost and sell at a price; which will result in
loss or low profits. Hence, sales staff should be cautioned while giving marginal cost.
4. Overheads of fixed nature cannot altogether be excluded particularly in large contracts,
while valuing the work-in- progress. In order to show the correct position fixed overheads
have to be included in work-in-progress.
expenses are neither totally variable nor wholly fixed. For example, various amenities
provided to workers may have no relation either to volume of production or time factor.
2. Contribution of a product itself is not a guide for optimum profitability unless it is linked
with the key factor.
3. Sales staff may mistake marginal cost for total cost and sell at a price; which will result in
loss or low profits. Hence, sales staff should be cautioned while giving marginal cost.
4. Overheads of fixed nature cannot altogether be excluded particularly in large contracts,
while valuing the work-in- progress. In order to show the correct position fixed overheads
have to be included in work-in-progress.
Monday, March 16, 2009
Advantages of Marginal Costing
1. The marginal cost remains constant per unit of output whereas the fixed cost remains
constant in total. Since marginal cost per unit is constant from period to period within a
short span of time, firm decisions on pricing policy can be taken. If fixed cost is included,
the unit cost will change from day to day depending upon the volume of output. This will
make decision making task difficult.2. Overheads are recovered in costing on the basis of pre-determined rates. If fixed
overheads are included on the basis of pre-determined rates, there will be underrecovery
of overheads if production is less or if overheads are more. There will be overrecovery
of overheads if production is more than the budget or actual expenses are less
than the estimate. This creates the problem of treatment of such under or over-recovery
of overheads. Marginal costing avoids such under or over recovery of overheads.
3. Advocates of marginal costing argues that under the marginal costing technique, the
stock of finished goods and work-in-progress are carried on marginal cost basis and the
fixed expenses are written off to profit and loss account as period cost. This shows the
true profit of the period.
constant in total. Since marginal cost per unit is constant from period to period within a
short span of time, firm decisions on pricing policy can be taken. If fixed cost is included,
the unit cost will change from day to day depending upon the volume of output. This will
make decision making task difficult.2. Overheads are recovered in costing on the basis of pre-determined rates. If fixed
overheads are included on the basis of pre-determined rates, there will be underrecovery
of overheads if production is less or if overheads are more. There will be overrecovery
of overheads if production is more than the budget or actual expenses are less
than the estimate. This creates the problem of treatment of such under or over-recovery
of overheads. Marginal costing avoids such under or over recovery of overheads.
3. Advocates of marginal costing argues that under the marginal costing technique, the
stock of finished goods and work-in-progress are carried on marginal cost basis and the
fixed expenses are written off to profit and loss account as period cost. This shows the
true profit of the period.
Presentation of Information:
In absorption costing the classification of expenses is
based on functional basis whereas in marginal costing it is based on the nature of
expenses. In absorption costing, the fixed expenses are distributed over products on
absorption costing basis, that is, based on a pre-determined level of output. Since fixed
expenses are constant, such a method of recovery will lead to over or under-recovery of
expenses depending on the actual output being greater or lesser than the estimate used
for recovery. This difficulty will not arise in marginal costing because the contribution is
used as a fund for meeting fixed expenses.
based on functional basis whereas in marginal costing it is based on the nature of
expenses. In absorption costing, the fixed expenses are distributed over products on
absorption costing basis, that is, based on a pre-determined level of output. Since fixed
expenses are constant, such a method of recovery will lead to over or under-recovery of
expenses depending on the actual output being greater or lesser than the estimate used
for recovery. This difficulty will not arise in marginal costing because the contribution is
used as a fund for meeting fixed expenses.
Control of expenses
The classification of expenses helps in controlling expenses.
Fixed expenses are said to be sunk costs as these are incurred irrespective of the level of
production activity and they are regarded as uncontrollable expenses. Since variable
expenses vary with the production they are said to be controllable. By this classification,therefore, responsibility for incurring variable expenses is determined in relation to activity
and hence the management is able to control these expenses. The departmental heads
always try to keep these expenses within limits set by the management.
Fixed expenses are said to be sunk costs as these are incurred irrespective of the level of
production activity and they are regarded as uncontrollable expenses. Since variable
expenses vary with the production they are said to be controllable. By this classification,therefore, responsibility for incurring variable expenses is determined in relation to activity
and hence the management is able to control these expenses. The departmental heads
always try to keep these expenses within limits set by the management.
Semi-variable expenses
These expenses (also known as semi-fixed expenses) do not
change within the limits of a small range of activity but may change when the output
reaches a new level in the same direction in which the output changes. Such increases or
decreases in expenses are not in proportion to output. An example of such an expense is
delivery van expense. Semi-variable expenses may remain constant at 50% to 60% level
of activity and may increase in total from 60% to 70% level of activity. These expenses
can be segregated into fixed and variable by using any one of the method, as given under
next heading. Depreciation of plant and machinery depends partly on efflux of time and
partly on wear and tear.
change within the limits of a small range of activity but may change when the output
reaches a new level in the same direction in which the output changes. Such increases or
decreases in expenses are not in proportion to output. An example of such an expense is
delivery van expense. Semi-variable expenses may remain constant at 50% to 60% level
of activity and may increase in total from 60% to 70% level of activity. These expenses
can be segregated into fixed and variable by using any one of the method, as given under
next heading. Depreciation of plant and machinery depends partly on efflux of time and
partly on wear and tear.
Fixed expenses
Fixed expenses or constant expenses are those which do not vary in
total with the change in volume of output for a given period of time. Fixed cost per unit of
output will, however, fluctuate with changes in the level of production. Examples of such
expenses are managerial remuneration, rent, taxes, etc. There may, however, be different
levels of fixed costs at different levels of output, as for example, where after certain level
of output extra expenditure may be needed. In the case of introduction of additional shift
working, fixed expenses will be incurred, say, for the appointment of additional
supervisors.
total with the change in volume of output for a given period of time. Fixed cost per unit of
output will, however, fluctuate with changes in the level of production. Examples of such
expenses are managerial remuneration, rent, taxes, etc. There may, however, be different
levels of fixed costs at different levels of output, as for example, where after certain level
of output extra expenditure may be needed. In the case of introduction of additional shift
working, fixed expenses will be incurred, say, for the appointment of additional
supervisors.
Sunday, March 15, 2009
Variable expenses
Apart from prime costs which are variable, the overhead expensesthat change in proportion to the change in the level of activity are also variable expenses.
Thus when expenses go up or come down in proportion to a change in the volume of
output, such that, with every increase of 20% in output, expenses also go up by 20% or
vice versa, these expenses are known as variable expenses. Variable expenses fluctuate
in total with fluctuations in the level of output but tend to remain constant per unit of
output. Examples of such expenses are raw material, power, commission paid to
salesmen as a percentage of sales, etc.
Thus when expenses go up or come down in proportion to a change in the volume of
output, such that, with every increase of 20% in output, expenses also go up by 20% or
vice versa, these expenses are known as variable expenses. Variable expenses fluctuate
in total with fluctuations in the level of output but tend to remain constant per unit of
output. Examples of such expenses are raw material, power, commission paid to
salesmen as a percentage of sales, etc.
Key factor
Key factor or Limiting factor is a factor which at a particular time or over a
period limits the activities of an undertaking. It may be the level of demand for the
products or services or it may be the shortage of one or more of the productive resources,
e.g., labour hours, available plant capacity, raw material’s availability etc. Examples of
Key Factors or Limiting Factors are:
(a) Shortage of raw material.
(b) Shortage of labour.
(c) Plant capacity available.
(d) Sales capacity available.
(e) Cash availability.
period limits the activities of an undertaking. It may be the level of demand for the
products or services or it may be the shortage of one or more of the productive resources,
e.g., labour hours, available plant capacity, raw material’s availability etc. Examples of
Key Factors or Limiting Factors are:
(a) Shortage of raw material.
(b) Shortage of labour.
(c) Plant capacity available.
(d) Sales capacity available.
(e) Cash availability.
Contribution
Contribution or the contributory margin is the difference between sales
value and the marginal cost. It is obtained by subtracting marginal cost from sales
revenue of a given activity. It can also be defined as excess of sales revenue over the
variable cost. The difference between sales revenue and marginal/variable cost is
considered to be the contribution towards fixed expenses and profit of the entire business.
The contribution concept is based on the theory that the profit and fixed expenses of a
business is a ‘joint cost’ which cannot be equitably apportioned to different segments of
the business. In view of this difficulty the contribution serves as a measure of efficiency of
operations of various segments of the business.
value and the marginal cost. It is obtained by subtracting marginal cost from sales
revenue of a given activity. It can also be defined as excess of sales revenue over the
variable cost. The difference between sales revenue and marginal/variable cost is
considered to be the contribution towards fixed expenses and profit of the entire business.
The contribution concept is based on the theory that the profit and fixed expenses of a
business is a ‘joint cost’ which cannot be equitably apportioned to different segments of
the business. In view of this difficulty the contribution serves as a measure of efficiency of
operations of various segments of the business.
Incremental cost
It is defined as, “the additional costs of a change in the level or
nature of activity”. As such for all practical purposes there is no difference between
incremental cost and differential cost. However, from a conceptual point of view,
differential cost refers to both incremental as well as decremental cost. Incremental cost
and differential cost calculated from the same data will be the same. In practice,
therefore, generally no distinction is made between differential cost and incremental cost.
One aspect which is worthy to note is that incremental cost is not the same at all levels.
Incremental cost between 50% and 60% level of output may be different from that which is
arrived at between 80% and 90% level of output. Differential cost or incremental costanalysis deals with both short-term and long-term problems.
nature of activity”. As such for all practical purposes there is no difference between
incremental cost and differential cost. However, from a conceptual point of view,
differential cost refers to both incremental as well as decremental cost. Incremental cost
and differential cost calculated from the same data will be the same. In practice,
therefore, generally no distinction is made between differential cost and incremental cost.
One aspect which is worthy to note is that incremental cost is not the same at all levels.
Incremental cost between 50% and 60% level of output may be different from that which is
arrived at between 80% and 90% level of output. Differential cost or incremental costanalysis deals with both short-term and long-term problems.
Differential cost :
It may be defined as “the increase or decrease in total cost or the
change in specific elements of cost that result from any variation in operations”. It
represents an increase or decrease in total cost resulting out of :
(a) producing or distributing a few more or few less of the products;
(b) a change in the method of production or of distribution;
(c) an addition or deletion of a product or a territory; and
(d) selection of an additional sales channel.
Differential cost, thus includes fixed and semi-variable expenses. It is the difference
between the total costs of two alternatives. It is an adhoc cost determined for the purpose
of choosing between competing alternatives, each with its own combination of income and
costs.
change in specific elements of cost that result from any variation in operations”. It
represents an increase or decrease in total cost resulting out of :
(a) producing or distributing a few more or few less of the products;
(b) a change in the method of production or of distribution;
(c) an addition or deletion of a product or a territory; and
(d) selection of an additional sales channel.
Differential cost, thus includes fixed and semi-variable expenses. It is the difference
between the total costs of two alternatives. It is an adhoc cost determined for the purpose
of choosing between competing alternatives, each with its own combination of income and
costs.
Saturday, March 14, 2009
Direct costing:
Direct costing is the practice of charging all direct cost to operations,
processes or products, leaving all indirect costs to be written off against profits in the
period in which they arise. Under direct costing the stocks are valued at direct costs, i.e.,
costs whether fixed or variable which can be directly attributable to the cost units.
In general, the terms marginal costing and direct costing are used as synonymous.
However, direct costing differs from marginal costing in that some fixed costs considered
direct are charged to operations, processes or products, whereas in marginal costing only
variable costs are considered. Marginal costing is mainly concerned with providing of
information to management to assist in decision making and for exercising control.
processes or products, leaving all indirect costs to be written off against profits in the
period in which they arise. Under direct costing the stocks are valued at direct costs, i.e.,
costs whether fixed or variable which can be directly attributable to the cost units.
In general, the terms marginal costing and direct costing are used as synonymous.
However, direct costing differs from marginal costing in that some fixed costs considered
direct are charged to operations, processes or products, whereas in marginal costing only
variable costs are considered. Marginal costing is mainly concerned with providing of
information to management to assist in decision making and for exercising control.
Definitions:
In order to appreciate the concept of marginal costing, it is necessary to
study the definition of marginal costing and certain other terms associated with this
technique. The important terms have been defined as follows:
1. Marginal costing : The ascertainment of marginal cost and of the effect on profit of
changes in volume or type of output by differentiating between fixed costs and variable
costs.
2. Marginal cost: The amount at any given volume of output by which aggregate variable
costs are changed if the volume of output is increased by one unit. In practice this ismeasured by the total variable cost attributable to one unit. Marginal cost can precisely be
the sum of prime cost and variable overhead.
study the definition of marginal costing and certain other terms associated with this
technique. The important terms have been defined as follows:
1. Marginal costing : The ascertainment of marginal cost and of the effect on profit of
changes in volume or type of output by differentiating between fixed costs and variable
costs.
2. Marginal cost: The amount at any given volume of output by which aggregate variable
costs are changed if the volume of output is increased by one unit. In practice this ismeasured by the total variable cost attributable to one unit. Marginal cost can precisely be
the sum of prime cost and variable overhead.
THEORY OF MARGINAL COSTING
The theory of marginal costing is that in relation to a given volume of output, additional
output can normally be obtained at less than proportionate cost because within limits the
aggregate of certain items of cost will tend to remain fixed and only the aggregate of the
remainder will tend to rise proportionately with increase in output. Conversely, a
decrease in the volume of output will normally be accompanied by a less than
proportionate fall in the aggregate cost.
The theory of marginal costing may therefore be explained in three steps:
(i) If the volume of output increases, the average cost per unit will, in the normal
circumstances, be reduced. Conversely, if the output is reduced, the average cost per
unit will go up. If the factory produces 1,000 units at a total cost of Rs. 3,000 and if by
increasing the output by one unit, the cost goes up to Rs. 3,002, the marginal cost of the
additional output is Rs. 2.
output can normally be obtained at less than proportionate cost because within limits the
aggregate of certain items of cost will tend to remain fixed and only the aggregate of the
remainder will tend to rise proportionately with increase in output. Conversely, a
decrease in the volume of output will normally be accompanied by a less than
proportionate fall in the aggregate cost.
The theory of marginal costing may therefore be explained in three steps:
(i) If the volume of output increases, the average cost per unit will, in the normal
circumstances, be reduced. Conversely, if the output is reduced, the average cost per
unit will go up. If the factory produces 1,000 units at a total cost of Rs. 3,000 and if by
increasing the output by one unit, the cost goes up to Rs. 3,002, the marginal cost of the
additional output is Rs. 2.
Criticism of Standard Costing:
The following is some of the criticism which may be levelled
against the standard costing system. The arguments have been suitably answered as stated
against each by advocates of the standard costing and hence they do not invalidate the
usefulness of the system to business enterprises.
(i) Variation in price: One of the chief problem faced in the operation of the standard costing
system is the precise estimation of likely prices or rate to be paid. The variability of prices is
so great that even actual prices are not necessarily adequately representative of cost. But the
use of sophisticated forecasting techniques should be able to cover the price fluctuation to
some extent. Besides this, the system provides for isolating uncontrollable variances arising
from variations to be dealt with separately.
against the standard costing system. The arguments have been suitably answered as stated
against each by advocates of the standard costing and hence they do not invalidate the
usefulness of the system to business enterprises.
(i) Variation in price: One of the chief problem faced in the operation of the standard costing
system is the precise estimation of likely prices or rate to be paid. The variability of prices is
so great that even actual prices are not necessarily adequately representative of cost. But the
use of sophisticated forecasting techniques should be able to cover the price fluctuation to
some extent. Besides this, the system provides for isolating uncontrollable variances arising
from variations to be dealt with separately.
Advantages of Standard Costing:
It serves as a basis for measuring operating performance and cost control. By setting
standards, proper classification and determination of variances, is possible. This serves as a
signal for prompt corrective action. This system provides for reporting on the principle of
exception. The basis of this principle is that only matters which are not proceeding according
to plan are reported upon. This enables the managers to concentrate upon essential matters
and leave the non-essentials to take care of themselves. By using special forms, any
excessive time taken, extra material used or additional services consumed can be brought to
light as part of the ordinary routine. In other words, if the variances are negligible, it means
that the performance is more or less in accordance with the standards. Significant variances
which warrant the attention of the manager are brought to his knowledge.
standards, proper classification and determination of variances, is possible. This serves as a
signal for prompt corrective action. This system provides for reporting on the principle of
exception. The basis of this principle is that only matters which are not proceeding according
to plan are reported upon. This enables the managers to concentrate upon essential matters
and leave the non-essentials to take care of themselves. By using special forms, any
excessive time taken, extra material used or additional services consumed can be brought to
light as part of the ordinary routine. In other words, if the variances are negligible, it means
that the performance is more or less in accordance with the standards. Significant variances
which warrant the attention of the manager are brought to his knowledge.
Friday, March 13, 2009
ABOUT GLOBAL COMMUNICATIONS
Global Communication Ltd. (GCL), manufacturers of Telephone Exchanges, had been
incorporated in the early 90s and has since grown rapidly. Today it is considered as one
of the largest Telecom Company in the country. Till only a few months back, being the
only manufacturer of such products, GCL was enjoying monopoly and huge Gross Profit
Margins to its credit. Costing was hence not thought to be important, except to facilitate
statutory Financial Audits. However, the Telecom revolution changed the scenario in no
time, with more business houses venturing into Exchange production. Sensing
competition, the management had been quick to hire the services of Mr. Ravi Shankar in
order to help implement a relevant Costing System for its plant located at Kanpur. The
system was to be such, so as to fulfil the requirements of Material and Expenses Control,
facilitate Statutory Audit, help in Pricing Decisions and provide for the day-to-day
requirements of Excise, etc. Since the variable cost component within the production
process was quite high a Standard Costing System was thought off to be most
appropriate.
incorporated in the early 90s and has since grown rapidly. Today it is considered as one
of the largest Telecom Company in the country. Till only a few months back, being the
only manufacturer of such products, GCL was enjoying monopoly and huge Gross Profit
Margins to its credit. Costing was hence not thought to be important, except to facilitate
statutory Financial Audits. However, the Telecom revolution changed the scenario in no
time, with more business houses venturing into Exchange production. Sensing
competition, the management had been quick to hire the services of Mr. Ravi Shankar in
order to help implement a relevant Costing System for its plant located at Kanpur. The
system was to be such, so as to fulfil the requirements of Material and Expenses Control,
facilitate Statutory Audit, help in Pricing Decisions and provide for the day-to-day
requirements of Excise, etc. Since the variable cost component within the production
process was quite high a Standard Costing System was thought off to be most
appropriate.
Overhead expenses variance
As discussed above, the Production Volume Variance
analyses the unrecovered fixed overheads. Apart from this, there can be variations in the
actual spending of both fixed and variable overheads when compared to what was established
as a standard. Such variations can be accounted for by analyzing a Overhead expenses
variance.
The following illustration shows how overhead expense rates are computed and variance
analysed.
analyses the unrecovered fixed overheads. Apart from this, there can be variations in the
actual spending of both fixed and variable overheads when compared to what was established
as a standard. Such variations can be accounted for by analyzing a Overhead expenses
variance.
The following illustration shows how overhead expense rates are computed and variance
analysed.
Production Volume Variance:
The term fixed overheads implies that the element of
cost does not vary directly in proportion to the output. In other words fixed overheads do not
change within a given range of activity. However the unit cost changes even though the fixed
overheads are constant in total within the given range of output. So, higher the level of
activity, the lower will be the unit cost or vice versa. The management is, therefore, faced with
a costing difficulty because it requires a representative rate for charging fixed overheads
irrespective of changes in volume of output.
cost does not vary directly in proportion to the output. In other words fixed overheads do not
change within a given range of activity. However the unit cost changes even though the fixed
overheads are constant in total within the given range of output. So, higher the level of
activity, the lower will be the unit cost or vice versa. The management is, therefore, faced with
a costing difficulty because it requires a representative rate for charging fixed overheads
irrespective of changes in volume of output.
Overheads
Normally, for several type of overhead expenses either a single recovery
rate or two recovery rates, one representing fixed overheads and the other representing
variable overheads, will be prepared. Refer to the ‘Estimated Standard Cost’ table on page
8,2. Overheads have been classified as both fixed and variable thereby giving a standard fixed
cost (overhead) per unit and standard variable cost (overhead) per unit. The recovery of the
fixed components of the estimated overheads depends upon capacity utilization.
rate or two recovery rates, one representing fixed overheads and the other representing
variable overheads, will be prepared. Refer to the ‘Estimated Standard Cost’ table on page
8,2. Overheads have been classified as both fixed and variable thereby giving a standard fixed
cost (overhead) per unit and standard variable cost (overhead) per unit. The recovery of the
fixed components of the estimated overheads depends upon capacity utilization.
Labour
Similar to material usage variance, labour efficiency variance measures the
efficiency of labour by identifying the difference between the actual hours worked and the
hours which should have been worked as per the established standards. Deviations in the
actual rate of pay and the ones estimated are measured by the labour rate variance.
Mathematically
Labour efficiency variance = Std. rate (Std. time – Actual time)
Labour rate variance = Actual time (Std. rate – Actual rate)
efficiency of labour by identifying the difference between the actual hours worked and the
hours which should have been worked as per the established standards. Deviations in the
actual rate of pay and the ones estimated are measured by the labour rate variance.
Mathematically
Labour efficiency variance = Std. rate (Std. time – Actual time)
Labour rate variance = Actual time (Std. rate – Actual rate)
Wednesday, March 11, 2009
Material
The two basic variances arising during material consumption are material
usage and material price variances. The former arises because of variations in the quantity of
material actually consumed when compared with what should have been consumed as per the
established standards and the latter because of the differences between the planned and the
actual material prices paid to the suppliers. Mathematically
Material usage variance = Std. price (Std. Qty. – Acutal qty.)
Material price variance = Actual qty. (Std. price – Actual price)
usage and material price variances. The former arises because of variations in the quantity of
material actually consumed when compared with what should have been consumed as per the
established standards and the latter because of the differences between the planned and the
actual material prices paid to the suppliers. Mathematically
Material usage variance = Std. price (Std. Qty. – Acutal qty.)
Material price variance = Actual qty. (Std. price – Actual price)
Controllable and un-controllable variances:
The purpose of the standard costing
reports is to investigate the reasons for significant variances so as to identify the problems
and take corrective action. Variances are broadly of two types, namely, controllable and
uncontrollable. Controllable variances are those which can be controlled by the departmental
heads whereas uncontrollable variances are those which are beyond their control. For
example, price variance is normally regarded as uncontrollable if the price increase is due to
fluctuations of prices in the market. It becomes controllable if the production controller has
failed to place orders in time and urgent purchase was made at extra cost.
reports is to investigate the reasons for significant variances so as to identify the problems
and take corrective action. Variances are broadly of two types, namely, controllable and
uncontrollable. Controllable variances are those which can be controlled by the departmental
heads whereas uncontrollable variances are those which are beyond their control. For
example, price variance is normally regarded as uncontrollable if the price increase is due to
fluctuations of prices in the market. It becomes controllable if the production controller has
failed to place orders in time and urgent purchase was made at extra cost.
THE PROCESS OF STANDARD COSTING
Standard costs are pre-determined by using a careful analysis of production methods, physical
conditions and price factors. They represent achievable targets and help to build up budgets,
gauge performance and obtain product costs. The actual costs will vary from month to month
or even from day to day. The basic objective, therefore, of standard costing system is to
assist the departmental head by identifying and describing the variances over which he has
control. Thus, a set of standards developed under the standard costing system outlines how a
task must be accomplished and how much it should cost. As work is done actual costs are
recorded and compared with standard cost to determine the variances.
conditions and price factors. They represent achievable targets and help to build up budgets,
gauge performance and obtain product costs. The actual costs will vary from month to month
or even from day to day. The basic objective, therefore, of standard costing system is to
assist the departmental head by identifying and describing the variances over which he has
control. Thus, a set of standards developed under the standard costing system outlines how a
task must be accomplished and how much it should cost. As work is done actual costs are
recorded and compared with standard cost to determine the variances.
Uses of Standard Costs
1. Use of standard costs is an effective way for planning and controlling costs.
2. Pricing decisions and decisions involving submission of quotations, answering tenders
etc., are also facilitated by the use of standard costs.
3. Identification and measurement of variances from standards has been made possible
with the use of standard cost, with a view to improve performance or to correct loose
standards, if any.
4. Facilitates management by exception.
2. Pricing decisions and decisions involving submission of quotations, answering tenders
etc., are also facilitated by the use of standard costs.
3. Identification and measurement of variances from standards has been made possible
with the use of standard cost, with a view to improve performance or to correct loose
standards, if any.
4. Facilitates management by exception.
NEED FOR STANDARD COSTS
Since standard costs are pre-determined costs computed before the production takes place,
they are preferable to actual costs. Moreover, certain conditions resulting from mass
production make standard costs necessary and strongly advisable. Some of such conditions
are:
(a) Historical costs may be too expensive to compute. For example, in a manufacturing
concern producing about 1,00,000 parts, divided into various lots, imagine the time and
clerical labour involved in arriving at the actual cost lot by lot and then averaging it to
determine the cost per unit.
(b) The unit costs computed on historical data may vary from day to day and they are of no
use to the sales department in setting selling prices. For example, if the historical costs per
unit of product in a week are Rs. 1.05, 0.99, 1.27, 1.18, 1.42, 1.56, the selling price cannot be
varied from day to day to match the costs.
they are preferable to actual costs. Moreover, certain conditions resulting from mass
production make standard costs necessary and strongly advisable. Some of such conditions
are:
(a) Historical costs may be too expensive to compute. For example, in a manufacturing
concern producing about 1,00,000 parts, divided into various lots, imagine the time and
clerical labour involved in arriving at the actual cost lot by lot and then averaging it to
determine the cost per unit.
(b) The unit costs computed on historical data may vary from day to day and they are of no
use to the sales department in setting selling prices. For example, if the historical costs per
unit of product in a week are Rs. 1.05, 0.99, 1.27, 1.18, 1.42, 1.56, the selling price cannot be
varied from day to day to match the costs.
Tuesday, March 10, 2009
Current standards:
These standards reflect the management’s anticipation of what
actual costs will be for the current period. These are the costs which the business will incur if
the anticipated prices are paid for the goods and services and the usage corresponds to that
believed to be necessary to produce the planned output. The variances arising from expected
standards represent the degree of efficiency in usage of the factors of production, variation in
prices paid for materials and services and difference in the volume of production.
actual costs will be for the current period. These are the costs which the business will incur if
the anticipated prices are paid for the goods and services and the usage corresponds to that
believed to be necessary to produce the planned output. The variances arising from expected
standards represent the degree of efficiency in usage of the factors of production, variation in
prices paid for materials and services and difference in the volume of production.
Basic or Bogey standards:
These standards are used only when they are likely to
remain constant or unaltered over a long period. According to this standard, a base year is
chosen for comparison purposes in the same way as statisticians use price indices. Since
basic standards do not represent what should be attained in the present period, current
standards should also be prepared if basic standards are used. Basic standards are,
however, well suited to businesses having a small range of products and long production runs.
Basic standards are set, on a long-term basis and are seldom revised. When basic standards
are in use, variances are not calculated as the difference between standard and actual cost.
Instead, the actual cost is expressed as a percentage of basic cost.
remain constant or unaltered over a long period. According to this standard, a base year is
chosen for comparison purposes in the same way as statisticians use price indices. Since
basic standards do not represent what should be attained in the present period, current
standards should also be prepared if basic standards are used. Basic standards are,
however, well suited to businesses having a small range of products and long production runs.
Basic standards are set, on a long-term basis and are seldom revised. When basic standards
are in use, variances are not calculated as the difference between standard and actual cost.
Instead, the actual cost is expressed as a percentage of basic cost.
Normal standards:
These are standards that may be achieved under normal operating
conditions. The normal activity has been defined as “the number of standard hours which willproduce at normal efficiency sufficient goods to meet the average sales demand over a term
of years”. These standards are, however, difficult to set because they require a degree of
forecasting. The variances thrown out under this system are deviations from normal efficiency,
normal sales volume, or normal productive volume. If the actual performance is found to be
abnormal, large variances may result and necessitate revision of standards.
conditions. The normal activity has been defined as “the number of standard hours which willproduce at normal efficiency sufficient goods to meet the average sales demand over a term
of years”. These standards are, however, difficult to set because they require a degree of
forecasting. The variances thrown out under this system are deviations from normal efficiency,
normal sales volume, or normal productive volume. If the actual performance is found to be
abnormal, large variances may result and necessitate revision of standards.
Ideal standards:
These represent the level of performance attainable when prices for
material and labour are most favourable, when the highest output is achieved with the best
equipment and layout and when the maximum efficiency in utilisation of resources results in
maximum output with minimum cost. These type of standards are criticised on three grounds:
(i) Since such standards would be unattainable, no one would take them seriously.
(ii) The variances disclosed would be variances from the ideal standards. These would not,
therefore, indicate the extent to which they could have been reasonably and practically
avoided.
(iii) There would be no logical method of disposing of these variances.
material and labour are most favourable, when the highest output is achieved with the best
equipment and layout and when the maximum efficiency in utilisation of resources results in
maximum output with minimum cost. These type of standards are criticised on three grounds:
(i) Since such standards would be unattainable, no one would take them seriously.
(ii) The variances disclosed would be variances from the ideal standards. These would not,
therefore, indicate the extent to which they could have been reasonably and practically
avoided.
(iii) There would be no logical method of disposing of these variances.
TYPES OF STANDARDS
The accuracy and relevance of an established standard cost depends upon the reliability of
the standards set up. In order to compute the standards we must know what degree of
accuracy is necessary. There are four different bases or standards which should be
considered.
the standards set up. In order to compute the standards we must know what degree of
accuracy is necessary. There are four different bases or standards which should be
considered.
Monday, March 9, 2009
Standard hour:
In industries like coal mining, where the products are homogeneous, the
calculation of output is relatively simple. But in concerns manufacturing several products it is
difficult to establish a satisfactory basis on which to measure output of the various
departments because of differences in volume of individual products, quality, etc.
The most satisfactory method of common measure is the use of standard hour. ICMA, London,
defines a standard hour as a hypothetical hour, which measures the amount of work which
should be performed in one hour. The standard hour is thus a unit of work and not of time.
calculation of output is relatively simple. But in concerns manufacturing several products it is
difficult to establish a satisfactory basis on which to measure output of the various
departments because of differences in volume of individual products, quality, etc.
The most satisfactory method of common measure is the use of standard hour. ICMA, London,
defines a standard hour as a hypothetical hour, which measures the amount of work which
should be performed in one hour. The standard hour is thus a unit of work and not of time.
Overhead expense standards:
In computing the overhead expense standards, consideration
should be given to the level of output and the expenses budgeted. A budget showing the level
of output to be considered for arriving at overhead expense standards may be based on the
practical manufacturing capacity or the average sales capacity or the budgeted capacity to be
utilised in the coming year. After having chosen one of the methods of output level, the
expenses can be budgeted under different heads under what the management calls good
performance for the level of output chosen. These expenses are classified under fixed and
variable categories.
should be given to the level of output and the expenses budgeted. A budget showing the level
of output to be considered for arriving at overhead expense standards may be based on the
practical manufacturing capacity or the average sales capacity or the budgeted capacity to be
utilised in the coming year. After having chosen one of the methods of output level, the
expenses can be budgeted under different heads under what the management calls good
performance for the level of output chosen. These expenses are classified under fixed and
variable categories.
Wage rate standard:
Standard wage rates may be set to cover various grades of labour. In
factories ‘where contracts with workers’ unions exist, the rates approved by contract usually
become the standard for the period for which the contract applies.
factories ‘where contracts with workers’ unions exist, the rates approved by contract usually
become the standard for the period for which the contract applies.
Material price standards:
Material prices are not altogether within the control of the
manufacturer; but the purchasing department, on being apprised of production quantities
required, should be able, from its knowledge of current market conditions and trends, to state
with reasonable accuracy price for the constituent items. The standards for prices of materials
should be based on the following factors, if price fluctuations are small and are not serious.
(a) Stock of materials on hand and the prices at which they are held;(b) The prices at which orders for future deliveries of materials have already been placed
and
(c) Anticipated fluctuation in price levels.
manufacturer; but the purchasing department, on being apprised of production quantities
required, should be able, from its knowledge of current market conditions and trends, to state
with reasonable accuracy price for the constituent items. The standards for prices of materials
should be based on the following factors, if price fluctuations are small and are not serious.
(a) Stock of materials on hand and the prices at which they are held;(b) The prices at which orders for future deliveries of materials have already been placed
and
(c) Anticipated fluctuation in price levels.
Price or Rate standards:
Broadly, the price or rate standards can be set on either of the
following bases:
(a) Actual average or mean price expected to prevail during the coming period, say one
year; or
(b) Normal prices expected to prevail during a cycle of seasons which may be of a number of
years.
following bases:
(a) Actual average or mean price expected to prevail during the coming period, say one
year; or
(b) Normal prices expected to prevail during a cycle of seasons which may be of a number of
years.
Problems faced while setting physical standards:
The problems involved while setting
physical standards will vary from industry to industry and may be illustrated as under:
(a) A situation may arise where the company is introducing the manufacture of a new line of
product. In such cases, it may be necessary to employ workers who have no experience in
the job. This creates a problem of setting standard time because it is necessary to make
adjustment for the inexperience of workers.
(b) Changes in technology may necessitate installation of sophisticated machines. When
such machines are installed, the precise estimation of output and standard of efficiency
achievable will pose a problem until after a long time when the working conditions are settled.
Thus, setting standards for these machines and estimating the standard costs will need
considerable amount of work.
physical standards will vary from industry to industry and may be illustrated as under:
(a) A situation may arise where the company is introducing the manufacture of a new line of
product. In such cases, it may be necessary to employ workers who have no experience in
the job. This creates a problem of setting standard time because it is necessary to make
adjustment for the inexperience of workers.
(b) Changes in technology may necessitate installation of sophisticated machines. When
such machines are installed, the precise estimation of output and standard of efficiency
achievable will pose a problem until after a long time when the working conditions are settled.
Thus, setting standards for these machines and estimating the standard costs will need
considerable amount of work.
Labour quantity standards:
The following are the steps involved in setting labour quantity
standards:
(a) Standardisation of product, as explained above.
(b) Product classification, as defined earlier.
(c) Standardisation of methods: Selection of proper machines to use proper sequence and
method of operations.
(d) Manufacturing layout: A plan of operation for each product listing the operations to be
performed is prepared.
(e) Time and motion study is conducted for selecting the best way of completing the job or
motions to be performed by workers and the standard time which an average worker will take
for each job.
(f) The operator is given training to perform the job or operations in the best possible
manner.
standards:
(a) Standardisation of product, as explained above.
(b) Product classification, as defined earlier.
(c) Standardisation of methods: Selection of proper machines to use proper sequence and
method of operations.
(d) Manufacturing layout: A plan of operation for each product listing the operations to be
performed is prepared.
(e) Time and motion study is conducted for selecting the best way of completing the job or
motions to be performed by workers and the standard time which an average worker will take
for each job.
(f) The operator is given training to perform the job or operations in the best possible
manner.
Material quantity standards:
The following procedure is usually followed for setting material
quantity standards.
(a) Standardisation of products: Detailed specifications, blueprints, norms for normal
wastage etc., of products along with their designs are settled.
(b) Product classification: Detailed classified list of products to be manufactured are
prepared.
(c) Standardisation of material: Specifications, quality, etc., of materials to be used in the
standard products are settled.
(d) Preparation of bill of materials: A bill of material for each product or part showing the
symbol or code, description and quantity of each material to be used is prepared.
(e) Test runs: Sample or test runs under regulated conditions may be useful in setting
quantity standards in a precise manner.
quantity standards.
(a) Standardisation of products: Detailed specifications, blueprints, norms for normal
wastage etc., of products along with their designs are settled.
(b) Product classification: Detailed classified list of products to be manufactured are
prepared.
(c) Standardisation of material: Specifications, quality, etc., of materials to be used in the
standard products are settled.
(d) Preparation of bill of materials: A bill of material for each product or part showing the
symbol or code, description and quantity of each material to be used is prepared.
(e) Test runs: Sample or test runs under regulated conditions may be useful in setting
quantity standards in a precise manner.
Physical standards:
The first step in manufacturing a product is to determine standard
quantity of different materials to be used under the manufacturing process; various subassemblies,
components, other small parts, etc. Besides this the length of time an average
worker should take to complete a job. These standards so determined are known as physicalstandards. The purposes of setting physical standards are:
(a) To secure economies in manufacture, and
(b) Set selling prices in advance to make it possible to estimate the cost. In printing
industry, for example, the standards relating to the printed output are necessary in submitting
quotations, for proposed jobs.
In manufacturing organisations, the task of setting physical standards is assigned to the
industrial engineering department.
quantity of different materials to be used under the manufacturing process; various subassemblies,
components, other small parts, etc. Besides this the length of time an average
worker should take to complete a job. These standards so determined are known as physicalstandards. The purposes of setting physical standards are:
(a) To secure economies in manufacture, and
(b) Set selling prices in advance to make it possible to estimate the cost. In printing
industry, for example, the standards relating to the printed output are necessary in submitting
quotations, for proposed jobs.
In manufacturing organisations, the task of setting physical standards is assigned to the
industrial engineering department.
SETTING UP OF STANDARD COST
A standard cost by definition is an estimate correlating a technical specification of materials
and labour to the prices and wage rates with the addition of overhead for a prescribed level of
output. It is thus a measure in quantities, hours and value of the factors of production. There
are three main parts of standard costs, viz., (a) direct material, (b) direct labour, and (c)
overhead expenses.
and labour to the prices and wage rates with the addition of overhead for a prescribed level of
output. It is thus a measure in quantities, hours and value of the factors of production. There
are three main parts of standard costs, viz., (a) direct material, (b) direct labour, and (c)
overhead expenses.
Friday, March 6, 2009
DEFINITION OF STANDARD COST
Standard cost is defined “as a pre-determined cost which is calculated from management’s
standards of efficient operation and the relevant necessary expenditure. It may be used as a
basis for price fixing and for cost control through variance analysis.”
The standard cost of a product has been defined by Blocker and Weltmer “as a predetermined
cost based upon engineering specification and representing highly efficient
production for quantity standards and forecasts of future market trends for price standards
with a fixed amount expressed in dollars for material, labour and overhead for an estimated
quantity of production.” It may be seen from this definition that engineering specifications are
the basis for quantity standards for materials and time standards for labour while budgets are
of importance in determining material price standards, labour rate standards and overhead
standards.
standards of efficient operation and the relevant necessary expenditure. It may be used as a
basis for price fixing and for cost control through variance analysis.”
The standard cost of a product has been defined by Blocker and Weltmer “as a predetermined
cost based upon engineering specification and representing highly efficient
production for quantity standards and forecasts of future market trends for price standards
with a fixed amount expressed in dollars for material, labour and overhead for an estimated
quantity of production.” It may be seen from this definition that engineering specifications are
the basis for quantity standards for materials and time standards for labour while budgets are
of importance in determining material price standards, labour rate standards and overhead
standards.
Where they require further processing
In this case, the net realisable value of the
by-product at the split-off point may be arrived at by subtracting the further processing
cost from the realisable value of by-products.
If total sales value of by-products at split-off point is small, it may be treated as per the
provisions discussed above under (i).
In the contrary case, the amount realised from the sale of by-products will be considerable and
thus it may be treated as discussed under (ii).
(Students must solve a large number of questions from process costing so as to acquire the
required proficiency in the area).
by-product at the split-off point may be arrived at by subtracting the further processing
cost from the realisable value of by-products.
If total sales value of by-products at split-off point is small, it may be treated as per the
provisions discussed above under (i).
In the contrary case, the amount realised from the sale of by-products will be considerable and
thus it may be treated as discussed under (ii).
(Students must solve a large number of questions from process costing so as to acquire the
required proficiency in the area).
When the by-products are of considerable total value
Where by-products are of
considerable total value, they may be regarded as joint products rather than as byproducts.
To determine exact cost of by-products the costs incurred upto the point of
separation, should be apportioned over by-products and joint products by using a logical
basis. In this case, the joint costs may be divided over joint products and by-products by
using relative market values ; physical output method (at the point of split off) or ultimate
selling prices (if sold).
considerable total value, they may be regarded as joint products rather than as byproducts.
To determine exact cost of by-products the costs incurred upto the point of
separation, should be apportioned over by-products and joint products by using a logical
basis. In this case, the joint costs may be divided over joint products and by-products by
using relative market values ; physical output method (at the point of split off) or ultimate
selling prices (if sold).
Treatment of By-Product Cost in Cost-Accounting
By-product cost can be dealt
in cost accounting in the following ways :—
(i) When they are of small total value : When the by-products are of small total value,
the amount realised from their sale may be dealt in any one the following two ways :
1. The sales value of the by-products may be credited to the Profit and Loss Account and
no credit be given in the Cost Accounts. The credit to the Profit and Loss Account here is
treated either as miscellaneous income or as additional sales revenue.
2. The sale proceeds of the by-product may be treated as deductions from the total costs.
The sale proceeds in fact should be deducted either from the production cost or from the
cost of sales.
in cost accounting in the following ways :—
(i) When they are of small total value : When the by-products are of small total value,
the amount realised from their sale may be dealt in any one the following two ways :
1. The sales value of the by-products may be credited to the Profit and Loss Account and
no credit be given in the Cost Accounts. The credit to the Profit and Loss Account here is
treated either as miscellaneous income or as additional sales revenue.
2. The sale proceeds of the by-product may be treated as deductions from the total costs.
The sale proceeds in fact should be deducted either from the production cost or from the
cost of sales.
Re-use basis
In some cases the by-product may be of such a nature that it can be
reprocessed in the same process as part of the input of the process. In that case the
value put on the by-product should be same as that of the materials introduced into the
process. If, however, the by-product can be put into an earlier process only, the value
should be the same as for the materials introduced into the process.
reprocessed in the same process as part of the input of the process. In that case the
value put on the by-product should be same as that of the materials introduced into the
process. If, however, the by-product can be put into an earlier process only, the value
should be the same as for the materials introduced into the process.
Thursday, March 5, 2009
Comparative price
Under this method, the value of the by-product is ascertained
with reference to the price of a similar or an alternative material. Suppose in a large
automobile plant a blast furnace not only produces the steel required for the car bodies
but also produces gas which is utilised in the factory. This gas can be valued at the price
which would have been paid to a gas company if the factory were to buy it from outside
sources.
with reference to the price of a similar or an alternative material. Suppose in a large
automobile plant a blast furnace not only produces the steel required for the car bodies
but also produces gas which is utilised in the factory. This gas can be valued at the price
which would have been paid to a gas company if the factory were to buy it from outside
sources.
Standard cost in technical estimates
By-products may be valued at standard
costs. The standard may be determined by averaging costs recorded in the past and
making technical estimates of the number of units of original raw material going into the
main product and the number forming the by-product or by adopting some other consistent
basis. This method may be adopted where the by-product is not saleable in the condition
in which it emerges or comparative prices of similar products are not available.
costs. The standard may be determined by averaging costs recorded in the past and
making technical estimates of the number of units of original raw material going into the
main product and the number forming the by-product or by adopting some other consistent
basis. This method may be adopted where the by-product is not saleable in the condition
in which it emerges or comparative prices of similar products are not available.
Market value or value on realisation
The realisation on the disposal of the byproduct
may be deducted from the total cost of production so as to arrive at the cost of the
main product. For example, the amount realised by the sale of molasses in a sugar factory
goes to reduce the cost of sugar produced in the factory.
When the by-product requires some additional processing and expenses are incurred in
making it saleable to the best advantage of the concern, the expenses so incurred should be
deducted from the total value realised from the sale of the by-product and only the netrealisations should be deducted from the total cost of production to arrive at the cost of
production of the main product. Separate accounts should be maintained for collecting
additional expenses incurred on :
(i) further processing of the by-product, and
(ii) selling, distribution and administration expenses attributable to the by-product.
may be deducted from the total cost of production so as to arrive at the cost of the
main product. For example, the amount realised by the sale of molasses in a sugar factory
goes to reduce the cost of sugar produced in the factory.
When the by-product requires some additional processing and expenses are incurred in
making it saleable to the best advantage of the concern, the expenses so incurred should be
deducted from the total value realised from the sale of the by-product and only the netrealisations should be deducted from the total cost of production to arrive at the cost of
production of the main product. Separate accounts should be maintained for collecting
additional expenses incurred on :
(i) further processing of the by-product, and
(ii) selling, distribution and administration expenses attributable to the by-product.
Market value method
This is the most popular and convenient method because it
makes use of a realistic basis for apportioning joint costs. Under this method joint costs
are apportioned after ascertaining “what the traffic can bear”. In other words, the products
are made to bear a proportion of the joint cost on the basis of their ability to absorb the
same. Market value means weighted market value i.e. units produced × price of a unit of
joint product.
makes use of a realistic basis for apportioning joint costs. Under this method joint costs
are apportioned after ascertaining “what the traffic can bear”. In other words, the products
are made to bear a proportion of the joint cost on the basis of their ability to absorb the
same. Market value means weighted market value i.e. units produced × price of a unit of
joint product.
Contribution margin method
According to this method, joint costs are segregated
into two parts - variable and fixed. The variable costs are apportioned over the joint
products on the basis of units produced (average method) or physical quantities. In casethe products are further processed after the point of separation, then all variable cost
incurred be added to the variable costs determined earlier. In this way total variable cost
is arrived which is deducted from their respective sales values to ascertain their
contribution. The fixed costs are then apportioned over the joint products on the basis of
the contribution ratios.
into two parts - variable and fixed. The variable costs are apportioned over the joint
products on the basis of units produced (average method) or physical quantities. In casethe products are further processed after the point of separation, then all variable cost
incurred be added to the variable costs determined earlier. In this way total variable cost
is arrived which is deducted from their respective sales values to ascertain their
contribution. The fixed costs are then apportioned over the joint products on the basis of
the contribution ratios.
Wednesday, March 4, 2009
Survey method
This method is also known as point value method. It is based on
technical survey of all the factors involved in the production and distribution of products.
Under this method joint cost are apportioned over the joint products, on the basis of
percentage/point values, assigned to the products according to their relative importance.
The percentage or points used for the purpose are usually computed by management with
the help of technical advisers. This method is considered to be more equitable than other
methods.
technical survey of all the factors involved in the production and distribution of products.
Under this method joint cost are apportioned over the joint products, on the basis of
percentage/point values, assigned to the products according to their relative importance.
The percentage or points used for the purpose are usually computed by management with
the help of technical advisers. This method is considered to be more equitable than other
methods.
Physical unit method
This method is based on the assumption that the joint
products are capable of being measured in the same units. Accordingly joint costs here
are apportioned on the basis of some physical base, such as weight or measure
expressed in gallons, tonnes etc. In other words, the basis used for apportioning joint cost
over the joint products is the physical volume of material present in the joint products at
the point of separation. Any loss arising during the stage of processing is also apportioned
over the products on the same basis. This method cannot be applied if the physical units
of the two joint products are different. The main defect of this method is that it gives equal
importance and value to all the joint products.
products are capable of being measured in the same units. Accordingly joint costs here
are apportioned on the basis of some physical base, such as weight or measure
expressed in gallons, tonnes etc. In other words, the basis used for apportioning joint cost
over the joint products is the physical volume of material present in the joint products at
the point of separation. Any loss arising during the stage of processing is also apportioned
over the products on the same basis. This method cannot be applied if the physical units
of the two joint products are different. The main defect of this method is that it gives equal
importance and value to all the joint products.
Method of apportioning joint cost over joint products
Proper apportionment of
joint cost over the Joint Products is of considerable importance, as this affects (a)
Valuation of closing inventory; (b) Pricing of products; and (c) Profit or loss on the sale of
different products.
The commonly used methods for apportioning total process costs upto the point of separation
over the joint products are as follows :
(i) Physical unit method
(ii) Average unit cost method
(iii) Survey method
(iv) Contribution margin method
joint cost over the Joint Products is of considerable importance, as this affects (a)
Valuation of closing inventory; (b) Pricing of products; and (c) Profit or loss on the sale of
different products.
The commonly used methods for apportioning total process costs upto the point of separation
over the joint products are as follows :
(i) Physical unit method
(ii) Average unit cost method
(iii) Survey method
(iv) Contribution margin method
Apportionment of joint costs
Joint product costs occur in many industries such
as : petroleum, oil refinery, meat-making, textiles, dairy, flour mill, saw mill and many
other process industries and top management of business concerns require the
Accountants to give their opinion for many managerial decisions such as to processfurther or to sell at split-off stage. To answer this question they require apportionment of
joint costs over different products produced.
The main problem faced in the case of joint products/by-products is the apportionment of the
total cost incurred upto the point of separation of joint products/or by products. For costs
incurred after the split off point there is no problem, as these costs can be directly allocated to
individual joint products or by-products. Thus the apportionment of joint costs over different
products produced involve the following two cases.
as : petroleum, oil refinery, meat-making, textiles, dairy, flour mill, saw mill and many
other process industries and top management of business concerns require the
Accountants to give their opinion for many managerial decisions such as to processfurther or to sell at split-off stage. To answer this question they require apportionment of
joint costs over different products produced.
The main problem faced in the case of joint products/by-products is the apportionment of the
total cost incurred upto the point of separation of joint products/or by products. For costs
incurred after the split off point there is no problem, as these costs can be directly allocated to
individual joint products or by-products. Thus the apportionment of joint costs over different
products produced involve the following two cases.
By-Products
These are defined as “products recovered from material discarded in a main
process, or from the production of some major products, where the material value is to be
considered at the time of severance from the main product.” Thus by-products emerges as a
result of processing operation of another product or they are produced from the scrap or waste
of materials of a process. In short a by-product is a secondary or subsidiary product which
emanates as a result of manufacture of the main product. Examples of by-products are
molasses in the manufacture of sugar, tar, ammonia and benzole obtained on carbonisation of
coal and glycerine obtained in the manufacture of soap.
process, or from the production of some major products, where the material value is to be
considered at the time of severance from the main product.” Thus by-products emerges as a
result of processing operation of another product or they are produced from the scrap or waste
of materials of a process. In short a by-product is a secondary or subsidiary product which
emanates as a result of manufacture of the main product. Examples of by-products are
molasses in the manufacture of sugar, tar, ammonia and benzole obtained on carbonisation of
coal and glycerine obtained in the manufacture of soap.
Tuesday, March 3, 2009
Co-Products
Joint products and co-products are used synonymously in common parlance,
but strictly speaking a distinction can be made between two. Co-products may be defined as
two or more products which are contemporary but do not emerge necessarily from the same
material in the same process. For instance, wheat and gram produced in two separate farms
with separate processing of cultivation, are the co-products. Similarly timber boards made
from different trees are co-products.
but strictly speaking a distinction can be made between two. Co-products may be defined as
two or more products which are contemporary but do not emerge necessarily from the same
material in the same process. For instance, wheat and gram produced in two separate farms
with separate processing of cultivation, are the co-products. Similarly timber boards made
from different trees are co-products.
Joint Products
Joint products represent “two or more products separated in the course of the
same processing operation usually requiring further processing, each product being in such
proportion that no single product can be designated as a major product”. In other words, two
or more products of equal importance, produced, simultaneously from the same process, are
known as joint products. For example, in the oil industry, gasoline, fuel oil, lubricants, paraffin,
coal tar, asphalt and kerosene are all produced from crude petroleum. These are known as
joint products.
same processing operation usually requiring further processing, each product being in such
proportion that no single product can be designated as a major product”. In other words, two
or more products of equal importance, produced, simultaneously from the same process, are
known as joint products. For example, in the oil industry, gasoline, fuel oil, lubricants, paraffin,
coal tar, asphalt and kerosene are all produced from crude petroleum. These are known as
joint products.
Meaning of Joint Products and By-Products
Agricultural product industries,
chemical process industries, sugar industries, and extractive industries are some of the
industries where two or more products of equal or unequal importance are produced either
simultaneously or in the course of processing operation of a main product. In all such
industries, the management is faced with the problems such as, valuation of inventory,pricing of product and income determination, problem of taking decision in matters of
further processing of by-products and/or joint products after a certain stage etc. In fact the
various problems relate to (i) apportionment of common costs incurred for various
products and (ii) aspects other than mere apportionment of costs incurred upto the point
of separation. Before taking up the above problems, we first define the various necessary
concepts.
chemical process industries, sugar industries, and extractive industries are some of the
industries where two or more products of equal or unequal importance are produced either
simultaneously or in the course of processing operation of a main product. In all such
industries, the management is faced with the problems such as, valuation of inventory,pricing of product and income determination, problem of taking decision in matters of
further processing of by-products and/or joint products after a certain stage etc. In fact the
various problems relate to (i) apportionment of common costs incurred for various
products and (ii) aspects other than mere apportionment of costs incurred upto the point
of separation. Before taking up the above problems, we first define the various necessary
concepts.
INTER-PROCESS PROFITS
In some process industries the output of one process is transferred to the next process not at
cost but at market value or cost plus a percentage of profit. The difference between cost and
the transfer price is known as inter-process profits. The advantages and disadvantages of
using inter-process profit, in the case of process type industries are as follows :
Advantages :
1. Comparison between the cost of output and its market price at the stage of completion is
facilitated.
2. Each process is made to stand by itself as to the profitability.
Disadvantages :
1. The use of inter-process profits involves complication.
2. The system shows profits which are not realised because of stock not sold out.
cost but at market value or cost plus a percentage of profit. The difference between cost and
the transfer price is known as inter-process profits. The advantages and disadvantages of
using inter-process profit, in the case of process type industries are as follows :
Advantages :
1. Comparison between the cost of output and its market price at the stage of completion is
facilitated.
2. Each process is made to stand by itself as to the profitability.
Disadvantages :
1. The use of inter-process profits involves complication.
2. The system shows profits which are not realised because of stock not sold out.
Valuation of work-in-progress
For the valuation of work-in-progress following
three methods are available :
(1) First-in-First Out (FIFO) method.
(2) Last-in-First Out (LIFO) method.
(3) Average Cost method (or weighted average cost method).
(1) First-in-first-out method - Under this method the units completed and transferred
include completed units of opening work-in-progress and subsequently introduced units.
Proportionate cost to complete the opening work-in-progress and that to process the
completely processed units during the period are derived separately. The cost of opening
work-in-progress is added to the proportionate cost incurred on completing the same to
get the complete cost of such units. Complete cost of such units plus cost of units
completely processed constitute the total cost of units transferred.
three methods are available :
(1) First-in-First Out (FIFO) method.
(2) Last-in-First Out (LIFO) method.
(3) Average Cost method (or weighted average cost method).
(1) First-in-first-out method - Under this method the units completed and transferred
include completed units of opening work-in-progress and subsequently introduced units.
Proportionate cost to complete the opening work-in-progress and that to process the
completely processed units during the period are derived separately. The cost of opening
work-in-progress is added to the proportionate cost incurred on completing the same to
get the complete cost of such units. Complete cost of such units plus cost of units
completely processed constitute the total cost of units transferred.
Monday, March 2, 2009
COSTING OF EQUIVALENT PRODUCTION UNITS
In the case of process type of industries it is possible to determine the average cost per unit
by dividing the total cost incurred during a given period of time by the total number of unitsproduced during the same period. But this is hardly the case in most of the process type
industries where manufacturing is a continuous activity. The reason is that the cost incurred in
such industries represents the cost of work carried on opening work-in-progress, closing workin-
progress and completed units. Thus to ascertain the cost of each completed unit it is
necessary to ascertain the cost of work-in-progress in the beginning and at the end of the
process.
The valuation of work-in-progress presents a good deal of difficulty because it has units under
different stages of completion from those in which work has just begun to those which are only
a step short of completion. Work-in-progress can be valued on actual basis, i.e., materials
used on the unfinished units and the actual amount of labour expenses involved. However, the
degree of accuracy in such a case cannot be satisfactory. An alternative method is based on
converting partly finished units into equivalent finished units.
by dividing the total cost incurred during a given period of time by the total number of unitsproduced during the same period. But this is hardly the case in most of the process type
industries where manufacturing is a continuous activity. The reason is that the cost incurred in
such industries represents the cost of work carried on opening work-in-progress, closing workin-
progress and completed units. Thus to ascertain the cost of each completed unit it is
necessary to ascertain the cost of work-in-progress in the beginning and at the end of the
process.
The valuation of work-in-progress presents a good deal of difficulty because it has units under
different stages of completion from those in which work has just begun to those which are only
a step short of completion. Work-in-progress can be valued on actual basis, i.e., materials
used on the unfinished units and the actual amount of labour expenses involved. However, the
degree of accuracy in such a case cannot be satisfactory. An alternative method is based on
converting partly finished units into equivalent finished units.
Abnormal gain
Sometimes, loss under a process is less than the anticipated normal figure. In
other words, the actual production exceeds the expected figures. Under such a situation the
difference between actual and expected loss or actual and expected production is known asabnormal gain. So abnormal gain may be defined as unexpected gain in production under
normal conditions. The process account under which abnormal gain arises is debited with the
abnormal gain. The cost of abnormal gain is computed on the basis of normal production.
other words, the actual production exceeds the expected figures. Under such a situation the
difference between actual and expected loss or actual and expected production is known asabnormal gain. So abnormal gain may be defined as unexpected gain in production under
normal conditions. The process account under which abnormal gain arises is debited with the
abnormal gain. The cost of abnormal gain is computed on the basis of normal production.
Abnormal process loss
It is defined as the loss in excess of the pre-determined loss.
This type of loss may occur due to the carelessness of workers, a bad plant design or
operation etc. Such a loss cannot obviously be estimated in advance. But it can be kept under
control by taking suitable measures. The cost of an abnormal process loss unit is equal to the
cost of a good unit. The total cost of abnormal process loss is credited to the process account
from which it arise. Cost of abnormal process loss is not treated as a part of the cost of the
product. In fact, the total cost of abnormal process loss is debited to costing profit and loss
account.
This type of loss may occur due to the carelessness of workers, a bad plant design or
operation etc. Such a loss cannot obviously be estimated in advance. But it can be kept under
control by taking suitable measures. The cost of an abnormal process loss unit is equal to the
cost of a good unit. The total cost of abnormal process loss is credited to the process account
from which it arise. Cost of abnormal process loss is not treated as a part of the cost of the
product. In fact, the total cost of abnormal process loss is debited to costing profit and loss
account.
Normal process loss
It is defined as the loss of material which is inherent in the
nature of work. Such a loss can be reasonably anticipated from the nature of the material,
nature of operation, the experience and technical data. The cost of normal process loss in
practice is absorbed by good units produced under the process. The amount realised by
the sale of normal process loss units should be credited to the process account.
nature of work. Such a loss can be reasonably anticipated from the nature of the material,
nature of operation, the experience and technical data. The cost of normal process loss in
practice is absorbed by good units produced under the process. The amount realised by
the sale of normal process loss units should be credited to the process account.
TREATMENT OF NORMAL PROCESS LOSS, ABNORMAL PROCESS LOSS AND
Loss of material is inherent during processing operation. The loss of material under different
processes arises due to reasons like evaporation or a change in the moisture content etc.
Process loss is defined as the loss of material arising during the course of a processing
operation and is equal to the difference between the input quantity of the material and its
output.
processes arises due to reasons like evaporation or a change in the moisture content etc.
Process loss is defined as the loss of material arising during the course of a processing
operation and is equal to the difference between the input quantity of the material and its
output.
Sunday, March 1, 2009
Costing Procedure
The Cost of each process comprises the cost of :
(i) Materials (ii) Labour
(iii) Direct expenses, and (iv) Overheads of production.
Materials - Materials and supplies which are required for each process are drawn against
material requisitions from stores. Each process for which the above drawn materials will be
used should be debited with the cost of materials consumed on the basis of the information
received from the Cost Accounting department. The finished product of first process generally
become the raw materials of second process; under such a situation the account of second
process, be debited with the cost of transfer from the first process and the cost of any
additional material required under this second process.
(i) Materials (ii) Labour
(iii) Direct expenses, and (iv) Overheads of production.
Materials - Materials and supplies which are required for each process are drawn against
material requisitions from stores. Each process for which the above drawn materials will be
used should be debited with the cost of materials consumed on the basis of the information
received from the Cost Accounting department. The finished product of first process generally
become the raw materials of second process; under such a situation the account of second
process, be debited with the cost of transfer from the first process and the cost of any
additional material required under this second process.
Basic features
Industries, where process costing can be applied, have normally
one or more of the following features :
1. Each plant or factory is divided into a number of processes, cost centres or departments,
and each such division is a stage of production or a process.
2. Manufacturing activity is carried on continuously by means of one or more process run
sequentially, selectively or parallely.
3. The output of one process becomes the input of another process.
one or more of the following features :
1. Each plant or factory is divided into a number of processes, cost centres or departments,
and each such division is a stage of production or a process.
2. Manufacturing activity is carried on continuously by means of one or more process run
sequentially, selectively or parallely.
3. The output of one process becomes the input of another process.
MEANING OF PROCESS COSTING
Process Costing is a method of Costing used in industries where the material has to pass
through two or more processes for being converted into a final product. It is defined as “a
method of Cost Accounting whereby costs are charged to processes or operations and
averaged over units produced”. Such type of costing method is useful in the manufacturing of
products like steel, soap, chemicals, rubber, vegetable oil, paints, varnish etc. where the
production process is continuous and the output of one process becomes the input of the
following process till completion.
through two or more processes for being converted into a final product. It is defined as “a
method of Cost Accounting whereby costs are charged to processes or operations and
averaged over units produced”. Such type of costing method is useful in the manufacturing of
products like steel, soap, chemicals, rubber, vegetable oil, paints, varnish etc. where the
production process is continuous and the output of one process becomes the input of the
following process till completion.
MULTIPLE COSTING
It refers to the method of costing followed by a business wherein a large variety of articles
are produced, each differing from the other both in regard to material required and
process of manufacture. In such cases, cost of each article is computed separately by
using, generally, two or more methods of costing. For instance, for ascertaining the cost
of a bicycle, cost of each part will be ascertained by using batch or job costing method
and, then the cost of assembling the parts will be ascertained by following the method of
single or output costing.
are produced, each differing from the other both in regard to material required and
process of manufacture. In such cases, cost of each article is computed separately by
using, generally, two or more methods of costing. For instance, for ascertaining the cost
of a bicycle, cost of each part will be ascertained by using batch or job costing method
and, then the cost of assembling the parts will be ascertained by following the method of
single or output costing.
Saturday, February 28, 2009
Preparation of Cost Sheet under Operating Costing
For preparing a cost sheet
under operating cost, costs are usually accumulated for a specified period viz., a month, a
quarter, or a year etc.
All of the accumulated costs should be classified under the following three heads:
1. Fixed costs or standing charges,
2. Variable costs or running charges,
3. Semi-variable costs or maintenance costs.
under operating cost, costs are usually accumulated for a specified period viz., a month, a
quarter, or a year etc.
All of the accumulated costs should be classified under the following three heads:
1. Fixed costs or standing charges,
2. Variable costs or running charges,
3. Semi-variable costs or maintenance costs.
Meaning of Operating Costing
It is a method of ascertaining costs of providing or
operating a service. This method of costing is applied by those undertakings which
provide services rather than production of commodities. The emphasis under operating
costing is on the ascertainment of cost of services rather than on the cost of
manufacturing a product. This costing method is usually made use of by transport
companies, gas and water works departments, electricity supply companies, canteens,
hospitals, theatres, schools etc.
operating a service. This method of costing is applied by those undertakings which
provide services rather than production of commodities. The emphasis under operating
costing is on the ascertainment of cost of services rather than on the cost of
manufacturing a product. This costing method is usually made use of by transport
companies, gas and water works departments, electricity supply companies, canteens,
hospitals, theatres, schools etc.
Economic Batch Quantity
In batch costing the most important problem is the
determination of optimum size of the batch (how much to produce) or Economic Batch
Quantity.
The determination of economic batch quantity involve two types of costs viz., (i) set up
cost (or preparation cost) and (ii) carrying cost. With the increase in the batch size, there
is an increase in the carrying cost but the set up cost per unit of product is reduced; this
situation is reversed when the batch size is reduced. Thus there is one particular batch
size for which both set up and carrying costs are minimum. This size is known as
economic or optimum batch quantity.
determination of optimum size of the batch (how much to produce) or Economic Batch
Quantity.
The determination of economic batch quantity involve two types of costs viz., (i) set up
cost (or preparation cost) and (ii) carrying cost. With the increase in the batch size, there
is an increase in the carrying cost but the set up cost per unit of product is reduced; this
situation is reversed when the batch size is reduced. Thus there is one particular batch
size for which both set up and carrying costs are minimum. This size is known as
economic or optimum batch quantity.
Meaning of Batch costing
This is a form of job costing. Under job costing,
executed job is used as a cost unit, whereas under batch costing, a lot of similar units
which comprises the batch may be used as a cost unit for ascertaining cost. In the case of
batch costing separate cost sheets are maintained for each batch of products by
assigning a batch number. Cost per unit in a batch is ascertained by dividing the total cost
of a batch by number of items produced in that batch. Such a method of Costing is used in
the case of pharmaceutical or drug industries, ready-made garments, industries manufacturing
electronic parts of T.V., radio sets etc.
executed job is used as a cost unit, whereas under batch costing, a lot of similar units
which comprises the batch may be used as a cost unit for ascertaining cost. In the case of
batch costing separate cost sheets are maintained for each batch of products by
assigning a batch number. Cost per unit in a batch is ascertained by dividing the total cost
of a batch by number of items produced in that batch. Such a method of Costing is used in
the case of pharmaceutical or drug industries, ready-made garments, industries manufacturing
electronic parts of T.V., radio sets etc.
Cost plus Contract
Under Cost plus Contract, the contract price is ascertained
by adding a percentage of profit to the total cost of the work. Such type of contracts are
entered into when it is not possible to estimate the Contract Cost with reasonable accuracy
due to unstable condition of material, labour services, etc.
Cost plus contracts have the following advantages and disadvantages :
Advantages :
(i) The Contractor is assured of a fixed percentage of profit. There is no risk of incurring any
loss on the contract.
(ii) It is useful specially when the work to be done is not definitely fixed at the time of making
the estimate.
by adding a percentage of profit to the total cost of the work. Such type of contracts are
entered into when it is not possible to estimate the Contract Cost with reasonable accuracy
due to unstable condition of material, labour services, etc.
Cost plus contracts have the following advantages and disadvantages :
Advantages :
(i) The Contractor is assured of a fixed percentage of profit. There is no risk of incurring any
loss on the contract.
(ii) It is useful specially when the work to be done is not definitely fixed at the time of making
the estimate.
Estimated profit
It is the excess of the contract price over the estimated total cost of
the contract.
the contract.
Notional profit
It represents the difference between the value of work certified and cost
of work certified. It is determined :
Notional profit = Value of work certified – (Cost of work to date – Cost of work not yet
certified)
of work certified. It is determined :
Notional profit = Value of work certified – (Cost of work to date – Cost of work not yet
certified)
Work-in-progress
In Contract Accounts, the value of the work-in-progress consists of (i)
the cost of work completed, both certified and uncertified; (ii) the cost of work not yet
completed; and (iii) the amount of profit taken as credit. In the Balance Sheet, the work-inprogress
is usually shown under two heads, viz., certified and uncertified. The cost of
work completed and certified and the profit credited will appear under the head ‘certified’
work-in-progress, while the completed work not yet certified and the cost of labour,
material and expenses of work which has not yet reached the stage of completion are
shown under the head “uncertified” work-in-progress.
the cost of work completed, both certified and uncertified; (ii) the cost of work not yet
completed; and (iii) the amount of profit taken as credit. In the Balance Sheet, the work-inprogress
is usually shown under two heads, viz., certified and uncertified. The cost of
work completed and certified and the profit credited will appear under the head ‘certified’
work-in-progress, while the completed work not yet certified and the cost of labour,
material and expenses of work which has not yet reached the stage of completion are
shown under the head “uncertified” work-in-progress.
Retention money
A contractor does not receive full payment of the work certified by the
surveyor. Contractee retains some amount (say 10% to 20%) to be paid, after sometime,
when it is ensured that there is no fault in the work carried out by contractor. If any
deficiency or defect is noticed in the work, it is to be rectified by the contractor before the
release of the retention money. Retention money provides a safeguard against the risk of
loss due to faulty workmanship.
surveyor. Contractee retains some amount (say 10% to 20%) to be paid, after sometime,
when it is ensured that there is no fault in the work carried out by contractor. If any
deficiency or defect is noticed in the work, it is to be rectified by the contractor before the
release of the retention money. Retention money provides a safeguard against the risk of
loss due to faulty workmanship.
Cost of work certified
All building contractors received payments periodically known as
“running payment” on the basis of the architect’s or surveyor’s certificates. But payments
are not equal to the value of the work certified, a small percentage of the amount due is
retained as security for any defective work which may be discovered later within the
guarantee period.
Mathematically :
Cost of work certified = Cost of work to date – (Cost of work uncertified + Material in hand
+ Plant at site)
The amount retained is called retention money. The full value of the work certified should
be credited to the Contract Account and debited to the account of the contract. Since the
cash received from him will be less, the balance in his account will be shown as an asset
in the balance sheet.
“running payment” on the basis of the architect’s or surveyor’s certificates. But payments
are not equal to the value of the work certified, a small percentage of the amount due is
retained as security for any defective work which may be discovered later within the
guarantee period.
Mathematically :
Cost of work certified = Cost of work to date – (Cost of work uncertified + Material in hand
+ Plant at site)
The amount retained is called retention money. The full value of the work certified should
be credited to the Contract Account and debited to the account of the contract. Since the
cash received from him will be less, the balance in his account will be shown as an asset
in the balance sheet.
Wednesday, February 25, 2009
Extra work
The extra work amount payable by the contractee should be added to the
contract price. If extra work is substantial, it is better to treat it as a separate contract. If itis not substantial, expenses incurred should be debited to the contract account as “Cost of
Extra work”.
contract price. If extra work is substantial, it is better to treat it as a separate contract. If itis not substantial, expenses incurred should be debited to the contract account as “Cost of
Extra work”.
Plant and Machinery
The value of the plant in a contract may be either debited to
contract account and the written down value thereof at the end of the year entered on the
credit side for closing the contract account, or only a charge (depreciation) for use of the
plant may be debited to the contract account.
contract account and the written down value thereof at the end of the year entered on the
credit side for closing the contract account, or only a charge (depreciation) for use of the
plant may be debited to the contract account.
Indirect Expenses
Indirect expenses (such as expenses of engineers, surveyors,
supervisors etc.) may be distributed over several contracts as a percentage of cost of
materials, or wages paid or of the prime cost. If however, the contracts are big, the labour
hour method may be used for the distribution of expenses.
supervisors etc.) may be distributed over several contracts as a percentage of cost of
materials, or wages paid or of the prime cost. If however, the contracts are big, the labour
hour method may be used for the distribution of expenses.
Tuesday, February 24, 2009
Labour Cost
Labour actually employed on the site of the contract is regarded as direct
(irrespective of the nature of the task performed) and the wages paid to them are charged
to the concerned contract directly or on the basis of a wage analysis sheet (if concurrently
a number of contracts are carried on and labourers are required to devote their time on
two or more contracts).
(irrespective of the nature of the task performed) and the wages paid to them are charged
to the concerned contract directly or on the basis of a wage analysis sheet (if concurrently
a number of contracts are carried on and labourers are required to devote their time on
two or more contracts).
Material Cost
All materials supplied from the
stores or purchased directly for the contract are debited to the concerned contract
account. In the case of transfer of excess material from one contract to other contract,
their costs would be adjusted on the basis of material transfer note, signed both by the
transferee and the transferor foreman. In case the return of surplus material appears
uneconomical on account of high cost of transportation, the same is sold and the
concerned contract account is credited with the sale price. Any loss or profit arising therefrom
is transferred to the Profit and Loss Account.
stores or purchased directly for the contract are debited to the concerned contract
account. In the case of transfer of excess material from one contract to other contract,
their costs would be adjusted on the basis of material transfer note, signed both by the
transferee and the transferor foreman. In case the return of surplus material appears
uneconomical on account of high cost of transportation, the same is sold and the
concerned contract account is credited with the sale price. Any loss or profit arising therefrom
is transferred to the Profit and Loss Account.
Meaning of Contract Costing
Contract or terminal costing, as it is termed, is one
form of application of the principles of job costing. In fact a bigger job is referred to as a
contract. Contract costing is usually adopted by building contractors engaged in the task
of executing Civil Contracts. Contract costing have the following distinct features :
1. The major part of the work in connection with each contract is ordinarily carried out at the
site of the contract.
2. The bulk of the expenses incurred by the contractor are considered as direct.
3. The indirect expenses, mostly consist of office expenses of the yards, stores and works.
form of application of the principles of job costing. In fact a bigger job is referred to as a
contract. Contract costing is usually adopted by building contractors engaged in the task
of executing Civil Contracts. Contract costing have the following distinct features :
1. The major part of the work in connection with each contract is ordinarily carried out at the
site of the contract.
2. The bulk of the expenses incurred by the contractor are considered as direct.
3. The indirect expenses, mostly consist of office expenses of the yards, stores and works.
CONTRACT COSTING
A contract usually takes several years to get itself completed. If the
profit on such contracts is recorded only after their completion, then wide fluctuations may
be noted in the profit figures of contractors from year to year. To avoid these fluctuations
in the reported profits and to reflect the revenue in the accounting period during which the
activity is undertaken, the profit in respect of each contract in progress is transferred to
the profit and loss account of the year by calculating the notional profit. The portion of
notional profit to be transferred to the profit and loss account depends on the stage of
completion of a contract. To determine such a profit figure the knowledge of various
concepts as discussed below is essential in contract costing.
profit on such contracts is recorded only after their completion, then wide fluctuations may
be noted in the profit figures of contractors from year to year. To avoid these fluctuations
in the reported profits and to reflect the revenue in the accounting period during which the
activity is undertaken, the profit in respect of each contract in progress is transferred to
the profit and loss account of the year by calculating the notional profit. The portion of
notional profit to be transferred to the profit and loss account depends on the stage of
completion of a contract. To determine such a profit figure the knowledge of various
concepts as discussed below is essential in contract costing.
Treatment of spoiled and defective work
Spoiled work is the quantity of production that
has been totally rejected and cannot be rectified. Defective work on the other hand refers
to production that is not as perfect as the saleable product but is capable of being
rectified and brought to the required degree of perfection provided some additional
expenditure is incurred.Normally, all the manufacturing operations are not fully successful; they result in turning
out a certain amount of defective work. Nonetheless, over a period of time it is possible to
work out a normal rate of defectives for each manufacturing process which would
represent the number of defective articles which a process shall produce in spite of due
care.
has been totally rejected and cannot be rectified. Defective work on the other hand refers
to production that is not as perfect as the saleable product but is capable of being
rectified and brought to the required degree of perfection provided some additional
expenditure is incurred.Normally, all the manufacturing operations are not fully successful; they result in turning
out a certain amount of defective work. Nonetheless, over a period of time it is possible to
work out a normal rate of defectives for each manufacturing process which would
represent the number of defective articles which a process shall produce in spite of due
care.
Monday, February 23, 2009
Price of a job
Price of a job may be arrived by adding the desired percentage of profit to
the total cost of the job.
the total cost of the job.
Accounting for Overhead
Manufacturing overheads are collected under suitable standing
order numbers and selling and distribution overheads against cost accounts numbers.
Total overhead expenses so collected are apportioned to service and production departments
on some suitable basis. The expenses of service departments are finally
transferred to production departments. The total overhead of production departments is
then applied to products on some realistic basis, e.g. machine hour; labour hour;
percentage of direct wages; percentage of direct materials; etc. It should be remembered
that the use of different methods will lead to a different amounts being computed for the
works overhead charged to a job hence to different total cost.
order numbers and selling and distribution overheads against cost accounts numbers.
Total overhead expenses so collected are apportioned to service and production departments
on some suitable basis. The expenses of service departments are finally
transferred to production departments. The total overhead of production departments is
then applied to products on some realistic basis, e.g. machine hour; labour hour;
percentage of direct wages; percentage of direct materials; etc. It should be remembered
that the use of different methods will lead to a different amounts being computed for the
works overhead charged to a job hence to different total cost.
Accounting for Labour
All direct labour cost must be analysed according to individual
jobs or work orders. Similarly, different types of indirect labour cost also must be collected
and accumulated under appropriate standing order or expenses code number.
The analysis of labour according to jobs or work orders is, usually, made by means of job
time cards or sheets. All direct labour is booked against specific jobs in the job time cards
or sheets. All the idle time also is booked against appropriate standing order expense
code number either in the job time card for each job or on a separate idle time card foreach worker (where the job time card is issued job-wise). The time booked or recorded in
the job time and idle time cards is valued at appropriate rates and entered in the labour
abstract or analysis book.
jobs or work orders. Similarly, different types of indirect labour cost also must be collected
and accumulated under appropriate standing order or expenses code number.
The analysis of labour according to jobs or work orders is, usually, made by means of job
time cards or sheets. All direct labour is booked against specific jobs in the job time cards
or sheets. All the idle time also is booked against appropriate standing order expense
code number either in the job time card for each job or on a separate idle time card foreach worker (where the job time card is issued job-wise). The time booked or recorded in
the job time and idle time cards is valued at appropriate rates and entered in the labour
abstract or analysis book.
Accounting for Materials
An essential requirement of job cost accounting is that direct
materials and their cost must be traced to and identified with specific job or work order.
This segregation of materials cost by jobs or work orders is brought about by the use of
separate stores requisitions for each job or work order. Where a bill of material is
prepared, it provides the basis for the preparation of these stores requisitions. But when
the entire quantity of materials specified in the bill of materials is drawn in one lot or in
instalments, the bill itself could be made to serve as a substitute for the stores requisition.
materials and their cost must be traced to and identified with specific job or work order.
This segregation of materials cost by jobs or work orders is brought about by the use of
separate stores requisitions for each job or work order. Where a bill of material is
prepared, it provides the basis for the preparation of these stores requisitions. But when
the entire quantity of materials specified in the bill of materials is drawn in one lot or in
instalments, the bill itself could be made to serve as a substitute for the stores requisition.
JOB COSTING
According to this method costs are collected and accumulated according to jobs, contracts,
products or work orders. Each job or unit of production is treated as a separate entity for the
purpose of costing. Job costing is carried out for the purpose of ascertaining cost of each job
and takes into account the cost of materials, labour and overhead etc. The job costing method
is also applicable to industries in which production is in batches since batch production
basically is of the same character as the job order production, the difference being mainly one
in the size of different orders. The method then may also be described as “Batch Costing”.
products or work orders. Each job or unit of production is treated as a separate entity for the
purpose of costing. Job costing is carried out for the purpose of ascertaining cost of each job
and takes into account the cost of materials, labour and overhead etc. The job costing method
is also applicable to industries in which production is in batches since batch production
basically is of the same character as the job order production, the difference being mainly one
in the size of different orders. The method then may also be described as “Batch Costing”.
Sunday, February 22, 2009
Overhead Adjustment Account
This account is to be debited for under-recovery of
overhead and credited with over-recovery of overhead amount. The net balance in this
account is transferred to Costing Profit & Loss Account.
Sometimes, Overhead Adjustment Account is dispensed with and under/over absorbed
overheads is directly transferred to Costing Profit & Loss Account from the respective
overhead accounts.
overhead and credited with over-recovery of overhead amount. The net balance in this
account is transferred to Costing Profit & Loss Account.
Sometimes, Overhead Adjustment Account is dispensed with and under/over absorbed
overheads is directly transferred to Costing Profit & Loss Account from the respective
overhead accounts.
Costing Profit & Loss Account
The net profit or loss in this account is transferred to
Cost Ledger Control Account.
Cost Ledger Control Account.
Cost of Sales Account
This account is debited with the cost of finished goods
transferred from Finished Goods Account for sale as well as with the amount of selling
and distribution overhead costs recovered. The balance of this account is ultimately
transferred to Sales Account or Costing Profit & Loss Account.
transferred from Finished Goods Account for sale as well as with the amount of selling
and distribution overhead costs recovered. The balance of this account is ultimately
transferred to Sales Account or Costing Profit & Loss Account.
Selling and Distribution Overhead Account
This account is debited with Selling and
Distribution Overhead incurred and credited with the recovered Overhead. The difference
between incurred and recovered overhead is transferred usually to Overhead Adjustment
Account.
Distribution Overhead incurred and credited with the recovered Overhead. The difference
between incurred and recovered overhead is transferred usually to Overhead Adjustment
Account.
Administrative Overhead Account
This account is debited with overhead incurred
and credited with Overhead recovered. The Overhead recovered are debited to Finished
Goods Account. The difference between Administrative Overhead incurred and recovered
are transferred to Overhead Adjustment Account.
and credited with Overhead recovered. The Overhead recovered are debited to Finished
Goods Account. The difference between Administrative Overhead incurred and recovered
are transferred to Overhead Adjustment Account.
Saturday, February 21, 2009
Manufacturing/Production/Works Overhead Account
This account is debited with
Indirect costs of production such as indirect material, indirect labour, indirect expenses
(carriage inward etc.). Overhead recovered is credited to this Account. The difference
between overhead incurred and overhead recovered is transferred to Overhead
Adjustment Account.
Indirect costs of production such as indirect material, indirect labour, indirect expenses
(carriage inward etc.). Overhead recovered is credited to this Account. The difference
between overhead incurred and overhead recovered is transferred to Overhead
Adjustment Account.
Wage Control Account
This account is debited with total wages paid (direct and
indirect). Direct wages are further transferred to Work-in-Progress Account and indirect
wages to Production Overhead; Administration Overhead or Selling & Distribution
Overhead Account, as the case may be. Wages paid for abnormal idle time are
transferred to Costing Profit & Loss Account either directly or through Abnormal Loss
Account.
indirect). Direct wages are further transferred to Work-in-Progress Account and indirect
wages to Production Overhead; Administration Overhead or Selling & Distribution
Overhead Account, as the case may be. Wages paid for abnormal idle time are
transferred to Costing Profit & Loss Account either directly or through Abnormal Loss
Account.
Finished Goods Control Accounts
This account is debited to the tune of “value of
goods” transferred from work-in-progress account, administration costs recovered. This
account is credited with the cost of goods sold and Cost of Sales Account is debited. The
balance of this account represents the value of goods lying at hand.
goods” transferred from work-in-progress account, administration costs recovered. This
account is credited with the cost of goods sold and Cost of Sales Account is debited. The
balance of this account represents the value of goods lying at hand.
Work-in-Progress Control Account
This account is debited with the total cost of
production, which includes—direct materials, direct labour, direct expenses, production
overhead recovered, and is credited with the amount of finished goods completed and
transferred. The balance in this account represents total balances of jobs/works-inprogress,
as shown by several job accounts.
production, which includes—direct materials, direct labour, direct expenses, production
overhead recovered, and is credited with the amount of finished goods completed and
transferred. The balance in this account represents total balances of jobs/works-inprogress,
as shown by several job accounts.
Stores Ledger Control Account
Total of material purchases are debited to this
account. Whereas issues of material are credited. The balance in this account indicates
the total balance of all the individual stores accounts. Abnormal losses or gains if any in
this account, are transferred to Costing Profit & Loss Account.
account. Whereas issues of material are credited. The balance in this account indicates
the total balance of all the individual stores accounts. Abnormal losses or gains if any in
this account, are transferred to Costing Profit & Loss Account.
Friday, February 20, 2009
Cost Ledger Control Account
This account is also known as General Ledger
Adjustment Account. This account is made to complete double entry. All items of
expenditure are credited to this account. Sales are debited to this account and net
profit/loss is transferred to this account. The balance in this account represents the net
total of all the balances of the impersonal accounts.
Adjustment Account. This account is made to complete double entry. All items of
expenditure are credited to this account. Sales are debited to this account and net
profit/loss is transferred to this account. The balance in this account represents the net
total of all the balances of the impersonal accounts.
Finished Goods Ledger
It contains an account for each item of finished product
manufactured or the completed job. If the finished product is transferred to stores, a credit
entry is made in the work-in-progress ledger and a corresponding debit entry is made in
this ledger.
manufactured or the completed job. If the finished product is transferred to stores, a credit
entry is made in the work-in-progress ledger and a corresponding debit entry is made in
this ledger.
Work-in-Progress Ledger
This ledger is also known as job ledger, it contains
accounts of unfinished jobs and processes. Each job account is debited with direct and
indirect costs related with the job and credited with the amount of finished goods
completed and transferred. The balance in a job account represents total balance of
job/work-in-progress, as shown by the job account.
accounts of unfinished jobs and processes. Each job account is debited with direct and
indirect costs related with the job and credited with the amount of finished goods
completed and transferred. The balance in a job account represents total balance of
job/work-in-progress, as shown by the job account.
Stores Ledger
It contains an account for each item of stores. The entries in each
account maintained in this ledger are made from the invoice, goods received note,
material requisitions, material received note etc. Accounts in respect of each item of
stores show receipt, issue and balance in physical as well as monetary terms.
account maintained in this ledger are made from the invoice, goods received note,
material requisitions, material received note etc. Accounts in respect of each item of
stores show receipt, issue and balance in physical as well as monetary terms.
Cost Ledger
This is the principle ledger of the cost department in which impersonal
accounts are recorded. This ledger also contains a Control Account for each subsidiary
ledger.
accounts are recorded. This ledger also contains a Control Account for each subsidiary
ledger.
Wednesday, February 18, 2009
NON-INTEGRATED ACCOUNTING SYSTEM
It is a system of accounting under which separate ledgers are maintained for cost and
financial accounts by Accountants. 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 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 and, bad debts and revenue/income
from ‘other than the sale of product or service’.
financial accounts by Accountants. 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 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 and, bad debts and revenue/income
from ‘other than the sale of product or service’.
Night shift allowance
Workers in the factories, which operate during night
time are paid some extra amount known as ‘night shift allowance’. This extra amount is
generally incurred due to the general pressure of work beyond normal capacity level and
is treated as production overhead and recovered as such.
If this allowance is treated as part of direct wages, the jobs/production carried at night will
be costlier than jobs/production performed during the day. However, if additional
expenditure on night shift is incurred to meet some specific customer order, such
expenditure may be charged directly to the order concerned. If night shifts are run due to
abnormal circumstances, the additional expenditure should be charged to the costing
profit and loss account.
time are paid some extra amount known as ‘night shift allowance’. This extra amount is
generally incurred due to the general pressure of work beyond normal capacity level and
is treated as production overhead and recovered as such.
If this allowance is treated as part of direct wages, the jobs/production carried at night will
be costlier than jobs/production performed during the day. However, if additional
expenditure on night shift is incurred to meet some specific customer order, such
expenditure may be charged directly to the order concerned. If night shifts are run due to
abnormal circumstances, the additional expenditure should be charged to the costing
profit and loss account.
Expenses for welfare activities
All expenses incurred on the welfare
activities of employees in a company are part of general overheads. Such expenses
should be apportioned between factory, office, selling and distribution overheads on the
basis of number of persons involved.
activities of employees in a company are part of general overheads. Such expenses
should be apportioned between factory, office, selling and distribution overheads on the
basis of number of persons involved.
Carriage and cartage expenses
It includes the expenses incurred on the
movement (inward and outwards) and transportation of materials and goods.
Transportation expenses related to direct material may be included in the cost of direct
material and those relating to indirect material (stores) may be treated as factory
overheads. Expenses related to the transportation of finished goods may be treated as
distribution overhead.
movement (inward and outwards) and transportation of materials and goods.
Transportation expenses related to direct material may be included in the cost of direct
material and those relating to indirect material (stores) may be treated as factory
overheads. Expenses related to the transportation of finished goods may be treated as
distribution overhead.
Canteen expenses
The loss incurred by the firm in running the canteen should be
regarded as a production overhead. If the canteen is meant only for factory workerstherefore this loss should be apportioned on the basis of the number of workers employed
in each department. If office workers also take advantage of the canteen facility, a
suitable share of the loss should be treated as office overhead.
regarded as a production overhead. If the canteen is meant only for factory workerstherefore this loss should be apportioned on the basis of the number of workers employed
in each department. If office workers also take advantage of the canteen facility, a
suitable share of the loss should be treated as office overhead.
Tuesday, February 17, 2009
Training expenses
Training is an essential input for industrial workers. Training
expenses in fact includes wages of workers, costs incurred in running training department,
loss arising from the initial lower production, extra spoilage etc. Training expenses of
factory workers are treated as part of the cost of production. The training expenses of
office; sales or distribution workers should be treated as office; sales or distribution
overhead as the case may be. These expenses can be spread over various departments
of the concern on the basis of the number of workers on roll.
Training expenses would be abnormally high in the case of high labour turnover such
expenses should be excluded from costs and charged to the costing profit and loss
account.
expenses in fact includes wages of workers, costs incurred in running training department,
loss arising from the initial lower production, extra spoilage etc. Training expenses of
factory workers are treated as part of the cost of production. The training expenses of
office; sales or distribution workers should be treated as office; sales or distribution
overhead as the case may be. These expenses can be spread over various departments
of the concern on the basis of the number of workers on roll.
Training expenses would be abnormally high in the case of high labour turnover such
expenses should be excluded from costs and charged to the costing profit and loss
account.
Bad debts
There is no unanimity among different authors of Cost Accounting
about the treatment of bad debts. One view is that ‘bad debts’ should be excluded from
cost. According to this view bad debts are financial losses and therefore, they should not
be included in the cost of a particular job or product.
According to another view it should form part of selling and distribution overheads,
especially when they arise in the normal course of trading. Therefore bad debts should be
treated in cost accounting in the same way as any other selling and distribution cost.
However extra ordinarily large bad debts should not be included in cost accounts.
about the treatment of bad debts. One view is that ‘bad debts’ should be excluded from
cost. According to this view bad debts are financial losses and therefore, they should not
be included in the cost of a particular job or product.
According to another view it should form part of selling and distribution overheads,
especially when they arise in the normal course of trading. Therefore bad debts should be
treated in cost accounting in the same way as any other selling and distribution cost.
However extra ordinarily large bad debts should not be included in cost accounts.
Expenses on removal and re-erection of machines
Expenses are sometime
incurred on removal and re-erection of machinery in factories. Such expenses may be
incurred due to factors like change in the method of production; an addition or alteration in
the factory building, change in the flow of production, etc. All such expenses are treated
as production overheads. When amount of such expenses is large, it may be spread over
a period of time.
If such expenses are incurred due to faulty planning or some other abnormal factor, then
they may be charged to costing Profit and Loss Account.
incurred on removal and re-erection of machinery in factories. Such expenses may be
incurred due to factors like change in the method of production; an addition or alteration in
the factory building, change in the flow of production, etc. All such expenses are treated
as production overheads. When amount of such expenses is large, it may be spread over
a period of time.
If such expenses are incurred due to faulty planning or some other abnormal factor, then
they may be charged to costing Profit and Loss Account.
Fringe benefits
These are the additional payments or facilities provided to the
workers apart from their salary and direct cost-allowances like house rent, dearness and
city compensatory allowances. These benefits are given in the form of overtime, extra
shift duty allowance, holiday pay, pension facilities etc.
These indirect benefits stand to improve the morale, loyalty and stability of employees
towards the organisation. If the amount of fringe benefit is considerably large, it may be
recovered as direct charge by means of a supplementary wage or labour rate; otherwise
these may be collected as part of production overheads.
workers apart from their salary and direct cost-allowances like house rent, dearness and
city compensatory allowances. These benefits are given in the form of overtime, extra
shift duty allowance, holiday pay, pension facilities etc.
These indirect benefits stand to improve the morale, loyalty and stability of employees
towards the organisation. If the amount of fringe benefit is considerably large, it may be
recovered as direct charge by means of a supplementary wage or labour rate; otherwise
these may be collected as part of production overheads.
Packing expenses
Cost of primary packing necessary for protecting the product
or for convenient handling, should become a part of the prime cost. The cost of packing to
facilitate the transportation of the product from the factory to the customer should become
a part of the distribution cost. If the cost of special packing is at the request of the
customer, the same should be charged to the specific work order or the job. The cost of
fancy packing necessary to attract customers is an advertising expenditure. Hence, it is to
be treated as a selling overhead.
or for convenient handling, should become a part of the prime cost. The cost of packing to
facilitate the transportation of the product from the factory to the customer should become
a part of the distribution cost. If the cost of special packing is at the request of the
customer, the same should be charged to the specific work order or the job. The cost of
fancy packing necessary to attract customers is an advertising expenditure. Hence, it is to
be treated as a selling overhead.
Monday, February 16, 2009
Depreciation
Depreciation “is the diminution in the intrinsic value of an asset due
to use and/or the lapse of time.” Depreciation is thus the result of two factors viz., the use,
and the lapse of time. We know that each fixed asset loses its intrinsic value due to their
continuous use and as such the greater the use the higher is the amount of depreciation.
The loss in the intrinsic value may also arise even if the asset in question is not in
service.
In Cost Accounting depreciation is charged to the cost of production.
to use and/or the lapse of time.” Depreciation is thus the result of two factors viz., the use,
and the lapse of time. We know that each fixed asset loses its intrinsic value due to their
continuous use and as such the greater the use the higher is the amount of depreciation.
The loss in the intrinsic value may also arise even if the asset in question is not in
service.
In Cost Accounting depreciation is charged to the cost of production.
Treatment of interest and financial charges
There is controversy whether
financial charges, specially interest, should be included in the costs or not. The following
arguments are generally advanced in favour of interest to be included in overhead
expenses.
(1) Computation of total cost is impossible unless interest is taken into account. Interest
is an element of cost and therefore, should be included in cost. This is specially true
in business where raw materials in different stages can be used. Thus a timber
merchant, if he buys standing trees and seasons the timber himself, would incur a
large amount of costs as interest. Another merchant who buys his timber already
seasoned would automatically have to pay a higher price; obviously, this price
includes interest.
financial charges, specially interest, should be included in the costs or not. The following
arguments are generally advanced in favour of interest to be included in overhead
expenses.
(1) Computation of total cost is impossible unless interest is taken into account. Interest
is an element of cost and therefore, should be included in cost. This is specially true
in business where raw materials in different stages can be used. Thus a timber
merchant, if he buys standing trees and seasons the timber himself, would incur a
large amount of costs as interest. Another merchant who buys his timber already
seasoned would automatically have to pay a higher price; obviously, this price
includes interest.
Idle facility
The term ‘facility’ has a wider connotation which may also include
prediction capacity. Facilities may be provided by fixed assets such as building space,
plants equipment capacity, etc. or by various service functions such as material services,
production services, personal services etc. If a firm fails to make full use of the facilities of
its disposal, the firm may be said to have idle facilities. Thus idle facilities refer to that
part of total facilities which remains unutilised due to any reason such as non-availability
of raw material, power, lack of demand etc. In Cost Accounting idle facilities are treated in
the same way as those of idle capacity.
prediction capacity. Facilities may be provided by fixed assets such as building space,
plants equipment capacity, etc. or by various service functions such as material services,
production services, personal services etc. If a firm fails to make full use of the facilities of
its disposal, the firm may be said to have idle facilities. Thus idle facilities refer to that
part of total facilities which remains unutilised due to any reason such as non-availability
of raw material, power, lack of demand etc. In Cost Accounting idle facilities are treated in
the same way as those of idle capacity.
Idle capacity cost
Costs associated with idle capacity are mostly fixed in nature. These
include depreciation, repairs and maintenance charges, insurance premium, rent, rates,
management and supervisory costs. These costs remain unabsorbed or unrecovered due to under-utilisation of plant and service capacity.
include depreciation, repairs and maintenance charges, insurance premium, rent, rates,
management and supervisory costs. These costs remain unabsorbed or unrecovered due to under-utilisation of plant and service capacity.
Idle capacity
It is that part of the capacity of a plant, machine or equipment which
cannot be effectively utilised in production. In other words, it is the difference
between the practical or normal capacity and capacity utilisation based on expected
sales. For example, if the practical capacity of production of a machine is to the tune
of 10,000 units in a month, but is used only to produce 8,000 units, because of
market demand of the product, then in such a case, 2,000 units will be treated as idle
capacity of the machine.
cannot be effectively utilised in production. In other words, it is the difference
between the practical or normal capacity and capacity utilisation based on expected
sales. For example, if the practical capacity of production of a machine is to the tune
of 10,000 units in a month, but is used only to produce 8,000 units, because of
market demand of the product, then in such a case, 2,000 units will be treated as idle
capacity of the machine.
Sunday, February 15, 2009
Actual capacity
It is the capacity actually achieved during a given period. This
capacity may lie between practical capacity and capacity based on sales expectancy.
capacity may lie between practical capacity and capacity based on sales expectancy.
Practical capacity
It is defined as actually utilised capacity of a plant. It is also
known as operating capacity. This capacity takes into account loss of time due to
repairs, maintenance, minor breakdown, idle time, set up time, normal delays,
Sundays and holidays, stock taking etc. Generally, practical capacity is taken
between 80 to 90% of the rated capacity. It is also used as a base for determining
overhead rates. Practical capacity is also called net capacity or available capacity.
known as operating capacity. This capacity takes into account loss of time due to
repairs, maintenance, minor breakdown, idle time, set up time, normal delays,
Sundays and holidays, stock taking etc. Generally, practical capacity is taken
between 80 to 90% of the rated capacity. It is also used as a base for determining
overhead rates. Practical capacity is also called net capacity or available capacity.
Rated capacity
It refers to the capacity of a machine or a plant as indicated by its
manufacturer. In fact this capacity is the maximum possible productive capacity of a
plant. It is also known as installed capacity of a plant. Due to the loss of operating
time of a plant it is difficult to achieve this rated capacity. In other words, it is only a
theoretical capacity and is therefore, seldom achieved.
manufacturer. In fact this capacity is the maximum possible productive capacity of a
plant. It is also known as installed capacity of a plant. Due to the loss of operating
time of a plant it is difficult to achieve this rated capacity. In other words, it is only a
theoretical capacity and is therefore, seldom achieved.
Saturday, February 14, 2009
Control of Selling & Distribution Overheads
Control of selling and distribution
expenses is a difficult task. The reasons for this are as follows :
1. The incidence of selling and distribution overheads depends mainly on external
factors, such as distance of market, extent and nature of competition, terms of sales,
etc. which are beyond the control of management.
2. These overheads are dependent upon the customers, behaviour, their liking and
disliking, tastes etc. Therefore, as such control over the overheads may result in loss
of customers.
3. These expenses being of the nature of policy costs, are not amenable to control.
In spite of the above difficulties, the following methods may be used for controlling them.
expenses is a difficult task. The reasons for this are as follows :
1. The incidence of selling and distribution overheads depends mainly on external
factors, such as distance of market, extent and nature of competition, terms of sales,
etc. which are beyond the control of management.
2. These overheads are dependent upon the customers, behaviour, their liking and
disliking, tastes etc. Therefore, as such control over the overheads may result in loss
of customers.
3. These expenses being of the nature of policy costs, are not amenable to control.
In spite of the above difficulties, the following methods may be used for controlling them.
Accounting of selling and distribution overheads
The collection and
accumulation of each expense is made by means of appropriate standing order numbers
in the usual way. Where it is decided to apportion a part of the administrative overhead to
the selling division the same should also be collected through appropriate standing order
numbers.
As in the case of administrative overheads, it is not easy to determine an entirely
satisfactory basis for computing the overhead rate for absorbing selling overheads. The
bases usually adopted are : (a) Sales value of goods; (b) Cost of goods sold; (c) Gross
Profit on sales; and (d) Number of orders or units sold.
accumulation of each expense is made by means of appropriate standing order numbers
in the usual way. Where it is decided to apportion a part of the administrative overhead to
the selling division the same should also be collected through appropriate standing order
numbers.
As in the case of administrative overheads, it is not easy to determine an entirely
satisfactory basis for computing the overhead rate for absorbing selling overheads. The
bases usually adopted are : (a) Sales value of goods; (b) Cost of goods sold; (c) Gross
Profit on sales; and (d) Number of orders or units sold.
ACCOUNTING AND CONTROL OF SELLING AND DISTRIBUTION OVERHEADS
Selling cost or overhead expenses are the expenses incurred for the purpose of promoting
the marketing and sales of different products. Distribution expenses, on the other hand,
are expenses relating to delivery and despatch of goods sold. Examples of selling and
distribution expenses have been considered earlier in this booklet. From the definitions it
is clear that the two type of expenses represent two distinct type of functions. Some
concerns group together these two type of overhead expenses into one composite class,
namely, selling and distribution overhead, for the purpose of Cost Accounting.
the marketing and sales of different products. Distribution expenses, on the other hand,
are expenses relating to delivery and despatch of goods sold. Examples of selling and
distribution expenses have been considered earlier in this booklet. From the definitions it
is clear that the two type of expenses represent two distinct type of functions. Some
concerns group together these two type of overhead expenses into one composite class,
namely, selling and distribution overhead, for the purpose of Cost Accounting.
Control of Administrative Overheads
Mostly administrative overheads are of fixed
nature, and they arise as a result of management policies. These fixed overheads are
generally non-controllable. But at the same time these overheads should not be allowed to
grow disproportionately. Some degree of control has to be exercised over them. The methods
usually adopted for controlling administrative overheads are as follows :
(i) Classification and analysis of overheads by administrative departments according
to their functions, and a comparison with the accomplished results: According to this
method the expenses incurred by each administrative department are collected under
standing order numbers for each class of expenditure. These are compared with similar
figures of the previous period in relation to accomplishment. Such a comparison will
reveal efficiency or inefficiency of the concerned department.
nature, and they arise as a result of management policies. These fixed overheads are
generally non-controllable. But at the same time these overheads should not be allowed to
grow disproportionately. Some degree of control has to be exercised over them. The methods
usually adopted for controlling administrative overheads are as follows :
(i) Classification and analysis of overheads by administrative departments according
to their functions, and a comparison with the accomplished results: According to this
method the expenses incurred by each administrative department are collected under
standing order numbers for each class of expenditure. These are compared with similar
figures of the previous period in relation to accomplishment. Such a comparison will
reveal efficiency or inefficiency of the concerned department.
Treating Administrative Overheads as a separate addition to Cost of
This method considers administration as a separate function like
production and sales and, as such costs relating to formulating the policy, directing the
organisation and controlling the operations are taken as a separate charge to the cost of
the jobs or a product, sold along with the cost of other functions. The basis which are
generally used for apportionment are :
(i) Works cost
(ii) Sales value or quantity
(iii) Gross profit on sales
(iv) Quantity produced
(v) Conversion cost, etc.
production and sales and, as such costs relating to formulating the policy, directing the
organisation and controlling the operations are taken as a separate charge to the cost of
the jobs or a product, sold along with the cost of other functions. The basis which are
generally used for apportionment are :
(i) Works cost
(ii) Sales value or quantity
(iii) Gross profit on sales
(iv) Quantity produced
(v) Conversion cost, etc.
Thursday, February 12, 2009
Treating Administrative Overheads as a separate addition to Cost of
This method considers administration as a separate function like
production and sales and, as such costs relating to formulating the policy, directing the
organisation and controlling the operations are taken as a separate charge to the cost of
the jobs or a product, sold along with the cost of other functions. The basis which are
generally used for apportionment are :
(i) Works cost
(ii) Sales value or quantity
(iii) Gross profit on sales
(iv) Quantity produced
(v) Conversion cost, etc.
production and sales and, as such costs relating to formulating the policy, directing the
organisation and controlling the operations are taken as a separate charge to the cost of
the jobs or a product, sold along with the cost of other functions. The basis which are
generally used for apportionment are :
(i) Works cost
(ii) Sales value or quantity
(iii) Gross profit on sales
(iv) Quantity produced
(v) Conversion cost, etc.
Charging to Profit and Loss Account
According to this method administrative
overheads are charged to Costing Profit & Loss Account. The reason for charging to
Costing Profit & Loss are firstly, the administrative overheads are concerned with the
formulation of policies and thus are not directly concerned with either the production or
the selling and distribution functions. Secondly, it is difficult to determine a suitable basis
for apportioning administrative overheads over production and sales departments. Lastly,
these overheads are the fixed costs. In view of these arguments, administrative
overheads should be charged to Profit and Loss Account.
Disadvantages :
(1) Cost of products are understated as administrative overheads are not charged to
costs.
(2) The exclusion of administrative overheads from cost of products is against sound
accounting principle.
overheads are charged to Costing Profit & Loss Account. The reason for charging to
Costing Profit & Loss are firstly, the administrative overheads are concerned with the
formulation of policies and thus are not directly concerned with either the production or
the selling and distribution functions. Secondly, it is difficult to determine a suitable basis
for apportioning administrative overheads over production and sales departments. Lastly,
these overheads are the fixed costs. In view of these arguments, administrative
overheads should be charged to Profit and Loss Account.
Disadvantages :
(1) Cost of products are understated as administrative overheads are not charged to
costs.
(2) The exclusion of administrative overheads from cost of products is against sound
accounting principle.
Apportioning Administrative Overheads between Production and Sales
sales departments. The reason for the apportionment of overhead
expenses over these departments, recognises the fact that administrative overheads are
incurred for the benefit of both of these departments. Therefore each department should
be charged with the proportionate share of the same. When this method is adopted,
administrative overheads lose their identity and get merged with production and selling
and distribution overheads.
Disadvantages :
(1) It is difficult to find suitable bases of administrative overhead apportionment over
production and sales departments.
(2) Lot of clerical work is involved in apportioning overheads.
expenses over these departments, recognises the fact that administrative overheads are
incurred for the benefit of both of these departments. Therefore each department should
be charged with the proportionate share of the same. When this method is adopted,
administrative overheads lose their identity and get merged with production and selling
and distribution overheads.
Disadvantages :
(1) It is difficult to find suitable bases of administrative overhead apportionment over
production and sales departments.
(2) Lot of clerical work is involved in apportioning overheads.
ACCOUNTING AND CONTROL OF ADMINISTRATIVE OVERHEADS
Definition - According to I.C.M.A. Terminology, Administrative overhead is defined as “The
sum of those costs of general management and of secretarial accounting andadministrative services, which cannot be directly related to the production, marketing,
research or development functions of the enterprise.” According to this definition,
administrative overhead constitutes the expenses incurred in connection with the
formulation of policy directing the organisation and controlling the operations of an
undertaking. These overheads are also collected and classified in the same way as the
factory overheads.
sum of those costs of general management and of secretarial accounting andadministrative services, which cannot be directly related to the production, marketing,
research or development functions of the enterprise.” According to this definition,
administrative overhead constitutes the expenses incurred in connection with the
formulation of policy directing the organisation and controlling the operations of an
undertaking. These overheads are also collected and classified in the same way as the
factory overheads.
Machine hour rate
By the machine hour rate method, manufacturing overhead
expenses are charged to production on the basis of number of hours machines are used
on jobs or work orders. There is a basic similarity between the machine hour and the
direct labour hour rate method insofar as both are based on the time factor. The choice of
one or the other method is conditioned by the actual circumstance of the individual case.
In respect of departments or operations in which machines predominate and the operators
perform relatively a passive part, the machine hour rate is more appropriate.
expenses are charged to production on the basis of number of hours machines are used
on jobs or work orders. There is a basic similarity between the machine hour and the
direct labour hour rate method insofar as both are based on the time factor. The choice of
one or the other method is conditioned by the actual circumstance of the individual case.
In respect of departments or operations in which machines predominate and the operators
perform relatively a passive part, the machine hour rate is more appropriate.
Wednesday, February 11, 2009
Labour hour rate
This method is an improvement on the percentage of direct
wage basis, as it fully recognises the significance of the element of time in the incurring
and absorption of manufacturing overhead expenses. This method is admirably suited to
operations which do not involve any large use of machinery. To calculate labour hour rate,
the amount of factory overheads is divided by the total number of direct labour hours.Suppose factory overheads are estimated at Rs. 90,000 and labour hours at 1,50,000.
The overhead absorption rate will be Re. 0.60. If 795 direct labour hours are spent on a
job, Rs. 477 will be absorbed as overhead. It can be calculated for each category of
workers.
wage basis, as it fully recognises the significance of the element of time in the incurring
and absorption of manufacturing overhead expenses. This method is admirably suited to
operations which do not involve any large use of machinery. To calculate labour hour rate,
the amount of factory overheads is divided by the total number of direct labour hours.Suppose factory overheads are estimated at Rs. 90,000 and labour hours at 1,50,000.
The overhead absorption rate will be Re. 0.60. If 795 direct labour hours are spent on a
job, Rs. 477 will be absorbed as overhead. It can be calculated for each category of
workers.
Percentage of direct labour cost
This method also fails to give full recognition to
the element of the time which is of prime importance in the accounting for and treatment
of manufacturing overhead expenses except in so far as the amount of wages is a product
of the rate factor multiplied by the time factor. Thus, the time factor is taken into
consideration only indirectly or partially in the computation of the overhead percentage
rate. This method therefore, cannot be depended upon to produce very accurate results
where the same type of work is performed in the same time by different type of workers,
skilled and unskilled, with varying rates of pay.
the element of the time which is of prime importance in the accounting for and treatment
of manufacturing overhead expenses except in so far as the amount of wages is a product
of the rate factor multiplied by the time factor. Thus, the time factor is taken into
consideration only indirectly or partially in the computation of the overhead percentage
rate. This method therefore, cannot be depended upon to produce very accurate results
where the same type of work is performed in the same time by different type of workers,
skilled and unskilled, with varying rates of pay.
METHODS OF ABSORBING OVERHEADS TO VARIOUS PRODUCTS OR JOBS
Before we describe various methods, it would be better to know how to judge whether a
method will give good results or not. The method selected for charging overheads toproducts or jobs should be such as will ensure :
(i) that the total amount charged (or recovered) in a period does not differ materially
from the actual expenses incurred in the period. In other words, there should not be
any significant over or under recovery of overhead; and
(ii) that the amount charged to individual jobs or products is equitable. In case of factory
overhead, this means :
(a) that the time spent on completion of each job should be taken into
consideration;
(b) that a distinction should be made between jobs done by skilled workers and
those done by unskilled workers. Usually, the latter class of workers needs more
supervision, causes greater wear and tear of machines and tools and waste a
larger quantity of materials.
method will give good results or not. The method selected for charging overheads toproducts or jobs should be such as will ensure :
(i) that the total amount charged (or recovered) in a period does not differ materially
from the actual expenses incurred in the period. In other words, there should not be
any significant over or under recovery of overhead; and
(ii) that the amount charged to individual jobs or products is equitable. In case of factory
overhead, this means :
(a) that the time spent on completion of each job should be taken into
consideration;
(b) that a distinction should be made between jobs done by skilled workers and
those done by unskilled workers. Usually, the latter class of workers needs more
supervision, causes greater wear and tear of machines and tools and waste a
larger quantity of materials.
Apportioning overhead expenses over various departments and reapportioning
After the
allocable overheads are related to the departments, expenses incurred for several
departments have to be apportioned over each department, e.g. rent, power, lighting,
insurance and depreciation. For distributing these overheads over different departments
benefiting thereby, it is necessary at first to determine the proportion of benefit received
by each department and then distribute the total expenditure proportionately on that basis.
allocable overheads are related to the departments, expenses incurred for several
departments have to be apportioned over each department, e.g. rent, power, lighting,
insurance and depreciation. For distributing these overheads over different departments
benefiting thereby, it is necessary at first to determine the proportion of benefit received
by each department and then distribute the total expenditure proportionately on that basis.
Allocation of overheads over various Departments or Departmentalisation of
different departments in the factory. Where such a division of functions had
been made, some of the departments should be engaged in actual production of goods,
and others in providing services ancillary thereto. At this stage, the factory overheads
which can be directly related to the various production or service departments are
allocated in this manner.
It may, sometime, become necessary to sub-divide a manufacturing organisation into
several cost centres, so that a closer distribution of expenses and a more detailed control
is practicable.
been made, some of the departments should be engaged in actual production of goods,
and others in providing services ancillary thereto. At this stage, the factory overheads
which can be directly related to the various production or service departments are
allocated in this manner.
It may, sometime, become necessary to sub-divide a manufacturing organisation into
several cost centres, so that a closer distribution of expenses and a more detailed control
is practicable.
Tuesday, February 10, 2009
Estimation and Collection of Manufacturing Overheads
The amount of factory
overheads is required to be estimated. The estimation is usually done with reference to
past data adjusted for known future changes. The overhead expenses are usually
collected through a system of standing orders.
Standing Orders : In every manufacturing business, expenses are incurred on direct
materials and direct labour in respect of several jobs or other units of production,
manufacture of which is undertaken. The incurring of these expenses is authorised by
production orders or work orders. The work order numbers are not ordinarily fixed or
permanent. They are generally allotted in a serial order according to the number of
manufacturing jobs undertaken by the business. In addition, indirect expenses are incurred
in connection with the rendering of services to the production departments, or to
the manufacturing process. The term “Standing Order” denotes sanction for indirect
expenses under various heads of expenditure.
overheads is required to be estimated. The estimation is usually done with reference to
past data adjusted for known future changes. The overhead expenses are usually
collected through a system of standing orders.
Standing Orders : In every manufacturing business, expenses are incurred on direct
materials and direct labour in respect of several jobs or other units of production,
manufacture of which is undertaken. The incurring of these expenses is authorised by
production orders or work orders. The work order numbers are not ordinarily fixed or
permanent. They are generally allotted in a serial order according to the number of
manufacturing jobs undertaken by the business. In addition, indirect expenses are incurred
in connection with the rendering of services to the production departments, or to
the manufacturing process. The term “Standing Order” denotes sanction for indirect
expenses under various heads of expenditure.
Treatment of over and under absorption of overheads
After the year end the total
amount of actual factory overheads is known. There is bound to be some difference
between the actual amount of overheads and the absorbed amount of overheads. The
difference has to be adjusted keeping in view of such differences and the reasons
therefor.
Students will thus see that the whole discussion as above is meant to serve the following
two purposes :
(a) to charge various products and services with an equitable portion of the total amount
of factory overheads ; and(b) to charge factory overheads immediately as the product or the job is completed
without waiting for the figures of actual factory overheads.
amount of actual factory overheads is known. There is bound to be some difference
between the actual amount of overheads and the absorbed amount of overheads. The
difference has to be adjusted keeping in view of such differences and the reasons
therefor.
Students will thus see that the whole discussion as above is meant to serve the following
two purposes :
(a) to charge various products and services with an equitable portion of the total amount
of factory overheads ; and(b) to charge factory overheads immediately as the product or the job is completed
without waiting for the figures of actual factory overheads.
Absorption
The production department overheads are absorbed over production
units. The overhead expenses can be absorbed by estimating the overhead expenses and
then working out an absorption rate. When overheads are estimated, their absorption is
carried out by adopting a pre-determined overhead absorption rate. This rate can be
calculated by using any one method as discussed in this chapter at the end.
As the actual accounting period begins, each unit of production automatically absorbs a
certain amount of factory overheads through pre-determined rates. During the year a
certain amount will be absorbed over the various products. This is known as the total
amount of absorbed overheads.
units. The overhead expenses can be absorbed by estimating the overhead expenses and
then working out an absorption rate. When overheads are estimated, their absorption is
carried out by adopting a pre-determined overhead absorption rate. This rate can be
calculated by using any one method as discussed in this chapter at the end.
As the actual accounting period begins, each unit of production automatically absorbs a
certain amount of factory overheads through pre-determined rates. During the year a
certain amount will be absorbed over the various products. This is known as the total
amount of absorbed overheads.
Re-apportionment
The next stage is to re-apportion the overhead costs of service
departments over production departments. Service departments are those departments
which do not directly take part in the production of goods. Such departments provide
ancillary services. Examples of such departments are boiler house, canteen, stores, time
office, dispensary etc. The overheads of these departments are to be re-apportioned over
the production departments since service departments operate primarily for the purpose of
providing services to production departments. At this stage, all the factory overheads are
collected under production departments.
departments over production departments. Service departments are those departments
which do not directly take part in the production of goods. Such departments provide
ancillary services. Examples of such departments are boiler house, canteen, stores, time
office, dispensary etc. The overheads of these departments are to be re-apportioned over
the production departments since service departments operate primarily for the purpose of
providing services to production departments. At this stage, all the factory overheads are
collected under production departments.
Sunday, February 1, 2009
Payroll procedure
The hours worked by each employee as reflected on the
completed clock cards are entered by an accounting department employee (or employees) on
the payroll sheet or payroll summary. All employees authorized for employment by the
personnel department are first listed on the payroll sheet. Hours and hourly rates are then
transferred from the clock cards, and total earnings are computed. Should a clock card for an
employee not listed on the payroll sheet be found, investigation of its propriety is required.
Likewise, there should be an explanation for any missing clock cards
completed clock cards are entered by an accounting department employee (or employees) on
the payroll sheet or payroll summary. All employees authorized for employment by the
personnel department are first listed on the payroll sheet. Hours and hourly rates are then
transferred from the clock cards, and total earnings are computed. Should a clock card for an
employee not listed on the payroll sheet be found, investigation of its propriety is required.
Likewise, there should be an explanation for any missing clock cards
Time-Booking
The clock card is required, essentially, for the correct determination of the
amount of wages due to a worker on the basis of time he has put in the factory. It merely
records day by day and period by period the total time spent by each individual worker in the
factory. But it does not show how that time was put to use in the factory—how an individual
worker utilised his time in completing jobs entrusted to him and how long he was kept waiting
for one reason or another due to lack of work, lack of material and supplies, lack of
instructions, machine breakdowns, power failures and the like. These are all vital pieces of
information necessary for the proper collection of cost data and for effective controlling of
costs. For the collection of all such information, a separate record, generally known as Time
(or Job) card, is kept.
amount of wages due to a worker on the basis of time he has put in the factory. It merely
records day by day and period by period the total time spent by each individual worker in the
factory. But it does not show how that time was put to use in the factory—how an individual
worker utilised his time in completing jobs entrusted to him and how long he was kept waiting
for one reason or another due to lack of work, lack of material and supplies, lack of
instructions, machine breakdowns, power failures and the like. These are all vital pieces of
information necessary for the proper collection of cost data and for effective controlling of
costs. For the collection of all such information, a separate record, generally known as Time
(or Job) card, is kept.
Friday, January 2, 2009
Audit of Stores and Stocks
Audit of the accounts of stores and stocks has been developed as a part of expenditure audit with
reference to the duties and responsibilities entrusted to C&AG. Audit is conducted to ascertain whether
the Regulations governing purchase, receipt, and issue, custody, sale and stock taking of stores are
well - devised and properly carried out. The aim is also to bring to the notice of the government any deficiencies in quantities of stores held or any defects in the system of control. The audit of purchase of
stores is conducted in the same manner as audit of expenditure, namely, that these are properly
sanctioned, made economical and in accordance with the Rules for purchase laid down by the
competent authority. The auditor has to ensure that the prices paid are reasonable and are in
agreement with those shown in the contract for the supply of stores, and that the certificates of quality
and quantity are furnished by the inspecting and receiving units. Cases of uneconomical purchase of
stores and losses attributable to defective or inferior quality of stores are specifically brought by the
audit. Accounts of receipts, issues and balances are checked regarding accuracy, correctness and
reasonableness of balances in stocks with particular reference to the specified norms for level of
consumption of stock holding.
reference to the duties and responsibilities entrusted to C&AG. Audit is conducted to ascertain whether
the Regulations governing purchase, receipt, and issue, custody, sale and stock taking of stores are
well - devised and properly carried out. The aim is also to bring to the notice of the government any deficiencies in quantities of stores held or any defects in the system of control. The audit of purchase of
stores is conducted in the same manner as audit of expenditure, namely, that these are properly
sanctioned, made economical and in accordance with the Rules for purchase laid down by the
competent authority. The auditor has to ensure that the prices paid are reasonable and are in
agreement with those shown in the contract for the supply of stores, and that the certificates of quality
and quantity are furnished by the inspecting and receiving units. Cases of uneconomical purchase of
stores and losses attributable to defective or inferior quality of stores are specifically brought by the
audit. Accounts of receipts, issues and balances are checked regarding accuracy, correctness and
reasonableness of balances in stocks with particular reference to the specified norms for level of
consumption of stock holding.
Audit of Receipts
The audit of receipts is neither all pervasive or as old as audit of expenditure but has come to stay in
some countries. Such an audit provides for checking; (i) whether all revenues or other debts due to
government have been correctly assessed, realised and credit to government account by the
designated authorities; (ii) whether adequate regulations and procedures have been framed by the
department/agency concerned to secure an effective check on assessment, collection and proper
allocation of cases; (iii) whether such regulations and procedures are actually being carried out; (iv)
whether adequate checks are imposed to ensure the prompt detection and investigation of irregularities,
double refunds, fraudulent or forged refund vouchers or other loss of revenue through fraud or wilful
omission or negligence to levy or collect taxes or to issue refunds; and (v) review of systems and
procedures to see that the internal procedures adequately secure correct and regular accounting of
demands collection and refunds and pursuant of dues up to final settlement and to suggest
improvement. The basic principle of audit of receipts is that it is more important to look at the general
than on the particular, though individual cases of assessment, demand, collection, refund, etc. are
important within the area of test check. A review of the judicial decisions taken by tax authorities is done
to judge the effectiveness of the assessment procedure.
some countries. Such an audit provides for checking; (i) whether all revenues or other debts due to
government have been correctly assessed, realised and credit to government account by the
designated authorities; (ii) whether adequate regulations and procedures have been framed by the
department/agency concerned to secure an effective check on assessment, collection and proper
allocation of cases; (iii) whether such regulations and procedures are actually being carried out; (iv)
whether adequate checks are imposed to ensure the prompt detection and investigation of irregularities,
double refunds, fraudulent or forged refund vouchers or other loss of revenue through fraud or wilful
omission or negligence to levy or collect taxes or to issue refunds; and (v) review of systems and
procedures to see that the internal procedures adequately secure correct and regular accounting of
demands collection and refunds and pursuant of dues up to final settlement and to suggest
improvement. The basic principle of audit of receipts is that it is more important to look at the general
than on the particular, though individual cases of assessment, demand, collection, refund, etc. are
important within the area of test check. A review of the judicial decisions taken by tax authorities is done
to judge the effectiveness of the assessment procedure.
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