Professional Documents
Culture Documents
3.1 Introduction
Management process involves decision making & control . Both this functions require
information relating to cost. Costing is a process & technique to give costing
information to managers for their decision making & control.
3.2
A) Basic Cost Terminology
a) Cost: It may be defined as the amount of expenditure (actual or notional)
incurred on or attributable to a given things or to ascertain the cost of a given
thing. In other words cost is the amount of resources used for something which
must be measured in terms of money. For example: Cost of preparing one cup tea
is the amount incurred on the elements like material, labour and other expenses,
similarly cost of offering any services like banking is the amount of expenditure
for offering that service.
b) Costing : It is defined as the technique and process of ascertaining costs
Costing involves in classification, recording, allocation, appropriation of
expenses incurred to facilitate the determination of cost of the product or service.
Thus costing involves Collection & analysis of relevant cost data for
interpretation & presentation to management for decision making & control.
It is a set of procedures used in refining raw data into useful information for:
- Managerial decision making
- Ascertaining products/services cost
- Ascertaining products/services profitability
c) Cost Accounting is the process of accounting of costs. It primarily deals with
collection, analysis of relevant cost data for interpretation and presentation for
various problems of management. It is concerned with actual cost incurred and
estimation of future cost.
d) Cost Accountancy: It is basically application of costing and cost accounting
principles, methods and techniques in the ascertainment of the costs and analysis
of savings/or excess as compared with previous experience or with standards
b) Cost Object
To guide their decisions, managers want to know how much a particular thing such as
product, machine, service or process costs. This is called cost object. It is an activity
or
operation in which resources like material, labour etc. are consumed. Cost may pertain
to more than one cost objects simultaneously e.g. material cost may be a part of
product cost as well as production department cost.
c) Cost Unit
It is a unit of product, service or combination of them in relation to which costs are
ascertained or expressed.
Selection of cost unit depends on:
Nature of business
M.I.S.
Requirements of costing system.
Ex. Of cost unit are:
Industry Cost unit
Automobile No.
Biscuit Kg.
Breweries Crate
Cigarettes Packs
Chemicals Lit/Kg/Ton
Textile Meters
d) Cost Ascertainment
It is the process of determining actual costs of process, product or activity after
these costs have been incurred, in the past.
Management is always interested to know exact cost for particular product, activity
or process, so that cost control & cost reduction becomes easy.
e) Cost estimation
It is the process of determining future costs in advance before any production or
activity starts.
Cost estimation is useful for
- Managerial control
- Filing tender
- Deciding price of product or price of job.
- Preparing budgets .
f) Cost Allocation
It is the process of allocating a particular cost item to product, process or cost center
e.g. salary of store keeper is allocated to stores department or cost of boiler
attendant is allocated to Boiler House .
g) Cost Apportionment
It is the process of charging common cost items to two or more cost centers on some
equitable basis .
e.g. Electricity expenses are apportioned on basis of light points used by cost
centers. Factory rent is apportioned on basis of floor area of different cost centers
h) Cost Absorption
It is charging cost from cost centers to products or services by means of absorption
rate. This rate is calculated with reference to some base such as machinehour,
Labor- hour etc.
i) Cost Management
Term is widely used in business today.
It is used to describe approaches & activities of managers in short-run & long-run
planning & control decisions that increase value for customers & lower costs of
products & services.
It is broad focused & not merely confined to continuous reduction of costs.
Planning & control of costs is linked with revenue & profit planning e.g. to
enhance revenues & profit managers often deliberately incur additional costs for
advertising & product innovation
Cost management is not practiced in isolation. It is an integral part of general
management strategies & the implementation.
Three features of cost management are:
(i) Calculating cost of products, services & other cost objects.
(ii) Obtaining information for planning, control and performance evaluation.
(iii) Analyzing relevant information for making decision
(c) Profit Center: It is defined as, a segment of the business entity by which both
revenues are received and expenses are incurred or controlled.
Center at which profit is generated and cost are assigned
Generally divisions of company are treated as Profit Centers
Profitability of firm is analysed as per each profit center
Targets for the center are in terms of profit
Divisional or profit Center head is responsible for achieving profit targets
He has powers & responsibilities for deciding
- price structure
- Sales volume
- Cost control actions
He generally reports to Board of a company
He plays key role in profit management of company
Profit center head is accountable for reduction in profits.
The profit center concept is used for evaluation of performance.
(d) Investment Center
Center which decides investments to be made
Investment Center head is responsible for
- Making investment in assets
- Managing assets
- Expansion/diversification
- Disposal of old assets
He has to achieve target in terms of R.O.I.
This is more responsible center than profit center.
He generally reports to Board of a company
He plays key role in investment management of company
Investment center head is accountable for reduction in R.O.I.
Prime Cost = (Direct Material cost) + (Direct Labour cost) + Direct Expenses
cost)
(a) Direct Material
Material which directly goe
s into the product that is which can be directly identified with the material
e.g. sugar used in Cadbury chocolate, quantity of glass in glass bottle, quantity
of milk in cup of tea etc.
It includes all materials consumed in process of manufacture up to its primary
packing. It consists of raw materials, bought outs & primary packing material.
(II) Overheads
It is total of Material, Labour & Expenses not directly related to production
1) Element wise
Costs can be collected under 3 main elements viz Material, Labour, Expenses.
When these costs can be identified easily with cost unit, operation or cost center they
are called direct or traceable costs.
When these costs cannot be allocated but can be apportioned to cost centers or cost
units they are called overheads.
2) Function wise
a) Production Cost: It is the cost of operating manufacturing division. Includes all direct
labour, direct material direct expenses & manufacturing overheads. All costs starting
with supply of material till production of finished goods are included in this cost.
Production manager controls this cost.
b) Factory/Works overheads
All indirect costs incurred in the factory for production of goods is termed as
factory/works overheads. Such costs are concerned with the running of the factory or
plant. These include indirect material, indirect labour and indirect expenses incurred
in the factory. Some examples are as follows:
Indirect factory materials:
i. Grease, oil, lubricants, cotton waste etc.
ii. Small tools, brushes for sweeping, sundry supplies etc.
iii. Cost of threads, gum, nails, etc.
iv. Consumable stores
v.Factory printing and stationery
Indirect factory wages
(i) Salary of factory manager, foremen, supervisors, clerks etc.
(ii) Salary of storekeeper
(iii) Salary and fee of factory directors and technical directors
(iv) Contribution to ESI, PF., Leave pay etc. of factory employee.
Indirect factory expenses
(i) Rent of factory buildings and land
ii) Insurance of factory building, plant, and machinery
(iii) Municipal taxes of factory building
(iv) Depreciation of factory building, plant and machinery, and their repairs
and maintenance charges
(v) Power and fuel used in factory
(vi) Factory telephone expenses.
d) Selling & Distribution Cost: All the costs related to distribution, marketing, sales &
after sales services of companys product are included in these costs.
These expenses represent the aggregate of indirect material, indirect labour, and
indirect expenses incurred by the selling and distribution department of the
organisation.
Some of the examples of selling overheads are as follows:
Indirect material
(i) Catalogues, price list (ii) Printing and stationery
(iii) Postage and stamps (iv) cost of sample
Indirect wages
(i) Salaries of sales managers, clerks and other employees
(ii) Salaries and commission of salesmen and technical representatives
(iii) Fees of sales directors
Indirect expenses
(i) Advertising
(ii) Bad debts
(iii) Rent and insurance of showroom
(iv) Legal charges incurred for recovery of debts
(v) Travelling and entertainment expenses
(vi) Expenses of sending samples
(vii) Market research expenses. Indirect costs incurred in relation to the procurement
of sale orders are termed as selling overheads.
Distribution overheads
Indirect costs incurred in relation to the execution of the sales order is termed as
distribution overheads. Some of the examples of distribution overheads are as follows:
Indirect material
(i) Cost of packing material
(ii) oil, grease, spare parts etc. for maintaining delivery vans
Indirect wages
(i) Salaries of godown employees
(ii) Wages of drivers of delivery vans
(iii) Wages of packers and dispatch staff.
e) Research & Development cost include all cost searching new products & process
and improving existing products & processes.
3) Behaviour wise
a) Variable costs: are those costs which tend to vary in accordance with level of
activity within relevant range of activity & within given period of time. There is
linear relationship between volume and variable costs. They are constant per unit.
Ex: Direct material cost, direct labour cost, transport, sales commission, fuel etc.
b) Fixed Costs: are those costs which are unaffected by changes in level of activity
during given period of time. They remain constant in total regardless of changes
in output & for certain period of time. Ex: Depreciation, interest on term loans,
insurance, property taxes.
c) Semi variable costs: They are neither perfectly variable nor absolutely fixed in
relation to changes in volume. They change in same direction as volume but not
indirect proportion. Ex: Telephone, Electricity, Maintenance cost.
4) Control wise
a) Controllable costs are those which can be controlled by specific action of a particular
member of organization e.g. sales & marketing expenses can be controlled by
marketing manager of a company, also cost like telephone, printing, stationary etc.
can be controlled.
b) Uncontrollable costs are those which cannot be controlled by action of a particular
manager.
e.g. depreciation & interest cost are uncontrollable by action of any particular
manager. These costs are generally incurred by actions of top management.
5) Normality wise
a) Normal costs are those incurred in normal course of business e.g. normal losses or
wastages. These costs must be considered while calculating cost of a product, process
or service.
b) Abnormal costs. it is an unusual cost whose occurrence is usually not regular and is
unexpected. This cost arises due to some abnormal situation of production. Abnormal
cost arises due to idle time, unexpected heavy breakdown of machinery etc. They are
not taken into consideration while computing cost of production or for decision
making.
6) According to time
a) Historical costs: These are the costs which are incurred in the past, i.e. in the past
year, past month etc. They are ascertained after the period is over. Though it has
limited importance, still they can be used for estimating the trends of the future.
b) Predetermined Cost: These costs relating to the product are computed in advance
of production, on the basis of a specification of all the factors affecting cost a and
cost data. Pre-determined cost may be either standard or estimated.
4) Sunk Cost
It is historical cost incurred in past. A sunk cost is the cost that has already been
incurred. Generally known as unavoidable cost, it refers to the past cost since these
amounts cannot be changed once the cost is incurred. They are the cost which have
been incurred by a decision made in the past and cannot be changed or avoided by
any decisions that is made in future. These costs are not relevant for decision making
about the future. E.g. the book value of an asset cannot be currently used for making
a decision to replace it.
e.g. While considering replacement of a plant, depreciated book value of old asset is
irrelevant as amount is sunk cost.
5) Product Cost:
The costs which are included in the manufacturing of the product are called product
cost. Thus it includes all the cost starting from the manufacturing activity i.e.
inventory cost till the product is sold, i.e. finished product.
6) Period cost:
It is described as the cost which is associated with a particular period or time. These
are not related to the products delivered to the customers. Such costs are charged to
the profit and loss A/c of that period. E.g. of period cost are Rent, salaries, traveling
expenses etc.
Product cost can be carried forward to next accounting period as part of unsold
finished stock whereas period cost is to be written off during the same accounting
period in which it is incurred.
7) Capital cost:
Capital expenditure provides benefits to the future periods. Capital cost is treated as
purchase of an asset for e.g. purchase of land and building, furniture, etc.
8) Revenue Cost:
It is the cost which is incurred to benefit the current period and is classified as an
expense. For e.g. Salaries, rent, printing and stationary, postage, etc.
9) Relevant cost:.
It is anticipated, future cost which differs among different alternatives under
consideration. e.g. many times fixed costs are irrelevant in decision making.
Relevant costs may also be defined as the cost which are affected and changed by a
decision. The 2 features of relevant cost are:
a. Relevant costs are only future costs that are cost which are expected to be incurred in
future.
b. Relevant cost is only incremental (additional). Incremental cost refers to the increase
in cost between two alternatives.
10) Irrelevant costs are those costs that would not be affected by the decisions of the
management. For e.g. when a manufacturer decided to close a certain unit of
manufacturing, the wages associated with it is a relevant cost as the wage payment
would siege with the closure of the firm, but the rent which has already been paid
under the lease agreement cannot be recovered, hence it is a irrelevant costs
2 Each cost are collected and accumulated Specialist sub-contractors are hired for
for each Job, work order or project electrical fittings, welding work, glass work,
separately plumbing work, etc.
3 Individual Jobs are identifiable and each Each contract becomes the cost unit
job becomes the cost centre
4 Each job has its own characteristics and Under contract costing most of expenses are
requires special attention direct in nature
5 Production is not done in anticipation of In case of incomplete contract, only
demand proportionate profit is taken to Profit and
Loss Account
6 Applicability : Printing press, Applicability: This method is used by
Construction of Building, bridges, ship builders, civil engineering contractors,
building, furniture making, machine construction and mechanical engineering
tool mfg., repairs of shops, painting firms etc.
job, Interior decorator, machine tool
mfg., foundries, Engg. workshop
3 Each batch of the product are unit cost Finished products are uniform in all respects
where the cost are ascertained such as shape, size, weight, quality, colour,
chemical content etc. Thus unit cost is
calculated by dividing total cost by number
of units produced
4 In Batch costing is products are Cost follow the flow of production whereby
produced as per anticipation in demand cost incurred in earlier process are transferred
to the following process along with the
output.
5 When the batch is completed the cost is Unit cost is a process. Output of one process
totaled and total cost is divided by the is input for another process.
total quantity produced. For eg. Cost per
dozen, per kg, per ton etc.
6 Applicable for: Mfg. of nuts, bolts, Applicable: Mines, quarries, cotton wool and
screws, pins etc., bakery products, jute textiles, chemicals, soap making, paper
readymade garments, drugs and plastics, oil refining, food processing
pharmaceuticals, spare parts, shoes industry, dairy, sugar mfg., confectionaries,
component parts etc. cement, Flour mill, Gas Etc.
3 A uniform service is rendered to the It is called unit costing because cost units are
customers identical.
4 The processes and stages involved in The production of goods are undertaken on
converting the basic materials and continuous basis and in anticipation of
facilities tot eh ultimate service demand
rendered are standardize, repetitive and
continuous.
5 Applicable For: Transport The end products are always uniform and
Undertaking: air, water and Road, identical.
Municipal services such as supply of
water and electricity, Hotel- Loading
and boarding, Hospitals, educational
institutions, service department,
Cinemas, sports , water pumping, fire
extinguisher etc.
6 Applicable: Quarries, flour mills, paper mills,
textile mills, brickmaking, stationary items
mfg., dairy products etc.
3.7 Cost Sheet
Detailed statement showing actual cost of products, job order, contract etc.
Significance :
a) It shows total cost of product & average cost per unit
b) Different elements of total cost are highlighted
c) Useful for cost control
d) Locates inefficient areas & products
e) Useful for controlling wastages
f) It is a basis for preparing budgets & tenders
g) Selling prices of products can be fixed on the basis of cost shown by cost
sheet.
h) Shows stocks of each product.
i) Useful for fixing responsibilities of diff. managers.
+ Administration overheads
= Cost of Sales
+ Profit
= Sales (Net of taxes)
Items to be excluded from cost: Expenses of pure Finance nature for e.g.
c) Administration Overheads
1) Office stationary
2) Counting House Salaries
3) Salary Manager/M.D/ General Manager
4) Salary Executives and Staff
5) Telephone charges
6) Salaries and Wages
7) Office rent, rates , taxes and Insurance
8) Office Heat/light/A.C.
9) Auditor fees, Directors fees , Legal expenses
10) Subscription to Trade Journals
11) Computer expenses (EDP)
12) Sundry / Miscellaneous office expenses
13) Office conveyance
14) Depreciation on Office Building
d) Selling Overheads
1) Catalogue/price list
2) Salesmen Salary & benefits
3) Commission on sales
4) Advertisement
5) Bad debts
6) Rent/Taxes of Sales and Marketing Dept.
7) Traveling expenses
8) Branch establishment
9) Market Research
10) Samples
e) Distribution Overheads
1) Secondary packing
2) Stores/spares
3) Godown employees salary
4) Wages of drivers, Packers, dispatch clerks
5) Warehouse rent/rates/Insurance
6) Carriage outward
7) Transit Insurance
8) Delivery Vans maintenance
9) Misc. selling expense
1) Gives overall costs & profits of Co. 1) Gives costs & profits for each product,
Process, Job etc.
3) Limited use for decision making 3) Extensive use for decision making
5) Focus is on historical cost data 5) Focus is on present & future cost data
10) Only monetary information is recorded 10) Both monetary and non-monetary is
recorded
2. From following particulars . Prepare a cost sheet for year end 31-3-2007.
Rs.
Stock of finished goods (31/3/07) 66,000
Stock of raw materials (1/4/06) 40,000
Work-in-progress (1/4/06) 75,000
Purchase of raw materials 5,75,000
Carriage inwards 12,500
Factory, rent taxes 27,250
Other production expenses 13,000
Stock of goods (31/3/07) 15,000
Wages 75,000
Managers salary (2:2:1 for Fty:Adm:S&D) 1,60,000
Factory employees salary 80,000
Power expenses 19,500
General expenses 12,500
Sale of the year 13,60,000
Stock of raw materials ( 31/3/07) 50,000
Work in-progress ( 31/3/07) 60,000
Salesmens Commission 32,000
3. Following particulars are available in respect of cost structure for the product 731 for
the quarter ended on 31st December, 2006
Rs.
Opening stock of raw materials 15,000
Purchases of raw materials 75,000
Freight & insurance on materials 6,000
Carriage inwards on materials 4,000
Return of material to suppliers 5,000
Closing stock of materials 20,000
Normal loss of materials 2,000
Accidental loss of materials 6,000
Productive wages paid 52,000
Wages outstanding 4,000
Factory Expenses 20,000
Office & Adm. Exp. 32,000
Office Rent 4,000
Office Exp. Prepaid 2,000
Selling expense 20,000
Distribution Expenses 5,000
The selling price is fixed by profit of 20% on selling price. Prepare a cost sheet.
5. The following figures relate to a job work of a manufacturing business which were
completed in the 2nd Week of June 2015. Compute the total cost by preparing a cost
sheet with this information
Charge works overheads at 50% of the direct labour and office overheads at 10%
on works cost. What shall be the job price if 10% profit is determined on the
supply price.
6. A factory uses a job costing system. The following cost data are available from the
books for the year ended 31st March 2015
Amount in Rs.
Direct Materials 9,00,000
Direct Wages 7,50,000
Profit 6,09,000
Selling and Distribution overheads 5,25,000
Administration Overheads 4,20,000
Factory Overheads 4,50,000
Required:
b. Prepare a Cost sheet indicating the Prime Cost, Works Cost, production Cost ,
cost of Sales and Sales Value
c. In 2015-16 the factory has received an order for a number of Jobs. It is estimated
that the direct materials would be Rs. 12, 00,000 and direct Labour would cost
Rs. 7, 50,000. What would be the price for these jobs if the factory intends to
earn the same rate of profit on sales, assuming that the selling and distribution
overhead has gone up by 15%. The factory recovers factory overheads as a
percentage of direct wages and administration and selling and distribution
overheads a percentage of works cost based on the cost rates prevalent in the
previous year.
4.1 Introduction
Material is an important component of cost. In most of the industries material cost is
around 60 to 70 % of total product cost. It is therefore top priority of management to
control material cost.
This unit covers all stages of material cost control & various techniques to control
material cost.
2. Purchase Order
Based on purchase requisition, purchase department initiates actions for purchase.
Quotations are called from different suppliers and one which is best suited to
organization is accepted.
Once supplier is fixed Purchase Order is raised on him. Purchase Order is the
document which gives all details relating to quantity, quality delivery schedule &
other terms of supply.
Purchase Order is a legal document which binds both company & vendor to the terms
specified in purchase order.
Format of purchase order.
Purchase Order
Please supply the following items on the terms and conditions mentioned below:
Sr. No. Particulars Qty. Rate P.U.(Rs.) Total Cost
1. Paint (Code No. ZX 103) 80 lit 300 24,000
2. Acetone (1 Normal) 200 lit 1,500 30,000
3. Caustic soda (0.2 N) 100 lit 1,800 18,000
Basic Price 72,000
+Packing & Forwarding 1,500
+Excise 8,500
+Sales Tax 10,000
TOTAL 92,000
Terms & Conditions :
i) Delivery within 15 days
ii) Credit One Month
S/d
( Purchase Manager )
BIN CARD
BIN CARD
MATERIAL : MAX LEVEL:
CODE NO: MIN. LEVEL:
LOCATION: REORDER LEVEL:
RECEIPTS ISSUES BALANCE REMARKS
( c ) Simple Average:
Simple of the prices according to the lots available in stock are worked out for
fixing the price of issue
For every new purchase a new average price is worked out
While calculating the simple average prices of the lots that have been
exhausted are not considered.
Issues are made in the same manner as First in First Out and the prices of the
lots are accordingly averaged for the purpose of issue.
Issue price= Total units prices of the materials in stock / Number of prices
STORES LEDGER
Shows Quantity & amount
Useful to costing department
Used for inventory valuation & material costing
1. Following is the record of receipts and issues of certain material in the factory during the
week of April 2015
Sept
1 Opening Balance 25 units value Rs. 162.50
4 Issues Req. No. 85 8 units
6 Receipts from B & Co GRN No. 26 50 units @ Rs.5.75
per.unit
7 Issues Rq. No. 97 12 units
10 Returns to B & Co. 10 units
12 Issues Req. No. 108 15 units
13 Issues Req. No. 110 20 units
15 Receipts from M& Co. GRN No. 33 25 units @ Rs. 6.10
per.unit
17 Issues Req. No.121 10 units
19 Received replacement from B& Co. GRN No. 38 10 units
20 Returned from department material of B & Co. MRN 5 units
No.4
22 Transfer from Job 182 to Job 187 in the Dept. MTN 6 5 units
26 Issues Req. No 146 10 units
29 Transfer from Dept. A to Dept. B MTN 10 5 units
30 Shortage in stock taking 2 units
Write up the priced stores leger on FIFO method and discuss how would you treat the
shortage in stock taking.
3. The following particulars have been extracted in respect of material X. Prepare a stores
ledger A/c showing the receipts & issues, pricing the material issued on the basis of
a. Simple average method
b. Weighted average method
Receipts
1-10-2014 Opening stock 200 units Rs. 3.50 per unit
3-10-2014 Purchased 300 units Rs. 4.00 per unit
13-10-2014 Purchased 900 units Rs. 4.30 per unit
23-10-2014 Purchased 600 units Rs. 3.80 per unit
Issued
5-10-2014 Issued 400 units
15-10-2014 Issued 600 units
25-10-2014 Issued 600 units
4. From the following information, prepare Store Ledger using First In First Out [FIFO],
Last In First Out [LIFO] and Weighted Average Method of pricing the issues.
Reorder level
- Level at which new order should be raised.
- At this point stores initiates purchase requisition
- It is between maximum & minimum level.
- Reorder level = maximum usage X maximum lead time
Minimum level:
- Lower limit of stock.
- Below this level stock of any stock item should not normally be allowed to fall.
- Also called safety or buffer stock level.
- Main object of establishing this level is to protect against stock-out of a stock-item.
- It is fixed by considering average rate of consumption and lead time.
- Minimum level =Recorder level (Av. or Normal usage X Av.or normal lead time
Maximum level
- Represents upper stock limit.
- Stocks not allowed to rise beyond this level.
- If the stocks go beyond this level, there is overstocking of materials &
- funds are blocked on which more interest is required to be paid.
Maximum level=Recorder level + Recorder Qty. or E.O.Q. (Min. usage X min. lead time)
Problems
(b) Max. level =(Recorder level) +(Recorder Quantity)-[Min. usage x Min. Re. period]
( P) = 600 + 350 - [ 30 x 4 ] = 830 units
(Q) = 400 + 600 - [ 30 x 2 ] = 940 units
(c) Min. level.= (Recorder level)-(Normal or av. usage x Normal or av. recorder period)
(P) = 600 - ( 65 x 5 ) = 275 units
(Q) = 400 - ( 65 x 3) = 205 units
E.O.Q. is that order Qty when. Ordering Cost = Carrying cost & Total Inventory Cost is
Minimum
E.O.Q. = 2AO / C
A = Annual Consumption
B = Ordering Cost per order
C = Carrying Cost per unit per year
No. of orders p.a. = Annual consumption / Ordered Quantity
Inventory Carried = Ordered Quantity / 2
Illustration 1 :
Annual consumption is 20,000 units. Purchase price per unit Rs. 100. Ordering cost per
order Rs. 1,000 inventory carrying cost per unit is 10% . Decide : E.O.Q.
Solution:
E.O.Q. = 2AO
C
A = Annual Consumption (units) = 20,000
O = Ordering Cost per order (Rs.) = 1,000
C = Carrying cost (Rs. ) = 10 [ 10% of 100 ]
Putting these valued in above formula
Ans.: EOQ = 100 Units and No of order per year = 18 order per annum
Illustration 3 :
From following information calculate:
(a) E.O.Q. (b) Annual carrying cost (c) Annual ordering cost
Annual consumption 3, 20,000 units
Price per unit Rs. 10
Carrying cost per unit is 10% .
Ordering cost per order Rs. 400
(b) Annual Carrying Cost = (Av. units in stocks) x (Carrying cost Per unit)
(c) Annual ordering Cost = (No. of orders) x (Ordering cost per order )
Illustration 4 :
Hemant Enterprises manufactures a special product TIM. The following particulars
were collected for the year 2014:
Illustration 5: Min. & Max. consumption is 25 & 75 units per week respectively. Reorder
quantity is 300 Units. Material is received within 4 to 6 weeks .
Calculate Max. Min. & Recorder level
Illustration 6: From following particulars calculate maximum, minimum, reorder & average
stock levels :
1) Cost of placing a purchased order Rs. 20
2) No. of unit sot be purchased during year 5,000
3) Annual cost of storage per unit Rs. 5
4) Lead time : Max. 15 days , Min. 6 days & average 10 days .
5) Consumption max. 20 units per day & average 15 units per day.
Just In Time
Major focus is on producing in response to needs of marketing rather than as per plans
& forecasts.
Instead of pushing inventory into the production system emphasis is on pull form
market
Also wastages during storage & due to over production are eliminated
Unit 4 : Overheads
Introduction
In every business two types of costs are involved, direct & indirect . Direct costs are
related to output but indirect costs i.e. overheads are incurred even if output is reduced
or there is no output.
It is thus important for management to pay more attention to overhead costs. In order
to control these costs it is necessary to classify properly allocate them on equitable
basis to different products, processes or activities. This unit deals with various aspects
of overhead accounting and control & their equitable allocation.
4.1 Meaning of Overheads
Where a cost can be clearly identified with a cost centre or cost unit, then it can be
allocated to that particular cost centre or cost unit. Allocation is the process by which
cost items are charged direct to a cost unit or cost centre.
Thus Allocation means charging overheads to particular product, process, or activity
Some costs cannot be identified as arising from the activities of one specific
department or function. Non allocable costs must be apportioned on some logical
basis to the cost centres. Thus Apportionment means division of overheads among
two or more cost centers or departments using appropriate base. Choice of base is a
matter of judgment with reference to particular circumstances of each company.
Following bases are generally used.
Personnel, Stores, Canteen etc. are service centers providing service to production
departments. Service departments may provide service to other service
departments & to itself. These overheads are also to be apportioned on the basis of
services taken by various departments.
Company
O/Hs
(100)
Primary Distribution
P1 P2 P3 S1 S2
(40) (20) (20) (12) (8)
secondary distribution
4.5 Absorption of Overheads
Process of distribution of overheads allocated to a particular department or cost
center over the units produced.
Done by applying overhead absorption rate
Rate = Budgeted or actual overheads / Budgets or actual Hours
Selling & distribution overheads rate is calculated with reference to sales
quantity or sales value.
Overhead absorption rate is useful to calculate overheads to be absorbed in a
particular product e.g. if overhead rate is Rs. 50 per labour hour & product
requires 3 labour hours, then overheads to be absorbed in product cost is 3x 50 =
Rs.150.
Predetermined overhead rates: These rates are determined in advance to be
applied in future period for product costing. At the end of the period actual
overheads are found and compared with overheads absorbed on basis of pre
determined rates & over / under absorbed overheads are determined to correct
pre-determined rate. At the end of year under & over absorbed overheads are
adjusted to costing P & L A/C.
Illustrations on Overheads
Illustration 1:
A,B,C are production departments &X,Y are service departments.
Overhead expenses for July,2007
Rent Rs. 12,000
Depreciation Rs. 50,000
Repairs Rs. 5,000
Traveling Rs. 15,000
Supervision Rs. 68,000
Other details:
Department A B C X Y
Area(sq.mtr.) 500 300 100 50 50
Machine cost(lacs) 5 2 2 1 -
Employee(Nos.) 10 5 20 5 10
No. of Hours. 200 150 100 - -
X [ distribution %] 20 30 40 - 10
Y [ distribution %] 40 20 30 10 -
Decide overhead absorption rate per hour
If direct material cost is Rs. 2,500 ,direct labour Rs.1,500 & direct expenses are
Rs.200 & product passes through Dept A for 0.5 hours, B for 1.2 hours & C for
1.5 hours decide cost of product.
Solution:
[ A ] Primary distribution of overheads
Expense Total Amt. Basis of Dept. A Dept.B Dept.C Dept.X Dept. Y
(Rs.) allocation (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
1.Rent 12,000 Area 6,000 3,600 1,200 600 600
2.Depreciation 50,000 m/c cost 25,000 10,000 10,000 5,000 -
3.Repairs 5,000 m/c cost 2,500 1,000 1,000 500 -
4.Traveling 15,000 Employees 3,000 1,500 6,000 1,500 3,000
5.Supervision 68,000 Employees 13,600 6,800 27,200 6,800 13,600
TOTAL 1,50,000 50,100 22,900 45,400 14,400 17,200
Working Notes:
Allocation :
1) Rent : Ratio is 500 : 300 : 100: 50 : 50 total
i.e. 5 : 3 : 1 : 0.5: 0.5
For Dept. A = 5/10 x 12,000 = 6,000
B = 3/10 x 12,000 = 3,600
C = 1/10 x 12,000 = 1,200
X = 0.5/10 x 12,000 = 600
Y = 0.5/10 x 12,000 = 600
2) Depreciation : Ratio is 5: 2: 2:1: - Total = 10
For A = 5/10 x 50,000 = 25,000
B = 2/10 x 50,000 = 10,000
C = 2/10 x 50,000 = 10,000
X = 1/10 x 50,000 = 5,000
Y = Nil
3) Repairs (same as above )
For A = 5/10 x 5,000 = 2,500
B = 2/10 x 5,000 = 1,000
C = 2/10 x 5,000 = 1,000
X = 1/10 x 5,000 = 500
Y = Nil.
4) Traveling :
Ratio 10:5 :20 :5 :10
For A = 10/50 x 15,000 = 3,000
B = 5/10 x 15,000 = 1,500
C = 20/50 x 15,000 = 6,000
X = 5/5 x 15,000 = 1,500
Y = 10/50 x 15,000 = 3,000
5) Traveling (same as above)
For A = 10/50 x 68,000 = 13,600
B = 5/50 x 68,000 = 6,800
C = 20/50 x 68,000 = 27,200
X = 5/ 50 x 68,000 = 6,800
Y = 10/50 x 68,000 = 13,600
[B] Secondary distribution of overheads
There are many methods of this distribution. We are going to use repeated distribution
method which is most logical .
A B C X Y
Total overheads 1,50,000 50,100 22,900 45,400 14,400 17,200
Distribution X 2,880 4,320 5,760 (14,400) 1,440
(as per given %)
Distribution Y 7,456 3,728 5,592 1,864 (18,640)
(as per given %)
Repeated distribution of X 373 559 746 (1,864) 186
(as per given %)
Repeated distribution of Y 74 37 56 19 (186)
(as per given %)
Repeated distribution of X 4 6 7 (19) 2
(as per given %)
Distribution of Y 1 - 1 - (2)
1,50,000 60,888 31,550 57,562 - -
NOTE : 1) In allocation figures are to be rounded off to nearest complete rupee & total is
to be adjusted accordingly
2) Do not continue process indefinitely . When small figure is left in service
departments it is logical allocated to production departments without
applying actual % ages given in problems.
[C] Deciding overhead absorption rate: Deptt.A Deptt B Deptt. C
Total overheads (Rs.) (a) 60,888 31,550 57,562
Total Hrs. worked (Nos.) (b) 200 150 100
Overhead Rate / Hour (Rs. [a/b] 304.44 210.33 575.62
[D] Deciding cost of a product , Amt. (Rs. )
Direct material 2,000
+ Direct labour 1,500
+ Direct Expenses 200
= Prime Cost (I) 3,700
Overheads in Deptts.
A - 304.44 x 0.5 152.22
+ B - 210.33 x 1.2 252.40
+ C - 575.62 x 1.5 863.43
= Total Overheads (II) 1,268.05
Total Cost (I + II ) 4,968.05
Problems :
1. Company has 3 production departments A, B and C and two service departments X &
Y , The following data are extracted from the records of the company for a particular
given period : Amt. Rs.
1. Rent and rates 25,000
2. General lighting 3,000
3. Indirect Wages 7,500
4. Power 7,500
5. Depreciation on machinery 50,000
6. Sundries 50,000
Addition Data, Department wise
Departments
Particulars Total A B C X Y
Direct wags (Rs.) 50,000 15,000 10,000 15,000 7,500 2,500
Horsepower of
Machines used 150 60 30 50 10 -
Cost of machinery 12,50,000 3,00,000 4,00,000 5,00,000 25,000 25,000
(Rs.)
Production hours - 6,226 4,028 4,066 -
Worked
Floor space used 10,000 2,000 2,500 3,000 2,000 500
(Sq. mt.)
Lighting points 60 10 15 20 10 5
(nos.)
Service Departments Expenses Allocation
Departments A B C X Y
X 20% 30% 40% - 10%
Y 40% 20% 30% 10% -
You are required to :
(a) Compute the overhead rate of production departments using the repeated
distribution method :
(b) Hence, determine the total cost of a product whose direct material cost and
direct labor cost are respectively Rs. 250 and Rs. 150 and which would
consume 4 hours , 5 hours and 3 hours in departments A, B & C
respectively.
2. Department A B C X Y
Overheads Rs. Lacs) 8 10 6 0.75 0.25
Overhead 20 40 30 - 10
Distribution(%) 30 30 30 10 -
Hours worked 2,000 2,000 2,000 - -
Decide overheads absorption rate per hour.
3. Company has manufacturing I , II & III & Service department S1, S2,. Details of
Overheads & its allocation & other particulars are : I II III S1 S2
Overheads (Rs. Lakhs) 5.0 10.0 8.0 1.0 1.50
Allocation (%) 30 40 20 - 10
20 30 30 20 -
Labour Hours 5,000 6,000 7,000
4. A company has two production departments A & B and two service departments S1 &
S2 . The budgeted expenses of the total company for 2005 is given below:
Supervision 24,00,000
Power 60,00,000
Electricity 12,00,000
Indirect wages 12,00,000
Administrative salaries 8,00,000
Depreciation of equipment 36,00,000
Depreciation of Building 36,00,000
Telephone expenses 6,00,000
Canteen expenses 8,00,000
Stores expenses 6,00,000
A B S1 S2
S1 60% 30% - 10%
S2 40% 50% 10% -
Reference Books: