S.V.Subrahmanyam M.Sc., ACMA, ACS,CAIIB Done Syllabus Today To do
• Introduction to cost accounting
• Introduction to cost concepts • Introduction to prime cost and overheads • Methods of cost accounting • Reconciliation and Integration Between Financial and Cost Accounts • Marginal costing • Budgets and budgetary control • Standard costing and variance analysis • Introduction to advanced cost management concepts Evaluation Criteria
S.no. Parameter Marks
1 MCQ 15 2 Assignment 10 3 Mid term test 20 4 Class test 15 Total 60 Table of Contents • Product costing • Job costing • Batch costing • Contract costing • Process costing • Operating costing • Preparation of cost sheet • Preparation of quotations Product Costing • Product costing methods may be grouped under the following 3 main categories: Specific order costing Continuous operation costing Service / function costing • Specific order costing is defined as the basic costing method applicable where work consists of separate contracts, jobs or batches each of which is authorized by a special order or contract. Job-order Costing • It is that form of specific order costing which applies where work is undertaken to customer’s specific requirements and each order is comparatively shorter duration. • The work is usually carried out within a factory or workshop and moves through processes and operations as a continuously identifiable unit. When is Job-order Costing relevant? • Manufacture of products to customer’s specific requirements. • Fabrication of certain materials where raw materials are supplied by customers. • Repairs are done within a factory or at customer’s premises. • Manufacturing goods for immediate delivery. • Internal capital expenditure jobs. Features of Job-order Costing • Production is generally against a customer’s order. • Each job is different and needs special treatment. • No uniformity in the flow of production from department to department. • Each job is treated as a cost unit. • Each job is identified by production order. • Cost of production of each job is ascertained at the completion of job. • WIP differs from period to period according to the number of jobs in hand. Advantages of Job-order Costing • Detailed analysis of cost of materials, wages and overheads used in the job order available. • Records costs more accurately. • To find out which job is profitable over others. • Provides basis for estimating cost of similar jobs taken up in future. • Establishes mechanism for budgetary control of overheads. • Wastage due to spoilage and defectives can be controlled. • Useful in quoting in cost plus contracts. • Determination of trends of cost possible. Disadvantages of Job-order Costing • Involves a lot of clerical work. • Scope of committing mistakes is high. • Cost comparison is difficult when drastic changes take place. • Determination of overhead rates requires budgeting of overhead expenses and bases of apportionment and absorption. • Job costing is a historical costing and cost is ascertained after it has been manufactured. Workflow for Job-order Costing • Receive an enquiry. • Estimation of the price of the job. • Receiving of order. • Issue of production order. • Recording of costs. • Completion of job. • Ascertain profit/loss on the job. Batch Costing • It is defined as that form of specific order costing which applies where similar articles are manufactured in batches, either for sale or for the use within the undertaking. • Cost is ascertained for collection of a lot of units which is called batch. • Separate cost sheets maintained for each batch of products by assigning a batch number. When is Batch Costing relevant? • Where the output of a job consists of a number of units. • Where customer’s requirements are to be supplied in uniform quantities over the period. • Where certain physical characteristics are required uniformly over a collection of units. • When an internal manufacturing order is made out for production of components / sub parts. Economic Batch Quantity • The optimum quantity for a batch is that quantity for which the setting up and carrying costs are minimum. • Such an optimum quantity is known as EBQ. • Factors influencing EBQ are, Set up cost Manufacturing cost Interest on capital Storage cost Rate of consumption Economic Batch Quantity • EBQ = √ (2*S*U)÷C where • Q is quantity or units of products • S is set up cost per batch • C is carrying cost per unit of production p.a • U is annual units of production Contract Costing • It is defined as aggregated cost relative to a single contract designated as a cost unit. • This usually applies to major long-term contracts. • It is that form of specific order costing which applies where work is undertaken to customer’s special requirements and each order is of long duration. • Contracts fall into 2 basic types: Fixed price contracts Cost plus contracts Features of Contract Accounts • Generally carried out at customer’s site. • Higher proportion of direct costs, low indirect costs (office expenses, stores, works etc.) • Problem of cost control and surplus materials. • Quite common to use sub-contractors for specialized work. • Separate account maintained for each contract. • The number of contracts undertaken by a contractor at a time is usually few. • The cost unit in contract costing is the contract itself. Usage of Plant and Machinery in Contracts • Two methods to charge P & M in contracts: Contract account debited with full value of the P & M and credited with depreciated value at the end. Contract account debited with an hourly rate of depreciation. Terms used in Contract Costing • Work-in-progress • Cost of work certified (value of work certified) • Cost of work uncertified • Progress payment • Retention money • Cash received • Notional profit • Estimated profit (excess of the contract price over the estimated total cost of the contract). Accounting in Running Contracts • Notional profit = Value of work certified – (Cost of work to date – Cost of work not yet certified). • Principles for taking notional profit in running contracts: Work completed is ≤25% - No transfer of profit to P & L. Work completed is >25% but <50% - Profit to be transferred to P & L is Notional profit*1/3*(cash received/work certified). Work completed is >50% but <90% - Profit to be transferred to P & L is Notional profit*2/3*(cash received/work certified). Accounting in Running Contracts Work completed is >90% but <99% - Profit to be transferred to P & L is Estimated profit*(work certified/contract price) * (cash received/work certified) Cost plus Contracts • Price will cover costs and profit. • Guarantees profit to the customer. • Avoids complex calculations due to cost escalations. • Customer is assumed of paying a reasonable amount of profit. • Avoids delay and chances of error in estimations. Escalation Clause • Escalation clause in a contract empowers a contractor to revise the price of the contract in case of increase in the prices of inputs due to some macro-economic or other agreed reasons. • This protects the contractor from adverse financial impacts and empowers the contractor to recover the increased prices. • As per this clause, the contractor increases the contract price if the cost of materials, employees and other expenses increase beyond a certain limit. • It is a risk mitigation measure for contractor. Process Costing • It 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”. • A separate account for each process is opened and all expenditure pertaining to a process is charged to that process account. Process Costing - Features • Each plant or factory is divided into a number of sub divisions and each such division is a stage of production or a process. • Manufacturing activity is carried on continuously by means of one or more process run sequentially, selectively or simultaneously. • Output of one process becomes the input of another process. • The end product usually is of like units not distinguishable from one another. • Tracing the identity of any particular lot of output to any lot of input materials not possible. • May give rise to Joint and/or By-Products. Treatment of Loss / Gain • Loss of material is inherent during processing operation. • 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. • There are two types of material losses: (i) Normal loss and (ii) Abnormal loss. Treatment of Loss / Gain • Normal Process Loss: It is defined as the loss of material which is inherent in the nature of work. It is unavoidable because of nature of the material or the process. It also includes units withdrawn from the process for test or sampling. • Treatment of Normal Process Loss in Cost Accounts: 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 Loss / Gain • Abnormal Loss: It is defined as the loss in excess of the predetermined loss (Normal process loss). Causes could be due to the carelessness of workers, a bad plant design or operation, sabotage etc. • Treatment of Abnormal Loss in Cost Accounts : 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 arises. The total cost of abnormal process loss is debited to costing profit and loss account. Equivalent Units • Equivalent units or equivalent production units, means converting the incomplete production units into their equivalent completed units. • Equivalent completed units = Actual number of units in the process of manufacture * % of work completed. Steps in Process Costing • Analyse the physical flow of production units. • Calculate equivalent units for each cost element. • Determine total cost for each cost element. • Compute cost per equivalent unit for each cost element. • Assign total costs to units completed and ending WIP. Inter-Process Profits • In some process industries the output of one process is transferred to the next process at market value or cost plus a percentage of profit. • The difference between cost and the transfer price is inter-process profits. • Advantages of Inter-Process Profits: Comparison between the cost of output and its market price at the stage of completion is facilitated. Each process is made to stand by itself as to the profitability. Inter-Process Profits • Disadvantages of Inter-Process Profits: The use of inter-process profits involves complication. The system shows profits which are not realised because of stock not sold out. Operating Costing • Also known as service costing. • It refers to cost of undertakings which do not manufacture any product but which provides services. • It is the cost of producing and maintaining a service. • It could be both for internal or external purpose. • Sometimes two measurement units are combined together to know the cost of service or operation which is called composite cost units. Operating Costing - Features • Deals with cost of repetitive services – not tangible products. • Resembles with unit costing. • Services are standardised. • Investment in fixed asset is high and working capital is low. • As fixed costs occupy major portion of total costs, economies of scale works favourably. Operating Costing – Cost Units • Weighted Average or Absolute basis – It is summation of the products of qualitative and quantitative factors. Eg.- To calculate absolute Ton-Km for a goods transport is calculated as follows.: ∑(Weight Carried × Distance)1 + (Weight Carried × Distance)2 +….+(Weight Carried × Distance)n • Simple Average or Commercial basis - It is the product of average qualitative and total quantitative factors. Eg. Commercial Ton-Km is calculated by ∑(Distance1 + Distance2 + …………...…+ Distancen) × (W1+W2+W3 -----+Wn)/n Operating Costing – Cost Units • Transport services • Passenger- km., or Ton- km • Electricity supply service • Kilowatt hour • Hospital • Patient per day, room per day or per bed, per operation etc. • Canteen • Per item, per meal etc. • Cinema • Per ticket per class Operating Costing – Cost Units • Hotels • Guest Days or Room Days • Bank or FIs • Per transaction, per services • Educational institutes • Per course, per student, per batch, per lecture etc. • IT and ITES • Cost per project, per module etc. • Insurance • Per policy, per claim Operating Costing – Statement of Cost • For preparing a statement of cost, costs are usually collected and accumulated for a specified period - A month, quarter or a year. • It could be either on the basis of functional classification or on the basis of variability. • Cost sheet on the basis of variability is prepared classifying all the costs into three different heads: Fixed costs or Standing charges Variable costs or Operating expenses Semi-variable costs or Maintenance expenses Service Costing Vs Product Costing • Unlike products, services are intangible and cannot be stored, hence, there is no inventory for the services. • Use of Composite cost units for cost measurement and to express the volume of outputs. • Unlike a product manufacturing, employee (labour) cost constitutes a major cost element than material cost. • Indirect costs like administration overheads are generally have a significant proportion in total cost of a service as unlike manufacturing sector. References
• Cost and Management Accounting by S.P Jain
and K.L Narang • Cost Accounting by Asish K. Bhattacharya • ICAI study material