Professional Documents
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We first classify costs according to the three elements of cost: Finally, within Product Costs, we have Conversion Costs: these are the costs
a) Materials b) Labour c) Expenses incurred in the factory that are incurred in the conversion of materials into finished goods.
Product and Period Costs: We also classify costs as either The classification of Period Costs:
1 Product costs: the costs of manufacturing our products; or
2 Period costs: these are the costs other than product costs that are charged to, The scheme shows five sub classifications for Period Costs. When we look at
debited to, or written off to the income statement each period. different organisations, we find that they have period costs that might have sub
classifications with entirely different names. Unfortunately, this is the nature of the
The classification of Product Costs: classification of period costs; it can vary so much according to the organisation, the industry
and so on. Nevertheless, such a scheme is useful in that it gives us the basic ideas to work
Direct costs: Direct costs are generally seen to be variable costs and they are called direct on.
costs because they are directly associated with manufacturing. In turn, the direct costs can
include: Administration Costs: Literally the costs of running the administrative aspects of an
organisation. Administration costs will include salaries, rent, Council Tax, electricity,
• Direct materials: plywood, wooden battens, fabric for the seat and the back, nails, water, telephone, depreciation, a potentially infinitely long list. Notice that there are costs
screws, glue. here such as rent, Council Tax, that appear in several sub classifications; in such cases, it
• Direct labour: sawyers, drillers, assemblers, painters, polishers, upholsterers should be clear that we are paying rent on buildings, for example, that we use for
• Direct expense: this is a strange cost that many texts don't include; but (International manufacturing and storage and administration and each area of the business must pay for its
Accounting Standard) IAS 2, for example, includes it. Direct expenses can include share of the total cost under review.
the costs of special designs for one batch, or run, of a particular set of tables and/or
chairs, the cost of buying or hiring special machinery to make a limited edition of a Without wishing to overly extend this listing now, we can conclude this discussion
set of chairs. by saying that the costs of Selling, the costs of Distribution and the costs of Research are all
accumulated in a similar way to the way in which Administration Costs are
Total direct costs are collectively known as Prime Costs and we can see that Product accumulated. Consequently, our task is to look at the selling process and classify the costs of
Costs are the sum of Prime costs and Overheads. running that process accordingly: advertising, market research, salaries, bonuses, electricity,
and so on. The same applies to all other classifications of period costs that we might use.
Indirect Costs: Indirect costs are those costs that are incurred in the factory but that cannot
be directly associate with manufacture. Again these costs are classified according to the Finance Costs: Finance costs are those costs associated with providing the permanent, long
three elements of cost, materials labour and overheads. term and short term finance. That is, within the section headed finance costs we will find
dividends, interest on long term loans and interest on short term loans.
• Indirect materials: Some costs that we have included as direct materials would be
included here. Finally, we should say that we can add any number of subclassifications to our
• Indirect labour: Labour costs of people who are only indirectly associated with scheme if we need to do that to clarify the ways in which our organisation operates. We will
manufacture: management of a department or area, supervisors, cleaners, also add further subclassifications if we need to refine and further refine out cost analysis.
maintenance and repair technicians
• Indirect expenses: The list in this section could be infinitely long if we were to try to
include every possible indirect cost. Essentially, if a cost is a factory cost and it has
not been included in any of the other sections, it has to be an indirect expense. Here
are some examples include:
3 4
COST SHEET – FORMAT Bad Debts ***
Cost of Sales (5) ***
Particulars Amount Amount Profit (balancing figure) ***
Opening Stock of Raw Material *** Sales ***
Add: Purchase of Raw materials ***
Add: Purchase Expenses *** Notes:-
Less: Closing stock of Raw Materials *** 1) Factory Over Heads are recovered as a percentage of direct wages
Raw Materials Consumed ***
Direct Wages (Labour) *** 2) Administration Over Heads, Selling and Distribution Overheads are recovered as a
Direct Charges *** percentage of works cost.
Prime cost (1) ***
Add :- Factory Over Heads:
Factory Rent ***
Factory Power *** MATERIAL
Indirect Material ***
Indirect Wages *** 1) Reorder level = Maximum usage * Maximum lead time
Supervisor Salary *** (Or) Minimum level + (Average usage * Average Lead time)
Drawing Office Salary ***
Factory Insurance *** 2) Minimum level = Reorder level – (Average usage * Average lead time)
Factory Asset Depreciation ***
Works cost Incurred *** 3) Maximum level = Reorder level + Reorder quantity – (Minimum usage *
Add: Opening Stock of WIP *** Minimum lead time)
Less: Closing Stock of WIP ***
Works cost (2) *** 4) Average level = Minimum level +Maximum level (or)
Add:- Administration Over Heads:- 2
Office Rent *** Minimum level + ½ Reorder quantity
Asset Depreciation ***
General Charges *** 5) Danger level (or) safety stock level
Audit Fees *** =Minimum usage * Minimum lead time (preferred)
Bank Charges *** (or) Average usage * Average lead time
Counting house Salary *** (or) Average usage * Lead time for emergency purposes
Other Office Expenses ***
Cost of Production (3) *** 6) EOQ (Economic Order Quantity - Wilson’s Formula) = √2AO/C
Add: Opening stock of Finished Goods *** Where A = Annual usage units
Less: Closing stock of Finished Goods *** O = Ordering cost per unit
Cost of Goods Sold *** C = Annual carrying cost of one unit
Add:- Selling and Distribution OH:- i.e. Carrying cast % * Carrying cost of unit
Sales man Commission ***
Sales man salary *** 7) Associated cost = Buying cost pa + Carrying cost pa
Traveling Expenses ***
Advertisement *** 8) Under EOQ Buying cost = Carrying cost
Delivery man expenses ***
Sales Tax ***
5 6
9) Carrying Cost = Average inventory * Carrying cost per unit pa * Carrying cost %
(Or) Average Inventory * Carrying cost per order pa c) Periodic simple average price method = Total unit price of certain period
Total Number of purchases of that period
10) Average inventory = EOQ/2 (This rate is used for all issues for that period. Period means a month (or) week (or) year)
11) Buying cost = Number of Orders * ordering cost d) Periodic weighted average price method = Total cost of certain period
Total Number of units of that period
12) Number of Orders = Annual Demand / EOQ e) Moving simple average price method
= Total of periodic simple average of certain number of periods
13) Inventory Turnover (T.O) Ratio = Material consumed Number of periods
Average Inventory
1) High Inventory T.O Ratio indicates that the material in the question is fast moving 4) Notional price method:-
2) Low Inventory T.O Ratio indicates over investment and locking up of working a) Standard price method = Materials are priced at pre determined rate (or)
Capital in inventories Standard rate
Pricing of material Issues:- b) Inflated price method = The issue price is inflated to cover the losses incurred
due to natural(or)climatic losses
1) Cost price method:-
a) Specific price method 5) Re use price method = When materials are returned (or) rejected it is valued at
b) First in First Out method (FIFO) different price. There is no final procedure for this method.
c) Last in First Out method (LIFO)
d) Base stock method ABC Analysis (or) Pareto Analysis :- In this materials are categorized into
1) Material received as replacement from supplier is treated as fresh supply 9) Abnormal spoilage should be charged to costing profit and loss a/c
5) FOB = Free on Board (Materials moving by sea – insurance premium is not 2) Payment by Results
paid)
a) Piece rate system
6) FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid i) Straight piece rate
by the company or purchase) ii) Differential piece rate
• Taylor system
7) For each receipt of goods = Goods Receipt note • Merrick system
8) For each issue of goods = Materials Requisition note (or) Material Issue note b) Group Bonus System
i) Budgeted Expenses
Accounting Treatment :- ii) Towne gain sharing scheme
iii) Cost efficiency bonus
1) Normal Wastage = It should be distributed over goods output increasing per unit iv) Priest man system
cost
c) Combination of Time and Piece rate
2) Abnormal Wastage= It will be charged to costing profit and loss a/c i) Gantt task and Bonus scheme
ii) Emerson Efficiency system
3) Sale value of scrap is credited to costing profit and loss a/c as an abnormal gain. iii) Point scheme
• Bedaux system
4) Sale proceeds of the scrap can be deducted from material cost or factory • Haynes manit system
overheads.
d) Premium bonus plans
5) Sale proceeds of scrap may be credited to particular job. i) Halsey premium plan
ii) Halsey weir premium plan
6) Normal Defectives = cost of rectification of defectives should be charged to iii) Rowan scheme
specific iv) Barth scheme
v) Accelerating premium bonus scheme
7) Abnormal Defectives = This should be charged to costing profit and loss a/c
9 10
e) Other incentive schemes vi) Halsey Weir Premium Plan = Basic wages + 30% of time saved * Hourly rate
i) Indirect monetary incentive
• Profit sharing vii) Rowan Plan = Basic wages + Time saved * Basic Wages
• Co-partnership Time allowed
ii) Non-Monetary Incentive
viii) Bedaus Point system = Basic wages + 75% * Bedaus point/60 * Rate/hr
1) Time rate system = Hours worked * Rate per hour (Basic wages) ix) Barth’s System = Hourly rate * √Std time *Time taken
i) Straight piece rate earnings = Number of units produced * Rate per unit 1) Separation rate method = Separation during the period
Average No. of worker’s during the period
ii) Differential Piece rate
2) Net labour T.O rate (or) Replacement method
a) F.W.Taylor’s differential rate system = Number of replacements
» 83% of piece rate when below standard Average No. of worker’s during the period
» 125% of piece rate when above or at standard
3) Labour flux rate = No. of separation + No. of replacement
b) Merrick differential or multiple piece rate system Average No. of worker’s during the period
i) Simultaneous equation method (or) Algebraic method k) Stores over heads = Direct material
• Equation is formed between service departments and is solved to find the amount
due. l) General over heads = Direct wages
ii) Repeated distribution method: Reapportionment of service department cost to production department :-
• Service department cost separated repeatedly till figure of service dept. is exhausted
or too small. 1) Maintenance dept. = Hours worked for each dept.
iii) Trial and Error method: 2) Pay roll and time keeping = Total labour (or) machine hours (or) Number of
• Cost of service department is apportioned among them repeatedly till the amount is employees in each department
negligible and the total is divided among production department.
3) Employment (or) Personnel department = Rate of labour T.O (or) No. of
Treatment of Over/Under absorption of overheads:- employees of each department
i) If under absorbed and over absorbed overheads are of small value then it should be 4) Stores Keeping department = No. of requisitions (or) value of materials of each
transferred to costing profit and loss a/c department
ii) If under and over absorption occurs due to wrong estimates then cost of product 5) Purchase department = No. of purchase orders value of materials of each
manufactured should be adjusted accordingly. department
iii) If the same accrued due to same abnormal reasons the same should be transferred 6) Welfare, ambulance, canteen, service, recreation room expenses
to costing profit & loss a/c = No. of employees in each department.
Apportionment of overhead expenses – Basis 7) Building service department = Relative area each dept.
a) Stores service expenses = Value of materials consumed 8) Internal transport service (or) overhead crane service
= weight, value graded product handled, weight and distance traveled.
b) Factory rent = Floor area
c) Municipal rent, rates and taxes = floor area 9) Transport department = Crane hours, truck hours, truck mileage,
Number of packages.
d) Insurance on Building and machinery = Insurable value
10) Power house (electric power cost) = Housing power, horse power machine hours,
e) Welfare department expenses No. of electric points etc.
2) Purely cost account items: - Notional Rent / Interest / Salary A job is “A customer order or task of relatively short duration”
Job costing is “A form of specific order costing; the attribution of cost to jobs”
3) Valuation of stock:-
Batch costing is not normally seen as much of an advance on job costing.
i) Raw-material = In financial a/c’s stock is valued at cost or market value
Whichever is less, while in cost a/c’s it is valued at LIFO, FIFO etc. A batch is A group of similar articles which maintains its identity throughout one or
more stages of production and is treated as a cost unit Batch costing is A form of specific
ii) Work in progress = In financial a/c’s administrative expenses are also order costing; the attribution of costs to batches.
considered while valuing stock, but in cost a/c’s it may be
valued at prime (or) factory cost (or) cost of production Economic Batch Quantity = EBQ = √2AS/C
Where A = Annual Demand
iii) Finished Goods = In financial a/c’s it is valued at cost or market price S = Setting up cost per batch
whichever is less, in cost a/c’s it is valued at total cost of production. C= Carrying cost / unit of production.
6) Abnormal Gains: In financial = Taken to profit & Loss a/c Particulars Un Rat Rs Particulars Un Rat Rs
In cost = Excluded to cost a/c’s or charged in costing it e . it e .
profit & Loss a/c To Direct material By Normal Loss
To Direct Labour By Units
To Indirect transferred
material to other process
To Other Expenses By Abnormal loss
JOB AND BATCH COSTING (B/F)
To Abnormal
With job costing, we are dealing with one off situations. We are dealing with gain(B/F)
organisations that carry out functions and services on a one at a time basis. Good examples Total Total
of job costing situations include jobbing builders: the builder who will provide a
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Format of Abnormal loss 5) FIFO Method: In these method total units transferred to next process includes
full opening stock units and the closing stock includes the units
Particulars Un Rs Particulars Un Rs introduced during the process. In this method the cost incurred
it . it . during the process is assumed as to be used
To Process By Sale of wasted
a/c units a) First to complete the units already in process
By costing P & L b) Then to complete the newly introduced units
a/c c) For the work done to bring closing inventory to given state of completion
Total Total
6) LIFO Method = Cost incurred in process is used for:
Format of Abnormal gain a/c
a) First to complete newly introduced units
Particulars Unit Rs Particulars Unit Rs
s . s . b) Then to complete units already in process in this method closing stock is
To Normal Loss By Process a/c (names of different divided into two :
a/c process) i) Units which represent opening stock but lie at the end of the period
To costing ii) Newly introduced units in closing stock.
P&la/c
Total Total 7) Average Method: In this method
a) No distinction is made between opening stock and newly introduced material.
1)To find the cost per unit for valuation of units to be trans. to next process and also
for abnormal, loss or gain = Total process cost – Salvage value of normal spoilage b) In finding cost per unit, cost incurred for opening stock is also to be added with
Total units introduced – Normal loss in units current cost. (This addition is not done in LIFO & FIFO method as cost
incurred in that process is only taken)
2) To find abnormal loss (or) gain (all in units):
= Units from previous process + fresh units introduced – Normal loss – units 8) Weighted average method: This method is only used when varied product in
transferred to next process (If the result is positive then abnormal loss. If processed through a single process. General procedure is adopted here.
negative then abnormal gain)
a) Statement of weighted average production should be prepared. Under this
3) In case of opening WIP and closing WIP are given then there are different statement output of each products is expressed in terms of points.
methods of valuation of closing WIP
i) FIFO Method ii) LIFO Method b) Cost of each type of product is computed on basis of Points.
iii) Average Method iv) Weighted Average Method
Points of vital importance in case of Abnormal Gain / Loss:
4) Various statements to be prepared while WIP is given:
i) Statement of equivalent production a) Calculate cost per unit by assuming there is no abnormal loss / gain
ii) Statement of cost
iii) Statement of apportionment of cost b) Cost per unit arrived above should be applied for valuation of both abnormal
iv) Process cost a/c Loss/gain units and output of the process.
Methods of apportioning joint cost over joint products : • Treat as other income in profit and loss a/c
1) Physical unit method = Physical base to measure (i.e.) output quantity is used to • Net Realizable value of Bi-product is reduced from cost of main product.
separate joint cost. Joint cost can be separated on the basis of ratio of output
quantity. While doing this wastage is also to be added back to find total quantity. • Instead of standard process, Standard cost or comparative price or re-use price is
credited to joint process a/c.
2) Average unit cost method = In this method joint cost is divided by total units
Produced of all products and average cost per unit is arrived and is multiplied
With number of units produced in each product.
OPERATION COSTING
3) Survey method or point value method = Product units are multiplied by points
or weights and the point is divide on that basis. Service costing is “A cost accounting method concerned with establishing the costs of
services rendered”. Service costing is also applied within a manufacturing setting.
4) Standard cost method = Joint costs are separated on the basis of standard cost set
for respective joint products. The Differences Between Product Costing and Service Costing?
• There may be very few, if any, materials to worry about
5) Contribution margin method = Cost are divided into two categories (i.e.) variable • Overheads will comprise the most significant portion of any costs of which, labour
and fixed. Variable costs are separated on unit produced. Fixed on the basis of costs may well comprise as much as 70%
contribution ratios made by different products.
No. Enterprise Cost per unit
6) Market value method:- 1. Railways or bus companies Per passenger-kilometer
2. Hospital Per patient/day, per bed/day
a) Market value at the point of separation: Joint cost to sales revenue percentage
3. Canteen Meals served , cups of tea
is found which is called as multiplying factor = Joint cost * 100
4. Water supply service Per 1000 gallons
Sales Revenue
5. Boiler House 1000 kg of steam
• Joint cost for each product is apportioned by applying this % on sales revenue
6. Goods Transport Per tonne km, quintal km
of each product.
7. Electricity Boards Per kilowatt – hours
• Sales revenue = Sales Revenue at the point of separation.
8. Road maintenance Per mile or road maintenance
• This method cannot be done till the sales revenue at the separation point is
department
given.
9. Bricks One thousand
10. Hotel Per room/day
b) Market value after processing: Joint cost is apportioned on the basis of total
sales Value of each product after further processing.
In this various terms such as passenger km, quintal km, tonne km, these are all
c) Net Realizable value method = Form sales value following items are deducted known as composite units and are computed in 2 ways:
i) Estimated profit margin
ii) Selling and distribution expenses if any included. a) Absolute (weighted average): (e.g.) tones km - Multiplying total distance by
iii) Post split off cost respective load quantity.
The resultant amount is net realizable value. Joint cost is apportioned on this basis.
b) Commercial (simple average): (e.g.) tonne Km–Multiplying total distance by
average load quantity
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All accumulated cost is classified into 3 categories: CONTRACT COSTING
1) Standing charges (or) fixed cost Contract costing is “A form of specific order costing; attribution of costs to individual
2) Running cost (or) variable cost contracts”.
3) Maintenance charges (or) semi variable cost
A contract cost is “Aggregated costs of a single contract; usually applies to major long term
Running charges = Fuel, Driver Wages, Depreciation, oil etc. contracts rather than short term jobs”.
Maintenance charges = Supervision salary, Repairs and Maintenance Features of long term contracts:
Note:- • By contract costing situations, we tend to mean long term and large contracts: such
• % of factory overheads on direct wages as civil engineering contracts for building houses, roads, bridges and so on. We
• % of administration overheads on works cost could also include contracts for building ships, and for providing goods and services
• % of selling & distribution overheads on works cost under a long term contractual agreement.
• % of profit on sales • With contract costing, every contract and each development will be accounted for
separately; and does, in many respects, contain the features of a job costing situation.
Operating cost sheet :- • Work is frequently site based.
Particulars Total cost Cost per km We might have problems with contract costing in the following areas
A Standing charges :-
License fees • Identifying direct costs
Insurance Premium • Low levels of indirect costs
Road tax • Difficulties of cost control
Garage rent • Profit and multi period projects
Driver’s wages
Attendant-cum-cleaner’s wages The source of the following has eluded me: my sincere gratitude for whoever the author
Salaries and wages of other staff might be.
Total
B Running charges :- "Contract Costing such jobs take a long time to complete & may spread over two or more of
Repairs and maintenance the contractor's accounting years”.
Cost of fuel (diesel, petrol etc.)
Lubricants, grease and oil Features of a Contract
Cost of tires, tubes and other spare parts
Depreciation • The end product
Total • The period of the contract
C Total charges [ (A) + (B) ] • The specification
• The location of the work
• The price
• Completion by a stipulated date
• The performance of the product
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Collection of Costs : Profit of Incomplete contract :-
Desirable to open up one or more internal job accounts for the collection of costs. If 1) When % of completion is less than or equal to 25% then full Notional profit is
the contract not obtained, preliminary costs be written off as abortive contract costs in P&L transferred to reserve.
In some cases a series of job accounts for the contract will be necessary:
• to collect the cost of different aspects 2) When % of completion is above 25% but less than 50% following amount should
• to identify different stages in the contract be credited to profit & loss a/c = 1/3 * Notional Profit * {Cash received / Work
certified}
Special features
3) When % of completion is more than or equal to 50% then the amount transferred
• Materials delivered direct to site. to profit is = 2/3 * Notional Profit * {Cash received / Work certified}
• Direct expenses [Balance is transferred to reserve a/c]
• Stores transactions. ☺ % of completion = {Work certified/Contract price} * 100
• Use of plant on site
4) When the contract is almost complete the amount credited to profit & loss a/c is
Two possible accounting methods:
a) Estimated total profit * {Work certified / Contract price}
Where a plant is purchased for a particular contract & has little further value to the business b) Estimated total profit * {Cash received / Contract price}
at the end of the contract c) Estimated total profit * {Cost of work done / Estimated total profit}
Where a plant is bought for or used on a contract, but on completion of the contract it has d) Estimated total profit*{Cost of work done*Cash received
further useful life to the business Estimated total cost * Work certified}
Alternatively the plant may be capitalised with Maintenance and running costs charged to
the contract." 5) Work-In-Progress is shown in Balance Sheet as follows:-
(Specify)
23 24
6) Escalation Clause = This is to safeguard against likely change in price of cost 10) Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit
elements rise by and certain % over the prices prevailing at the time tendering the
contractee has to bear the cost. 11) Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio
1) Sales = Total cost + Profit = Variable cost + Fixed cost + Profit = Change in Fixed cost (in Rs.)
Change in P/Ratio
2) Total Cost = Variable cost + Fixed cost
= Change in Fixed cost (in Rs.)
3) Variable cost = It changes directly in proportion with volume Change in Variable cost ratio
4) Variable cost Ratio = {Variable cost / Sales} * 100 15) Shut down point = Point at which each of division or product can be closed
5) Sales – Variable cost = Fixed cost + Profit = Maximum (or) Specific (or) Available fixed cost
P/V Ratio (or) Contribution per unit
6) Contribution = Sales * P/V Ratio If sales are less than shut down point then that product is to shut down.
Note :-
Labour :-
i) Actual margin per unit (AMPU) = Actual sale price – selling cost per unit
SR*ST SR*AT (paid) SR*RST AR*AT SR*AT(worked)
(1) (2) (3) (4) (5) ii) Budgeted margin per unit (BMPU) = Budgeted sale price – selling price per unit
c) Material usage variance = SP (SQ – AQ) c) Standard OH = Standard hrs for actual output * Standard OH rate per hour
d) Material mix variance = SP (RSQ – AQ) d) Absorbed OH = Actual hrs * Standard OH rate per hour
e) Material yield variance = (AY – SY for actual input) Standard material cost per e) Budgeted OH = Budgeted hrs * Standard OH rate per hour
unit of output
f) Actual OH = Actual hrs * Actual OH rate per hour
f) Material revised usage variance (calculated instead of material yield variance)
= [standard quantity – Revised standard g) OH cost variance = Absorbed OH – Actual OH
for actual output quantity ] * Standard price
Variable Overheads variance :-
Labour :-
a) Variable OH Cost Variance = Standard OH – Actual OH
a) Labour Cost variance = SC – AC = (SH*SR) – (AH*AR)
b) Variable OH Exp. Variance = Absorbed OH – Actual Variable OH
b) Labour Rate variance = AH (SR - AR)
c) Variable OH Efficiency Variance = Standard OH – Absorbed OH
c) Labour Efficiency or time variance = SR (SH –AH) = [Standard hours for – Actual * Standard rate
actual output hours] for variable OH
d) Labour Mix or gang composition Variance = SR(RSH-AH)
Fixed Overheads variance :-
e) Labour Idle Time Variance = Idle hours * SR
a) Fixed OH Cost Variance = Standard OH – Actual OH
f) Labour Yield Variance = [Actual Output – Standard output for actual input]
* Standard labour cost/unit of output b) Fixed OH expenditure variance = Budgeted OH – Actual OH
g) Labour Revised Efficiency Variance (instead of LYV) = c) Fixed OH Efficiency Variance = Standard OH (units based) – Absorbed OH
[Standard hours for actual output – Revised standard hours] * Standard rate (Hours based)
Verification :- d) Sales margin mix variance = Standard profit – Revised Standard profit
= {Actual quantity – Revised standard quantity} * Standard profit per unit
i) Variable OH cost variance = Variable OH Expenditure + Variable OH Efficiency
variance variance e) Sales margin quantity variance = Revised standard profit - Budgeted profit
= {Revised standard quantity – Budgeted quantity} * Standard profit per unit
ii) Fixed OH cost variance = Fixed OH Expenditure variance + Fixed OH volume
variance STANDARD COSTING
iii) Fixed OH volume variance = Fixed OH Efficiency + Capacity + Calendar Diagrammatic Representation: -
Variance variance variance Material Variance: -
Sales variances :-
d) Sales mix variance = [Actual quantity – Revised standard quantity] * Standard Labour Variances:-
price
= Standard sales – Revised sales
Profit method:-
a) Total sales margin variance = (Actual Profit–Budgeted price) Labour Cost variance = SC – AC = (SH*SR) – (AH*AR)
= {Actual quantity * Actual profit per unit}-
{Budgeted quantity * Standard profit per unit}
31 32
Fixed Overhead Variance : -
a) Standard OH = Standard hrs for actual output * Standard OH rate per hour
Revised Budgeted Hour (Budgeted hours for actual days) = Actual days * Budgeted hours
per day
ii) Production Overhead a/c Dr Selling & Distribution Overhead Suspense a/c Dr
Administrative Overhead a/c Dr To Selling & Distribution Overhead a/c
Selling & Distribution Overhead a/c Dr
To Wage control a/c g) In case the Under/Over absorbed overheads are transferred to costing profit & loss
a/c then the relevant entries are:
c) Direct Expenses on a particular job i) For Over recovery: Production Overhead a/c Dr
Job a/c Dr To Costing Profit & Loss a/c
To Cost ledger control a/c
ii) For Under recovery: Costing Profit & Loss a/c Dr
Overheads:- To Administration Overhead a/c
d) Administrative Overhead recovered from finished goods The main accounts which are usually prepared when a separate cost ledger is maintained is
Finished goods ledger control a/c Dr as follows:-
To Administrative Overhead a/c
i) Cost ledger control a/c
37 38
ii) Stores ledger control a/c iii) If no market for Intermediate product
iii) Work-in-progress control a/c Cost of supplying division of optimum level
iv) Finished goods control a/c (-) Cost of the supplying division at previous output level.
v) Wage control a/c Difference in Output
vi) Manufacturing/Production/Works Overheads a/c
vii) Administrative Overhead a/c (This would be equal to Variable cost when Fixed Cost is same at all levels)
Viii) Selling & Distribution Overhead a/c
ix) Cost of sales a/c Note:-
x) Costing profit & loss a/c
i) Ignore Variable Selling expenses on Inter Department Transfer
Transfer Pricing ii) In case of (ii) above If selling expenses is not given we have to assume some % as
selling Expenses but it should not exceed 5% .
A transfer price is the amount of money that one unit of an organisation charges for
goods and services to another unit of an organisation. Budgetary Control
One of the key aspects here is that a transfer price is equivalent to an ordinary selling Budget Ratios:-
price and that any department or division that sets a transfer price is effectively selling its
goods and services at a profit or a loss to another department or division within its 1) Capacity usage Ratio
organisation. Any part of an organisation using transfer pricing will be classed as a profit = . Budgeted Hours . * 100
centre: since it is operating with a view to making a profit (whether positive, profit, or Maximum possible working hours in budget period
negative, loss). If goods and services are transferred between departments and divisions at
cost, then no profit or loss arises and the issue of transfer pricing does not, or should not, 2) Standard Capacity Employed Ratio
arise. = Actual Hours Worked * 100
Budgeted hours
Organisations have a system of transfer pricing, therefore, in order to assess the
efficiency and effectiveness of its department and divisional managers. This maybe in spite 3) Level of Activity Ratio
of the fact that transfer prices may be artificial in the sense that it is felt that there is no = Standard Hours for Actual Production * 100
rationale for “selling” between departments and divisions. Standard Hours for Budgeted Production
In Traditional Method we split the Over Head incurred in production, based on Sunk costs: Past costs, not relevant for decision making
machine hours which are not acceptable for many reasons.
Committed costs: This is future in nature but which arise from past decisions, perhaps as
In ABC method Over Head are splited according to the related activity, for each type the result of a contract.
of Over Head. Overhead are apportioned among various Production cost centers on the basis
of Activity cost drivers. Relevant Costs: Problem areas:
Relevant Costing - some theory 1 Problems in determining the relevant costs of materials:
Introduction: -
When considering various decisions, if the any materials required is not taken from
A management decision involves predictions of costs & revenues. Only the costs and existing stocks but would be purchased on a later date, then the estimated purchase price
revenues that will differ among alternative actions are relevant to the decision. The role of would be the relevant material cost. A more difficult problem arises when materials are
historical data is to aid the prediction of future data. But historical data may not be relevant taken from existing stock. In this situation the relevant cost of materials for a particular job
to the management decision itself. Qualitative factors may be decisive in many cases, but to (say job X) depends on
reduce the number of such factors to be judged, accountants usually try to express many Material is in regular use of the company
decision factors as possible in quantitative terms. Material is not in regular use of the company
Material is in short supply.
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If the material is in regular use of the company then the material taken from existing PROBLEMS
stock requires replacement for the purpose of regular use therefore the relevant cost of
material will be the Replacement cost. 1. In a firm, material A has no alternative uses and 200 units of which lie in stock. The
information below has been collected. You are required to find the relevant price of 120
If the material is not in regular use of the company the relevant cost of the materials units and 250 units respectively.
depends on their alternative use. The alternative use of the materials will be either to sell Book value Current price Sale price obtainable
them or to use them on other jobs. Hence the cost of using the materials results in an Rs.2 per kg Rs.3 per kg Rs.2.80 per kg
opportunity cost consisting of either
2. Assume in the above problem the material is in regular use of the company
The net sales revenue if the materials were sold (or) The expense that would be avoided if
the materials were used on some other job Whichever is greater. 3. Assume in the above problem the material is in short supply and it is not possible to
obtain the stock of material for some more time. At present the material is used in another
If the material is in short supply the only way material for the job under product on which a contribution at the rate of Rs.1 O/unit is earned (aftr meeting the
consideration can be obtained is by reducing production of some other product / job. This material cost). Each unit of the product requires1 KG of Raw material A.
would release material for the order. but the reduced production will result in loss of
contribution which should be taken in to account when ascertaining the relevant costs for the Cash and fund flow statement
specific order. Therefore the relevant cost will be Contribution lost (before the material cost
since the material cost will be incurred in any case) will be the relevant cost. Rules for preparing schedule of changes in working capital :-
labour:
Increase in a current asset, results in increase in working capital – so Add
2 Determining the direct labour that are relevant to short - term decision depends on the Decrease in current asset, results in decrease in working capital – so Decrease
circumstances. Increase in current liability, results in decrease in working capital – so Decrease
Decrease in current liability results in increase in working capital – so Add
Where a company has temporary sparse capacity and the labour force is to be
maintained in the short - term, the direct labour cost incurred will remain same for all Funds from operations – Format
alternative decisions. The direct labour cost will therefore be irrelevant for short - term
decision - making purposes. Particulars Rs. Rs.
However where casual labour is used and where workers can be hired on a daily Net profit ***
basis; a company may then adjust the employment of labour to exactly the amount required Add : Depreciation ***
to meet the production requirements. The labour cost will increase if the company accepts Goodwill written off ***
additional work, and will decrease if production is reduced. In this situation the labour cost Preliminary Exp. Written off ***
be a relevant cost for decision - making purposes. Discount on share written off ***
Transfer to General Reserve ***
In a situation where full capacity exists and additional labour supplies are Provision for Taxation ***
unavailable in the short - term, and where no further overtime working is possible, the only Provision for Dividend ***
way that labour resources could then be obtained for a specific order would be to reduce Loss on sale of asset ***
existing production. This would release labour for the order. but the reduced production Loss on revaluation of asset *** ***
will result in loss of contribution, which should be taken in to account when ascertaining the ***
relevant costs for the specific' order. Therefore the relevant cost will be Contribution lost Less : Profit on sale of asset ***
(before the labour cost) will be the relevant cost. Profit on Revaluation of *** ***
asset
Fund flow statement ***
43 44
Fund flow statement
Notes : - Remarks : -
• Quick Asset = Current Asset – Stock • In debt equity ratio higher the debt fund used in capital structure, greater is the risk.
• Quick Liability = Current liability – Cash credit, Bank borrowings, OD and other • In debt equity ratio, operates favorable when if rate of interest is lower than the
Short term Borrowings. return on capital employed.
• Secured loan is a current liability and also come under cash credit • In total liability to Net worth Ratio = Lower the ratio, better is solvency position of
• Sundry debtors considered doubtful should not be taken as quick asset. business, Higher the ratio lower is its solvency position.
• Creditors for capital WIP is to be excluded from current liability. • If debt equity ratio is comparatively higher then the financial strength is better.
• Current asset can include only marketable securities.
• Loans to employees in asset side are long term in nature and are not part of current D) Profitability Ratio : -
assets.
• Provision for gratuity is not a current liability. 1) Gross Profit Ratio = Gross Profit * 100
• Gratuity fund investment is not a part of marketable securities. Sales
• Trade investments are not part of marketable securities.
2) Net Profit Ratio = Net Profit * 100
Remarks : - Sales
• Higher the current ratios better the liquidity position.
3) Operating Profit ratio = Operating profit * 100
Sales
C) Capital structure ratios : -
4) Return to shareholders = Net profit after interest and tax
1) Debt equity ratio = Debt = External Equity = Long term debt = Share holders fund
Share holders fund
(or) Leverage ratio Equity Internal Equity Long term fund Long term fund
Step 1: Check whether the problem is balanced or unbalanced by checking 2. For maximation problem the constraints would be < sign.
whether row is equal to column, if unbalanced add dummy column or For minimization problem the constraints would be > sign.
row to balance the problem
3. Introduce slack variable
Step 2: Identify Least Number in each row and subtract with all number in that For < sign – add the slack variable ie. Add S1
Row. For > sign – subtract the slack variable and add artificial variable
ie. Subtract S1, add A1.
Step 3: Identify least number of each column and subtract with all number in that
column. 4. Change the Objective function
For S1 – Add ‘0S1’
Step 4: Check whether solution is reached with zero selection in one row and For A1 – Add ‘MA1’
column, ie. Cover all the zero with minimum number of lines, solution is
reached only when selected zeros is equal to number of rows or columns 5. Simplex table format:-
or number of lines is equal to order of matrix.
Cj
Quantity Variable Const. X Y Z S1 S2 RR
Step 5: If solution is not reached so maximum sticking
S1
Step 6: Select the least element in within the unstriked Element S2
Zj
Step 7: The element selected above is Cj -
i) Subtracted with all the unstriked element Zj
ii) Added to all the double striked element (Intersection of two lines) Zj is arrived by summation of constant column with X,Y,Z columns
Step 8: Check the solution 6. Criteria for selecting the key column :-
For Maxima ion Problem – Highest value of Cj – Zj
Step 9: If solution is not reached continue with the process from step 5. For Minimization Problem – Lowest Value of Cj – Zj
11. If solution is not reached next table is formed. 5. From the entire Row or Column minimum is selected.
12. Input for next table is 6. Strike the row or column which gets eliminated.
First key row in the next table is filled by dividing all the numbers in the key row of
the previous table with the key element. 7. Continue until the entire item in the table is strike.
Remaining all the rows is arrived as follows: -
Corresponding previous _ (Value relating to that * Corresponding 8. Write separately Initial solution table.
Table row element row in the key column element in key row
in the 2nd table as 9. Check for Degeneracy. Degeneracy occurs when all the elements in the initial
filled in previous step) solution is equal to (Row + column – 1)
13. Check the optimal solution, if not reached form the third table. 10. If degeneracy occurs introduce efcilon – ‘e’. ‘e’ is introduced in least independent
cell.
14. If solution is reached then answer is amount in quantity column corresponding to the
variable. 11. Form UV Matrix. It is formed by the element in the original solution corresponding
to the element in the Initial solution.
Other Points : -
12. Find unalloted elements in the UV Matrix
• We can convert the Minimization Problem into Maximation Problem. This is known
as duality. 13. Find Ij i.e.(Original Matrix element – Unalloted element found above)
• We can change the > sign to < sign to match the problem 14. Check for optimal solution ie. All items must be zero or positive.
E.g. X + Y < 100
is converted into -X - Y > -100 15. If not reached select the maximum negative in Ij matrix.
• Steps for the problem is : - 1. If there is zero in Ij matrix while arriving at optimal solution then there is another
solution for the problem.
1. Convert profit matrix into loss matrix.
2. Dummy column can be introduced in profit or loss matrix.
2. Balance the problem.
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3. If there is penalty/redundancy payment for unsatisfying demand etc. is given then 4. Find total float
fills the dummy row or column with that amount or fill it with zeros.
5. Find free float. Wherever total float column has zero free float column is also taken
4. If there is constraint in the problem first satisfy the constraint and then solve. has zero and remaining elements is filled as said above
5. various other methods for solving the problem is 6. Find Independent float. Wherever free float column has zero Independent float
• Least cost method column is also taken has zero and remaining elements is filled as said above
• North west corner rule
Notes: -
6. Generally VAM method is used 1. ES = Earliest Start. Indicates earliest time that the given activity can be scheduled
Network Analysis (CPM/PERT) 2. EF = Earliest Finish. Time by which the activity can be completed at the earliest.
CPM
3. LF = Latest Finish. Latest allowable occurrence time of the head event of the
• Total float = LS – ES (or) LF – EF activity.
• Independent float = Free float – Tail event slack 5. Total duration of the critical path is the maximum time/amount consumed for the
activity. This should be crashed with respect to crashing days and crashing cost. This
• In the diagram Es = Lf in the critical path crashing should not change the critical path.
PERT : -
• Critical path is the longest duration
• Expected (or) Average time is found by assigning weights as follows : -
• To find the minimum time associated cost (i.e. Additional cost incurred per unit of
time saved) following formula is used :- 1 for optimistic
4 for Most likely
Crash cost per day (or) Activity cost supply
1 for pessimistic
= Crash cost – Normal cost
Average time = 1 optimistic + 4 most likely + 1 pessimistic
Normal time – Crash time
6
• Interfacing float = It is the part of the total float which causes reduction in the float • Standard Deviation = (Pessimistic time – Optimistic time)
of the succession activities. In other words it is the portion of activity float which 6
cannot be continued without affecting adversely the float of the subsequent activity • Variance = (Standard Deviation)2
or activities.
• Probability of completing the project in N days
• Steps in proceeding the problem : - = Required time(N) (-) Expected time (critical path duration)
Standard Deviation
2. First find and fill the ES and LF column from the diagram. [Nothing but Z = (X - Mean) / Standard deviation]
= Y (say)
3. Then find LS and EF as follows :- = Find Z(y)
Ls = Lf – Duration = Probability %
Ef = Es + Duration - If required time > Expected time then = 0.5 + Z(Y)
- If required time < Expected time then = 0.5 – Z(Y)
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Learning Curve Spread Rate = Offer Rate – Bid Rate
Learning is the process of acquiring skill, Knowledge, and ability by an individual. Spread Rate (%) = Offer Rate – Bid Rate * 100 (111lr to that of NP Ratio)
According to learning curve theory the productivity of the worker increases with increase in Offer Rate
experience due to learning effect. The learning theory suggests that the best way to master a
task is to “learn by doing”. In other words, as people gain experience with a particular job or Swap points is ascending stage it is at premium. If it is descending stage it is at
project they can produce each unit more efficiently than the preceding one. discount.
The speeding up of a job with repeated performance is known as the learning effect If it is said as INR/$ then the meaning is
or learning curve effect. • Numerator factor = Local Currency = INR
• Denominator factor = Foreign Currency = $
The cumulative average time per unit produced is assumed to fall by a constant
percentage every time the total output is doubled. So generally learning effect is found in the Forward Quotation (%) (I.e. Premium/Discount expressed at annualized %)
multiples of 2. If learning curve effect is asked between two even numbers then Learning = Forward Rate – Spot Rate * 12 * 100 (in months)
curve equation is formed ie. Learning curve effect is expressed mathematically as follows: Spot Rate n
Learning curve equation = = Forward Rate – Spot Rate * 365 * 100 (in days)
Y = a(x) -b Where Y = Average time per unit Spot Rate n
a = Total time for first unit
x = Cumulative number of units manufactured If the quote is direct or Indirect is to be found and the relation is with £ (pound) both
b = the learning curve index direct and Indirect quote is to be said.
Learning curve index (b) = log (1- % decrease) Maturity Value = P (1+r) n
Log 2
Interest Rate Parity:
Management Accounting and Financial Analysis i) Domestic Rate < Foreign Rate + Forward Premium / Discount
(In this case invest in foreign currency)
International Financial Management ii) Domestic Rate > Foreign Rate + Forward Premium / Discount
(In this case invest in Domestic Currency)
1. Direct Quote (eg) 1$ = Rs.49
Forward Rate: It is rate negotiated for the delivery to be made / taken on a future date for
2. Indirect Quote (eg) Rs.1 = .0204$ present transaction.
3. TT Rate = Telegraphic Transfer Rate Future spot rate: It is actual rate prevailing on the agreed future date.
Note:- Call Option: - Gives buyer “Right but not the obligation” to buy the share.
i) In certainty Equivalent approach rate of discount is the risk less rate of Interest as Put Option: - Gives buyer “Right but not the obligation” to sell the share.
the risk is adjusted with CFAT.
ii) In this case CFAT is multiplied with certainty equivalent and PV is calculated by Value of the Call Option:-
risk less rate of interest. i) Black Scholes Model:-
iii) If projects are ranked with respect of risk and return. Project with respect Value of the call option = VO
= [S * N (d1)] – [(x) * (e-t*rf) * (N (d2))]
to risk requires ∑ NPV (i.e. ∑(NPV * Probability)) and the project with respect Where d1 = ln (s/x) + (rf + { 2 / 2}) * t
to
√t
return find co-efficient Of variation = / NPV
ln = Natural log
∑
d2 = d1 - √t
s = Present spot rate
iv) Probability that NPV would be Zero or less
x = Future strike (excise) price
Z = 0 – NPV The Z Value is converted with the ‘Z Table’
rf = Risk free rate
values and the probability of the NPV being
zero or less would be = 0.5 – (Z Value). Seven step to solve the problem:-
v) Probability that NPV being greater than Zero would be i) Find log (s/x)
1 – (Probability less than Zero) ii) Find d1
iii) Find d2
vi) Probability that NPV within the range X and Y iv) Find N (d1)
Z1 = X – NPV Z2 = Y – NPV v) Find N (d2)
iv) Find N (d1) Normal Table Value
vii) If in the Risk adjusted Discount approach both cost of control and Risk adjusted v) Find N (d2) + 0.5
discount rate is given
• For the CF of the years apply Risk adjusted discount rate to find Discounted vi) Find ‘e’ value
CF. vii) Apply Black Schools Model.
• For the Scrap value of the machine after the end of the life the CF on sale is
discounted at cost of capital % to find Discounted CF. Sub step to step 1:-
viii) If probability (or) Certainty equivalence is given then find the Adjusted a) Log (s/x) = Log s – Log x
CF (CF * Probability) and then use the Risk less Rate of return to find Discounted CF. 0.4343
b) If x and s are 2 digit figure the value shall be (1 + Log table value).
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c) If x and s are 3 digit then the value shall be (2 + Log table value). Note:-
Sub step to step 6:- i) Changes to be made in computation of Black Scholes model for dividend stocks:-
a) It is to find the power value of ‘e’. Substitute in all the places of “s” with “s – PV of dividend”
b) e-t*rf = 1 (or) 1 . ii)In the above all PV is found at Risk free rate.
1 + r/365 * No. of days (t) 1 + r/365 * No. of Months (t)
Beta
Value of Put option: -
= [(x) * (e-t*rf) * (N (-d2))] - [S * N (-d1)] Beta means, it measures the volatility of securities to the changes in the market.
probability. β should always be applied on risk premium and not to the entire return.
Expiration value: - Excise price – Expected Value rs = rf + (rm – rf ) * β Where rf = Risk free rate
rs = Expected return on securities (or) [Capital
Expected (or) Theoretical value of the call option price at expiration (Pay off of Call Appreciation + Dividend of the company]
option):- rm = Expected return on market portfolio (or)
[Market index {Market rate} appreciation + Market dividend yield %]
= ∑ (Estimated market price – Excise Price) * Probability (or)
= [Max (s – x), 0] * Probability Portfolio Theory (PT):-
Pay off of call option rp (expected return under CML) = rf + (rm – rf) * ( p / m)
The above formula is based on total risk.
Expected (or) Theoretical value of the put option price at expiration (Pay of put option):- Where p = SD of efficient portfolio.
= ∑ (Excise Price - Estimated market price) * Probability (or) When expected return under efficient portfolio is asked then
= [Max (x – s), 0] * Probability rp (expected return under efficient portfolio) = Capital market line(CML) –
Express equilibrium price relationship between expected return and DS
Pay off of Put option
Capital Asset Pricing Model (CAPM):-
Where (Estimated market price – Excise Price) is called pay off. If it is negative it is taken rs (expected return portfolio in CAPM) = rf + (rm – rf) * [( s / m)*
as zero. cor(s,m)]
s = Estimated Market Price. (or) rf + [(rm – rf)] * β
Put call parity = Put call parity equation is Where rm = rf + Market premium
(Value of call option + Present value of excise price) = (value of put option +
Spot rate) Beta of the portfolio = ( βa * Pa ) + ( βb * Pb )