Professional Documents
Culture Documents
MANAGEMENT
ACCOUNTING
Published by
Symbiosis Center for Distance Learning,
Pune.
2005 Batch
PREFACE
Failure of majority of the industrial undertakings is mainly attributable to the lack of awareness
about the wrong financial decisions affecting the business, particularly accounting and costing
decisions. The crux of wrong financial decisions is that the implications of the wrong financial
decisions are not realized immediately, and by the time they are realized, it is too late. As
such, it is most important to take proper financial decisions at proper point of time. For this,
clear understanding of basic financial and costing principles is a must for everybody.
My objective of writing this book is to introduce the basic concept of financial and cost accounting
in the simplest possible language to the readers. I have attempted to explain the basic concepts
with the help of examples and illustrations. Good number of problems have been incorporated
for self-study.
I am thankful to Symbiosis Center for Distance Learning and particularly to Ms. Swati Chaudhary,
Director, SCDL, for providing me this opportunity to reach out to a very wide spectrum of
readership.
All the efforts have been done to make the text free of errors. Still, I don’t rule out the possibility
of some omissions. I will be obliged if such omissions can be pointed out and intimated so
that necessary modifications can be done in the subsequent editions.
Prof. Satish Inamdar is holding a Master’s Degree in Commerce and Bachelor’s Degree in
Law. He is fellow Member of the Institute of Chartered Accountants of India, Graduate Member
of The Institute of Cost & Works Accountants of India and Associate Member of The Institute
of Company Secretaries of India. He is associated with the industry for the last two decades
in various senior capacities. For the past fifteen years, he is associated with Symbiosis
Institute of Business Management as a Faculty of Finance. He has conducted Management
Development Programmes and Executive Development Programmes for various private sector
and public sector organisations. He has authored three books on the subjects like Cost &
Management Accounting and Financial Management. He is Charter Member of Rotary Club
of Pune, Kothrud.
CONTENTS
Chapter Page
No. TITLE No.
1 Introduction 1
a) Streams of Accounting - Financial, Cost and
Management
b) Definition, Objects and Scope of Management
Accounting
c) Disadvantages/Limitations of Management Accounting
d) Comparison with Financial and Cost Accounting
3 Process of Accounting 35
a) Journalising, Posting, Control Ledgers, Balancing of
Accounts, Preparation of Final Accounts
b) Illustration with Solutions
c) Problems for Students to Solve
A business is an activity carried out with the intention of earning the profits. A person carrying
out the business is interested in knowing basically two facts about his business -
(a) What is the result of operations of the business activity? In other words, whether the
business has resulted into the profit or loss? Excess of revenue over the expenses will
be in the form of profits whereas excess of expenditure over the revenue will be in the
form of loss.
(b) Where the business stands in financial terms at any given point of time.
Providing the answers to the above questions is not possible unless the transactions relating
to the business are recorded in a systematic manner. Here the process of accounting comes
into the picture. According to American Institute of Certified Public Accountants, “Accounting
is the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are of a financial character and interpreting the results
thereof.” The process of recording the business transactions in a defined set of records, which
in technical words are called as Books of Accounts, is referred to as Book Keeping. Accounting
refers to the process of analyzing and interpreting the information already recorded in the
books of accounts with the ultimate intention of answering the above stated questions.
This intention is satisfied by preparing what are called as Financial Statements. The financial
statements prepared by the organization are basically in two forms-
(a) Profitability Statement, which is the answer to the first question i. e, what is the result of
operations of the business activity. Thus, profitability statement indicates the amount of
profit earned or the amount of loss incurred.
(b) Balance Sheet, which is the answer to the second question i.e. where the business
stands in financial terms at any given point of time. Thus, balance sheet indicates the
financial status of the business at any given point time in terms of its assets and liabilities.
Introduction 1
The nature of these financial statements is discussed in details in the following pages.
Thus, the process of book keeping is more procedural and clerical in nature while the process
of accounting is more managerial in nature. As such, the job of book keeping is entrusted to
junior level employees, whereas the job of accounting needs more professional expertise.
STREAMS OF ACCOUNTING
Financial Accounting
Financial Accounting is the process .of systematic recording of the business transactions in
the various books of accounts maintained by the organization with the ultimate intention of
preparing the financial statements there from. These financial statements are basically in two
forms. One, Profitability Statement which indicates the result of operations carried out by the
organization during a given period of time and second Balance Sheet which indicates the
state of affairs of the organization at any given point of time in terms of its assets and liabilities.
This nature of Financial Accounting indicates following characteristic features of Financial
Accounting -
(a) Financial Accounting considers those transactions which can be expressed in terms of
money. All those transactions which can not be expressed in terms of money, howsoever
important they may be from business point of view, find no place in financial accounting
and hence in financial statements. E.g. Assuming that the business of an organization
is such that it is likely to be injurious to the health of local community. As such, there is
a strong opposition from the local community for the company’s carrying on the business
at that location. This opposition is something which can not be expressed in terms of
money and hence finds no place in financial accounting and hence in financial statements
though, it is affecting the business operations of the organization to a very great extent.
2 Management Accounting
(c) In practical circumstances Financial Accounting is more or less a legal requirement. In
case of certain organizations like Company form of organization, Banks, Insurance
Companies etc., not only it is necessary to maintain the financial accounting records
and prepare the financial statements there from, but it is obligatory to get these financial
statements audited also by an independent Chartered Accountant. In some cases, there
may not be direct legal requirement to prepare the financial statements, but indirectly it
is necessary to prepare the financial statements. E.g. If a partnership firm wants to file
its Income Tax Return as per the provisions of Income tax Act, 1961, preparation of
financial statements is a must to ascertain the profits.
(d) Financial Accounting is meant for those people who are external to the organization. In
other words, financial accounting is basically meant for those people who are not a part
of decision-making process regarding the organization. This class of people may consist
of the people like investors, customers, suppliers, banks, financial institutions etc.
(e) The information available from Financial Accounting, i.e. financial statement, is available
at a delayed point of time. E.g. Balance Sheets as on 31st March 2002 is available after
31st March 2002 is over. The various legal provisions also allow sufficient time lag for the
preparation of financial statements. For decision-making purposes, immediate availability
of financial data is a prerequisite which is not satisfied by financial accounting. In this
sense, financial accounting has the limitation. Further, as sufficient time is allowed for
the preparation of financial statements, they are expected to be accurate.
(f) Financial Accounting discloses the financial performance and financial status of the
business as a whole. It does not indicate the details about the individual department or
job or process inside the organization, the information which is more significant from
decision-making point of view. In this sense, financial accounting has the limitation.
(g) Financial statements are essentially interim reports and cannot be the final ones. E.g. In
order to understand the correct profitability and correct position of the assets and liabilities
of an organization, it will be necessary to stop the business operations, dispose off all
the assets of the organization and liquidate all the liabilities. Obviously it is not feasible
and practicable. In order to prepare the financial statements for a specific period, it may
be necessary to cut off various transactions involving costs and incomes at the date of
closing the accounts. This may involve personal judgements. Various policies and
principles are required to be formulated and followed consistently for such cutting off of
incomes and costs.
(h) As the “going concern principle” is followed while preparing the financial statements, the
various assets and liabilities are shown at the historical prices which may not necessarily
represent the current market prices or the liquidation prices. This may affect profitability
Introduction 3
also due to incorrect provision for depreciation on assets. This problem may be more
critical during the periods of extreme inflation or depression.
(i) The process of Financial Accounting gets largely affected due to the various accounting
policies followed by the accountants. Even though, attempts are being made to bring in
the uniformity in the various accounting policies followed by the accountants, still the
accounting policies may differ from organization to organization. These accounting policies
may differ basically in two fields :
l Valuation of Inventory
l Calculation of Depreciation
The effect of these different accounting polices is discussed in the following chapters.
Cost Accounting
Cost accounting is the process of classifying and recording of the expenditure in a systematic
manner with the intention of ascertaining the cost of a cost centre with the intention of controlling
the cost. The Institute of Cost and Management Accountants, London has defined Cost
Accounting as “the application of costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control and the ascertainment of profitability
as well as the presentation of information for the purpose of managerial decision making.” The
above description of Cost Accounting reveals the following characteristic features of Cost
Accounting -
(a) Cost Accounting views the organization from the angle of individual components of the
organization like department or job or process etc. Cost Accounting is interested in
ascertaining the profitability of these individual components of the organization.
l Ascertainment of cost and profitability with the help of various principles, methods
and techniques.
l Cost Control - This indicates the process of controlling the costs of operating the
business.
(c) Cost Accounting is meant for those people who are internal to the organization. In other
words, Cost Accounting is meant for those people who are a part of decision-making
process of the organization. The people who are external to the organization do not have
any access to the cost accounting records. In fact the basic objective of cost accounting
is to facilitate professional decision-making process on the part of managers.
4 Management Accounting
(d) Cost Accounting is not a legal requirement. Maintenance of cost accounting records is
not mandatory. However, maintenance of cost accounting records may be a legal
requirement in some exceptional cases. Section 209 (1) (d) if the Companies Act, 1956,
makes it mandatory for companies falling under certain class of industries to maintain
cost accounting records and also get them audited from an independent Cost Accountant
(which is technically referred to as “Cost Audit”).
(e) Cost Accounting does not necessarily restrict itself to the historical transactions or
historical events. Future transactions or events may find the place in cost accounting. In
fact, each and every transaction, whether past or future, which is likely to have an impact
on the business is of concern to the cost accounting.
(f) As Cost Accounting is supposed to facilitate professional decision making on the part of
manager, immediate availability of data is the prerequisite of cost accounting. As such,
accuracy is not insisted upon by cost accounting to the extent of hundred percent.
Management Accounting
Management Accounting is the process of analysis and interpretation of financial data collected
with the help of financial accounting and cost accounting with the ultimate intention to draw
certain conclusions therefrom in order to assist the management in the process of decision-
making.
In the olden days, when size of business operations was small and the complexities involved
in the same were limited, financial accounting was considered to be sufficient. Financial
Accounting ultimately aims at preparing financial statements which are basically in two forms.
(1) Profit and Loss statement which is a period statement and relates to a certain period,
usually one year. This tells about the result of operations, either profit or loss, arising out
of the conduct of business operations during that period.
(2) Balance Sheet which is a position statement and relates to a particular point of time.
This tells about the various properties held by the business (termed as ‘assets’) and
obligations accepted by the business (termed as liabilities’) as on a particular date.
The preparation of these financial statements was considered to be sufficient to serve the
requirements of all the interested parties, both outsiders as well as insiders.
However, due to the increasing size and complexities of the business operations and specifically
due to the segregation of ownership and management, only financial accounting was realised
to be insufficient. This was specifically due to certain limitations of financial accounting.
Introduction 5
(a) Financial accounting considers only those transactions which may be expressed in
financial terms, either fully or at least partially. However, it ignores the fact that there may
be other types of non-financial transactions which may have a bearing on business
operations, e.g.. Prestige of business, credit standing of business, efficiency and loyalty
of employees, efficiency and intensity of management etc.
(b) Financial accounting deals with recording of the past events and as such it is the post-
mortem record of business transactions. For taking correct decisions regarding the
business, the management may need, not only the past details but also the future
events, and future events are not the subject matter of financial accounting.
The Institute of Chartered Accountants of England and Wales has defined management
accounting as “any from of accounting which enables a business to be conducted more
efficiently”.
American Accounting Association has defined the term ‘Management Accounting as “the
application of appropriate techniques and concepts in processing historical and projected
economic data of an entity to assist management in establishing plans for reasonable economic
objectives and in the making of rational decisions with a view towards these objectives.”
The various definitions of the term ‘Management Accounting’ reveal the following features of
the same.
(1) Management Accounting is a service function which is concerned with providing various
information to the management to facilitate decision making and review of implementation
of those decisions.
6 Management Accounting
(2) Management Accounting uses not only the historical data but may also use the data
based on projections and forecasts for the purpose of evaluation of various possible
alternatives.
(3) Management Accounting assists the management in establishing the plans to attain the
economic objectives and in taking proper decisions required to be taken for the attainment
of these objectives.
(4) Management Accounting involves the application of various special techniques and
concepts for the attainment of its objects. The techniques used in the process of
management accounting are discussed in the following chapters.
The above discussions reveal that the Management Accountant is an invaluable aid to the
management to discharge the basic functions of planning, execution and control. This is done
by -
(1) Making available accounting and other data to enable the management to plan effectively.
(2) Measuring the actual performance and reporting the same to the various levels of
management to indicate the effectiveness of the organisational methods used.
(3) Computation of deviation of actual performance from the plans and standards set.
(4) Presenting to the management the operating and financial statements at reasonable
intervals and interpreting the same to enable the management to take action/decisions
regarding future policy and operations.
After considering the various objectives the Management Accounting aims at, it can be noted
that the scope of Management Accounting is much wider. It covers virtually every area and
every aspect of business operations. However, to be more precise, the various areas covered
by Management Accounting can be stated as below.
(1) Accounting : It deals with recording, summarising and analysing various business
transactions. The process of accounting may take basically two forms.
(a) Financial Accounting : It deals with recording the business transaction which are
financial in nature. It aims at the preparation of what is called financial statements
which may be basically in two forms. Firstly, the Balance Sheet which tells about
the state of affairs of the business in terms of the various assets and liabilities and
Secondly, the profitability statement which tells about the result of operations of
Introduction 7
the business i.e. profit earned or loss incurred. The financial statements are mainly
meant for the outsiders dealing with the business.
(b) Cost Accounting : It deals with recording of income and expenditure, ascertainment
of cost and profitability and the presentation of information derived therefrom for the
purpose of managerial decision making. Thus, the cost accounting is basically
meant for the management to enable it to take decisions.
(2) Cost Control Procedures : It deals with the various steps involved in the process of
controlling the cost. Thus, in turn it may deal with.
(a) Establishment of plans or budgets for the future.
(b) Comparison of actual performance with the planned or budgeted performance.
(c) Computation of variations between the planned and actual performance.
(3) Reporting : It deals with the presentation of cost data, statistical data or any other
information to the various levels of management. It may be required for the purpose of
decision making or for the purpose of fulfillment of various legal obligations.
(4) Taxation : It deals with the computation of income as per the law and filing the tax
returns and making the tax payments.
(5) Audit : It deals with devising the internal control systems and internal audit system to
cover the various operational areas of business. In many cases, it may also deal with the
management audit which is the evaluation of the managerial performance.
(6) Methods and Services : It deals with providing the management services and the
management information systems. It also deals with the various methods of reducing
the cost and improve efficiency of accounting and other office operations and preparing
and issuing the accounting and other operational manuals.
In spite of the various advantages available from the management accounting in the era of ever
increasing complex business operations, it suffers from some limitations,
(1) A very wide scope of management accounting is the limitation by itself. It attempts to
operate in a wide range of areas and it is quite possible that it may not be able to make
proper justification to all of them.
(2) In spite of the fact that the management accounting provides the various details required
for qualitative decision making thus attempting to avoid the possibility of intuitive decision
making, in many cases in practice, the decisions are based upon the intuition of the
decision maker rather than the scientific data available therefor.
8 Management Accounting
(3) The installation and operation of management accounting requires a very elaborate
organisational structure and a large number of rules and regulations. It may make the
management accounting system a costly proposition which can be implemented only
by large scale organisations.
(4) Management Accounting system is still in the evolution stage and hence suffers from
the various limitations which any system may face in the initial stages like the requirement
of constant improvements of the techniques and uncertainty about the application of the
system etc.
(5) The installation and operation of management accounting system may call for the radical
changes in the entire organisational structure which may cause severe opposition and
resistance from the existing personnel.
(a) Financial Accounting is concerned about the calculation of the profitability and state of
affairs of the organization as a whole with the help of preparation of the financial
statements. Financial Accounting takes into consideration only the historical data which
may not be of any use from the cost control point of view.
Cost Accounting may deal with the ascertainment of cost and calculation of profitability
of the individual products, departments, branches and so on. Cost Accounting involves a
much-detailed study of costs and profitability which takes into consideration not only
historical data but also the future events and possibilities. As such, cost accounting
proves to be better proposition from the cost control point of view.
(b) Due to the various statutory regulations, maintenance of financial accounting records
and preparation of financial statements therefrom is more or less a legal requirement.
(c) Financial Accounting primarily protects the interests of the outsiders dealing with the
organization in various capacities like investors, suppliers, customers, banks, financial
institutions, government authority etc.
Cost Accounting is primarily meant for the management to enable the same to discharge
various functions in a proper manner i.e. planning, execution, co-ordination and decision-
making.
Introduction 9
This relationship between Cost Accounting and Financial Accounting can be better
explained with the help of the following illustration which states the presentation of the
profitability statement under both the sets accounting.
Profit and Loss Account for the year ended on 31st march 1990.
Products
Total A B C
10 Management Accounting
Financial Accounting and Management Accounting compared
(a) For the purpose of extracting the data required for managerial decision-making,
Management Accounting may use the information appearing in the financial statements.
This information may be used as it is or it can be rearranged or regrouped if required. As
such, financial accounting becomes a source of information for management accounting.
(b) Financial Accounting considers only the historical financial transactions and does not
consider the non-financial transactions.
(c) As stated earlier, due to the various statutory regulations, maintenance of financial
accounting records and preparation of financial statements therefrom is more or less a
legal requirement. Moreover, the format in which the financial statements are required to
be prepared is also standardized.
(d) As stated earlier, financial accounting primarily protects the interests of the outsiders
dealing with organization in various capacities like investors, suppliers, customers, banks,
financial institutions, government authorities etc.
The reports generated by management accounting are meant for the use by management
for effective decision-making.
(e) As stated earlier, the financial statements which are generated as a result of financial
accounting, report the financial performance of the organization as a whole.
Reports generated by the management accounting may deal with the various parts of
the organization. As such, management accounting reports may deal with the individual
department or the individual product also.
(f) The reports generated by financial accounting which are in the form of financial statements
are available only after the relevant accounting period is over. E.g. Balance Sheet as on
31st March 2002 is available after 31st March 2002. As such, financial accounting data
may not be available to the management for decision-making purposes. Moreover, as
the financial accounting data is available after a time lag, the financial statements are
required to be accurate.
Introduction 11
In case of management accounting, more emphasis is on making the data available to
the management as quickly as possible to facilitate the effective decision-making. If up-
to-date information is not made available to the management for decision-making,
management accounting will loose its utility. As such, accuracy is not the prerequisite
of management accounting.
Cost Accounting and Management Accounting are similar to each other in many respects.
Both the streams of accounting primarily aim at the effective decision making on the part of
management. Both the streams of accounting are on and average not a legal requirement. The
various techniques which are used by management accounting viz. Marginal Costing, Budgetary
Control, Standard Costing, Uniform Costing etc. are basically regarded as the advanced
methods of Cost Accounting. As such Cost Accounting may be considered to be a part of
Management Accounting. Management Accounting is an extension of managerial aspects of
cost accounting with the ultimate intention to protect the interests of the business.
There may be various techniques with the help of which the basic functions of management
accounting can be discharged. We will discuss the following techniques in details in the
following chapters-
l Budgetary Control
l Standard Costing
l Uniform Costing
12 Management Accounting
QUESTIONS
1. Explain the nature and characteristic features of Financial Accounting and Cost
Accounting. How are they related to each other?
Introduction 13
NOTES
14 Management Accounting
Chapter 2
BASICS OF FINANCIAL ACCOUNTING
As stated earlier, financial accounting is the process of recording the past financial business
transactions and calculating the net result of these transactions, with the intention to
communicate the same to the various persons dealing with the business in the external
capacity. However, financial accounting is the technical process. Before we consider the
technicalities of financial accounting, let us consider some of the fundamental issues relating
to the financial accounting.
ACCOUNTING PRINCIPLES
In order to bring the uniformity in recording the business transactions, the accountants follow
certain basic procedures universally. These are referred to as the Accounting Principles. The
Accounting Principles can be classified in two categories –
a. Accounting Concepts
b. Accounting Conventions
Accounting Concepts
Accounting Concepts indicate those basic assumptions upon which the basic process of
accounting is based. Following are the important Accounting Concepts :
This accounting concept proposes that the business is assumed to be a distinct entity than
the person who owns the business. The accounting process is carried out for the business
and not for the person who owns the business. E.g. If there is a partnership concern carrying
on the business in the name of M/s. XYZ & Co., where Mr. A and Mr. B are the equal partners,
M/s. XYZ & Co. is supposed to be a separate entity from Mr. A and Mr. B. The financial
statements prepared on the basis of accounting records are of M/s. XYZ & Co. and not of Mr.
A or Mr. B individually. It should be noted in this connection that the business entity concept
has nothing to do with the legal entity of the business. It applies to both corporate organization
This concept proposes that every business transaction has two aspects. However, basic
relationship between assets and liabilities i.e. assets are equal to liabilities, remains the
same. E.g. If Mr. A starts the business by introducing the capital of Rs. 50,000, the assets
and liabilities structure will be as below -
Liabilities Assets
Capital 50,000 Cash 50,000
Now, if Mr. A uses the cash to purchase the material worth Rs. 40,000, the assets and
liabilities structure will change as below –
Liabilities Assets
Capital 50,000 Cash 10,000
Stock in Trade 40,000
50,000 50,000
If Mr. A sells the above material worth Rs. 40,000 for Rs. 45,000 on credit basis, the assets
and liabilities structure will change as below –
Liabilities Assets
Capital 55,000 Cash 10,000
Receivables 45,000
55,000 55,000
This concept proposes that the business organization is going to be in existence for an
indefinitely longer period of time and is not likely to close down the business in the shorter
period of time. This affects the valuation of assets and liabilities. As such, the assets are
disclosed in the Balance Sheet at cost less depreciation and not at the current market price.
If the assets are to be disclosed in the Balance Sheet at correct value, the current market
price will be most suitable. However, as the business is likely to exist for an indefinitely longer
period of time and as the assets are not likely to be sold off in the market in the near future, the
market price becomes immaterial.
Even if the Going Concern Concept proposes that the business is going to be in existence for
an indefinitely longer period of time, in order to facilitate the preparation of financial statements
on periodical basis, the indefinitely longer life span on the business is divided into shorter time
16 Management Accounting
segments, each one being in the form of Accounting Period. Profitability is computed for this
accounting period (by preparing the profitability statement) and the finanial position is assesseed
at the end of this accounting period (by preparing the balance sheet). It should be noted that
the selection of accounting period may depend upon the various factors like characteristics of
the business organization, tax considerations, statutory requirements etc.
Cost Concept
This concept proposes that the assets acquired by the organization are recorded at their cost
of acquisition and this cost is considered for all the subsequent accounting purposes say
charging of depreciation. This concept does not take into consideration current market prices
of the various assets.
This concept proposes that only those transactions and facts find the place in accounting
which can be expressed in terms of money. As such, all those transactions and facts which
can not be expressed in terms of money (E.g. Morale and motivation of the workers, credibility
of the business organization in the market etc.) do not find any place in accounting and that is
why in financial statements, though they may be having direct or indirect bearing on the
business. This concept imposes severe restrictions on the kind of information available from
the financial statements. In fact, this is one of the major drawbacks of financial accounting
and financial statements.
Matching Concept
This concept proposes that while calculating profit for the accounting period in a correct
manner, the expenses and costs incurred during the period, whether paid or not, should be
matched with the revenues generated during the period. E.g. If the accounting period ends on
31st March, the salaries for the month of March should be considered as cost for the year
ending on 31st March, even if they are actually paid for in the month of April. Otherwise,
calculation of the profits for the year ending on 31st March will go wrong as the income will be
for 12 months while the expenses will be for 11 months only.
Accounting Conventions
Accounting Conventions indicate those customs and traditions that are followed by the
accountants while preparing the financial statements. Following are the important Accounting
Conventions.
Convention of Conservation
This convention is usually expressed as “anticipate all the future losses and expenses, however
do not consider the future incomes and profits unless they are actually realized.” This convention
generally applies to the valuation of current assets and as such, the current assets are valued
Convention of Materiality
This convention proposes that, while accounting for the various transactions, only those
transactions will be considered which have material impact on profitability or financial status
of the organization and other insignificant transactions will be ignored. E.g. If the organization
purchases some postal stamps, some of which remain unused at the end of the accounting
period. According to matching concept, the cost of such non-used postal stamps should not
be considered as the item of cost. However as its impact on the overall profitability is likely to
be negligible, the cost of non-used postal stamps may be ignored treating the cost of purchases
as the expenditure. Which transactions should be treated as material ones is a subjective
concept and depends upon the judgment and knowledge of the accountant.
Convention of Consistency
This convention proposes that the accounting polices and procedures should be followed
consistently on period-to-period basis so as to facilitiate the comparison of finanacial statements
on period-to-period basis. If there is any change in the accounting policies and procedures,
this fact coupled with its effect on profitabity should be disclosed explicitly while preparing the
financial statements.
SYSTEMS OF ACCOUNTING
In this system of accounting, expenses are considered to be the expenses only when
they are paid for and the incomes are considered to be incomes only when they are
actually received. This system of accounting is mainly used by the organizations
established not for earning the profits. This system of accounting is considered to be
defective in nature, as it may not represent the true picture of the profitability as well as
of the state of affairs.
In this system of accounting, expenses are considered as expenses during the period to
which they pertain. Similarly, incomes are considered to be incomes during the period to
which they pertain. When the expenses are actually paid for or when the incomes are
actually received is not significant in case of Mercantile or Accrual system of accounting.
This system of accounting is considered to be more ideal, generally preferred by the
accountants. However, as the time of physical receipt of cash is immaterial in this system
of accounting, Accrual System of Accounting may result into the unrealized profits being
18 Management Accounting
reflected in the books of accounts on which the organization may be required to pay
the taxes also.
It will not be out of place to mention here that, as per the provisions of Section 209
of the Companies Act, 1956, all the company form of organizations are legally required
to follow Mercantile or Accrual system of accounting. Other organizations have a
choice to select either of the systems of accounting.
TYPES OF EXPENDITURE
For the purpose of accounting, the amount of money that is paid for is classified in three
ways –
a. Capital Expenditure
Capital Expenditure indicates the amount of funds paid for acquiring the infrastructural
properties required for doing the business that are technically referred to as Fixed
Assets. Fixed Assets do not give the returns during the same period during which
they are paid for. As such, benefits available from capital expenditure are long-term
benefits. Hence, it will be wrong to consider the capital expenditure as expenses
while calculating the profitability during a certain period. In technical words, capital
expenditure never affects the Profitability Statement, except in case of Depreciation,
which in simple words indicates that part of capital expenditure returns equivalent to
which are received during the corresponding period.
b. Revenue Expenditure
Revenue Expenditure indicates the amount of funds paid during a certain period with
the intention to receive the return during the same period. As such, the benefits
available from revenue expenditure are received during the same period during which
they are paid for. The entire amount of revenue expenditure affects the Profitability
Statement.
Deferred Revenue Expenditure indicates the amount of funds paid which does not
result into the acquisition of any fixed asset. However, at the same time benefits
from this expenditure are not received during the same period during which they are
paid for. The examples of Deferred Revenue Expenditure are –
a. Initial Advertisement Expenditure
b. Research and Development Expenditure
c. In case of company form of organization, Preliminary Expenses or Company
Formation Expenses.
1. Account – Account is the record of all the transactions pertaining to a person, asset,
liability, income or expenditure which have taken place during a specified period and
shows the net effect of all these transactions finally.
2. Debit Side – Debit Side of the account is left hand side of the account.
3. Credit Side – Credit Side of the account is right hand side of the account.
5. Entry – Entry means the record of a financial transaction in the books of accounts.
6. To debit – To debit an account means to make the entry on debit side of the account.
7. To credit – To credit an account means to make the entry on credit side of the account.
8. Journal – Journal is the Book of Original Entry or the Book of Prime Entry where the
financial transactions are recorded in the chronological order as and when they take
place.
9. Ledger – Ledger is the book where the transactions of the similar nature are pooled
together under one Ledger Account. Ledger or General Ledger as it is referred to in
practical circumstances, maintains all types of accounts i.e. Personal, Real and Nominal.
Whichever transactions are recorded in the Journal or Subsidiary Books in chronological
order, the same transactions are posted in the Ledger, account wise.
12. Posting – Posting refers to the process of transferring the transaction entered into the
book or original entry or subsidiary book to the ledger account.
20 Management Accounting
13. Folio – Folio refers to the page number of the book of original entry or the ledger.
14. Brought Forward – When the balances in the ledger account or cash/bank book of the
previous year or previous period are entered in the current year’s books of accounts, the
balances are said to be Brought Forward.
15. Carried Forward – When the balances in the ledger account or cash/bank book of the
current year or current period are to be transferred to the next year’s books of accounts,
the balances are said to be Carried Forward.
16. Assets – All the properties owned by the business are collectively referred to as the
assets of the business.
17. Liabilities – All the amounts owed by the business to various providers of funds or services
are collectively referred to as liabilities.
18. Capital – Capital indicates the amount of funds invested by the owner of the business in
the business.
19. Drawings – Drawings indicates the amount of funds or goods withdrawn by the owner of
the business for the personal use.
20. Debtor – A Debtor is a customer who owes the money to the business for the goods or
services supplied to him on credit basis.
21. Creditor – A Creditor is a supplier to whom the business owes the money for the goods
or services bought from him on credit basis.
22. Debit Note – Debit Note is an intimation sent to a person dealing with the business that
his account is being debited for the purpose indicated therein.
23. Credit Note – Credit Note is an intimation sent to a person dealing with the business that
his account is being credited for the purpose indicated therein.
24. Trade Discount – Trade Discount is the discount received on purchases or discount
allowed on sales which is an adjustment with the basic purchase or sales price. Trade
discount is not accounted for in the books of accounts. Purchase value or sales value is
accounted for net of trade discount.
25. Cash Discount – Cash discount is the discount received from the suppliers or allowed to
customers for making the early payment of dues. Cash discount is accounted for in the
books of accounts. Cash discount received from the suppliers is revenue income and
cash discount allowed to the customers is revenue expenditure.
27. Bills Payable – Bills Payable indicates the amount payable to the suppliers for which the
negotiable instrument in the form of Bill of Exchange is given to the suppliers.
28. Bills Receivable – Bills Receivable indicates the amount receivable from the customers
for which the negotiable instrument in the form of Bill of Exchange is received from the
customer.
29. Depreciation – The term Depreciation applies to fixed assets like Land, Buildings,
Machinery, Furniture, Vehicles etc. The term indicates reduction in the value of fixed
assets which can arise either due to time factor or use factor or both. A detailed note on
Depreciation Accounting is enclosed in the Annexure.
The basic presumption made by the Double Entry System of Accounting is that every business
transaction has two elements i.e. when the business receives something, it has to pay
something. Eg. If the business pays the telephone bill in cash, it gets the benefit of using the
telephone, but at the same time cash goes out. Similarly, if goods are sold to the customer for
cash, goods of the business go out, but it receives the corresponding amount of cash.
Accordingly, if Double Entry System of Accounting is followed, every business transaction
affects two accounts. One account is debited, while another account is credited by the similar
amount. Thus, Double Entry System of Accounting follows the principle of “every debit has a
corresponding credit” and hence, total of all debits has to be equal to the total of all credits.
c. The correct result of operations can be ascertained by preparing the final accounts
periodically.
d. Correct valuation of assets and liabilities is possible at any given point of time by preparing
the Balance Sheet.
TYPES OF ACCOUNTS
The various accounts for the purpose of Financial Accounting get classified under the following
categories –
22 Management Accounting
1. Personal Accounts - These are the accounts of persons with whom the organization
deals in various capacities. In practical circumstances, personal accounts may consist
of the following types of accounts –
Ø Accounts of the suppliers
Ø Accounts of the customers
Ø Bank / Financial Institutions
Ø Capital Account
2. Real Accounts – These are the accounts of assets and liabilities. In practical
circumstances, real accounts may consist of the following types of accounts –
Ø Land Account
Ø Building Account
Ø Machinery Account
Ø Furniture Account
Ø Vehicles Account
Real Accounts may also consist of the accounts of some intangible assets like –
Ø Goodwill Account
Ø Patents and Trade Marks Account
Ø Salary Account
Ø Wages Account
Ø Printing & Stationary Account
Ø Insurance Account
Ø Telephone Expenses Account
Ø Interest paid or Received Account
Ø Commission paid or Received Account
While entering into various financial transactions in the records maintained by the organization,
following basic rules for accounting are followed –
a. In case of Personal Accounts – Debit the Receiver, Credit the Giver
b. In case of Real Accounts – Debit What Comes in, Credit What Goes out
c. In case of Nominal Accounts – Debit all the expenses, Credit all the incomes
Depreciation Accounting
Depreciation can be defined as a permanent, continuous and gradual reduction in the book
value of a fixed asset. Normally, all the fixed assets except land, depreciate in value rendering
the asset useless after the end of certain specific period. Following may be stated as the main
causes of depreciation.
(1) Use factor : The fixed assets depreciate because they are used for the purpose they are
meant for. It is applicable in case of tangible assets like machinery, furniture, office
equipments etc.
(2) Time factor : The fixed assets depreciate due to the passage of time.
(3) Obsolescence : It is the reduction in the value of fixed assets, say a machine, due to its
supersession at a date before it is completely worn out. It may take place due to new
inventions, modifications or improvements.
According to the nature of fixed assets, these are those assets which may be used for the
business purposes over a certain number of future accounting periods and the benefit received
from them is spread over the said number of future accounting periods. According to the
matching principle of accounting, the costs incurred during an accounting period are required
to be matched with the benefits or revenues earned daring that period. Hence, it is necessary
to distribute the cost of a fixed asset, less the scrap or salvage or realisable value, after the
useful life of the fixed asset is over, in such a way so as to allocate it as equitably as possible
to the periods during which the benefits are received from the use of fixed assets. This system
or procedure is called depreciation accounting. Thus the depreciation accounting is necessary
for two main purposes.
(a) To ascertain due profits by correctly matching the various costs and expenses incurred
with various incomes and revenues earned during various accounting periods.
(b) To represent the value of a fixed asset on the Balance Sheet at its unexpired cost i.e. at
book value less depreciation. If depreciation is not provided, the asset may appear in the
Balance Sheet at an overstated amount.
It may also be noted in this connection that the depreciation forms a part of cost for arriving at
the profits which can be distributed to the owners of the business in the form of dividend. By
providing the depreciation, the amount of distributable profits is reduced and retained in the
business, which can be utilized for the replacement of the asset at the end of its economic
life.
24 Management Accounting
Methods for Calculating Depreciation :
There may be various methods available for calculating the amount of depreciation to be
charged to Profit and Loss Account. Amount of depreciation is a function of various factors.
(1) Time, (2) Usage, (3) Time and Usage, (4) Time and Cost of maintaining the fixed asset,
(5) Provision of funds for replacing the assets.
As such the various methods available for charging the depreciation can be described as
below.
= Rs. 10,000
The benefit of this method is that equal amount of depreciation is charged every year throughout
the life of the asset, making the calculation of depreciation and cost comparison easy. The
main drawback of this method is that the amount of depreciation in later years is high when
the utility of the asset is reduced.
R
D = 1- n
C
where n = number of years
R = Residual / Scrap Value
C = Cost of the asset
The main benefit of this method is that it recognizes the fact that in the initial years of life of the
asset, the repairs and maintenance cost is less which goes on increasing gradually with the
progressing life of asset. According to this method, the higher amount of depreciation in the
initial years and a gradual decrease therein is counterbalanced by the lower amount of repairs
and maintenance cost in the initial years and a gradual increase therein. It should be noted
here that the written down value can never become zero.
According to this method, depreciation is provided at a predetermined rate per unit which in
turn is calculated on the basis of total number of units lo be produced during the life of the
asset.
= Rs. 2
26 Management Accounting
If in a particular year, 7,000 units are produced, the depreciation to be charged will be :
7,000 units x Rs. 2 per unit = Rs. 14,000.
This method gives more stress on usage factor rather than time factor. Higher the number of
units produced, higher is the amount of depreciation and vice versa.
This method is similar to the production unit method except that instead of number of units to
be produced during the life of asset, number of hours for which the asset is expected to work
are taken into consideration.
= Rs. 4
If in a particular year, the machine works for 2,500 hours, the depreciation to be charged will
be :
2,500 hours x Rs. 4 per hour = Rs. 10,000
According to this method, the depreciation is provided partly at a fixed rate on time basis and
partly at a variable rate on usage basis.
Depreciation :
This method assumes that the amount of capital invested in the fixed assets would have
earned interest had it been invested otherwise. The depreciation to be charged under this
method is a constant proportion of the aggregate of the cost of the asset depreciated and
interest at the specific rate on written down value of the asset at the beginning of each period.
The amount of depreciation is very high under this method and covers the opportunity cost of
non-investment of the capital anywhere else.
28 Management Accounting
Eg. Cost of the asset (c) Rs. 1,00,000
Life of the asset (n) 5 years
Rate of interest (r) 10%
This method is similar to sinking fund method. Under this method, an insurance policy is
taken out for the amount required to replace the asset at the end of life of the asset. The
amount of depreciation to be charged is equal to the annual premium payable on the insurance
policy, which is decided by the insurance company.
According to this method, the asset is revalued periodically. The amount of depreciation for
that period is the difference between the cost of the asset at the beginning of the period and
the amount of revaluation at the end of the period.
This method of charging the depreciation is extensively used for the assets like livestock,
patterns etc.
According to this method, the full cost of the asset is charged as depreciation during the
period in which asset is renewed. No depreciation is charged in between the period. This
method of charging can be used if the asset is of small value and is renewed frequently.
1. In spite of the fact that there are various methods available for calculating the depreciation,
the final choice of the method depends upon the individual organization. It should be
noted that Income Tax Act, 1961 which is a very important piece of legislation applicable
to all types of business organizations, recognizes only one method for calculating the
depreciation i.e. Written Down Value method. The rates at which the depreciation is to
be calculated are also specified in the Income Tax Act, 1961. If the organization wants to
calculate the depreciation on some different basis or at some different rates, it can do so
for financial accounting purposes. However, for calculating the tax liability, the depreciation
has to be calculated on Written Down Value basis and that too at the specified rates.
2. The company form of organizations to whom the provision of Companies Act, 1956 apply
are required to calculate the depreciation as per the provisions of Schedule XIV of the
Companies Act, 1956. The salient features of Schedule XIV of the Companies Act, 1956
can be stated as below -
a. Schedule XIV of the Companies Act, 1956 provides that the company can calculate
the depreciation by using either Written Down Value method or Straight Line method.
The companies are given the choice to select between these two methods. The
actual choice of the method may depend upon the effect on the profitability of the
company. If the company wants to change the method of calculating the depreciation,
it amounts to the change in accounting policy. Any change in the method of
calculating the depreciation has to be effected with retrospective effect from the
date of incorporation of the company. The company is required to disclose the fact
of change in the method of calculating the depreciation while preparing its financial
statements along with the effect of change in the method of calculating the
depreciation.
b. The rates at which the companies are required to calculate the depreciation are
also specified in Schedule XIV. For this purpose, the fixed assets are classified in
various categories. The broad categorization of the fixed assets is as below -
30 Management Accounting
The rates for calculation of depreciation are as below -
c. If during the financial year, any addition has been made to any asset or any asset
has been sold, the depreciation on such asset will be calculated on a pro rata basis
from the date of such addition or upto the date on which such asset has been sold.
There are some of the questions which are normally raised in respect of the nature
of depreciation.
Yes, depreciation is a cost because of the obvious reasons that it reduces the
profitability and it is a charge against the profit. At the same time, it should
also be noted that it is a non-cash cost as it is never paid or incurred in cash.
1. What do you mean by various accounting principles? Explain the various accounting
concepts and conventions used in the financial accounting.
3. What do you mean by depreciation? What are the objectives for calculating the
depreciation? Explain the various methods for calculating the depreciation.
32 Management Accounting
NOTES
34 Management Accounting
Chapter 3
PROCESS OF ACCOUNTING
JOURNALIZING
Journalizing refers to the process of recording the business transaction in the Journal that is
referred to as the Book of Original Entry or the Book of Prime Entry. The various transactions
are entered in the journal in the chronological order, as and when the transactions take place.
Journal
a. Date – It refers to the date on which a particular transaction has taken place.
c. L.F. – This is the abbreviation of Ledger Folio. This column refers to the page number of
the ledger. The nature of Ledger is discussed in the following paragraphs.
Process of Accounting 35
Illustration
a. Mr. Sen commenced business with cash Rs. 10,000, Machinery Rs. 10,000, Buildings
Rs. 30,000 and Furniture Rs. 15,000.
b. Installed and paid for Neon Sign Board at a cost of Rs. 1,000
c. Mr. Sen borrowed Rs. 25,000 from his wife and the same were deposited by him in bank
to open an account.
e. Mr. Sen purchased goods worth Rs. 10,000 from Mr. Rao on credit @2% Cash Discount.
f. Sold goods to Ramdas worth Rs. 15,000 against cash after allowing 5% Trade Discount.
g. Paid Rs. 1,995 to Mr. Rajesh for purchases of goods after allowing 5% Cash Discount on
the invoice.
h. Sent a cheque of Rs. 1,000 to Chief Minister’s Fund as Mr. Sen’s personal contribution.
i. Placed an order for goods worth Rs. 2,000 with M/s Archana Traders.
j. A personal table fan worth Rs. 450 brought in the office for office use.
Solution
36 Management Accounting
Date Particulars L.F. Debit – Rs. Credit – Rs.
Process of Accounting 37
Compound Journal Entry
If the similar transactions take place on the same day and the same account is either debited
or credited, instead of passing different journal entries, it can be accounted for by passing a
compound journal entry. It avoids duplication and makes the journal less bulky.
Illustration
Mr. A commenced the business with cash Rs. 10,000, Machinery worth Rs. 25,000 and the
Computer worth Rs. 50,000. The transaction will be journalized as below –
SUBSIDIARY BOOKS
If the volume of transactions is very large, recording all the transactions in the Journal may
prove to be a voluminous job. Hence, the transactions of the similar nature may be entered
into a separate Subsidiary Book and the net effect of the similar transactions may be transferred
into the main records.
In the practical circumstances, following subsidiary books are used very frequently –
a. Cash Book – This records all the cash transactions i.e., Cash Receipts and Cash
Payments. In some cases, Cash and Bank Book may be maintained which records
Cash as well Bank Receipts and Cash as well as Bank Payments.
Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank
b. Purchases Register or Purchases Day Book – This records all the credit purchases
transactions.
Note : “L.F.” stands for Ledger Folio Number which indicates the Page Number in the
Creditors’ Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs.
38 Management Accounting
c. Sales Register or Sales Day Book – This records all the credit sales transactions.
Note : “L.F.” stands for Ledger Folio Number which indicates the Page Number in the
Debtors’ Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs.
d. Purchases Returns Register – This records the transactions of return of goods to the
suppliers from whom purchases were made on credit basis.
Note : “L.F.” stands for Ledger Folio Number which indicates the Page Number in the
Creditors’ Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. The Debit Note stands for an intimation sent to the supplier at the
time of returning the goods which informs the supplier that his account is being debited
on account of goods returned to him.
e. Sales Returns Register – This records all the transactions of return of goods by the
customers to whom sales were made on credit basis.
Note : “L.F.” stands for Ledger Folio Number which indicates the Page Number in the
Debtors’ Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. The Credit Note stands for an intimation sent to the customer at
the time of accepting the returned goods which informs the customer that his account is
being credited on account of goods returned by him.
f. Journal Proper – This records all the residual transaction which cannot be entered into
any other subsidiary book.
The transactions which can be entered in the Journal proper are –
a. Opening Entries
b. Closing Entries
c. Rectification Entries
d. Adjustment Entries
Process of Accounting 39
LEDGER POSTING
If Journal or Subsidiary Books are the books which record of the transactions in the chronological
order, Ledger is the book where the transactions of the similar nature are pooled together
under one Ledger Account. Ledger or General Ledger as it is referred to in practical
circumstances, maintains all types of accounts i.e. Personal, Real and Nominal. Whichever
transactions are recorded in the Journal or Subsidiary Books in chronological order, the same
transactions are posted in the Ledger, account wise. Thus, a ledger account can be defined
as the record of all the transactions pertaining to a person, asset, liability, income or expenditure
which have taken place during a specified period and shows the net effect of all these
transactions finally. As such, the transactions are first entered into Journal or Subsidiary
Book when they take place and from there they are transferred to Ledger and this process is
called as Ledger Posting.
Type I
Dr. Cr.
Type II
Control Ledgers
In practical circumstances, if the transactions of purchases and sales are very large, it may
not be feasible to carry the accounts of all the suppliers and customers in the Main or General
Ledger. In such cases, apart from the Main Ledger or General Ledger, the Control Ledgers can
be maintained. Control Ledgers carry the individual accounts whereas the Main Ledger or
General Ledger records the consolidated effect of the individual transactions. As such, the
balance shown by the consolidated account in the Main Ledger or General Ledger has to tally
with the balances in the individual ledger accounts maintained in the control ledger. In practical
circumstances, control ledgers may be maintained for the following purposes –
a. Sundry Debtors
b. Sundry Creditors
c. Advances to Staff
40 Management Accounting
Balancing of Ledger Accounts
To ascertain the net effect of all the transactions recorded in the Ledger Account, the account
is required to be “balanced”. Balancing of Ledger Account involves the following steps –
Illustration
Machinery Account
Steps explained –
a. Before considering the Balancing Figure, the total of debit side is Rs. 95,000 and the
total of credit side is Rs. 10,000. As such, debit side is heavy.
c. As the debit side is heavy, the difference of Rs. 85,000 is put on the credit side.
Trial Balance
Trial Balance is the summary of all the balances in all the accounts listed in the General
Ledger and Cash / Bank Book of an organization at any given date. Tallying of the Trial
Balance is the evidence of the fact that all the transactions have properly been posted in the
General Ledger. As such, tallying of Trial Balance generally ensures the arithmetical accuracy
of the process of Ledger Posing.
Process of Accounting 41
Format of Trial Balance
For the preparation of Trial Balance, all the accounts in the General Ledger need to be balanced
to ascertain the Closing Balance. Similarly, Cash Book / Bank Book is also required to be
balanced to ascertain the Closing Balance. Accounts having the Debit Balance are shown on
the Debit Side whereas the accounts having the Credit Balance are shown on the Credit Side.
Generally, accounts of the assets will have Debit Balance and hence will be shown on Debit
Side. Generally, accounts of all liabilities will have Credit Balance and hence will be shown on
Credit Side. Generally, accounts of all the Expenses will have Debit Balance and hence will be
shown on Debit Side. Generally, accounts of all the Incomes will have Credit Balance and
hence will be shown on Credit Side.
Preparation of the financial statements is the basic objective of financial accounting. These
financial statements are basically in two forms –
b. Balance Sheet – The purpose of this financial statement is to disclose the financial
status of the organization in terms of its assets and liabilities at any given point of time.
Thus, in simple language, Balance Sheet is a listing of the assets and liabilities of an
organization at any given point of time. Whichever sources are used by an organization
for raising the required amount of funds create an obligation or liability for the organization
and whichever ways the funds are used or applied by an organization create the properties
or assets for the organization. Hence, in practical circumstances, the liabilities are referred
to as “Sources of Funds” and the assets are referred to “Application of Funds”. As such,
by nature Balance Sheet is a position statement in the sense it relates to a specific
point of time or date. Hence, Balance Sheet is always referred to as “Balance Sheet as
on 31st March 2002.”
42 Management Accounting
PROFIT AND LOSS ACCOUNT
As stated earlier, Profit and Loss Account is prepared to disclose the result of operation of the
business transactions during a certain duration of time. In technical language, Profit and Loss
Account may have following four components –
a. Manufacturing Account – This part of Profit and Loss Account discloses the result of
manufacturing operations carried out by the organization. The final result disclosed by
the Manufacturing Account is the Cost of Production incurred by the organization.
Following is the specimen of Manufacturing Account.
Total Total
b. Trading Account – This part of Profit and Loss Account discloses the result of trading
operations carried out by the organization. The final result disclosed by the Trading
Account is the Gross Profit earned by the organization. Following is the specimen of
Trading Account.
Process of Accounting 43
Trading Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount
Opening Stock Sales (Net of Sales Returns)
Finished Goods
Closing Stock
Cost of Production Finished Goods
(Brought from Manufacturing A/c)
Gross Profit
Total Total
c. Profit and Loss Account – This part of Profit and Loss Account discloses the final
result of business transactions of the organization. The final result disclosed by the
Profit and Loss Account is the Profit After Tax (PAT) earned by the organization. Following
is the specimen of Profit and Loss Account.
Profit & Loss Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount
Administrative Expenses Gross Profit b/fd
Office Salaries
Postage & Telephone Other Income
Traveling & Conveyance Discount Received
Legal Charges Commission Received
Office Rent
Depreciation Non-Trading Income
Audit Fees Interest Received
Insurance Rent Received
Repairs & Renewals
Abnormal Income
Selling & Distribution Expenses Profit on the sale of assets
Advertisement
Carriage Outward
Free Samples
Bad Debts
Sales Commission
44 Management Accounting
Particulars Amount Particulars Amount
Financial Expenses
Interest & Bank Charges
Other Expenses
Loss on the sale of assets
Salary to Working Partners
Interest on Capital
Provision for Taxation
Total Total
d. Profit and Loss Appropriation Account – This part of Profit and Loss Account, which
is mainly applicable to company form of organization, discloses the manner in which the
PAT earned by the organization is appropriated. The amount of profit not appropriated or
retained is transferred to Reserves and Surplus in the Balance Sheet. Following is the
specimen of Profit and Loss Appropriation Account.
Profit & Loss Appropriation Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount
Dividend Paid Profit After Tax b/fd
Total Total
BALANCE SHEET
As stated earlier, the purpose of preparing the Balance Sheet is to disclose the financial
status of the organization in terms of its assets and liabilities at any given point of time. As
such, the Balance Sheet has two sides –
a. Liabilities
b. Assets
Process of Accounting 45
Liabilities
Credit balances in all the Personal and Real Accounts appear on Liabilities side. Following
items may appear on the liabilities side –
a. Capital
Capital indicates the amount of funds contributed by the owners of the business to the
requirement of funds of the business. As owner of the business is considered to be a
separate entity than the business itself, any amount contributed by the owner is a liability
for the business. Similarly, any amount of profit earned in the past which is not distributed
to the owner also belongs to the owner and becomes a part of the capital.
c. Current Liabilities
This indicates the liabilities which are supposed to be paid off within a very short span of
time say one year. In practical circumstances, it may consist of the flowing items –
Assets
Debit balances in all the Personal and Real Accounts appear on Asset side. Following items
may appear on the assets side –
a. Fixed Assets
As stated earlier, fixed assets indicate the value of infrastructural properties acquired by
the business where the benefits are likely to be received over a longer duration of time.
Fixed assets are the assets which are not supposed to be sold, but they are supposed
to be used to do the business to earn the profits. Some of the fixed assets which can be
found in practical circumstances are Land, Building, Machinery, Furniture, Vehicles, and
Computers etc.
46 Management Accounting
b. Investments
This indicates the amount of funds invested by the organization outside the business.
c. Current Assets
Current Assets are the assets which are likely to be converted in the form of cash or
likely to be consumed during the normal operating cycle of the business within a very
short span of time say one year. The purpose of holding the current assets is to sell the
current assets or use them during the normal course of operations. Current assets
change their form very frequently while doing the business. Some of the current assets
which can be found in practical circumstances are Stock, Sundry Debtors, Cash & Bank
Balances, Prepaid Expenses etc.
Total Total
Adjustments
While preparing the final accounts from the Trial Balance, it should be remembered that the
Trial Balance might not reflect all the transactions which have the impact on profitability for the
relevant period or the state of affairs of the organization on a particular date. As such, before
preparing the final accounts, the effect of such transactions needs to be considered. The
same is done by passing the Adjustment Entries. Thus, the effect of Adjustment Entries is yet
Process of Accounting 47
to be reflected in the Trial Balance. As such, according to the Double Entry principles, the
Adjustment Entries always have two effects. Following are some of the main adjustment
entries made while preparing the final accounts from the Trial Balance.
a. Closing Stock
This indicates the amount of stock in hand on the date of Balance Sheet. The basic
principle on which the closing stock is valued is at cost or market price whichever is
less. Accordingly, the first effect of the closing stock is that it is shown on the credit side
of Manufacturing and/or Trading Account and the second effect is that it is shown on
Balance Sheet Asset side. The Journal Entry passed for this is –
b. Depreciation
This indicates the reduction in the value of fixed assets due to wear and tear. As the
basic cost of the fixed assets is not transferred to Profit and Loss Account, this adjustment
is necessary to reflect the cost for the use of fixed asset during the year. Accordingly,
the first effect of the adjustment for Depreciation is that the amount is debited to Profit &
Loss Account reducing the profit or increasing the loss and the second effect is that the
corresponding amount is reduced from the value of fixed asset in the Balance Sheet. In
other words, the value of fixed assets in the Balance Sheet is net of depreciation. The
Journal Entry passed for this is –
c. Outstanding Expenses
This indicates the amount of expenses pertaining to the relevant period which are not
paid during the said period. According to Matching Principle of Accounting, income for a
certain period needs to be compared with the expenses for the same period, whether it
is paid for or not. Accordingly, the first effect of this adjustment is that the corresponding
amount of expenses are increased reducing the profit or increasing the loss and the
second effect is that the corresponding amount is shown as Current Liability on the
Balance Sheet liabilities side. The Journal Entry passed for this is –
48 Management Accounting
d. Prepaid Expenses
This indicates the amount of expenses pertaining to the next period which are paid in
advance during the relevant period. According to Matching Principle of Accounting, income
for a certain period needs to be compared with the expenses for the same period.
Accordingly, the first effect of this adjustment is that the corresponding amount of
expenses are reduced, thus increasing the profit or reducing the loss and the second
effect is that the corresponding amount is shown as Current Asset on the Balance Sheet
Asset side. The Journal Entry passed for this is –
e. Accrued Income
This indicates the amount of income for the current period which is not received during
the current period. According to Matching Principle of Accounting, income for a certain
period needs to be compared with the expenses for the same period. Accordingly, the
first effect of this adjustment is that the corresponding amount of income is increased,
thus increasing the profit or reducing the loss and the second effect is that the
corresponding amount is shown as Current Asset on the Balance Sheet Asset side. The
Journal Entry passed for this is –
This indicates the amount of income for the next period which is received during the
current period. According to Matching Principle of Accounting, income for a certain
period needs to be compared with the expenses for the same period. Accordingly, the
first effect of this adjustment is that the corresponding amount of income is reduced,
thus reducing the profit or increasing the loss and the second effect is that the
corresponding amount is shown as Current Liability on the Balance Sheet Liabilities
side. The Journal Entry passed for this is –
g. Bad Debts
This indicates the unrecoverable amount from the customers on account of credit sales
made to them. If the customer is not likely to pay the amount due from him, the same is
written off as Bad Debts. Accordingly, the first effect of this adjustment is that the amount
Process of Accounting 49
of Bad Debts is debited to Profit and Loss Account, thus reducing the profits or increasing
the losses and the second effect is that the amount of Sundry Debtors is reduced. The
Journal Entry passed for this is –
Provision for doubtful debts is necessary due to the possibility that all the customers to
whom the credit sales have been made may not pay the entire amount. Accordingly, the
first effect of this adjustment is that the amount equivalent to the provision for doubtful
debts is written off to Profit and Loss Account and the second effect is that the
corresponding amount is reduced from the Sundry Debtors in the Balance Sheet. It
should be noted that if the provision for bad and doubtful debts is to be maintained at a
certain percentage of Sundry Debtors and if the provision to some extent has already
been made in the books of account, the differential amount only needs to be debited to
Profit and Loss Account. The Journal Entry passed for this is –
In some cases it is necessary to allow cash discount to the customers for making the
early payment. As the amount of debtors who are likely to avail the cash discount is not
known in advance, a provision is made in the books of account for the discount to be
allowed to debtors. Accordingly, the first effect of this adjustment is that the amount
equivalent to the provision for discount on debtors is written off to Profit and Loss Account
and the second effect is that the corresponding amount is reduced from the Sundry
Debtors in the Balance Sheet. The Journal Entry passed for this is –
j. Interest on Capital
In order to calculate the profit earned by the organization properly, in some cases interest
may be provided on the amount of capital introduced by the proprietor or partner in the
business. It may not be out of place to mention here that in case of partnership firms,
interest on capital is considered to be an allowable expenditure for calculating the tax
liability as per the provisions of Income tax Act, 1961 if it is payable to the Working
Partners at the rate which is not exceeding 12% p.a. Accordingly, the first effect of this
50 Management Accounting
adjustment is that the amount of Interest on Capital is debited to Profit and Loss Account,
thus reducing the profits or increasing the losses and the second effect is that the
corresponding amount is credited to the Capital Account of proprietor or partner. The
Journal Entry passed for this is –
k. Drawings
This represents the amount of cash or value of goods withdrawn by the proprietor or
partner for personal use. If the amount is withdrawn in cash, the same may be entered in
the books of account regularly and thus will be reflected in the Trial Balance. However,
the value of goods withdrawn by the proprietor or partner may be required to be considered
by way of adjustment. Accordingly, the first effect of this adjustment is that the amount
of Sales will be increased, thus increasing the profits or reducing the loss and the second
effect is that the corresponding amount will be debited to the Capital Account of the
proprietor or partner. The Journal Entry passed for this is –
This represents that part of Deferred Revenue Expenditure, returns equivalent to which
are received during the current period. Accordingly, the first effect of this adjustment is
that the deferred revenue expenditure written off will be debited to Profit and Loss Account,
thus reducing the profit or increasing the loss and the second effect is that the
corresponding amount will be reduced from the Asset side of the Balance Sheet. The
Journal Entry passed for this is –
It should be noted that Deferred Revenue Expenditure Written Off Account is a Nominal
Account whereas Deferred Revenue Expenditure Account is a Real Account.
In some cases, the organization incurs the loss of stock due to some abnormal events
like fire, earthquake etc. Accordingly, the first effect of this adjustment is that the Trading
Account is credited with the cost of goods lost due to fire, earthquake etc. and the
corresponding amount is debited to Profit and Loss Account as Loss due to Fire Account.
The Journal Entry passed for this is –
Process of Accounting 51
Loss due to Fire Account Dr.
To, Stock Destroyed Account
In some cases, the stock held by the organization is insured with the Insurance Company.
After the abnormal event like fire or earthquake takes places, the insurance company
settles the claim, either in full or in part. The actual loss incurred by the organization is
to the extent of difference between the cost of goods destroyed and the amount of claim
settled by the insurance company. In such event, the amount of claim settled by the
insurance company is debited to the Insurance Company’s Account and only the net
amount of loss is debited to Profit and Loss Account. The Journal Entry passed for this
is –
This represents the value of goods distributed as free samples as a part of sales promotion
effort of the organization. This is in the form of advertisement. Accordingly, the first effect
of this adjustment is that the amount of goods distributed as free samples is debited to
Profit and Loss Account, thus reducing the profits or increasing the losses and the
second effect is that the amount of Sales is increased thus increasing the profit or
reducing the loss. The Journal Entry passed for this is –
Goods sent to the customers on approval basis should not be treated as the sales till the
goods are finally approved by the customers or the period as agreed upon by both the
parties is over. This is due to the fact that the property in the goods is not transferred until
the said period is over. If the amount of such goods sent on approval basis is treated as
the sales, the effect of this entry needs to be reversed. At the same time, the closing
stock needs to be increased by the cost of such goods sent on approval basis.
52 Management Accounting
l As a percentage of profit after charging such commission to Profit and Loss Account.
In both the cases, the amount of profit needs to be calculated before the commission is
calculated and then the amount of commission is calculated based upon the methods to
be used for calculating the same. The journal Entry passed for this is –
Illustration 1
From the following particulars in respect of M/s Pam Industries, Journalize the following
transactions, post them to the ledger, prepare the trial balance and prepare the final accounts.
Date Particulars
March
2002
1 Started business with the capital of Rs. 50,000
2 Opened a Bank Account by paying Rs. 35,000
3 Purchased goods from Ajay on credit Rs. 20,000
5 Sold the goods to Vijay on credit Rs. 14,000
7 Paid Ajay by cheque Rs. 19,500 in full settlement
9 Received Rs. 13,000 from Vijay in full settlement by cheque
15 Purchased furniture of Rs. 10,000 and paid the amount by cheque
18 Paid for traveling expenses in cash Rs. 3,000
21 Sold the goods to Vinod for cash Rs. 10,000
25 Goods purchased from Ashok against cash Rs. 8,000
27 Cash deposited in bank Rs. 5,000
28 Amount withdrawn by cheque for personal purpose Rs. 3,000
30 Paid salary in cash Rs. 2,000
Adjustments –
a. Value of goods unsold on 31st March 2002, valued at cost, Rs. 17,000
b. Depreciate furniture @2%
c. Telephone bill for the month of March 2002 not yet paid Rs. 1,500
Process of Accounting 53
Solution
54 Management Accounting
General Ledger of M/s Pam Industries for March 2002
Cash Account
Bank Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
1 To Cash A/c 35,000 7 By Ajay 19,500
9 To Vijay 13,000 15 By Furniture 10,000
27 To Cash 5,000 27 By Drawings 3,000
31 By Balance c/fd 20,500
53,000 53,000
Purchases Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
3 To Ajay 20,000 31 By Trading A/c 28,000
25 To Cash 8,000
28,000 28,000
Sales Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
31 To Trading A/c 24,000 By Vijay 14,000
By Cash 10,000
24,000 24,000
3,000 3,000
Process of Accounting 55
Salary Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
30 To Cash 2,000 31 By Profit & Loss A/c 2,000
2,000 2,000
1,500 1,500
Discount Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
9 To Vijay 1,000 7 By Ajay 500
By Profit & Loss A/c 500
1,000 1,000
Depreciation Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
31 To Furniture 200 31 By Profit & Loss A/c 200
200 200
Ajay Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
7 To Bank 19,500 3 By Purchases 20,000
7 To Discount 500
20,000 20,000
Vijay Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
5 To Sales 14,000 9 By Bank 13,000
9 By Discount 1,000
14,000 14,000
56 Management Accounting
Capital Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
28 To Bank 3,000 1 By Cash 50,000
31 To Balance c/fd 47,000
50,000 50,000
Furniture Account
Date Particulars Folio Rs. Date Particulars Folio Rs.
15 To Bank 10,000 31 By Depreciation 200
31 By Balance c/fd 9,800
10,000 10,000
Process of Accounting 57
Trading Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount
Profit & Loss Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount
52,800 9,800
Current Assets
Current Liabilities Stock 17,000
Outstanding Expenses 1,500 Cash 7,000
Bank 20,500
58 Management Accounting
Illustration 2
From the following balances and information, prepare Trading and Profit & Loss Account of Mr. X for
the year ended 31st March 1998 and a Balance Sheet as on that date.
Particulars Dr. Rs. Cr. Rs.
X’s Capital Account 10,000
Plant and Machinery 3,600
Depreciation on Plant and Machinery 400
Repairs to Plant 520
Wages 5,400
Salaries 2,100
Income Tax of Mr. X 100
Cash in Hand and at Bank 400
Land and Building 14,900
Depreciation on Building 500
Purchases 25,000
Purchase returns 300
Sales 49,800
Bank Overdraft 760
Accrued Income 300
Salaries Outstanding 400
Bills Receivable 3,000
Provision for Bad Debts 1,000
Bills Payable 1,600
Bad Debts 200
Discount on Purchases 708
Debtors 7,000
Creditors 6,252
Opening Stock 7,400
70,820 70,820
Information –
a. Stock as on 31st March 1998 was Rs. 6,000
b. Write off further Rs. 600 for bad Debt and maintain a provision for bad Debts at 5% on
Debtors.
c. Goods costing Rs. 1,000 were sent to customer for Rs. 1,200 on 30th March 1998 on
sale or return basis. This was recorded as actual sales.
d. Rs. 240 paid as rent of the office were debited to Landlord Account and were included in
the list of Debtors.
Process of Accounting 59
e. General Manager is to be given commission at 10% of net profits after charging the
commission of works manager and his own.
f. Works manager is to be given commission at 12% of net profits before charging the
commission of General Manager and his own.
Solution
Profit & Loss Account for the year ended on 31st March 1998
Particulars Amount Particulars Amount
Salaries 2,100 Gross Profit b/fd 18,100
Depreciation on Plant 400 Discount 708
Depreciation on Building 500
Repairs to Plant 520
Rent 240
Bad Debts 200
Add : Additional Bad Debts 600
Add : Provision for Bad Debts 248
Less : Existing Provision 1000 48
60 Management Accounting
Balance Sheet as on 31st March 1998
Capital & Liabilities Amount Assets & Properties Amount
Capital Fixed Assets
Balance 10,000 Plant & Machinery 3,600
Add : Profit for year 12,000 Building 14,900
Less : Income Tax 100
21,900 18,500
Current Liabilities Current Assets
Creditors 6,252 Closing Stock (Including stock on 7,000
Bills Payable 1,600 Approval)
Overdraft 760 Cash 400
Outstanding Salaries 400 Debtors 7,000
Commission Payable 3,000 Less : Bad Debts 600
Less : Goods on approval 1,200
Less : Due from Landlord 240
4,960
Less: Provision for Bad Debt 248 4,712
Bills Receivables 3,000
Accrued Income 300
Total 33,912 Total 33,912
Working Notes :
Rs.
Profit before calculating the commission 15,000
Commission payable to Works Manager @12% 1,800
Commission payable to General Manager on 13,200
Commission payable to General Manager @10% 1,200
Illustration 3
The following Trial Balance is of Shri Om as on 31st March 1991. You are requested to prepare
the Trading and Profit & Loss Account for the year ended 31st March 1991 and a Balance
Sheet as on that date after making the necessary adjustments.
Process of Accounting 61
Particulars Dr. Rs. Cr. Rs.
Sundry Debtors 5,00,000
Sundry Creditors 2,00,000
Outstanding Liabilities for Expenses 55,000
Wages 1,00,000
Carriage Outwards 1,10,000
Carriage Inwards 50,000
General Expenses 70,000
Cash Discount 20,000
Bad Debts 10,000
Motor Car 2,40,000
Printing and Stationery 15,000
Furniture and Fittings 1,10,000
Advertisement 85,000
Insurance 45,000
Salesman’s Commission 87,500
Postage and Telephones 57,500
Salaries 1,60,000
Rates and Taxes 25,000
Drawings 20,000
Capital Account 14,43,000
Purchases 15,50,000
Sales 19,87,500
Stock as on 1st April 1990 2,50,000
Cash at Bank 60,000
Cash in Hand 10,500
36,30,500 36,30,500
b. A provision for Bad and Doubtful Debts are to be made to the extent of 5% on Sundry
Debtors.
62 Management Accounting
c. Depreciate Furniture & Fixture by 10% and Motor Car by 20%.
d. Shri Om had withdrawn goods worth Rs. 25,000 during the year.
e. Sales include goods worth Rs. 75,000 sent out to Santi & Company on approval and
remaining unsold on 31st March 1991. The cost of the goods was Rs. 50,000.
h. Printing and Stationery expenses of Rs. 55,000 relating to 1989-90 had not been provided
in that year but were paid in this year by debiting outstanding liabilities.
Solution
Process of Accounting 63
Profit & Loss Account for the year ended on 31st March 1991
64 Management Accounting
Illustration 4
5,11,330 5,11,330
a. Included among the Debtors is Rs. 3,000 due from Ram and included among the Creditors
Rs. 1,000 due to him.
Process of Accounting 65
b. Provision for Bad and Doubtful Debts to be created at 5% and for Discount @2% on
Sundry Debtors.
d. Personal purchases of Hari amounting to Rs. 600 had been recorded in the Purchases
Day Book.
g. Credit Purchase Invoice amounting to Rs. 400 had been omitted from the book.
Prepare Trading and Profit & Loss Account for the year ended on 31st December, 1994 and
the Balance Sheet as on that date.
Solution
66 Management Accounting
Profit & Loss Account for the year ended on 31st December 1994
Process of Accounting 67
Illustration 5
From the following trial balance and information, prepare Trading and Profit & Loss Account of
Mr. Rishabh for the year ended 31st march 1999 and a Balance Sheet as on that date.
2,97,380 2,97,380
68 Management Accounting
Information –
b. Fire occurred on 23rd March, 1999 and Rs. 10,000 worth of general goods were destroyed.
The insurance company accepted claim for Rs. 6,000 only and paid the claim money on
10th April, 1999.
c. Bad Debts amounting to Rs. 400 are to be written off. Provision for bad and Doubtful
Debts is to be made at 5% and for discount at 2%.
d. Received Rs. 6,000 worth of goods on 27th March ,1999, but the invoice of purchase was
not recorded in Purchase Book.
e. Rishabh took away goods worth Rs. 2,000 for personal use but no record was made
thereof.
f. Charge depreciation at 2% on Land and Building, 20% on Plant and Machinery and 5%
on Furniture.
Solution
Process of Accounting 69
Profit & Loss Account for the year ended on 31st March 1999
70 Management Accounting
Illustration 6
Hira and Manik are partners in a firm sharing profits and losses in equal proportion. Following
is the Trial Balance as at 31st March, 1989.
You are required to prepare Trading and Profit & Loss Account of the firm for the year ended on
31st March 1989 and the Balance Sheet on that date after taking into consideration following
adjustments –
a. Closing Stock Rs. 45,000.
b. Depreciate Plant @10% and Furniture @20%. Appreciate Land and Building to
Rs. 90,000.
Process of Accounting 71
d. Advertisement Suspense Account to be written off against revenue over five years.
e. Partners’ Drawings are to bear interest @10% p.a. Amounts were withdrawn on
31st December, 1988.
f. Annual charges for insurance Rs. 1,000. Balance represents amount paid in advance.
g. Hira gave loan to the firm on 30th September, 1988 which carries the interest @6% p.a.
i. The partners agree to contribute 50% of the distributable profit to the National Defence
Fund.
Solution
Profit & Loss Account for the year ended on 31st March, 1989
72 Management Accounting
Particulars Amount Particulars Amount
Contribution to National Defence Fund 61,613
Illustration 7
Process of Accounting 73
Particulars Dr. Rs. Cr. Rs.
Capital Account H. Pandit 1,00,000
Capital Account K. Pandit 1,00,000
Drawings H. Pandit 16,000
Drawings K. Pandit 16,000
Buildings 80,000
Furniture 20,000
Purchases 2,00,000
Sales 3,00,000
Stock (1st April, 1991) 50,000
Wages 44,000
Rates and Taxes 1,600
Office Expenses 10,000
Salaries 50,000
Sundry Debtors 25,000
Sundry Creditors 12,000
Cash in Hand 400
Bank Overdraft 29,000
Carriage Inwards 28,000
74 Management Accounting
You are required to prepare Trading and Profit & Loss Account for the year ended on 31st
March, 1992 and the Balance Sheet on that date.
Solution
Profit & Loss Account for the year ended on 31st March 1992
83,150
H. Pandit 11,869
K. Pandit 11,869
Process of Accounting 75
Balance Sheet as on 31st March, 1992
Current Liabilities
Sundry Creditors 12,000
Bank Overdraft 29,000
(108075 – 83150)
—————————— x 5
105
Illustration 8
The following is the Trial Balance of Shri Arihant as on 31st December 1999.
76 Management Accounting
Particulars Dr. Rs. Cr. Rs.
Travelling Expenses 23,000
Miscellaneous Expenses 35,000
Printing and Stationery 27,000
Advertisement Expenses 25,000
Postage and Telegram 13,000
Discounts 7,600 14,500
Bad Debts written off (after adjusting recovery of bad
debts of Rs. 6,000 written off in 1997) 14,000
Building 10,00,000
Machinery 75,000
Furniture 40,000
Debtors 1,50,000
Provision for Doubtful Debts 19,000
Creditors 1,60,000
Investments (12% Purchased on 1st October, 1999) 6,00,000
Bank Balance 83,900
40,93,500 40,93,500
Adjustments –
b. Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books.
c. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off
against Profit & Loss Account. This asset is to be brought into account on
1st January, 1999 taking depreciation at 10% per annum on straight line basis upto
31st December, 1998.
f. The manager is entitled to a commission of 5% of net profits after charging his commission.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a
Balance Sheet as on that date.
Process of Accounting 77
Solution
Profit & Loss Account for the year ended on 31st December 1999
Sub-Total 2,90,600
78 Management Accounting
Balance Sheet as on 31st December, 1999
Furniture 40000
Current Liabilities
Current Assets
Debtors 150000
Note
Process of Accounting 79
Illustration 9
Capital 8,00,000
Drawings 60,000
Opening Stock 75,000
Purchases 15,95,000
Freight on Purchases 25,000
Wages (11 months up to 29th February, 2000) 66,000
Sales 23,10,000
Salaries 1,40,000
Postage, Telegrams, Telephones 12,000
Printing and Stationery 18,000
Miscellaneous Expenses 30,000
Creditors 3,00,000
Investments 1,00,000
Discount Received 15,000
Debtors 2,50,000
Bad Debts 15,000
Provision for Bad Debts 8,000
Building 3,00,000
Machinery 5,00,000
Furniture 40,000
Commission on sales 45,000
Interest on Investments 12,000
Insurance (Year up to 31st July 2000) 24,000
Bank Balance 1,50,000
34,45,000 34,45,000
80 Management Accounting
Adjustments –
b. Machinery worth Rs. 45,000 purchased on 1st October, 1999 was shown as purchases.
Freight paid on the machinery was Rs. 5,000 which is included in the freight on purchases.
d. Investments were sold at 10% profit, but the entire sale proceeds have been taken as
sales.
e. Write off Bad Debts Rs. 10,000 and create a provision for Doubtful Debts at 5% of
Debtors.
f. Depreciate building by 2.5% p.a. and Machinery and Furniture at 10% p.a.
Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2000 and the
Balance Sheet on that date.
Solution
Process of Accounting 81
Profit & Loss Account for the year ended on 31st March 2000
82 Management Accounting
Illustration 10
From the following particulars extracted from the books of Ganguli, prepare Trading and Profit
& Loss Account for the year ended on 31st March 1994 and Balance Sheet on that date after
making the necessary adjustments.
Adjustments –
a. Value of stock as on 31st March, 1994 is Rs. 39,300. This includes goods returned by
customers on 31st March, 1994 of the value of Rs. 1,500 for which on entry has been
passed in the books.
Process of Accounting 83
b. Purchases include furniture purchased on 1st January 1994 for Rs. 1,000.
d. Bank Loan as on 1st April, 1993 was Rs. 5,000. An amount of Rs. 5,000 was borrowed
on 31st March, 1994.
e. Sundry Debtors include Rs. 2,000 due from Robert and Sundry Creditors include
Rs. 1,000 due to him.
g. Interest received represents Rs. 100 from the Sundry Debtors and the balance on
investments and deposits.
h. Provide for interest payable on Bank Loan and for interest receivable on investments and
deposits.
i. Make a provision for doubtful debts @5% on the balance under Sundry Debtors. No such
provision is necessary for the deposits.
Solution
84 Management Accounting
Profit & Loss Account for the year ended on 31st March 1994
Process of Accounting 85
QUESTIONS
1. If the Trial Balance does not agree, what steps will you take to ensure that it tallies?
2. What do you mean by Final Accounts? Explain in brief the structure of Profitability
Statement and Balance Sheet.
3. What are the various components of Profit and Loss Account ? Explain the purpose of
each component.
4. How would you deal with the following while preparing the final accounts –
e. Interest on Capital
86 Management Accounting
PROBLEMS
Q.1. The following is the Trial Balance of Shri Paras as on 31st March 1991. You are requested
to prepare the Final Accounts after giving effect to the adjustments.
17,65,800 17,65,800
b. A provision for Bad and Doubtful Debts is to be made to the extent of 5% on Sundry
Debtors.
Process of Accounting 87
d. Wages include a sum of Rs. 20,000 spent on erection of a cycle shed for employees and
customers.
e. Salaries for the month of March 1991 amounting to Rs. 15,000 were unpaid.
f. Insurance includes a premium of Rs. 1,700 on a policy, expiring on 30th September,
1991.
Q.2. Mr. A, a Shopkeeper had prepared the following trial balance from his ledger as on
31st March 1989.
14,87,200 14,87,200
You are requested to prepare Trading and Profit & Loss Account for the year ended 31st
March, 1989 and Balance Sheet as on that date. You are also given the following further
information –
88 Management Accounting
a. Cost of goods in stock as on 31st March, 1989 Rs. 1,45,000
b. Mr. A had withdrawn goods worth Rs. 5,000 during the year.
c. Purchases include purchase of furniture worth Rs. 10,000.
d. Debtors include Rs. 5,000 Bad Debts.
e. Creditors include a balance of Rs. 4,000 to the credit of Mr. B in respect of which it has
been decided and settled with the party to pay only Rs. 1,000.
f. Sales include goods worth Rs. 15,000 sent to Ram & Co. on approval and remaining
unsold as on 31st March 1989 and the cost of goods was Rs. 10,000.
g. Provision for bad debts is to be created at 5% on Sundry Debtors.
h. Depreciate furniture by 15% and Motor Car by 20%
i. The salesmen are entitled to a commission of 10% on total sales.
Q.3. From the following balances extracted from the books of Mr. Yellow, prepare Trading and
Profit & Loss Account for the year ended 31st December, 1990 and a Balance Sheet as
on that date.
1,77,692 1,77,692
Process of Accounting 89
Adjustments –
a. Closing Stock on 31st December, 1990 was valued at cost Rs. 25,000 (Market Value
Rs. 16,200)
b. Rs. 6,000 paid to Mr. Red against Bill Payable were debited by mistake to Mr. Green’s
Account and included in the list of Sundry Debtors.
c. Travelling expenses paid to sales representative Rs. 5,000 for the month of December
1990 were debited to his personal account and included in the list of Sundry Debtors.
d. Depreciation on furniture & fittings shall be provided at 10% per annum.
e. Provide for doubtful debts at 5% on Sundry Debtors.
f. Goods costing Rs. 1,500 used by the proprietor.
g. Salaries include Rs. 12,000 paid to sales representative who is further entitled to a
commission of 5% on net sales.
h. Stationary charges Rs. 1,200 due on 31st December, 1990.
i. Purchases include opening stock valued at Rs. 7,000 (cost price)
j. Sales representative further entitled to an extra commission of 5% on net profit after
charging his extra commission.
k. No depreciation need to be provided for computer as it had been purchased on
31st December, 1990 and not put to use.
Q.4. From the following trial balance of Hari and additional information, prepare Trading and
Profit & Loss Account for the year ended 31st March, 1995 and a Balance Sheet as on
that date.
90 Management Accounting
Particulars Dr. Rs. Cr. Rs.
Creditors 1,20,000
Drawings 24,000
Provision for Bad Debts 6,000
Printing and Stationery 8,000
Insurance 12,000
Opening Stock 50,000
Office Expenses 12,000
Provision for Depreciation 2,000
5,58,000 5,58,000
Additional Information –
c. Salaries for the month of March 1995 amounting to Rs. 3,000 were unpaid which must
be provided for. However, salaries include Rs. 2,000 paid in advance.
Q.5. The following is the Trial Balance of Shri Arihant as on 31st December, 1999.
Process of Accounting 91
Particulars Dr. Rs. Cr. Rs.
Travelling Expenses 23,000
Miscellaneous Expenses 35,000
Printing and Stationery 27,000
Advertisement Expenses 25,000
Postage and Telegram 13,000
Discounts 7,600 14,500
Bad Debts written off (after adjusting recovery of bad
debts of Rs. 6,000 written off in 1997) 14,000
Building 10,00,000
Machinery 75,000
Furniture 40,000
Debtors 1,50,000
Provision for Doubtful Debts 19,000
Creditors 1,60,000
st
Investments (12% Purchased on 1 October 1999) 6,00,000
Bank Balance 83,900
40,93,500 40,93,500
Adjustments –
a. Closing Stock Rs. 2,25,000.
b. Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books.
c. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off
against Profit & Loss Account. This asset is to be brought into account on 1st January
1999 taking depreciation at 10% per annum on straight line basis upto 31st December,
1998.
d. Depreciation on Building at 2.5%, Machinery at 10% and Furniture at 10%.
e. Provision for Doubtful Debts should be 6% on Debtors.
f. The Manager is entitled to a commission of 5% of net profits after charging his commission.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a
Balance Sheet as on that date.
Q.6. From the following information, you are required to prepare Trading Account, Profit &
Loss Account and Balance Sheet as on 31st December, 1999 for “SANPAT” Co.
92 Management Accounting
Particulars Dr. Rs. Cr. Rs.
Sundry Debtors 40,000
Bills Receivables 18,500
Goodwill 40,500
Land & Building 1,10,000
Plant & Machinery 40,000
Furniture 40,200
Motors 50,800
Telephone Bills 11,200
Opening Stock 18,700
Wages 2,000
Advertisement 11,700
Royalty 12,000
Power & Fuel 12,800
Legal Charges 1,200
Audit Fees 4,090
Lighting 2,000
Salaries 3,500
Repairs 110
Purchases 22,000
Rent 1,700
Cash in Hand 78,000
Depreciation Fund 8,000
Outstanding Taxes 1,800
Bills Payable 2,200
Sundry Creditors 4,700
Bank Overdraft 3,200
Capital 1,50,000
General Reserves 38,000
Bank Loan 1,00,000
Provident Fund 40,000
Purchases Returned 1,000
Sales 1,20,500
Bank Loan 50,400
Outstanding Interest 1,200
5,21,000 5,21,000
Process of Accounting 93
Adjustments –
a. Interest on Capital 10%.
b. Closing Stock Rs. 75,000.
c. Goods costing Rs. 8,000 lost by fire and insurance company admitted a claim of
Rs. 6,500.
d. Depreciation on Motors 10%, Furniture 20%, Plant & Machinery 5%.
e. Provide RDD 10% on Debtors.
f. Outstanding Wages Rs. 1,000.
g. Prepaid Telephone Bill Rs. 1,200.
Q.7. Following Trial Balance was taken out on 31st March, 1996 from the books of Mr. Raman.
You are required to prepare Trading and Profit & Loss Account for the year ended 31st
March, 1996 and Balance Sheet as at that date, after making the necessary adjustments.
94 Management Accounting
Adjustments –
e. Goods of the value of Rs. 100 were given away as free samples.
Q.8. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss
Account for the year ending 31st December 1997 and Balance Sheet as on that date.
Adjustments –
1. Closing stock was valued at cost Rs. 37,500.
2. Outstanding salaries amounted to Rs. 1,500.
3. Commission received but not earned Rs. 250.
Process of Accounting 95
Q.9. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss
Account for the year ending 31st December, 1997 and Balance Sheet as on that date.
Adjustments –
1. Write off Bad Debts Rs. 500 and create 5% RDD on Debtors.
Q.10. Melon and Lemon are partners sharing profits equally. From the following Trial Balance
and the additional information, prepare Trading and Profit & Loss Account for the year
ending 30th June, 1982 and Balance Sheet on that date.
96 Management Accounting
Debit Balances Rs. Credit Balances Rs.
Drawings - Melon 2,000 Capital - Melon 35,000
- Lemon 3,500 - Lemon 25,000
Land & Building 36,000 Sales 95,500
Machinery 18,000 Returns 1,300
Salaries 3,700 Bad Debts Reserve 800
Motor Car 10,500 Creditors 3,000
Trade Expenses 1,900 Commission 1,500
Carriage Inward 400 Bank Loan taken 0n 1.1.82 20,000
Royalties 1,800
Purchases 45,300
Return Inwards 2,500
Debtors 24,600
Discounts 1,000
Insurance 1,200
Stock on 1.7.81 23,800
Advertisement 3,000
Cash at Bank 2,900
Additional Information
a. Stock on 30th June, 1982 was worth Rs. 36,000 at cost while its market value was
Rs. 39,000
b. Goods worth Rs. 4,000 taken by Lemon for personal use were not entered in the books
of accounts.
c. Of the debtors, Rs. 600 were bad and should be written off and reserve for doubtful debts
should be maintained at 5%.
Process of Accounting 97
Q.11. From the Trial Balance of M/s. Hocus and Pocus, you are required to prepare Trading
and Profit & Loss Account for the year ending 31st December 1982 and the Balance
Sheet as on that date after taking into account the additional information. Partners
share the profits and losses equally.
Additional Information.
a. Stock as on 31st December, 1982 was Rs. 1,60,000.
b. It is discovered that sales effected on 31st December, 1982 of the value of Rs. 2,000 has
not been recorded in the books.
c. Stock worth Rs. 3,000 uninsured has been destroyed by fire.
d. Depreciate Plant & Machinery by 20% and Furniture by 5%
e. Provide for bad and doubtful debts Rs. 6,000.
f. Outstanding Expenses – Salaries Rs. 2,500, Wages Rs. 1,000.
g. Prepaid insurance Rs. 500.
98 Management Accounting
Q.12. The Accountant of M/s. Kasturi Agencies extracted the following Trial Balance as on
31st March, 1987.
2,28,500 2.68,500
The Accountant located the following errors but is unable to proceed further any more.
a. A totalling error in bank column of payment side of cash book whereby the column was
undercast by Rs. 500.
b. Interest on Bank loan paid for the quarter ending 31st December, 1986, Rs. 450, was
omitted to be posted in the ledger. There was no further payment of interest.
c. You are required to set right the Trial Balance and prepare the Trading and Profit and
Loss Account for the year ended on 31st March, 1987 and the Balance Sheet on that
date, after carrying out the following –
1. Depreciation is to be provided on the assets as follows :
l Buildings 2.5% p.a.
l Furniture 10% p.a.
l Motor Van 10% p.a.
2. Balance of interest due on the loan is also to be provided for.
Process of Accounting 99
NOTES
If the account is opened in a bank in the name of business, the bank periodically gives the
bank passbook or the bank statement. The bank passbook or the bank statement is the
extract of the account in the name of business as it appears in the books of the bank.
Similarly, in the books of business also, it maintains the bank book which is the extract of
bank transactions as it appears in the book of business. As both the bank book in the books
of business and bank passbook as per the books of bank record the same transactions, the
balance as per bank book should match with the balance as per passbook. However, in
reality, the said balances may not match with each other. These balances may not match with
each due to the following reasons –
1. Cheques issued but not debited - The business might have issued some cheques
which are not yet presented in the bank for clearing. As such, the balance as per bank
pass book may be higher.
2. Cheques deposited but not cleared - The business might have deposited some
cheques in the bank account, but the bank might not have received the payment for the
same and hence the amount is not yet credited to the bank account. As such, balance
as per bank book may be higher.
3. Other Reasons – There may be a possibility that certain items may appear only in the
passbook without any corresponding effect of the same in the bank book. This may be
possible due to following reasons –
a. The bank debits periodical bank charges and bank interest to the account. These
amounts appear only in the bank passbook. The business organization makes the
entry of the same on the receipt of intimation from the bank. Till the entry is passed
in the bank book, the bank book may show higher balance than the passbook.
d. In some cases, the business organization may give the standing instructions to the
bank to make the recurring payments like rent, electricity bills, telephone bills etc.
as and when they become due for payment. Accordingly, the bank might have paid
these amounts and on payment, they are debited to the account. The business
organization makes the entry of the same on the receipt of intimation from the
bank. Till the entry is passed in the bank book, the bank book may show higher
balance than the passbook.
e. In some cases, the bank is given the responsibility of collecting the investment
income or the principal amount of investment or the bills of exchanges on the date
of maturity. Accordingly, the bank collects the same and credits the same to the
account. The business organization makes the entry of the same on the receipt of
intimation from the bank. Till the entry is passed in the bank book, the bank book
may show lower balance than the passbook.
f. There may be some clerical error on the part of bank when certain amounts may be
wrongly debited or credited by the bank to the account. The business organization
makes the entry of the same on the receipt of intimation from the bank. Till the
entry is passed in the bank book, the bank book may show lower or higher balance
than the passbook depending upon the nature of error on the part of bank.
Bank Reconciliation Statement is the statement prepared to explain the reasons as to why
the bank balance as per passbook and bank balance as per bankbook does not match.
The bank reconciliation starts with the Closing Bank Balance as per Bank Book and by
making the additions and subtractions therefrom, the Bank Balance as per the Bank Statement
or Pass Book is arrived at. Alternatively, the bank reconciliation statement may start with
Balance as per the Bank Statement or Pass Book and by making the additions and subtractions
therefrom, the Bank Balance as per the Bank Book may be arrived at. For preparing the bank
reconciliation statement, entries on the payment side of Bank Book are compared with the
withdrawal column of the Pass Book or Bank Statement and the entries on the receipts side
of Bank Book are compared with the deposits column of Bank Statement or Pass Book. If
entries on the payment side or receipt side of the Bank Book appear on the withdrawal or
deposit column of Bank Statement or Pass Book respectively, bank reconciliation statement
b. If the bank has given the overdraft facility, generally the Bank Book will show closing
balance as credit balance. If the bank reconciliation statement is prepared starting with
bank balance as per Bank Book, amounts added in the above specimen need to be
subtracted and the amounts subtracted in the above specimen need to be added.
c. If the bank reconciliation statement prepared discloses the amounts for which the entries
have not been made in the Bank book, those entries should be made in the books of
accounts and the balance as per the Bank book should be modified accordingly.
e. For the purpose of preparation of Trial Balance, bank balance as per Bank Book will be
considered and not the balance as per Bank Statement or Pass Book.
Illustration
Following are the entries recorded in the Bank Column of the Cash Book of Mr. X for the month
ending 31st March 1997.
On 31st March, 1997, Mr. X received the Bank Statement. On perusal of the statement, Mr. X
ascertained the following information –
b. Interest on securities collected by the bank but not recorded in cash book Rs. 1,080
d. Dividend collected by the bank directly but not recorded in the cash book Rs. 1,000
f. Interest debited by the bank but not recorded in the cash book Rs. 1,000
From the above information you are asked to prepare a Bank reconciliation statement to
ascertain the balance as per Bank Statement.
Illustration
From the following extracts of the cash book (bank column) and bank pass book of Mr.X,
prepare the bank reconciliation statement for the month ending on 31st March, 1997.
Solution
Following particulars are extracted from the books of accounts of Mr. Bose for the month
ending 31st March, 1989.
b. Cheques issued but presented after 31st March, 1989 Rs. 1,000.
c. Three cheques were issued for Rs. 500, Rs. 1,000 and Rs. 1,500 respectively, but the
cheque for Rs. 1,000 was presented on 3rd April, 1989.
d. Cheques issued but not recorded in the cash book Rs. 750.
e. Cheques deposited but credited after 31st March, 1989 Rs. 250.
f. Three cheques were deposited for Rs. 1,000, Rs. 1,200 and Rs. 1,600 respectively, but
the cheque for Rs. 1,600 was credited on 2nd April.
g. Cheques deposited into the bank but not recorded in the cash book Rs. 1,000.
j. Bank interest credited for Rs. 150 and debited for interest Rs. 50 not recorded in the
cash book.
k. Dividend collected by the bank not recorded in the cash book Rs. 1,000.
l. A debtor directly deposited into bank but not recorded in the cash book Rs. 500.
m. Rs. 1,000 in respect of dishonoured cheques appeared in the pass book but not in the
cash book.
n. Bank met a Bill Payable of the firm Rs. 1,500 on 30th March, 1989 under an advice to the
firm on 2nd April, 1989.
o. Bank’s charges for a cheque book Rs. 5 were entered in the cash book twice.
p. A cheque for Rs. 50 drawn by Mr. Mukherjee had been charged to Mr. Bose’s account in
error in March, 1989.
Prepare the bank reconciliation statement as on 31st March, 1989 before and after making
the necessary adjustments in the cash book.
Sub-Total 7,055
Sub-Total
Illustration
From the following particulars, prepare the bank reconciliation statement for Mr. S.Sarkar as
on 31st December, 1985 before and after making necessary adjustments in the cash book.
d. A cheque drawn for Rs. 100 has been incorrectly entered as Rs. 10 in the cash book.
e. A debtor directly deposited into Sarkar’s bank account but not recorded in the cash
book Rs. 1,000.
h. Bank paid a Bill Payable for Rs. 1,450 but it was recorded in the cash book as Rs. 1,540.
i. The receipt column of cash book was overcast by Rs. 1,000.
j. Discount allowed Rs. 410 has been entered through mistake with the cheque in the bank
column of the cash book.
k. Pursuant to instructions dated 30th December, 1985, asking the banker to transfer
Rs. 10,000 to fixed deposit account and entry for this was made in the cash book but the
bank acted in January 1986.
l. The bank debited the account with Rs. 500 being the amount of cheque received from a
customer and returned unpaid but not entered in the cash book.
m. Cheques amounting to Rs. 300 though actually banked were not entered in the cash book.
To Creditor 90 By Creditor 90
By Discount 410
By Debtors 500
Sub-Total 11,280
Sub-Total 7,500
Illustration
Following are the cash book and pass book of Mr. X for the month of April, 2002.
Cash Book (Bank Column only)
38,000 38,000
Solution
Bank Reconciliation Statement as on 30th April, 2002
Fun Fare Limited have a current account with National Bank Limited. The following is the
extract from the Bank’s books of account for the last week of June, 1988.
It is understood that –
a. Cheque no. 214 drawn in favour of T.W.Traders for Rs. 2,100 was not yet presented to the bank.
b. Advice regarding the incidental charges, interest on loan and dividend warrants reached
Fun Fare Limited only in July.
c. Cheque favouring Lal Chand was towards rent for the month of June.
From the above data you are required to prepare a cash book (bank column only) of Fun Fare
Limited and a bank reconciliation statement in their books at the end of the month.
Solution :
Cash Book (Bank Column only)
Date Particulars Rs. Date Particulars Rs.
30.6.88 To Balance b/fd 21,000 30.6.88 By Gopal Brothers 4,000
To Madhu Industries 5,000 By N Traders 7,200
To Ram Gopal 7,500 By T W Traders 2,100
By Gopal Brothers 4,100
By Cash 2,400
By Rent 1,000
By Balance c/fd 12,700
33,500 33,500
QUESTIONS
1. What do you mean by Bank Reconciliation Statement ? What are the reasons for
difference between the balance shown by cash book and the one shown by the pass
book?
2. What are the different causes of discrepancy between bank balance as per cash book
and pass book ?
Q. 1
The Bank account of Mukesh was balanced on 31st March, 1992. It showed an overdraft of
Rs. 5,000. The Bank Statement of Mukesh showed a credit balance of Rs. 76,750. Prepare a
Bank reconciliation statement taking the following information into account –
a. Cheques issued but not presented for payment till 31st March, 1992 Rs. 12,000.
b. Cheques deposited but not collected by bank till 31st March, 1992 Rs. 20,000.
c. Interest on term loan Rs. 10,000 debited by bank on 31st March, 1992 but not accounted
in Mukesh’s books.
d. Bank charges Rs. 250 was debited by bank but accounted in the books of Mukesh on
4th April, 1992.
Q. 2
From the following particulars, prepare a Bank Reconciliation Statement as on 31st December,
1993.
a. On 31st December, 1993, the cash book of a firm showed a bank balance of Rs. 6,000
(Debit Balance).
b. Cheques had been issued for Rs. 5,000, out of which cheque worth Rs. 4,000 only were
presented for payment.
c. Cheques worth Rs. 1,400 were deposited in the bank on 28th December, 1993 but had
not been credited by the bank. In addition to this, one cheques for Rs. 500 was entered
in the cash book on 30th December, 1993 but was banked on 3rd January, 1994.
d. A cheque from Susan for Rs. 400 was deposited in the bank on 26th December, 1993
but was dishonoured and the advice was received on 3rd January, 1994.
f. One of the debtors deposited a sum of Rs. 500 in the bank account of the firm on 20th
December, 1993 but the intimation in this respect was received from the bank on 2nd
January, 1994.
g. Bank Passbook showed a credit balance of Rs. 5,180 on 31st December, 1993.
On 31st May, 1994, the cash book of ABC Ltd. showed a bank overdraft of Rs. 1,234. On an
examination of the cash book and bank pass book, the following information was gathered –
a. Two cheques received from P and Q for Rs. 234 and Rs. 456 respectively were deposited
with the bank on 30th May, 1994, but they were cleared only on 1st June 1994.
b. A cheque for Rs. 345 issued on 26th May, 1994 was presented to the bank for payment
on 3rd June, 1994.
c. A cheque for Rs. 567 deposited by a customer in the company’s account with bank
directly on 25th May, 1994.
d. Rs. 5,678 being proceeds of a bill collected on 30th May, 1994 did not appear in the cash book.
e. A bill payable for Rs. 5,789 was duly paid off on 31st May, 1994 according to the instructions
of the company, entry of which was made in the cash book on 1st June, 1994.
Q. 4
On 31st January, 1988, my cash book showed a bank overdraft of Rs. 12,500. On comparing
it with the pass book, following differences were located –
a. Cash and cheques amounting Rs. 1,340 were sent to bank on 27th January, but cheques
worth Rs. 230 were credited on 2nd February and one cheque for Rs. 45 was returned by
them as dishonoured on 4th February.
b. During the month of January, I issued cheques worth Rs. 1,760 to my creditors. Out of
these, cheques worth Rs. 1,370 were presented for payment on 5th February.
c. According to my standing orders, the bankers have paid during the month of January the
following –
• Life insurance premium Rs. 170
• Driving license fee Rs.40
d. My bankers have collected Rs. 150 as dividend on the shares.
e. My bankers have given me wrong credit for Rs. 150.
f. A bill receivable for Rs. 100 discounted with the bank in December, 1987 has been
dishonoured on 31st January, 1988.
g. Interest charged by the bank Rs. 125.
Prepare a bank reconciliation statement on 31st January, 1988.
From the following particulars, find out adjusted bank balance as per cash book and prepare
thereafter bank reconciliation statement as on 31st December, 1995 of Raja Brothers –
Particulars Rs.
Bank Overdraft as per Cash Book 80,000
Cheques deposited as per bank statement but not entered in cash book 3,000
Cheques recorded for collection but not sent to the bank 10,000
Credit side of bank column cast short 1,000
Bank charges recorded twice in the cash book 100
Customers’ cheques returned as per bank statement only 4,000
Cheques issued but dishonoured on technical grounds 3,000
Bills collected by bank directly 20,000
Cheques received entered twice in cash book 5,000
Q. 6
The cash book of a firm showed an overdraft of Rs. 30,000 on 31st March, 1999. A comparison
of the entries in cash book and pass book revealed that –
a. On 22nd March, 1999, cheques totaling Rs. 6,000 were sent to bankers for collection. Out
of these, a cheques for Rs. 1,000 was wrongly recorded on the credit side of the cash book
and cheques amounting to Rs. 300 could not be collected by bank before 1st April, 1999.
b. A cheque for Rs. 4,000 was issued to a supplier on 28th March, 1999. The cheque was
presented to bank on 4th April, 1999.
c. There were debits of Rs. 2,600 in the pass book for interest on overdraft and bank
charges, but the same had not been recorded in the cash book.
d. A cheque for Rs. 1,000 was issued to a creditor on 27th March 1999, but by mistake the
same was not recorded in the cash book. The cheque was however duly encashed on
31st March, 1999.
e. As per standing instructions, the banker collected dividend of Rs. 500 on behalf of the
firm and credited the same to its account by 31st March, 1999. The fact was however
intimated to the firm on 3rd April, 1999.
You are required to prepare a bank reconciliation statement as on 31st March, 1999.
On 31st March, 1998, Mehta’s Pass Book showed a debit balance of Rs. 6,350. From the
following information, prepare a Bank Reconciliation Statement as on that date –
1. Out of total cheques of Rs. 6,000 deposited into the bank in March. 1998, one cheque of
Rs. 500 was collected on 28th March, 1998 and another cheque of Rs. 1,000 was
collected on 3rd April, 1998.
2. The bank had paid a premium of Rs. 300 on 17th March for which there was no entry
made in the cash book.
3. The total of debit side bank column of cash book was undercast by Rs. 100.
4. Amount withdrawn from the bank on 26th March Rs. 200 was not recorded in the cash
book at all.
5. During March, cheques issued amounted to Rs. 2,000 of which cheques for Rs. 1,500
were presented to the bank on 2nd April 1998.
Q. 8
D. Diwakar’s Pass Book shows a balance of Rs. 5000 (Credit) on 30th June, 1998. His cash
book shows a different balance. On an examination, it is found that –
a. No record has been made in the cash book for dishonour of a cheque for Rs. 100.
b. Cash and cheques amounting to Rs. 700 were paid into the bank on 29th June, 1998 and
the same had not been entered in the pass book.
c. Bank charges of Rs. 15 have not been entered in the cash book.
d. Cheques amounting to Rs. 1,800 issued by P. Prabhakar and paid into the bank on 28th
June, 1998 had not been credited.
Q. 9
On 30th September 1998, cash book of a firm showed a bank balance of Rs. 7,500. From the
following information, prepare a bank reconciliation statement showing the balance as per
pass book –
a. Cheques amounting to Rs. 1,200 were paid on 28th September, 1998 had not been
credited by the bank. One cheque for Rs. 375 was entered in the cash book on 28th
September, 1998 but was banked on 3rd October, 1998.
b. Cheques issued for Rs. 900 had not yet been presented for payment at the bank.
d. Bank charges of Rs. 15 were debited in the pass book by the bank.
e. There was an entry in the pass book for the receipt of Rs. 600 collected by the bank as
interest.
Q. 10
From the following particulars, ascertain the balance by means of a statement that would
appear in the pass book of Mr. S.Gavaskar as on 31st December 1998.
b. Interest on overdraft for six months ending 31st December, 1998 Rs. 120.
d. Cheques drawn but not cashed by the customers prior to 31st December, 1998 Rs. 1,326.
e. Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 2,412.
f. A Bill Receivable originally discounted with the bank in November 1998 is dishonoured
Rs. 800.
Q. 11
From the following particulars, ascertain the balance that would appear in the cash book of
Mr. M. Ranganathan as on 31st December, 1998 –
b. Cheques amounting to Rs. 8,200 were paid into the bank on 28th December, 1998 out of
which only Rs. 600 was credited by the bank in the pass book till 31st December, 1998.
c. Cheques for Rs. 5,400 were issued on 28th December, 1998 out of which only one
cheque for Rs. 800 was presented for payment.
d. There is a debit of Rs. 200 for interest and Rs. 50 for bank charges in the pass book
which have not been entered in the cash book.
e. Rs. 400 debited to bank account in the cash book has been omitted to be banked.
On 30th June, 1990, the pass book of Sunil & Co. showed a balance of Rs. 9,800 as cash at
bank –
a. Prior to that date, they had issued cheques amounting to Rs. 3,500, of which, cheques
amounting to Rs. 1,900 have so far been presented for payment.
b. Out of the cheques for Rs. 2,000 paid by him into the bank before that date, only cheques
for Rs. 1,200 were credited in the pass book.
c. He had also received a cheque for Rs. 680 which although entered in the cash book had
been omitted to be paid into bank.
Q. 13
From the following particulars, prepare a Bank Reconciliation Statement as on 28th February,
1989. Thiru Pandiyan had an overdraft balance of Rs. 80,500 as shown by the bank columns
of the cash book. Cheques amounting to Rs. 10,000 had been paid into the bank on 24th
February, 1989 but of these only Rs. 7,500 were credited in the pass book. He had issued
cheques amounting to Rs. 25,000, of which Rs. 20,000 worth only seem to have been presented.
The bank has debited in the pass book Rs. 750 for interest. A cheque for Rs. 600 which was
debited in the bank column in the cash book has been omitted to have been presented. An
entry appears in the pass book for Rs. 3,000 for a direct deposit by a customer of Thiru
Pandiyan.
Q. 14
On 31st March 1991 the cash book of Mr. X showed a bank balance of Rs. 14,850. While
verifying with the pass book, the following facts were noted –
a. Cheques sent in for collection before 31st March, 1991 and not credited by bank amounted
to Rs. 845.
b. Cheques issued before 31st March, 1991 but not presented for payment amounted to Rs. 885.
c. The banker has debited a sum of Rs. 100 towards the bank charges and credited Rs. 250
for interest received and Rs. 1,000 for dividend collected.
e. Mr. Y has paid into the bank a sum of Rs. 300 on 28th March, 1991 which has not been
entered in the cash book.
f. A cheque for Rs. 200 sent for collection returned dishonoured has not been entered in
the cash book.
Find out the balance as per pass book from the following particulars –
a. Bank overdraft as per cash book on 30th April, 1992 was Rs. 2,000.
c. Cheques deposited but not yet collected by the banker Rs. 500.
d. Bank charges Rs. 80 debited by the bank not yet entered in the cash book.
e. Interest on investments collected by the bankers and credited in the pass book amounted
to Rs. 905.
Q. 16
From the following particulars, ascertain the balance that would appear in the cash book of B
as on 31st December, 1998, before and after making necessary adjustments –
a. Overdraft as per pass book as on 31st December 1998 Rs. 13,880.
b. Interest on overdraft for six months ending 31st December 1998 not yet entered in the
cash book Rs. 240.
c. Bank charges for the above period not yet entered in the cash book Rs. 60.
d. Cheques drawn but not encashed by customers before 31st December, 1998 Rs. 3,300.
e. Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 4,340.
f. A Bill Receivable, discounted with the bank in November, dishonoured on 31st December,
1998 Rs. 1,000.
Q. 17
From the following particulars taken on 31st December, 1989, you are required to prepare a
bank reconciliation statement to reconcile the bank balance shown in the cash book with that
shown in the pass book –
a. Balance as per pass book on 31st December, 1989 Rs. 1,027 (Credit).
b. Four cheques drawn on 31st December but not cleared till January Rs. 1,144.
e. Cost of cheque book Rs. 5 entered twice erroneously in cash book in November.
f. A Bill Receivable for Rs. 250 on 29th December, 1989 was passed to the bank for
collection on 28th December, 1989 and was entered in the cash book forthwith, whereas
the proceeds were credited in the pass book only in January following.
h. Bank Charges of Rs. 5 had been debited in the pass book twice erroneously.
Q. 18
On 30th June, 1981, the pass book of M/s Thin and Short showed a balance of Rs. 2,000 at
the bank. They had sent cheques amounting to Rs. 10,000 to the bank before 30th June, 1981
but it appears from the pass book that cheques worth Rs. 9,000 had been credited before that
date. Similarly, out of the cheques for Rs. 5,000 issued during the month of June, cheques for
Rs. 4,000 were presented and paid in July. The pass book showed the following payments –
The pass book showed that the bank had collected Rs. 1,800 as interest on Government
Securities. The bank had charged as interest Rs. 50 and incidental expenses Rs. 20. There
was no entry in the cash book for the payment of interest etc. A bill sent for collection was
returned dishonoured on 29th June amounting to Rs. 600.
Q. 19
From the following particulars, prepare a bank reconciliation statement showing the balance
as per pass book on 31st March, 1989.
a. Cheques for Rs. 7,900 was paid into bank in March, 1989 but were credited only in April,
1989.
b. Cheques for Rs. 11,000 were issued in March, 1989 but were cashed in April, 1989 only.
c. A cheque for Rs. 1,000 which was received from a customer was entered in the bank
column of the cash book in March, 1989 but the same was paid into the bank in April,
1989 only.
d. The pass book shows a credit of Rs. 2,500 for interest and a debit of Rs. 500 for bank
charges.
e. The bank balance as per cash book was Rs. 1,80,000 on 31st March, 1989.
From the following particulars, prepare a bank reconciliation statement as at 31st December, 1991.
a. As on 31st December, 1991, bank overdraft as per cash book Rs. 2,49,900.
d. Draft deposited in the bank but not yet credited in the pass book Rs. 13,500.
e. Dividend collected by the bank Rs. 42,500 has not yet been entered in the cash book.
f. A direct payment into the bank by a customer Rs. 16,000 has not been recorded in the
cash book.
g. Bank column on the debit side of the cash book has been undercast by Rs. 3,500.
Q. 21
From the following particulars, prepare a bank reconciliation statement showing the balance
as per cash book as on 31st December, 1997.
The following cheques were paid into the bank in December 1997 but were credited by the
bank in January, 1998.
The following cheques were issued by the firm in December, 1997 but were presented for
payment in January, 1998.
• Suresh Rs. 400
• Ramesh Rs. 450
A cheque for Rs. 100 which was received from a customer was entered in the bank column of
cash book in December, 1997 but was omitted to be banked in the month of December, 1997.
The pass book shows a credit of Rs. 100 for interest and a debit of Rs. 20 for bank charges.
The bank balance as per pass book was Rs. 6,200 as on 31st December, 1997.
Q. 22
According to the cash book of Gopi, there was a balance of Rs. 44,500 standing to his credit
on 30th June, 1996. On investigation you find that –
1. Cheques amounting to Rs. 60,000 issued to creditors have not been presented for payment
till that date.
3. A dividend of Rs. 4,000 and rent amounting to Rs. 6,000 received by the bank and
entered in the pass book but not recorded in the cash book.
4. Insurance premium (up to 31st December, 1996) paid by the bank Rs. 2,700 not entered
in the cash book.
5. The payment side of the cash book had been undercast by Rs. 50.
6. Bank charges Rs. 50 shown in the pass book had not been entered in the cash book.
7. A bill payable for Rs. 2,000 has been paid by the bank but is not entered in the cash
book and bill receivable for Rs. 6,000 has been discounted with the bank at a cost of
Rs. 100 which has also not been recorded in the cash book.
Q. 23
From the following extracts of the cash book (bank column) and bank pass book of Mr.X,
prepare the bank reconciliation statement for the month ending on 31st March, 1997.
Q. 24
On 31st December, 1982, the bank column of the cash book of P shows a debit balance of
Rs. 922. On examination of cash book and statement, you find that –
a. Cheques amounting to Rs. 1,260 issued before 31st December and entered in the cash
book were not presented for payment till that date.
b. Cheques amounting to Rs. 500 entered in the cash book as sent to the bank on
31st December were entered in the bank statement after that date.
c. A cheque from a debtor for Rs. 146 had been dishonoured prior to 31st December but no
record appeared in the cash book.
d. A dividend warrant for Rs. 76 was paid direct to the bank and nothing appeared in the
cash book.
e. Bank interest and charges amounting to Rs. 84 were not entered in the cash book but
appeared in the bank statement.
f. There was no entry in the cash book for a club membership subscrption Rs. 20 paid by
banker’s order in November, 1982.
g. Bank charges for a cheque book received by P Rs. 2 were entered in the cash book
twice.
Make appropriate adjustment in the cash book to bring down the correct balance and prepare
a bank reconciliation statement reconciling the corrected cash book balance with the balance
as per bank statement.
Q. 25
When Sweetex Limited received its bank statement for the period ended 30th June, 1984, this
did not agree with the balance shown in the cash book of Rs. 2,972 in the company’s favour.
An examination of the cash book and bank statement disclosed the following –
a. A deposit of Rs. 492 paid on 29th June 1984 had not been collected by the bank until
1st July, 1984.
b. Bank charges amounting to Rs. 17 had not been entered in the cash book.
c. A debit of Rs. 42 appeared in the bank statement for an unpaid cheque which had been
returned marked “out of date”. The cheque had been re-dated by the customer of Sweetex
Limited and paid into the bank again on 3rd July, 1984.
d. A standing order for payment of an annual subscription amounting to Rs. 10 had not
been entered in the cash book.
e. On 25th June, 1984, managing director had given the cashier a cheque for Rs. 100 to
pay into his personal account at the bank. The cashier had paid the same into company’s
account by mistake.
f. On 27th June, two customers of Sweetex Limited had paid direct to the company’s bank
account Rs. 499 and Rs. 157 respectively for the payment of goods supplied. The advices
were not received by the company until 1st July and were not entered in the cash book
until that date.
g. On 30th March, 1984, the company had entered into a hire purchase agreement to pay
by banker’s order a sum of Rs. 26 on the 10th day of each month, commencing April. No
entries had been made in the cash book.
h. A cheque for Rs. 364 received from Mr. B and paid into the bank had been entered twice
in the cash book.
i. Cheques issued amounting to Rs. 4,672 had not been presented to the bank for payment
until 30th June, 1984.
After making the adjustments required by the foregoing, the bank statement reconciled with
the balance in the cash book.
1. to show the necessary adjustments in the cash book of Sweetex Limited bringing down
the correct balance on 30th June, 1984.
The errors in accounting can be classified into the following main groups –
l Errors while carrying forward figures from one page to another page
d. Compensating Error – These errors refer to a situation where excess or less debits in
one or more accounts are compensated by equal amount of excess or less credits in
one or more accounts. Due to these errors arithmetical accuracy of the Trial Balance
does not get affected.
Tallying of Trial Balance is the primary indication about the arithmetical accuracy of the books
of account. However, it cannot be the conclusive evidence of the total accuracy of the books of
accounts maintained. This is due to the fact that certain errors as stated above do not affect
the trial balance. As such, locating the errors requires a lot of skills, particularly when they do
not affect the agreement of trial balance.
a. Wrong totalling of subsidiary books – If the total of any subsidiary books is taken
wrongly but the posting to the individual accounts is made correctly, it will affect the
agreement of trial balance. Eg. Total of Purchase Register for the month of March is
taken as Rs. 1,50,000 instead of Rs. 1,55,000. Posting to the individual accounts of
suppliers total to the correct amount of Rs. 1,55,000, but the Purchases Account is
debited by Rs. 1,50,000, the trial balance will not agree.
e. Error in balancing – If an error has been committed while calculating the closing balance
of cash book or a ledger account, the trial balance will not agree.
Following types of errors may not affect the agreement of Trial Balance.
b. Errors of Omission – If a transaction is totally omitted while making the entries in the
books of accounts, it will not affect the agreement of trial balance. Eg. A bill for the
purchase of material worth Rs. 15,000 has been received, but it is not entered in the
Purchase Register at all, the trial balance will still agree but it will not show a true and fair
view.
e. Compensating Errors – If one type of error is compensated by the error of the opposite
nature, it will not affect the agreement of trial balance. Eg. While balancing the traveling
expenses account, the closing debit balance is taken as Rs. 1,40,000 instead of
Rs. 1,50,000. Similarly, while balancing the sales account, the closing credit balance is
taken as Rs. 28,90,000 instead of Rs. 29,00,000. The trial balance will still agree but it
will not show a true and fair view.
If the errors result into the disagreement of trial balance, following steps should be taken to
locate the errors.
a. Total of all the subsidiary books and cash book should be checked carefully. Similarly,
the total of trial balance should be checked carefully.
b. It should be ensured that all the opening balances have been correctly brought forward in
the current year’s books of account.
c. It should be ensured that all the ledger accounts have been properly balanced and the
balances of all the ledger accounts have been reflected in the Trial Balance.
d. If an amount of Rs. 24,000 is debited to a certain account instead of crediting the same
to the same account, the difference between the debit side and credit side of trial balance
e. If the difference in the trial balance is divisible by 9 without any reminder, it may indicate
the transposition or transplacement of the amounts. Eg. If the cash payment of Rs. 176
is posted as Rs. 167, the difference in the trial balance will be divisible by 9.
f. The trial balance of the current year can be compared with the trial balance of the previous
year to locate certain highlighting error.
I. In some cases, if the trial balance does not agree but the books have to be closed, the
difference is placed to a Suspense Account and the trial balance is tallied. If the credit
side of the trial balance is heavy by Rs. 50,000 and same amount is placed on the debit
side of Suspense Account. Subsequently, attempts are made to locate the errors and
the rectification entries are routed through the Suspense Account. After all the errors
have been located, the balance in Suspense Account will become zero. It should be
remembered that the Suspense Account is operated till the errors are located and finally
the balance in Suspense Account has to become zero. Further, only the errors affecting
the agreement of trial balance are routed through the Suspense Account.
Illustration
A merchant while balancing his books of account finds that, the trial balance shows excess
credit of Rs. 1,700. Being required to prepare the final accounts, he places the difference to a
newly opened Suspense Account which he carries forward. In the next accounting year, the
following errors are discovered –
a. Goods bought from Narayan amounting to Rs. 5,000 had been posted to the credit of
Narayan as Rs. 5,500.
b. An item of Rs. 1,000 entered in the sales returns book was posted to the debit of Pandey
who had returned the goods.
c. Sundry items of furniture sold for Rs. 26,000 had been entered in the sales book. Ignore
depreciation and profit or loss on the sale.
d. Discount amounting to Rs. 200 from a creditor had been duly entered in the creditor’s
account, but not posted to discount account.
Draft journal entries necessary for rectifying the abovementioned errors. Prepare the Suspense
Account and show the ultimate effect of the errors on the last year’s profit by preparing the
Profit and Loss Adjustment Account.
a. Goods bought from Narayan had been posted to the credit of Narayan Account by
Rs. 5,500 instead of Rs. 5,000. As such, Narayan Account has been credited more by
Rs. 500. As such, this excess credit needs to be reversed by passing following entry –
b. Goods supplied to Pandey worth Rs. 1,000 should have appeared on the debit side of
Pandey’s account. Instead of that the entry has been made on the credit side of Pandey’s
account. This excess credit needs to be reversed by passing the following entry –
c. As the amount of furniture sold has been entered in the sales book, sales account has
been wrongly credited. This wrong credit needs to be reversed by debiting sales account.
The journal entry to be passed is –
d. Discount received from the creditor has been entered in the creditor’s account but discount
account has not been credited. As such, the error will be rectified by passing the following
entry –
Suspense Account
II. The errors which affect two accounts and which do not affect the agreement of trial
balance may be rectified by passing the rectification entries. The basic principle for
rectifying the errors by this means suggests the following steps to be taken –
c. Nullify the wrong effect by reversing the same and reinstate the correct by passing
the rectification entry.
Illustration
a. An amount of Rs. 200 withdrawn by the proprietor for his personal use has been debited
to trade expenses account.
b. A purchase of goods from Nathan amounting to Rs. 300 has been wrongly entered
through the sales book.
c. A credit sale of Rs. 100 to Santhanam has been wrongly passed through the purchase
book.
e. Rs. 375 paid on account of salary to the cashier Dhawan stands debited to his personal
account.
f. A contractor’s bill for the extension of premises amounting to Rs. 2,750 has been debited
to building repairs account.
g. On 25th June, goods of the value of Rs. 500 were returned by Akashdeep and were taken
into stock but the returns were entered in the books under date 3rd July i.e. after the
expiration of the financial year on 30th June.
h. A bill of Rs. 200 for old office furniture sold to Sethi was entered in the sales daybook.
i. The periodical total of the sales book was cast short by Rs. 100.
QUESTIONS
1. It is said that tallying of Trial Balance is not the conclusive proof of accuracy of the books
of account. Why ?
2. What are errors in financial accounting ? What are the different types of errors ?
4. What are errors in financial accounting? Do all the errors affect the Trial Balance? State
the errors that affect the Trial Balance and the errors that do not affect the Trial Balance.
PROBLEMS
Q.1
Ganesh drew a Trial Balance of his operations for the year ended 31st March 1992. There was
a difference in the Trial Balance which he closed with a Suspense Account. On a scrutiny by
the Auditors, the following errors were found –
a. Purchases day book for the month of April 1991, was undercast by Rs. 1,000.
c. A furniture purchased for Rs. 8,100 was entered in the Furniture Account as Rs. 810.
d. A bill for Rs. 10,000 drawn by Ganesh was not entered in the Bills Receivable Book.
e. A machinery purchased for Rs. 10,000 was entered in the purchase day book.
Pass necessary journal entries to rectify the same and ascertain the difference in the Trial
Balance that was shown under the Suspense Account in respect of the above items.
Q.2
A bookkeeper while preparing his Trial Balance finds that the debit exceeds by Rs. 7,250.
Being required to prepare the final accounts, he places the difference to a Suspense Account.
In the next year, the following mistakes were discovered –
a. A sale of Rs. 4,000 has been passed through the Purchase daybook. The entry in
customer’s account has been correctly recorded.
b. Goods worth Rs. 2,500 taken away by the proprietor for his use has been debited to
Repairs Account.
c. A bill receivable for Rs. 1,300 received from Krishna has been dishonoured on maturity
but no entry passed.
d. Salary Rs. 650 paid to a clerk has been debited in his Personal Account.
e. A purchase of Rs. 750 from Raghubir has been debited to his account. Purchase Account
has been correctly debited.
f. A sum of Rs. 2,250 written off as depreciation on furniture has not been debited to
Depreciation Account.
Draft the Journal Entries for rectifying the above mistakes and prepare Suspense Account.
Q.3
The accountant of X prepared the Trial Balance for the year ended 31st March 1996. But there
was a difference and the accountant put the difference in Suspense Account. Rectify the
following errors found and prepare the Suspense Account.
a. The total of the Returns Outward book, Rs. 420 has not been posted in the ledger.
b. A purchase of Rs. 350 from Y has been entered in the sale book. However, Y’s account
has been correctly entered.
d. Old furniture sold for Rs. 5,400 has been entered as Rs. 4,500 in sales account.
e. Goods taken by proprietor, Rs. 500 have not been entered in the books at all.
Q.4
A bookkeeper finds the difference in the Trial Balance amounting to Rs. 1,000 and puts it in
the Suspense Account. Later on he detects the following errors –
b. Received one bill for Rs. 25,000 from Arun but recorded in Bills Payable Book.
c. An item of Rs. 3,500 relating to prepaid rent account was omitted to be brought forward.
d. An item of Rs. 2,000 in respect of purchase returns, had been wrongly entered in the
purchase book.
e. Rs. 25,000 paid to Hari against our acceptance were debited to Harish Account.
f. Bills received from Janaki for repairs done to radio Rs. 2,500 and radio supplied for
Rs. 45,000 were entered in the Purchase Book as Rs. 46,000.
Give rectifying journal entries with full narration and prepare Suspense Account.
Q.5
There is a difference in the Trial Balance of Shri Om. Subsequently, the following errors were
found to have been committed. Pass journal entries to rectify them and ascertain the difference
in the Trial Balance.
a. A sale of Rs. 2,000 to Shanti & Co. was credited to their account.
b. The Returns Inward Book had been cast Rs. 1,000 short.
c. A sale of Rs. 10,000 had been passed through the Purchase Day Book. The customer’s
account, had, however been correctly debited.
d. Rs. 3,750 paid for wages to workmen for making showcases had been charged to Wages
Account.
e. A purchase of Rs. 6,710 had been posted to the debit of the creditor’s account as
Rs. 6,170. The creditor was Paras & Co.
There was difference in the Trial Balance of Shri Arihant which was put to newly opened
Suspense Account. Subsequently, the following mistakes were discovered. Pass journal entries
to rectify them and ascertain the difference in the Trial Balance.
a. Materials costing Rs. 700 in the erection of machinery and the wages paid for amounting
to Rs. 400 were included in the Purchase Account and Wages Account respectively.
b. Goods sold under credit terms Rs. 16,900 to Mohan were recorded properly in the Sales
Book but were debited to his account as Rs. 19,600 and carriage outward freight paid
Rs. 700 chargeable from him were posted to Sales Expenses Account.
c. Sales Returns by Yogesh Rs. 2,300 were correctly recorded in the Sales Returns Book
from where they were debited to Yogesh Account by Rs. 3,200.
d. Old furniture originally purchased for Rs. 1,800 written down to Rs. 1,100 was sold for
cash Rs. 1,700 and was credited to Furniture Account.
e. Machinery purchased on credit Rs. 17,000 was recorded in Purchase Book and transport
charges for the machine Rs. 1,200 were debited to Trade Expenses Account.
Q.7
a. Rs. 2,500 paid for the purchase of a radio set for the personal use of the proprietor
debited to general expenses account.
b. Rs. 1,300, the amount of sale of old machinery, has been posted to sales account.
c. A sum of Rs. 160 paid by way of rent has been debited to landlord’s personal account.
d. Rs. 245 cost of repairing the floor of room has been charged to buildings account.
e. A payment of Rs. 250 made to Harish Brothers for cash purchase of goods from him
stands debited to his account.
Q.8
a. Goods taken by the proprietor Rs. 1,500 for gift to his daughter were not recorded at all.
b. Rs. 1,500 received from Praveen against debts previously written off as bad debts have
been credited to his personal account.
d. A cheque received from Amar, a debtor, for Rs. 2,000 was directly received by the proprietor
who deposited it into his personal bank account.
Q.9
While preparing the final accounts for the year ended 31st March 1995, Mr. Smart could not
get his Trial Balance agreed. He transferred the difference to Suspense Account and prepared
the final accounts. In April 1995, following errors were discovered in the books of accounts for
the year 1994-95 –
a. The sales book for January 1995 was undercast by Rs. 1,000.
b. Entertainment expenses Rs.150 incurred on 5th January 1995 were omitted to be posted
from cash book to the ledger.
c. Discount column on the receipt side of the cash book for February 1995 was added as
Rs. 2,230 instead of Rs. 2,130.
d. A purchase from Mr. Sumer for Rs. 8,200 on 3rd March 1995 was correctly recorded in
the purchase book. But the supplier was wrongly debited for the purchase.
Pass the necessary journal entries to rectify the above-mentioned errors without affecting the
profit for the year 1995-96. Also prepare Suspense Account and Profit & Loss Adjustment
Account. Assume that all the errors have been located.
Q.10
An accountant could not tally the Trial Balance. The difference was temporarily placed to
Suspense Account for preparing the final accounts. The following errors were discovered later
on –
b. Entertainment expenses Rs. 95 though correctly entered in the cash book were omitted
to be posted in the ledger.
c. Commission of Rs. 25 paid was posted twice, once to discount account and again to
commission account.
d. A sales of Rs. 139 to Ramnath, though correctly entered in the sales book was posted
wrongly to his account as Rs. 193.
Q.11
The Trial Balance of N Ltd. does not tally. In order to give it a semblance of agreement, the
accountant of the company transfers the difference to a newly opened Suspense Account.
Later on, he discovers the following errors –
a. An item of Rs. 5,850 paid for purchase of a new typewriter for the accounts department
has been wrongly passed through the purchases book.
b. An item of Rs. 780 in the sales book has been posted as Rs. 960 in the customer’s
account.
c. An addition in the returns inward book has been cast Rs. 240 short.
d. An item of Rs. 450 appearing in the discount column on the credit side of the cash book
has been posted to the credit side of the concerned personal account as Rs. 540.
e. A bill of exchange for Rs. 2,650 accepted by R & Co. and later discounted with the bank
has been returned by the bank as dishonoured. On dishonour, the amount of the bill has
been debited to sales account.
Give journal entries to rectify the above mentioned errors and also show the Suspense Account.
Q.12
a. A purchase amounting to Rs. 1,000 made for a staff member was recorded in the purchases
book.
b. Wages paid to workers for installing machinery, Rs. 750 were debited to wages account.
c. A dishonoured bill receivable for Rs. 5,000 returned by the bank with whom it was
discounted was credited to bank and debited to bills receivable account.
d. A sum of Rs. 1,000 drawn by the proprietor for his personal use was debited to traveling
expenses account.
b. A credit sale of Rs. 587 was recorded in the sales book as Rs. 857.
c. Goods sold to Prem for Rs. 170 were returned by him, but no entry was passed in the
books.
d. A bill receivable for Rs. 2,000 accepted by Vimal was recorded in bills payable book.
Q.14
Pass journal entries to rectify the following errors and prepare Suspense Account.
a. Rs. 1,080 received from Mohan was posted to the debit of his account.
b. Rs. 200 being purchase returns were posted to the debit of purchases account.
c. Rs. 400 received as discount was posted to the debit of discount account.
d. Rs. 1,148 paid for repairs of motor car was debited to motor car account as Rs. 148.
Q.15
On 28th February 1999, the Trial Balance of X did not agree. X put the difference in a newly
opened Suspense Account. Subsequently, following errors were located –
a. The returns inward book for January 1999 had been cast Rs. 1,000 short.
b. A purchase of Rs. 1,671 had been posted to the debit of the creditor’s account as
Rs. 1,617. The creditor is Panna & Co.
c. A sale of Rs. 2,000 to Singhi & Co. was credited to the account of the customer.
d. A sale of Rs. 4,000 has been passed through the purchase book. The customer’s account
has however been correctly debited.
e. While carrying forward the total of sales book from one page to the next, the amount was
written as Rs. 1,76,658 instead of Rs. 1,67,568.
Q.16
An accountant prepared a Trial Balance on 31st January 2000, which revealed a difference in
the books of account. He put the difference in a newly opened Suspense Account. During
February 2000, he detected the following errors –
a. The total of the returns outward book, Rs. 4,200 had not been posted in the ledger.
b. A purchase of Rs. 3,500 from Y had not been entered in the purchase book. However,
Y’s account had been correctly credited with the amount.
c. A sale of Rs. 3,900 to Z had been credited to his account as Rs. 2,900.
d. Furniture sold for Rs. 5,400 had been entered as Rs. 4,500 in the sales book.
e. Goods worth Rs. 500 taken by the proprietor for personal use had not been recorded at
all.
f. Wages paid for an installation of machinery Rs. 1,000 had been debited to wages account.
Pass journal entries to rectify the abovementioned errors and prepare Suspense Account
assuming that all the errors have been located.
Q.17
Give journal entries to rectify or adjust the following in the books of both the head office and the
branch.
a. Goods costing Rs. 16,000 purchased by branch, but payment made by head office. The
head office has debited the amount to its own purchase account.
b. Branch paid Rs. 30,000 as salary to a visiting head office official. The branch has debited
the amount to salaries account.
c. Depreciation, Rs. 50,000 in respect of branch assets whose accounts are kept in the
head office books is to be recorded by both the parties.
d. Expenses Rs. 70,000 to be charged to the branch for work done on its behalf by the
head office.
On finding a difference between two sides of the Trial Balance, the accountant transferred the
excess debit of Rs. 770 to a suspense account. Subsequently, the following errors were
detected. Give journal entries to rectify the errors and show the suspense account.
3. The total of the Returns Inwards Book Rs. 400 was not posted.
4. A purchase of Rs. 590 from Sathe was posted to his account as Rs. 950.
5. The bank column of the receipt side of the cash book was undercast by Rs. 110.
6. A cash sale of Rs. 200 to Ramesh was entered both in the cashbook and sales book.
8. Cash Rs. 150 paid to Brijmohan was posted twice to his account.
9. A credit balance of Rs. 450 to Malasingh’s account was carried forward as Rs. 540 on
the debit side.
10. The name of Vinod, a creditor, to whom we owed Rs. 500 was omitted from the list of
sundry creditors.
Q.19
2. Goods purchased from Sahani Rs. 531 was debited to his account as Rs. 351.
3. A television purchased for the workers’ canteen in the factory for Rs. 25,000 was debited
to Factory Expenses.
4. An amount of Rs. 15,000 paid for the construction of a new hall in the building was
debited to Repairs Account.
5. The total of the Sales Book for the month of February was cast short by Rs. 10.
7. A sum of Rs. 500 paid to Poonawalla for salary was debited to his personal account.
8. A credit sale of Rs. 1,000 to Rashid was correctly entered in the Sales Book but was
posted to the credit of his account in the ledger as Rs. 100.
9. Goods sold to Devidas Rs. 590 was recorded in the Sales Book as Rs. 950.
INTRODUCTION :
The Institute of Cost and Management Accountants, London has defined the Cost Accountancy
as “The Application of Costing and Cost Accounting principles, methods and techniques to
the science, art and practice of cost control and the ascertainment of profitability as well as
presentation of information for the purpose of managerial decision making.”. The analysis of
the above definition reveals the following facts.
(1) Cost Accountancy is a science, art and practice of a Cost Accountant. Science indicates
the possession and the application of relevant systematic knowledge. Art indicates the
skill and ability of the Cost Accountant. Practice indicates a continuous effort on the part
of the Cost Accountant.
(2) The terms costing and cost accounting should not be confused. Costing indicates the
process of ascertaining the costs which can be done arithmetically also. Cost accounting
indicates the process of recording the costs in a formal and systematic manner with the
intention of preparing statistical data therefrom to ascertain the cost.
(a) Ascertainment of cost and profitability with the help of various principles, methods
and techniques.
(b) Cost control – This indicates the process of controlling the costs of operating the
business. This process, in turn, involves the following stages. To plan the operations
(which can be done by the establishment of budgets and standards), execute the
plans, measuring the actual performance, comparison of planned and actual
performance, computing the variations between planned and actual performance
and taking the decisions to maintain favourable variations or to remove unfavourable
variations.
Cost Centre is defined as a location, person, or item of equipment (or a group of these) in or
connected with an undertaking, in relation to which costs may be ascertained and used for the
purpose of cost control. Correct identification of a cost centre is pre-requisite for the successful
implementation of cost accounting process as the costs are ascertained and controlled with
respect to the cost centres. Similarly, correct identification of cost centre facilitates the fixation
of responsibility in a correct manner. Eg. A person in-charge of a cost centre may be held
responsible for the proper functioning and cost control in relation to that cost centre. As cost
centres facilitate this control function, in many cases, they are termed as ‘Responsibility
Centres’. There may not be any fixed principle for deciding the number and size of cost
centres. It depends upon the nature and size of organisation, expenditure involved, requirements
of management from cost control point of view and so on. However, following pattern of
classification may be followed to decide the cost centres.
An impersonal cost centre consists of location or item of equipment (or group of these).
Eg. A region of sales, a branch, a department, a grinding machine and so on. A personal
cost centre consists of a person or a group of persons. Eg. Finance Manager, Sales
Manager, Works Manager and so on.
Production cost centre is the one where the production activity is carried on. Eg. Machine
shop, Paint shop, Assembly shop and so on.
Service cost centre is the one which assists the production activity. Eg. Store Dept.,
Internal Transport Dept., Labour Office, Maintenance Dept., Accounts/Costing Dept.,
and so on.
CONCEPT OF COST :
The term cost indicates the amount of expenditure (actual or notional) incurred on or attributable
to, a given thing.
Direct Cost indicates that cost which can be identified with the individual cost centre. It
consists of direct material cost, direct labour cost and direct expenses. It is also termed
as Prime Cost.
Indirect Cost indicates that cost which cannot be identified with the individual cost centre.
It consists of indirect material cost, indirect labour cost and indirect expenses. It is also
termed as overheads. As it is not possible to identify these costs with individual cost
centres, such identification is done in the indirect way by following the process of allocation,
apportionment and absorption. (It is discussed in details in the following chapters).
Fixed cost indicates that portion of total cost which remains constant at all the levels of
production, irrespective of any change in the later. As the volume of production increases,
per unit fixed cost may reduce, but not the total fixed cost.
Variable cost indicates that portion of the total cost which varies directly with the level of
production. Higher the volume of production, higher the variable cost and vice versa,
though per unit variable cost remains constant at all the levels of production.
Semi-variable or semi-fixed cost indicates that portion of the total cost which are partly
fixed and partly variable in relation to the volume of production.
Controllable cost indicates that cost which can be controlled by a specific number of
person(s) in the organisation. Eg. A person in charge of a responsibility centre may be in
the position to control the costs in relation to that responsibility centre.
Uncontrollable cost indicates that cost which cannot be controlled by a specific number
of person(s) in the organisation. Eg. The costs relating to one responsibility centre cannot
be controlled by a person who is in-charge of another responsibility centre.
It should be noted here that a clear-cut distinction between controllable and uncontrollable
costs may not be possible. The cost which is controllable for one person may not be
controllable by another one. In fact, no cost is completely uncontrollable. The degree of
controllability varies in relation to a particular individual and a level of management. In a
very broad sense, it can be said that the variable costs are controllable at the lower level
of management while fixed costs are controllable at the top level of management.
Normal Cost indicates that cost which is normally incurred at a certain level of output
under normal circumstances.
Abnormal cost indicates that cost which is normally not incurred at a certain level of
output under normal circumstances.
In very simple language, opportunity cost is the cost of opportunity foregone. The resource
like men, material, machine, money etc. may be having various alternative uses each
one having some specific yield or return. However, if they are used in one particular way,
they cannot be used in any other way. Opportunity cost refers to the return or yield
which is not available if the resources are used in any specific manner. Eg. Mr. A has Rs.
1,00,000 to invest. He is having two options open.
(i) Keep the same with some Bank in Fixed Deposit and get the interest of 10% p.a.
(ii) Invest the money in the business and get the return on investment of 12%.
If Mr. A decides to invest the money in business, he cannot get the interest on
Fixed Deposit from Bank. As such, opportunity cost of investing the money in the
business is in the form of lost interest on Fixed Deposits with the Bank. It should
be noted that the opportunity cost itself finds no place in the accounting process.
However, it is required to be considered in the decision making process, for the
comparison purpose. The returns available from a proposal should be more than
the cost of opportunity lost, then and then only the proposal can be accepted.
Differential cost indicates increased or decreased cost due to the increased or decreased
volume of operations. While assessing the acceptability of a proposed change, the
differential costs are compared with differential revenues, and so long as differential
revenues are more than the differential costs, the proposed change may be accepted.
Sunk cost indicates historical cost which is incurred in past. This type of cost is normally
not relevant in the decision-making process. Eg. While deciding about the replacement
of a machine, the depreciated book value of the machine may not be relevant being in the
form of sunk cost.
At the outset, it should be noted that if it is decided to install a costing system in an organisation
there may not be any standard type of costing system applicable. The details of costing
system may be required to be worked out in such a way that they satisfy the individual
requirements of the organisation. Following factors will have to be considered before installing
a costing system.
Before installing the costing system, the nature of product in respect of which the system
is to be installed will have to be studied. If the product is material intensive, more stress
may be necessary on inventory control procedures, if the product is labour intensive,
more stress may be necessary on control procedures and so on.
The nature of the organisation may be required to be studied from the various angles.
(3) The procedures presently followed in the respect of accounting of material cost,
labour cost and overheads.
Before installing the costing system, the technical process involved in the manufacturing
of the product will have to be studied. This may involve the study from the stage of
designing of the product, the quantity, quality and mix of the materials used, the degree
of automation involved, the production control techniques implemented, the degree of
complexities involved in the production process and so on.
The costing system to be installed should be simple to understand and easy to operate.
The costing system should be economic in terms of cost of installing and operating the
system, and the results obtained therefrom should justify the cost.
The costing system should be designed in such a way that it generates proper reports in
a proper way to facilitate cost control decisions from the management’s side. The reporting
system should be based upon the principle of Management by Exception. Forms and
records required to be maintained to facilitate correct reporting should be designed in
such a way that it involves minimum clerical work and minimum cost.
Some problems may arise while installing a costing system in an organisation. However, they
are faced mainly where the system is not properly planned, executed and communicated.
These problems are definitely not of the costing principles as such and can easily be overcome
by having systematic planning and communication procedures. The problems which are usually
faced while installing a costing system can be stated as below.
(1) The costing system may not be suitable considering the nature of product and nature of
business.
(2) The employees and the executives may resist the installation of the costing system
feeling that it is meant for pointing out their drawbacks. This arises only out of ignorance
and suspicion.
(4) The cost involved in installing a costing system may be too high.
(5) Laxity on the part of various employees to complete the forms of cost office and to
forward them to the cost office.
Explain the factors which need to be considered for installing a costing system for a
medium sized engineering organisation.
In case of a typical manufacturing type of operation, the activity may consist of conversion of
raw material in the form of finished goods with the help of labour and other services and selling
the finished goods in the market to earn the profits. In order to interpret the term cost correctly
and to ascertain the cost with respect to the centres, the cost attached with the manufacturing
process may be subdivided into what is known as Elements of Cost. Broadly there can be
three elements of costs.
(A) Material :
This is the cost of commodities and materials used by the organization. It can be direct or
indirect.
Direct Material indicates that material which can be identified with the individual cost centre
and which becomes an integral part of the finished goods. It basically consists of all raw
materials, either purchased from ourside or manufactured in house.
Indirect Material indicates that material which cannot be identified with the individual cost
centre. This material assists the manufacturing process and does not become an integral part
of finished goods. The examples of this type of material may be consumable stores, cotton
waste, oils and lubricants, stationery material etc.
(B) Labour :
This is the cost of remuneration paid to the employees of the organisation. It can be direct or
indirect.
Direct Labour Cost indicates that labour cost which can be identified with the individual cost
centre and is incurred for those employees who are engaged in the manufacturing process.
Indirect Labour Cost indicates that labour cost which cannot be identified with the individual
cost centre and is incurred for those employees who are not engaged in the manufacturing
process but only assist in the same. The examples of this type of cost are wages paid to
foreman/storekeeper, salary of works manager, Accounts/Personnel department salaries etc.
This is the cost of services provided to the organisation (and the notional cost of assets
owned). It can be direct or indirect.
Direct Expenses are those expenses, which can be identified with the individual cost centres.
The examples of these expenses are hire charges of machinery/ equipments required for a
particular job, cost of defective work for a particular job etc.
Indirect Expenses are those expenses, which cannot be identified with the individual cost
centres. The examples of these expenses are rent, telephone expenses, insurance, lighting
etc.
Cost
The aggregate of Direct Material Cost, Direct Labour Cost and Direct Expenses is termed as
‘Prime Cost’.
The aggregate of Indirect Material Cost, Indirect Labour Cost and Indirect Expenses is termed
as ‘Overheads’.
Overheads :
As discussed above, the aggregate of Indirect Material cost, Indirect Labour cost and Indirect
Expenses is termed as ‘Overheads’. For the proper interpretation and presentation of cost,
the term overheads may be further classified as below.
These overheads consist of all overhead costs incurred from the stage of procurement of
material till the stage of production of finished goods. They include :
l Indirect Material such as consumable stores, cotton waste, oil and lubricants etc.
These overheads consist of all overhead costs incurred for the overall administration of
the organization. They include :
l Indirect Labour cost such as salaries paid to Accounts and Administration staff,
Directors’ remuneration etc.
These overheads consist of all overhead costs insured from the stage of final manufacturing
of finished goods till the stage of sale of goods in the market and collection of dues from
the customers. They include :
l Indirect Labour like salaries paid to sales personnel, commission paid to sales
manager etc.
Indirect Material
Indirect Expense
Indirect Material
Indirect Expense
Indirect Material
Indirect Expense
The various elements/components of the cost as discussed above can be presented in the
form of a statement, popularly known as ‘Cost Sheet’ or ‘Cost Statement’. The cost sheet
may be prepared separately for each cost centre and may have the columns like cost per unit
or cost of previous period etc.
Direct Expenses
PRIME COST
Add : Profit
SALES
PROFIT
ADMINISTRATION
OVEREHEADS
FACTORY
OVERHEADS
DIRECT
EXPENSES
COST OF SALES
FACTORY COST
PRIME COST
TOTAL COST
DIRECT
LABOUR
SALES
DIRECT
MATERIAL
Note :
The difference between sales and factory/works cost is termed as ‘Gross Profit’ and the
difference between sales and cost of sales is termed as ‘Net Profit’ or ‘Operating Profit’. As
such, the difference between Gross Profit and Office and Administration Overheads and Selling
and Distribution may be different from the ‘Net Profit’ or ‘Operating Profit’. This Net Profit may
be different from the net Profit as disclosed by the financial statement in the form of Profit and
Loss Account. This is due to the fact that the Profit and Loss Account considers the various
non-operating incomes/expenses or incomes/expenses of purely financial nature (as discussed
below) while they may be ignored by the cost statement.
These represent incomes which arise not as a part of regular operations of the organisation.
Eg. Profit on the sale of assets/investment, dividend received, windfall income etc. Due
to these, the operating profit as per cost statement may be less than profit as per Profit
and Loss Account.
These represent expenses which arise not as a part of regular operations of the
organisation. Such expenses may be in the form of those incurred as a result of policy.
Sales
It goes without saying that if an organisation maintains cost records and financial records
separately, there may be a need to reconcile the profits as disclosed by the cost records and
the profit as disclosed by the financial records.
ILLUSTRATIVE PROBLEMS
(1) From the following list of balances, prepare a statement showing Cost of Sales, Gross
Profit, Operating Expenses, Operating Profit and Net Profit.
Rs.
Sales 7,80,000
Purchases 4,83,375
Sales Returns 30,000
Salaries : Office 40,350
Selling 22,950 63,300
Rent and Taxes : Office 2,700
Selling 1,350 4,050
Stationery and Postage 3,850
Depreciation 13,950
Advertising 4,700
Selling expenses 2,350
Travelling expenses 3,000
Solution :
COST STATEMENT
80,350
- Salaries 22,950
- Rent and Taxes 1,350
- Advertising 4,700
- Selling Expenses 2,350
- Sundry Expenses 8,250
39,600 1,19,950
1,60,550
Notes :
(a) From the available details, it appears that the above activity is a trading activity. As such
there will be no factory overheads and prime cost will consist of only material cost.
(b) In want of sufficient information, depreciation and travelling expenses are treated as
office and administration overheads.
(c) Dividend on shares may indicate the non-operating income also. However, in want of
sufficient information, it is treated as dividend paid by the company i.e. a part of non-
operating expenses.
(2) From the books of accounts of M/s. Aryan Enterprises, the following details have been
extracted for the year ending March, 1994.
Rs.
Stock of Materials – Opening 1,88,000
– Closing 2,00,000
Materials purchased during the year 8,32,000
Direct Wages paid 2,38,400
Indirect Wages 16,000
The manager’s time is shared between the factory and the office in the ratio of 20:80.
From the above details, you are required to prepare :-
a. Prime Cost
b. Factory Overheads
c. Factory Cost
d. Administration Overheads
e. Selling Overheads
f. Total Cost
Solution :
COST SHEET
Direct Materials Cost Rs. Rs.
Opening Stock 1,88,000
Add : Purchases 8,32,000
Less : Closing Stock 2,00,000
8,20,000
Add : Freight Inward 32,000
Administration Overheads
Salaries 40,000
Rent, Rates and Taxes 6,400
Travelling Expenses 12,400
Depreciation – Furniture 2,400
Directors’ Fees 24,000
General Charges 24,800
Manager’s Salary 38,400
1,48,400
OFFICE COST 14,59,200
Selling Overheads
(4) Pune Equipments Ltd. manufactured and sold 1,000 refrigerators in year ending
31 December, 1984. The Trading and Profit & Loss Account is as below:
To, Mgn. & Staff Salary 60,000 By, Gross Profit 1,50,000
To, Rent, Rates etc. 10,000
To, Selling Expenses 30,000
To, General Expenses 20,000
To, Income Tax 5,000
To, Net Profit 25,000
1,50,000 1,50,000
Solution :
Note :
(1) Material Cost and Direct Cost increases both due to increase in volume and increase in
prices.
(3) Expenditure in the form of income tax will be ignored being non-operating expenditure.
Tabulate the above data in the form of a suitable statement and indicate in the factory
cost per unit, under each of the above methods if the daily production is (a) 15 units
(b) 20 units (c) 25 units.
Solution :
COST SHEET
Alternative I Alternative II
(b) Prime Cost (Rs) 12.00 18.00 22.50 12.00 18.00 22.50
(c) Factory overheads (Rs) 7.50 12.00 15.00 9.60 14.40 18.00
(d) Total factory cost i.e. b+c 19.50 30.00 37.50 21.60 32.40 40.50
(e) Factory cost per unit i.e. d/a (Rs) 1.30 1.50 1.50 1.44 1.62 1.62
Note :
You are given the following set of information, from which you are requested to find out the
profit or loss made on each brand showing clearly, the following elements.
Brands
A B C D
Factory overhead expenditure for the month was Rs. 1,62,000. Selling and distribution cost
should be assumed @ 20% of works cost. Factory overhead expenses should be allocated to
each brand on the basis of the units which could have been produced in a month when a single
brand production was in operation.
Solution :
Rs. 1,62,000
= Rs. 3.60/per unit
45,000 units
On this basis, the cost sheet for each product can be worked out as below.
A B C D
(7) A manufacturing company has an installed capacity of 1,20,000 units per annum. The
cost structure of the product manufactured is as under –
The capacity utilisation for the next year is estimated at 60% for 2 months, 75% for 6 months
and 80% for the balance part of the year. If the company is planning to have a profit of 25% on
the selling price, calculate the estimated selling price for each unit of production. Assume that
there is no opening or closing stock.
Solution :
6000 x 2 months + 7500 units x 6 months + 8000 units x 4 months = 89,000 units
Total
Materials (Rs.) 96,000 360,000 256,000 7,12,000
Labour 112,000 360,000 256,000 7,28,000
Overheads 36,000 135,000 96,000 2,67,000
Semi-variable Overheads 8,000 30,000 20,000 58,000
Fixed Overheads 1,04,000
Cost of Production 18,69,000
Per Unit Cost of Production i.e. 18,69,000/89,000 = Rs. 21
As profit is 25% on the selling price, selling price will be Rs. 28 per unit.
(8) AB & Co. manufactures two types of pens P and Q. The cost data for the year ended
30th September, 1990 is as follows –
Rs. 7,20,000
Prepare a statement showing per unit cost of production, profit and total sales value and profit
separately for two types of pens P and Q.
Solution :
Particulars P Q
Direct Material 1,60,000 2,40,000
Direct Wages 80,000 1,44,000
Production Overheads 24,000 72,000
Administration Overheads 1,60,000 2,88,000
a. Cost of Production 4,24,000 7,44,000
a. Direct Materials
Let per unit direct materials cost of Q be Rs. X. Hence, per unit direct materials cost of
P will be 2X Total Direct Materials Cost will be – 40,000 units x 2X + 1,20,000 units x X
= 4,00,000.
Solving for X, we get X = Rs. 2
Hence, Direct Materials Cost for P will be Rs. 1,60,000 and Direct Materials Cost for Q
will be Rs. 2,40,000.
b. Direct Wages
Let rate of labour be Rs. X for P Hence, rate of labour for Q will be 0.6X for Q
Total Direct Wages will be – 40,000 units x X + 1,20,000 units x 0.6X = 2,24,000
Solving for X, we get X = 2
Hence, Direct Wages Cost for P will be Rs. 80,000 and Direct Wages Cost for Q will be
Rs. 1,44,000.
(9) A company presently sells an equipment for Rs. 35,000. Increase in prices of labour and
material are anticipated to the extent of 15% and 10% respectively in the forthcoming
year. Material cost represents 40% of cost of sales and labour cost 30% of cost of sales.
The remaining relate to overheads. If the existing selling price is retained, despite the
increase in labour and material prices, the company would face a 20% decrease in the
existing amount of profit on the equipment.
You are required to arrive at a selling price so as to give the same percentage of profit on
increased cost of sales, as before. Prepare a statement of profit/loss per unit showing the new
selling price and cost per unit in support of your answer.
Solution :
Let cost of sales per unit be Rs. X. Then per unit profit will be 35000 – X.
Per unit cost structure will be as below –
Material Cost 0.4X
Labour Cost 0.3X
Overheads 0.3X
After the price increase, per unit cost structures will change as below –
Material Cost 0.44X
Labour Cost 0.345X
Overheads 0.3X
Solving for X, we get X = 24,561. Hence, the existing per unit cost of sales is Rs. 24,561.
As such, following is the per unit cost structure with the existing prices and after the price
increase,
Existing Future
Materials Cost 9,825 10,808
Labour Cost 7,368 8,473
Overheads 7,368 7,368
10,439
X 100 = 42.5%
24,561
If the same profit percentage is to be maintained after the cost increase, the new selling price
will be –
(10) A firm has purchased a plant for manufacturing a new product, the cost data for which is
given below.
Hence,
24000X = 96000 + 14400 + 24000 + 28800 + 3600X + 24480
24000X = 187680 + 3600X
20400X = 187680
X = 9.20
QUESTIONS
1. What do you mean by Elements of Cost? Explain in details. Draw a standard format of
cost sheet for a machine tool manufacturing company. Assume suitable data.
2. How the cost is classified into various elements for presenting the same in the form of a
cost sheet. Prepare a standard format of cost sheet for a furniture making unit. Assume
suitable data.
(1) The following figures relates to the trading activities of Hind Traders for the year ended
30.6.79. Prepare a statement showing net operating income.
Rs. Rs.
Sales 5,20,000 Office Salaries 27,000
Purchases 3,22,250 Rent 2,700
Opening Stock 76,250 Stationery & Postage 2,500
Closing Stock 98,500 Depreciation 9,300
Sales Returns 20,000 Other charges 16,500
Interest on Debentures 15,300 Provision for Tax 40,000
Advertising 4,700
Travelling 2,000
(2) From the following list of balances, prepare a statement showing net operating income.
Rs.
Sales 5,40,000
Purchases 1,60,000
Sales Returns 40,000
Purchases Returns 10,000
Opening Stock 50,000
Closing Stock 60,000
Rent Received 1,50,000
Profit on sale of asset 1,00,000
Office Expenses 25,000
Manufacturing Expenses 30,000
Selling Expenses 10,000
Depreciation 13,000
Interest on Loan 2,000
Income Tax 150
What selling price should be quoted by the Company if it intends to earn a profit of 20% on
selling price?
(4) Honesty Engineering Works has a machining shop in which it manufactures two Auto
Parts P1 and P2 out of forgings F1 and F2. For the quarter ending December 1993,
following cost data are available –
b. Direct wages paid were Rs. 36,000 incase of P1 and Rs. 32,000 for P2. This is used for
apportioning Wages and Salaries and Factory Overheads.
P1 – 550 P2 – 450
d. Stores & Spares, Repairs & Maintenance, Power, Insurance and Depreciation are charged
to cost of both the products on the basis of machine hours used.
Required – Prepare cost sheets of both the products and work out profit earned of each of
them.
(5) The cost of manufacturing 5,000 units of a commodity comprises Material Rs. 20,000,
Wages Rs. 25,000, Chargeable Expenses Rs. 400. Fixed Overheads Rs. 16,000, Variable
Overheads Rs. 4,000.
For manufacturing every 1,000 extra units of the commodity, the cost of production
increases as follows.
1. Materials : Proportionately.
2. Wages : 10% less than proportionately.
3. Chargeable Expenses : No extra cost.
4. Fixed Overheads : Rs. 200 extra.
5. Variable Overheads : 25% less than proportionately.
Calculate the estimated cost of producing 8,000 units of the commodity and show by
how much it would differ if a flat rate of factory overhead were charged.
(6) The following is the profit and loss account of a manufacturing company for the year
1987-88 (figures in lakhs).
During the year 6000 units were manufactured and 4800 units were sold. The costing records
show that works expenses have been charged @ Rs. 300 per article,and administration
expenses @ Rs. 150 per article. The costing books show a profit of Rs. 12 lakhs.
(7) A firm manufactured and sold 500 units during the year ended on 31st March, 2001. The
summarised Trading and Profit & Loss Account is as below :
Prepare a statement showing the price in such a way that profit will be 20% on selling price.
Materials 2,80,000
Labour 1,00,000
Processing Charges 1,00,000
Of the total output, 10% was defective and had to be sold after a discount of 10% off the
normal price. The scrap arising out of the production realized a sum of Rs. 8,760. The sale
price is calculated to yield 15% profit on sales. You are required to find out the normal price as
well as the discounted price of per MT of M.S. Rods.
(9) In a factory, the methods mentioned below are adopted for the allocation of office and
selling overheads.
The factory deals with five different types of products viz. B, C, D, E and F. The following
information has been collected from its books.
Factory overhead charges are 80% of direct wages. Office and sales expenses are :
Rs.
Direct Selling Costs 81,000
Other Items 53,280
Credit and Collection Expenses 8,100
Advertisement and Sales Promotion 79,920
Prepare a statement showing the costs incurred and the profit earned in respect of each
product. (Calculations may be made to the nearest rupee).
Material cost is the first and probably the most important element of cost. In case of some
specific types of industries, say cement, sugar, chemicals, iron and steel etc., the materials
cost forms a very significant portion of the overall cost of production.
The term material refers to all commodities which are consumed in the production process.
The materials which can be consumed in the production process can be basically classified
as:
The meaning of both these terms has already been discussed. The basic objective of cost
accounting i.e. ascertainment of cost and control of cost is equally applicable to material cost
as well. The ascertainment of material cost is made from basically two documents i.e. the
invoice of the supplier of material and material requisition slip specifying material issued from
stores department to production department. However, a whole lot of organisational procedures
are also involved in the process, which affect the material cost, either directly or indirectly.
E.g. Purchases from improper source of supply may be expensive, non-availability of material
in time may result into hold ups and so on. As such, a proper study of the various procedures
involved in case of the movement of materials and a proper control thereon enables an
organisation to exercise the control on a sizeable manufacturing cost.
(A) Procurement of Materials : Though the practices may differ from organisation to
organisation, normally, the process of purchasing the materials involves the following
stages.
(ii) When it is required : Unless the material is required for regular production
purposes (when the storekeeper himself will place the purchase requisition as
soon as it reaches the ordering level), purchase requisition should mention
the last date by which the material is required. Ideally, the material should be
purchased whenever the market for the same is favourable.
(iii) How much to be purchased : Purchase requisition should state the quantity
of the material required. Before deciding the quantity of material to be
purchased, the principle which should be kept in mind is that there should not
be any overstocking or understocking of materials as both these situations
involve costs.
- Frantic eleventh hour purchases which may result into unfavourable prices
and quality.
(iii) Funds availability - Amounts which are kept aside for drawing up purchase
budget should be considered.
The purchase requisition should be signed by Head of the Department drawing the same.
A standard form of Purchase Requisition is as shown below :
PURCHASE REQUISITION
For this purpose, the purchase department may call for the quotations from the prospective
suppliers of a certain type of material. In practice, following types of quotations may be
called for :
(a) Single Tender : It is addressed to only one selected source when there is only
one source of supply available.
(c) Open Tender : It is open to all who can supply specified quality and quantity of the
required material. Tenders are called by giving advertisements in the newspapers,
journals etc.
(d) Global Tender : Anybody from any part of the world can respond to these tenders.
To discourage unreliable and unwanted sources from quoting, some tender deposit may be
insisted upon.
Comparative Statements :
After receiving the tenders as stated above, a comparison has to be made among the various
available sources so that the best possible source can be selected. All the offers are tabulated
in a comparative statement. The authority which is authorised to accept the tender should be
specified. The criteria for selecting the final source of supply may depend upon the terms of
offer which can be compared in respect of price offered, quality, other terms (like Sales Tax,
Octroi, Freight etc.), terms of delivery, terms of payment, guarantee offered by the supplier,
goodwill of the supplier etc. Lowest quotation may not necessarily be the best quotation.
The contractual obligation between the supplier and purchaser starts from purchase
order. It is drawn in favour of the supplier by the purchase department. It may specify a
number of facts.
- Material to be supplied (Description as well as code numbers and quality).
- Quantity to be supplied.
- Price and other terms (e.g. excise duty, sales tax, octroi, insurance, packing and
transportation etc.).
- Cash and trade discount.
- Instructions in respect of delivery.
- Guarantee clause.
- Liquidated damages clause.
- Escalation clause.
- Inspection clause.
- Method of settlement of disputes.
- Details in respect of letters of credit, import licence etc.
- Details in respect of interest payable in the event of late payment of dues.
PURCHASE ORDER
No. –
Date –
Requisition No.–
Date –
Please supply the following material on such terms and conditions as stated therein.
Description Code No. Quantity Rate Rs. Value Rs. Delivery Date Remarks
Purchase Manager
– Accept the material ordered and return the excess to the supplier.Before accepting,
material may be subjected to inspection. The extent of inspection may vary from
material to material.
(5) Checking invoice and accounting for purchases : The supplier’s invoice received for
the supply of material is subjected to scrutiny before a voucher is passed for the same
for making the entry in the books of accounts. For this purpose, the supplier’s invoice
may be compared alongwith the following documents.
If the quantity and/or rate as per purchase order and invoice match with each other, the
invoice of the supplier is passed for making the entry in the books of accounts. If the
quantity and/or rate as per purchase order and invoice differ from each other, the difference
is adjusted by raising a debit or credit note in favour of the supplier.
(B) Storing and Issue of Material : After the material is received, inspected and approved,
the process of storing comes into operation which deals with storing the material in good
condition till it is required for use by production departments and issuing the same
whenever required.
As far as the movement of the material from the stores point of view is concerned, there
can be basically four types of movements.
No.
Date
S. No. Description Code Qty. Recd. Qty. Accepted Qty. Rejected Remarks
– One copy to Purchases Department for comparing with purchases order and approving
the invoice of the supplier.
– One copy to Accounts Department for making the payment of supplier’s invoice.
– One copy to Costing Department for pricing and entering in stores record.
Ideally, GRN/GRR should be serially numbered in order to locate the material which is physically
received but for which invoice is not received.
The material physically received when compared with material ordered as per the purchase
order may reveal certain discrepancies which may take any of the following forms.
Excess quantity received may be retained and accepted, if required, with the approval of the
purchase department. Alternatively, if it is not accepted, it may be returned to the supplier with
Goods Returned Note. The usual form in which Goods Returned Note is prepared is as below:
To : No.
Date :
Following material supplied by you vide your D.C. No.____________ and Invoice
No.____________against our Purchase Order No. ______________is being returned to
you for the reasons stated below:
Signature
Usually, three copies of Goods Returned Note are prepared to be distributed as below :
Excess Quantity Accepted : If excess quantity is already billed in the invoice, it will be
approved and paid. If not, either the supplier may be asked to give a supplementary invoice or
credit note may be issued to the supplier for amending the amount.
Excess Quantity Returned : If excess quantity is already billed in the invoice, debit note may
be issued to the supplier for amending the amount.
In case the quantity received is short, purchase department may take up the case with the
supplier or carrier or insurer as per the terms of purchases. If quantity short supplied is billed
in the invoice, invoice is suitably amended and debit note is issued to the supplier.
If quantity received is of different quality and is rejected in inspection, it can either be retained
or returned. It may be retained by accepting some mutually decided concessional price. The
variation in prices may be adjusted by issuing either the credit note or debit note in favour of
the supplier.
(2) Issue of Material : Here, the issue of material refers to issue of material from stores
department to production department. The material should not be issued from the stores
unless a proper authority in writing is produced before the stores department. Usually,
this authority is in the form of Material Requisition Note or Material Requisition Slip.
Normally, it is prepared in three copies.Two copies to Stores Department which in its turn
passes one copy to Costing Department for pricing while second copy is retained by the
Stores Department. One copy is for demanding department.
There can be some situations, when material once issued to production departments is
returned back to the stores. It can happen in the following circumstances.
Under these circumstances, a document in the form of Materials Returned Note is prepared,
which is to record return of unused materials. The usual form in which this document is
prepared is as below :
As far as the valuation of the returned material is concerned, it may be treated as the fresh
receipt of the material or alternatively, it may be treated as the negative(minus) issues.
(4) Transfer of Materials :In some situations, considering the urgency for the requirement
of the material, it may be necessary to transfer the material from one production/job
order to another. Such transfer of material is usually accompanied by preparing a document
in the form of Material Transfer Note. The usual form in which this document is prepared
is as below :
No.
Date :
From…………Dept. To…………..Dept.
Production/Job Production/Job
Order No. Order No.
Description Code No. Qty. Cost (for costing Dept. only)
Rate per unit Amount Rs.
As discussed earlier, proper conduct of storage function requires that material should be
properly stored in good condition till it is required for use by production departments and
should be issued whenever required. This proper conduct is ensured by what is known as
“Perpetual Inventory System”. The aims of the perpetual inventory system are two fold.
(1) Recording receipts and issues in such a way so as to know at any time, the stock in
hand, in quantity and/or value, without the need of physical counting. This aim is achieved
by maintaining what is called as Bin Card and Stores Ledger.
Bin Card
It is only a quantitative record of receipts, issues and closing balance of an item of material.
Separate bin card is maintained for each item of material. The usual form in which a bin card
is maintained is as below.
BIN CARD
Entries in receipts column are made on the basis of Goods Received Note or Material Returned
Note. Entries in issues column are made on the basis of Material Requisition Note. After every
entry of either receipts or issues, the balance quantity is calculated and recorded so that the
balance can be known at any point of time. The levels indicated on bin card enable the stores
department to keep a watch on balance and replace the material as soon as it reaches the
reorder level.
Stores Ledger
Like Bin Card, it is maintained to record all receipts and issue transactions of material but with
the exception that it records not only the quantities received or issued or in stock but also the
financial expressions of the same. The usual form in which the stores ledger is maintained is
as following :
STORES LEDGER
By summing up the amounts appearing in the ‘issues’ column of stores ledger, one can get
the cost of material issued to Production Department which forms the ‘Material Cost’.
As in case of bin card, separate store ledger sheets are maintained in case of each item of
material. The stores ledger sheets are maintained either in loose form or in bound book form.
If the stores ledger is having all the information mentioned in a bin card plus some additional
information is also available, the next question which arises is why is it necessary to maintain
both bin card and stores ledger simultaneously as it will be only duplication of work. In the
situations of computerized inventory accounting system, maintenance of bin card and sotres
ledger simultaneously can be avoided. However, in the situations of manual inventory accounting
system, it will be ideal to maintain bin card and stores ledger simultaneously due to the
following reasons.
(1) Bin card is maintained by stores department while stores ledger is maintained by costing
department.
As the source documents for the entries in Bin Card and Stores Ledger are the same, the
closing balances disclosed by both of them should match with each other. But in practice,
they may not match due to the following reasons.
(1) Arithmetical error in calculating balance.
(2) Non-posting of certain document in either of these documents.
(3) Posting on wrong bin card or stores ledger sheet.
(4) Treating receipts transaction as issue transaction or vice versa.
If the closing balance as per bin card and stores ledger is not matching, the very purpose of
maintaining these two documents simultaneously will be defeated. As such, it is necessary
to reconcile both balances at regular intervals by keeping all the postings upto date. If the
balances as on a particular day are not matching, all the previous transactions should be
checked to locate differences.
As discussed above, the stores ledger considers not only the movement of material in terms
of quantity but also in terms of its financial implications. As such, it is necessary that all the
possible movements of material are valued properly and are expressed in terms of money. We
will consider this problem under the following heads.
(a) Valuation of receipts.
(b) Valuation of issues.
(c) Valuation of returns from production department to stores department.
Valuation of receipts is relatively an easy task, as the invoice or bill received from the
supplier of the material is available as a starting point. Following propositions should be
considered for this purpose.
(1) The price as billed by the supplier will be the valuation of the receipts. The trade
discount is deducted from the basic price and all other amounts as billed by the
supplier are added viz. Excise Duty, Sales Tax, Octroi Duty, Transport/Insurance
charges etc. There are different opinions in respect of the treatment of cash discount.
One opinion says that cash discount should be ignored being purely of financial
nature while valuing the receipts, while another opinion says that it should be
considered while valuing the receipt of the material.
(3) In case of the imported material, the cost of the material consists of basic price
(which may be stated in foreign currency and should be converted in Indian Rupees),
Customs Duty, Clearing Charges, Transport Charges, Octroi Duty etc. In some
cases, the point of receipt of imported material and the point of making the payment
of invoice amount may be different. As such, rate of foreign currency may be different
at the time of payment of customs duty and at the time of payment of invoice
amount. In such cases, the rate of exchange existing at the time of making the
payment of invoice amount should be considered for valuing basic cost of material
imported.
Illustration :
The particulars relating to 1,200 kgs. of a certain raw material purchased by a company during
June, were as below.
(a) Lot prices quoted by suppliers and accepted by the company for placing the purchase
order.
(b)
Lot upto 1000 kgs.
Between 1000 - 1500 kgs.
Between 1500 - 2000 kgs
(g) Insurance at 2.5% (on net invoice value) paid by the purchaser.
The containers are returned .in due course. Draw up a suitable statement to show :
Rs. 23,121.63.
= Rs. 19.268/kg.
1,200 kgs.
Illustration :
The particulars related to the import of Sealing Ring made by AB & Co. during December 85
are given below.
(a) Sealing Ring 1,000 pieces invoiced @ £ 2 CIF, Bombay Port.
(b) Customs Duty was paid @ 100% on invoice value (which was converted to Indian Currency
by adopting an Exchange Rate of Rs. 17.20 per £)
(d) Freight charges : Rs. 1,400 for transporting the consignments from Bombay Port to
Factory premises.
It was found on inspection that 100 pieces of the above material were broken and therefore
rejected. There is no scrap value for the rejected part. No refund of the broken material would
be admissible as per the terms of contract. The management decided to treat 60 pieces as
normal loss and the rest 40 pieces as abnormal loss. The entire quantity of 900 pieces was
issued to production.
Calculate :
Also state briefly how the value of 100 pieces rejected in inspection will be treated in costs.
Solution :
As loss of 40 pieces is considered as abnormal loss, it will be transferred to Costing Profit and
Loss Account.
Rs. 72,000
∴ Abnormal Loss = X 40 pieces
1,000 pieces
= Rs. 2,880
Balance of the cost (i.e. Rs. 72,000 - Rs. 2,880 = Rs. 69,120)Includes cost of units treated as
normal loss i.e. 60 pieces.
= Rs. 76.80
(b) Valuation of Issues :
This is a more complex process than the valuation of the receipts. It is because of the
reason that the material may be issued out of the various lots which might have been
purchased at various prices. As such, a problem may arise as to which of the receipt
prices should be used to value the material requisition notes. Various methods may be
used for this purpose, main methods of which may be discussed as below.
(a) First In First Out (FIFO)Under this method, the price of the earliest available lot is
considered first and if that lot is exhausted, the price of the next available lot is
considered. It should be remembered that the physical issue of the material may
not be made out of the said lots, though it is presumed that it is made out of these
lots as stated above.
Illustration :
Following transactions have taken place in respect of a material during March 1990.
Date :
1 Opening Balance 500 units @ Rs. 6 per unit.
5 Purchased 100 units @ Rs. 7 per unit.
7 Issued 400 units.
9 Purchased 300 units @ Rs. 8 per unit.
19 Issued 250 units.
22 Issued 50 units.
25 Purchased 300 units @ Rs. 7.50 per unit.
30 Issued 250 units.
Prepare the Stores Ledger assuming that the issues are valued on FIFO basis.
100 6
19 MRN No. 100
50
} 7
8
1700 250 8 2,000
Value of closing stock is Rs. 1,875 which considers latest available market price of the material.
(b) It considers the valuation of closing stock at the current market prices.
(c) It can be conveniently applied if transactions are not too many and the prices of the
material are fairly steady.
(a) Calculations become complicated if the lots are received frequently and at varying prices.
(b) Costs may be wrongly presented if the price of different lots of material are used for
pricing issues to various batches of production.
(c) In case of varying prices, the pricing of issues does not consider current market prices.
Under this method, the price of the latest available lot is considered first and if that lot is
exhausted, the price of the lot prior to that is considered. Here also, it should be
remembered, that the physical issue of the material may not be made out of the said
lots, though it is presumed that it is made out of the lots as stated above.
Illustration :
Following transactions have taken place in respect of a material during March 1990.
Date:
22 Issued 50 units.
Prepare the stores ledger assuming that the issues are valued on LIFO basis.
} }
19 MRN No. 250 8 2,000 200 6 1,600
50 8
22 MRN No. 50 8 400 200 6 1,200
25 GRN No. 300 7.5 2,250 200
300 } } 6
7.5
3,450
Value of closing stock is Rs. 1,575 which consists of 200 units valued at Rs. 6 per unit which
happens to be the earliest available price of the material i.e. price of the opening balance
available.
(b) The cost of materials issued considers fairly recent and current prices. The prices quoted
on this cost fairly represent its real cost.
(c) It can be conveniently applied if transactions are not too many and prices of the material
are fairly steady.
(a) Calculations become complicated if the lots are received frequently and at varying prices.
(b) Costs may be wrongly presented if the price of different lots of material are used for
pricing issues to various batches of production.
(c) In case of falling prices in the market, this method may give wrong results.
Both the above methods i.e. FIFO and LIFO, consider the exact or actual cost for valuing
the issue of material. However these methods may prove to be disadvantageous if the
transactions are too many and are at varying prices. In such cases, instead of considering
the exact or actual cost, average cost may be considered to lessen the effect of variation
in prices, either upward or downward.
Rs. 24,000
The issues will be considerably under-valued and closing stock will be considerably over
valued, as compared to the current market prices.
If LIFO method is followed to price the issues, the issues will be valued as below.
Rs. 50,000
The closing stock will be considerably under valued as compared to the current prices.
To lessen the effect of such drastic price variation, both on the valuation of issues as well
as of closing stock, instead of considering the actual/exact price of Rs. 10 per unit or
Rs. 30 per unit, average price may be taken into consideration.
There are mainly two ways in which average prices may be considered.
Illustration :
Following transactions have taken place in respect of a material during March 1990.
Date :
1 Opening Balance 500 units @ Rs. 6 per unit
5 Purchased 100 units @ Rs. 7 per unit.
7 Issued 400 units.
9 Purchased 300 units @ Rs. 8 per unit.
19 Issued 250 units.
22 Issued 50 units.
25 Purchased 300 units @ Rs. 7.50 per unit.
30 Issued 250 units.
Prepare the stores ledger assuming that the issues are valued on Simple Average basis.
Stores Ledger
(2) Weighted Average Method :As stated above, the simple average method of valuation
of issues may lead to wrong results, if the quantity of each lot of material received varies
widely. Eg. Assume the following situation.
Rs. 1,51.000
On March 20, 4800 units were issued to production. As both the lots are possible lots for
making the issue, the average of prices of both the lots will be taken into account if
simple average method is considered. Hence, per unit issue price will be -
Rs. 10 + Rs. 30
i.e. Rs. 20
2
As such, the issue quantity will be priced at : 4,800 units x Rs.20 i.e. Rs. 96,000, which
will be incorrect, as considering the quantity of issue, the price of the material received
on March 10 should get more weightage.
To overcome this drawback of simple average method, weighted average method may be
used which considers not only the price of each lot but also the quantity of the same.
Though this method involves considerable amount of clerical work, in practice, this method
proves to be very useful in the event of varying prices and quantities. In practice, the
calculation of weighted average rate proves to be very simple. The products of quantity
and price divided by the total quantity of all lots, just before the issue, gives the unit price
in respect of the subsequent issues.
Illustration :
Following transactions have taken place in respect of a material during March 1990.
Date :
1 Opening Balance 500 units @ Rs. 6 per unit
5 Purchased 100 units @ Rs. 7 per unit.
7 Issued 400 units.
9 Purchased 300 units @ Rs. 8 per unit.
19 Issued 250 units.
22 Issued 50 units.
Prepare the Store Ledger assuming that the issues are valued on Weighted Average Basis.
Stores Ledger
(d) Highest In First Out :This method assumes that the stock should always be shown at
the minimum value and hence the issues should always be valued at the highest value of
receipts. E.g. Assume a situation as follows.
On March 20, 120 units are issued to production and they will be valued at Rs. 18 per
unit being the highest price. This method is not very popular. It always overvalues the
issues and undervalues the closing stock. This method may be useful in case of the
organisations dealing with monopoly products which is a rare possibility.
The defect in respect of this method is that the price concessions obtained in respect of
bulk purchases are not reflected in cost of material.
If the material is purchased against a specific job or production order, the issue of material
is priced at actual purchase price.
This is the normal or ideal price which will be paid in the normal circumstances, based
on the basis of estimated market conditions, transportation costs and normal quantity of
purchases. Any issue of material will be priced at standard prices irrespective of actual
prices. This enables the simplification of accounting system with reduced clerical work
and also enables to decide the efficiency of purchase department,
The original price of issue will be a base for valuing the returns for which original
material requisition note will be the base.
The method which is followed for valuing the issue on the same date is considered
for valuing the returns.
This will avoid the clerical efforts, but at the same time the track of original issue of
material can’t be maintained.
Treatment of shortages :
In some cases, the physical verification of stock may reveal that the physical stock is less
than the stock as per stores ledger. For proper accounting, the shortage has to be treated as
an issue so that the book stock can be brought down to the level of physical stock. The
Inventory Control :
The object of inventory control is to reduce the investment in inventory without affecting the
efficiency in the area of production and sales. It should be remembered that the object is not
only to reduce the investment in inventory. If that would have been the object, no organisation
would have maintained inventory of any kind, thereby making the investment in inventory as
Nil. However, that is not the ultimate object as it is likely to affect the production and sales
function adversely. E.g. If sufficient stock of raw material is not available, the production
activity is likely to be interrupted. If sufficient stock of finished goods is not available, it may
not be possible for the organisation to serve the customers properly and they may shift to the
competitors. The object of inventory control is to avoid the situation of over investment as well
as under investment. The level of inventories should be maintained at the optimum level.
It indicates that quantity which is fixed in such a way that the total variable cost of
managing the inventory can be minimised. Such cost basically consists of two parts.
First, Ordering Cost (which in turn consists the costs associated with the administrative
efforts connected with preparation of purchase requisitions, purchase enquiries,
comparative statements and handling of more number of bills and receipts) Second,
Carrying Cost i.e. the cost of carrying or holding the inventory (which in turn consists of
the cost like godown rent, handling and upkeep expenses, insurance, opportunity cost
of capital blocked i.e. interest etc.) There is a reverse relationship between these two
types of costs i.e. If the purchase quantity increases, ordering cost may get reduced but
the carrying cost increases and vice versa. A balance is to be struck between these two
factors and it is possible at Economic Order Quantity where the total variable cost of
managing the inventory is minimum.
It is possible to fix the Economic Order Quantity with the help of mathematical formula.
The following assumptions may be made for this purpose.
A Q
= X O + XC
Q 2
The intention is that the value of Q should be such that the total cost should be minimum.
Hence, taking the first derivative of the equation with respect to Q and setting the result
to zero,
do 1 C
= AO ( – ) + = O OR
dq Q2 2
√
Q = 2xAXO Where
C
Illustration :
A manufacturer uses 200 units of a component every month and he buys them entirely from
outside supplier. The order placing and receiving cost is Rs. 100 and annual carrying cost is
Rs. 12. From this set of data, calculate Economic Order Quantity.
Solution :
√
EOQ = 2xAxO
C
=
√ 2 x 2400 x 100
12
= 200 units
√
EOQ = 2xAxO
where
Cxi
Illustration :
From the Following data, work out the EOQ of a particular component.
Solution :
√
EOQ = 2 x 5000 x 60
15% of 100
= 200 units
200
Carrying Cost - X 15% of 100 Rs. 1,500
2
(Based on average inventory) Rs. 3,000
Now, the next question is whether the purchases in Economic Order Quantity really reduce
the total cost of managing inventory to the minimum, We can verify this, by trial and error
method, by considering the above results.
It can be observed from the above, that the order size of 200 units proves to be the most
economic one in terms of minimum total cost. If the purchases are made in any other way, the
same may not necessarily result into minimum total cost.
Illustration :
Kapil Motors purchase 9,000 motor spare parts for its annual requirements, ordering one-
month usage at a time. Each spare part costs Rs. 20. The ordering cost per order is Rs. 15
and the carrying charges are 15% of the average inventory per year. You have been asked to
suggest a more economical purchasing policy for the company. What advice would you offer
and how much would it save the company per year.
Solution :
Present Policy :
Annual Requirement
Number of Orders =
Order size
= 9000
= 12
750
Ordering Cost = 12 X 15 = 180 ...(1)
Order Size
Carrying Cost = X Cost Price X Carrying cost in %
2
= 750
X 15% of Rs. 20
2
= 375 X 3 = 1,125 ...(2)
√
2xAxO
EOQ =
Cxi
= √ 2 x 9000 x 15
15% of 20
= 300 units
9000
Number of Orders = = 30
300
300 X 15% of 20
Carrying Cost = ...(5)
2
= 150 X 3 = 450
Thus, purchases in Economic Order Quantity will result into the yearly saving of Rs. 405 (i.e.
Rs. 1305 - Rs. 900)
Fixation of various inventory levels facilitates initiating of proper action in respect of the
movement of various materials in time so that the various materials may be controlled in
a proper way. However, the following propositions should be remembered.
(i) Only the fixation of inventory levels does not facilitate the inventory control. There
has to be a constant watch on the actual stock level of various kinds of materials so
that proper action can be taken in time.
(ii) The various levels fixed are not fixed on a permanent basis and are subject to
revision regularly.
It indicates the level above which the actual stock should not exceed. If it exceeds, it
may involve unnecessary blocking of funds in inventory. While fixing this level, following
factors are considered.
(vi) Nature of material e.g. If a certain type of material is subject to Government regulations
in respect of import of goods etc., maximum level may be fixed at a higher level.
It indicates the level below which the actual stock should not reduce. If it reduces, it may
involve the risk of non-availability of material whenever it is required. While fixing this
level, following factors are considered.
It indicates that level of material stock at which it is necessarily to take the steps for
procurement of further lots of material. This is the level falling in between the two extremes
of maximum level and minimum level and is fixed in such a way that the requirements of
production are met properly till the new lot of material is received.
This is the level fixed below minimum level. If the stock reaches this level, it indicates the
need to take urgent action in respect of getting the supply. At this stage, the company
may not be able to make the purchases in a systematic manner but may have to make
rush purchases which may involve higher purchases cost.
The various levels can be decided by using the following mathematical expressions.
(2) Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage X Minimum
Lead Time).
Note : It should be noted that the expression of the Reorder Quantity in the calculation of
Maximum Level indicates Economic Order Quantity.
Illustration :
Solution :
As stated above, the expression of the Reorder Quantity in the calculation of Maximum level
indicates Economic Order Quantity. Hence, in some cases, it may be necessary to decide
the Economic Order Quantity before fixing the inventory levels.
Illustration :
√ 2xAxO
C
where
A = Annual Requirement
∴ EOQ =
√ 2 x 12000 x 100
15
= 400 units
According to this method, the various inventory levels as discussed above may be fixed as
below.
Illustration :
You have been asked to calculate the following levels for Part No. 007 from the information
given thereunder:
(iii) Purchase price per unit including transportation costs Rs. 50.
Solution :
Working Notes :
√ 2xAxO
where
C
A = Annual requirement
O = Ordering cost per order
C = Carrying cost per unit per year.
Hence,
EOQ =
√ 2 X 500 X 20
5
= 200 units.
It can be calculated as -
Safety Stock + (Normal Usage x Normal Leadtime)
= 150 units + (15 units X 10 days)
= 150 units + 150 units = 300 units.
= 150 units.
EOQ
Safety Stock +
2
200
= 150 units + units = 250 units
2
Inventory turnover indicates the ratio of materials consumed to the average inventory
held. It is calculated as below :
Inventory turnover can be indicated in terms of number of days in which average inventory
is consumed. It can be done by dividing 365 days (a year) by inventory turnover ratio.
From the following data for the year ended 31st December, 1986, calculate the inventory
turnover ratio of the two items and put forward your comments on them.
Material A Material B
Rs. Rs.
Opening Stock 1.1.86 10,000 9,000
Purchases during the year 52,000 27,000
Closing Stock 31.12.86 6,000 11,000
Solution :
Material A Material B
Inventory Turnover = 56,000 25,000
8,000 10,000
= 7 2.5
Material A Material B
Inventory Turnover Period = 365 365
7 2.5
= 52 days 146 days
A high inventory turnover ratio or low inventory turnover period indicates that maximum material
can be consumed by holding minimum amount of inventory of the same, thus indicating fast
moving items. Thus high inventory turnover ratio or lower inventory turnover period will always
be preferred.
Thus, knowledge of inventory turnover ratio or inventory turn over period in case of various
types of material will enable to reduce the blocked up capital in undesirable types of stocks
and will enable the organisation to exercise proper inventory control.
This technique assumes the basic principle of “Vital Few Trivial Many” while considering the
inventory structure of any organisation and is popularly known as “Always Better Control”. It is
an analytical method of inventory control which aims at concentrating efforts in those areas
where attention is required most. It is usually observed that, in practice, only a few number of
items of inventory prove to be more important in terms of amount of investment in inventory or
A 300 6 5,60,000 70
B 1500 30 1,60,000 20
C 3200 64 80,000 10
In order to exercise proper inventory control, A Class items are watched very closely and
control is exercised right from initial stages of estimating the requirements, fixing minimum
level/leadtimes, following proper purchase/ storage procedures etc. Whereas in case of C
Class of items, only those inventory control measures may be implemented which are
comparatively simple, elaborate and inexpensive in nature.
(a) A close and strict control is facilitated on the most important items which constitute a
major portion of overall inventory valuation or overall material consumption and due to
this the costs associated with inventions may be reduced.
(b) The investment in inventory can be regulated in a proper manner and optimum utilisation
of the available funds can be assured.
(c) A strict control on inventory items in this manner helps in maintaining a high inventory
turnover ratio.However it should be noted that the success of ABC analysis depends
mainly upon correct categorisation of inventory items and hence should be handled by
only experienced and trained personnel.
In order to ensure proper inventory control, the ‘basic principle to be kept in mind is that proper
material is available for production purposes whenever it is required. This aim can be achieved
by preparing what is normally called as “Bill of Materials”.
A bill of material is the list of all the materials required for a job, process or production order.
It gives the details of the necessary materials as well as the quantity of each item. As soon as
the order for the job is received, bill of materials is prepared by Production Department or
Production Planning Department.
BILL OF MATERIALS
Department authorised
(1) Bill of material gives an indication about the orders to be executed to all the persons
concerned.
(2) Bill of material gives an indication about the materials to be purchased by the Purchases
Department if the same is not available with the stores.
(3) Bill of material may serve as a base for the Production Department for placing the material
requisitions ships.
(4) Costing/Accounts Department maybe able to compute the material cost in respect of a
job or a production order. A bill of material prepared and valued in advance may serve as
a base for quoting the price for the job or production order.
(1) Maintenance of Bin Cards and Stores Ledger in order to know about the stock in
quantity and value at any point of time.
(2) Continuous verification of physical stock to ensure that the physical balance and
the book balance tallies.
The continuous stock taking may be advantageous from the following angles :
(1) Physical balances and book balances can be compared and adjusted without waiting
for the entire stocktaking to be done at the year-end Further, it is not necessary to
close down the factory for Annual stocktaking.
(2) The figures of stock can be readily available for the purpose of periodic Profit and
Loss Account.
(4) Fixation of various levels and bin cards enables the action to be taken for the
placing the order for acquisition of material.
(6) Stock details are available correctly for getting the insurance of stock.
ILLUSTRATIVE PROBLEMS
(1) The following informative is extracted from the Stores ledger in respect of Material X
Complete the receipts and issues valuation by adopting the First In First Out, Last In First Out
and Weighted Average method. Tabulate the values allocated to Job W 16 and 17 and the
closing stock under the methods aforesaid.
Rs. 300
Weighted Average Rate = = Rs. 1.50/Unit
200 units
(1) Issues
FIFO LIFO Weighted Average
Qty. Rate Amt. Qty. Rate Amt. Qty. Rate Amt.
Date Unit Rs. Rs. Unit Rs. Rs. Unit Rs. Rs.
W 16 W 17
Rs. Rs.
FIFO 60 80
LIFO 120 100
Weighted Average 90 90
(2) From the records of an oil distributing company, the following summarised information is
available for the month of March 1986.
On the basis of the above information, work out the following using FIFO and LIFO
methods of inventory valuation assuming pricing of issues is being done at the end of the
month (after all receipts during the month).
Solution :
(1) FIFO :
Under this method, the value of closing stock will constitute the value of latest available lot for
consumption, earlier lots assumed to have been consumed. As such, value of closing stock
will be:
(2) LIFO :
Under this method, the value of closing stock will constitute the value of earliest available lot
for consumption, latest lots assumed to have been consumed. As such, value of closing stock
will be :
25,77.500 25,77,500
Less : Closing Stock (as per ‘a’ above) 9,13,000 8,48,000
16,64,500 17,29,500
Rs. 17,65,000
(3) A company uses annually 50,000 units of an item each costing Rs.1.20. Each
older costs Rs. 45 and inventory carrying costs 15% of the annual average inventory
value.
(b) If the company operates 250 days a year, the procurement time is 10 days, and
safety stock is 500 units, find reorder level, maximum, minimum and average
inventory.
√ 2 X A X O
Ci
=
√ 2 X 50,000 X 45
15% of 1.20
= 5,000 units
= 5,500 units
EOQ
Safety Stock +
2
5000 units
= 500 units +
2
= 3000 units
(4) M/s. Kailas Pumps Ltd. uses about 75,000 valves per year and the usage is fairly constant
at 6,250 per month. The valve costs Rs. 1.50 per unit when purchased in quantities and
inventory carrying cost is 20%. The average inventory investment on annual basis. The
cost to place an order and to process the delivery is Rs. 18. It takes 45 days to receive
from the date of an order and minimum stock of 3,250 valves is desired. You are required
to determine -
c. The most economic order quantity if valve costs Rs. 4.50 each instead of Rs. 1.50
each.
Solution :
√
2xAxO
EOQ = Ci
√ 2 x 75,000 x 18
= = 3,000 units
20% of 1.50
Number of Orders :
Annual Consumption
EOQ
75,000 units
= = 25
3,000 units
= 12,625 units
√
2xAxO
EOQ =
Ci
√
= 2 x 75,000 x 18
20% of 4.50
= 1,732 units
The annual requirement for the material is 5000 tonnes. The delivery cost per order is Rs.
1,200 and the stock holding cost is estimated at 20% of material cost per annum. You are
required to advice the Purchase Department the most economic purchase level.
Solution :
As the price discount varies with lot size, EOQ will have to be decided by Trial and Error
Method.
1 2 3 4 5 6(3+4+5)
(6) (a) A company needs 24,000 units of raw materials which costs Rs. 20 per unit and
ordering cost is expected to be Rs. 100 per order. The company maintains safety
stock of 1 month’s requirements to meet emergency. The holding cost of carrying
inventory is supposed to be 10% per unit of average inventory. Find out :
1. Economic lot size.
2. Ordering cost
3. Holding cost
4. Total cost
(b) The supplier of raw material has agreed to supply the goods at a discount of 5% in
price on a lot size of 4,000 units. Find whether the concession price should be
availed.
Solution :
√
2xAxO
Ci
√
= 2 x 24,000 x 100
10% of 20
Annual Requirement
X Ordering cost per order
EOQ
= 24,000
X 100 = Rs. 1,548 (Approx.)
1550
As the company maintains safety stock of one month’s requirement, the average inventory
held at any point of time will not only be EOQ/2 but safety stock + EOQ/2. Assuming
that the usage of raw material is steady throughout the year i.e. 2,000 units per month,
holding cost will be :
1,550 units
= (2,000 units + ) X 10% of Rs. 20
2
= Rs. 5,550
As order size is going to be 4,000 units, total 6 orders will be placed. Hence total ordering cost
will be -
Order Size
(Safety Stock + ) x Carrying cost per unit per year
2
4000 units
= (2,000 units + ) x 10% of Rs. 19
2
= Rs. 7,600
If purchased in Economic Lot Size, total cost (including material cost) is Rs. 4,87,098.
If purchased in Lot Size of 4,000 units with 5% discount, total cost (including material cost) is
Rs. 4,64,200.
As purchases in Lot Size of 4,000 units result in the saving of Rs. 22,898 (i.e. Rs. 4,87,098 -
Rs. 4,64,200) that alternative will be preferred.
QUESTIONS
1. Explain the various steps in which a raw material moves in a manufacturing organization
till it gets consumed in the production. Give the format of various documents which are
prepared in the process.
a) Valuation of Receipts
b) Valuation of Issues
c) Valuation of Returns
(1) The following is the record of receipts and issues of certain material in a factory during
the week ending May 1979.
Opening balances 100 tons at Rs. 10 per ton.
Issued 60 tons.
Received 120 tons at Rs. 10 per ton
Issues - 50 tons (Stock verifier reported shortage of 2 tons)
Received back from order 20 tons (originally issued at Rs. 9.90)
Issued 80 tons.
Received 44 tons at Rs. 10.20 per ton.
Issued 66 tons.
Issued 66 tons.
From the above particulars prepare stores ledger separately under e method charging
issues at weighted and simple average method.
(2) Following transactions appeared in a specified material during month of August 1980.
The stock verifier noticed shortage in stock on 26th August of 5 tons and on 29th August
of 4 tons. Write up stores ledger by charging issues by FIFO and by weighted average
methods.
(3) The following is the history of the receipt and issue of materials in a factory during
February 1980,
Issues are to be priced on the principle of LIFO and simple average method. The stock
verifier of the factory noted that on the 15th he had found a shortage of 5 tons and on 27th
another shortage of 8 tons. Write out complete stores ledger account in respect of the
material.
(4) A cloth manufacturer commenced the business on 1.1.82. Textile materials used include
two types - M & N. During 6 months ending on 30.6.82, transactions were as
follows :
(5) The stores ledger account of material C in the books of Saurabh and Sweta Ltd. revealed
following transactions for September 1984,
5 Received from supplier 400 kgs at Rs. 7.75 per kg GRN 448
10 Received from supplier 500 kgs at Rs. 7.90 per kg. GRN 45
16 Received from supplier 250 kgs at Rs. 8.00 per kg GRN 469
19 Received from supplier 600 kgs at Rs. 8.25 per kg GRN 561
You are required to price the issues and draw out the closing balance in the stores
ledger account under the pricing method in which the material costs charged to production
would be closely related to current prices.
(6) Record the following transactions in a store ledger and show the cost of consumption
and closing stock by using FIFO method of pricing issues.
(8) The following is a summary of the receipts and issues of a material in a factory during a
month.
Stock verification revealed that on 15th there was a shortage of 5 units and another on
27th of 8 units. Prepare Stores Ledger Account on the basis of FIFO basis.
1st 40 15.00 -
2nd 20 16.50 -
3rd - - 30
4th 50 14.30 -
5th - - 20
6th - - 40
Calculate the cost of material issued under FIFO method and Weighted Average method
of issue of materials.
(11) From the following details of stores receipts and issues of Material EXE in a manufacturing
unit, prepare the stock ledger using “Weighted Average” method of valuing the issues.
Nov. 9 Returned to stores 100 units by production department (from the issues of Nov. 3)
(12) The following are the transactions in respect of purchases and issues of components
forming part of an assembly of a product manufactured by a firm which requires, to
update its cost of production very often for bidding tenders and finalising cost plus
contracts.
The stock on 1st January 1986 was 5,000 Nos. valued at Rs. 1.10 each. State the
method you would adopt in pricing the issues of components giving reasons. What value
would you place on stocks as on 31st March which happens to be the financial year end
and how would you treat the difference in value, if any, on the stock account.
(13) The following are the extract from the transactions on the bin card of Job No. 12-3-89 for
March 1987
Date On order Receipt Rate Issue Balance
2 - 40 25.00 - 40
6 - - - 20 20
8 - 50 28.00 - 70
12 - - - 30 40
15 - 30 24.00 - 70
18 50 - 26.00 - 70
28 - - - 50 20
(14) XYZ Ltd. requires 20,000 units of product A per annum. The purchase price is Rs. 4 per
unit. The inventory carrying cost is 20% per annum and the cost of ordering is Rs. 100
per order. Advise the company, on how many times they should order in a year, so as to
minimise the cost of product A?
(15) A Manufacturer buys certain essential spares from outside suppliers at Rs. 40 per set.
Total annual requirements are 45000 sets. The annual cost of investment in inventory is
10% and costs like rent, stationery, insurance, taxes etc. per unit per year work to Re.
1, cost of placing an order is Rs. 5. Calculate the Economic Order Quantity.
Calculate Economic Order Quantity and total annual inventory cost in respect of the
particular raw material.
(17) From the particulars given below, you are required to compute.
(a) Economic Order Quantity
(b) Maximum Level
(c) Minimum Level
(d) Re-ordering Level
(e) Average stock Level
(i) Quantity required annually 3,000 units @ Rs. 5 per unit.
(ii) Interest and cost of storing 10%.
(iii) Cost of placing an order Rs. 30 per order.
(iv) Consumption per week Normal 60 units
Maximum 70 units
Minimum 50 units.
(v) Lead time (in weeks) Normal 5
Maximum 6
Minimum 4
Receipts Issues
Physical verification on September 30, 1989 revealed an actual stock of 3,800 units. You are
required to :
(b) Complete the above account by making entries you would consider necessary including
adjustments, if any, and giving explanations for such sdjustments.
Particulars A B
Normal Usage Units 50 50
Minimum Usage Units 25 25
Maximum Usage Units 75 75
Lead Time Week 4-6 2-4
Annual Consumption Units 9,000 6,250
Ordering cost per order Rs. 45 100
Carrying cost per unit per year Rs. 9 5
(20) P. Ltd. uses three types of materials, A, B and C for production of X, the final product.
The relevant monthly data for the components are as given below :
A B C
(21) The following data are available from the records of M/s. Naveen Industries Ltd. using two
types of materials A and B for the manufacture of their product.
A B
Calculate :
(i) Reordering Level
(ii) Maximum Level
(iii) Minimum Level
(iv) Average Level
(23) Certain purchased part of which annual requirements are 8000 units, involves ordering
cost equal to Rs. 12.50 per order, cost per piece Re. 1 and the annual carrying cost
20%. In addition, average daily usage is 32 units (based on 250 operating days per
year), lead time is 10 days and safety stock has been calculated to be 100 units.
Calculate :
(a) Economic Order Quantity
(b) Reorder point
(24) (i) XYZ Company buys in the lot of 500 boxes which is a 3 months supply. The cost
per box is Rs. 125 and the ordering cost is Rs. 150. The inventory carrying cost is
estimated at 20% of unit value. What is the total annual cost of the existing inventory
policy?
(ii) How much money could be saved by employing the economic order quantity?
(26) A manufacturer requires 10 lakhs components for use during the next year which is
assumed to consist of 250 working days. The cost of storing one component for one
year is Rs. 4 and the cost of placing order is Rs. 32. There must always be a safety
stock equal to two working days usage and the lead time from the supplier, which has
been guaranteed, will be 5 working days throughout the year.
Assuming usage takes place steadily throughout the working days, delivery takes place
at the end of the day and orders are placed at the end of working day, you are required to
calculate.
(27) Anil Company buys its annual requirement of 36,000 units in six instalments. Each unit
costs Re. 1 and the ordering cost is Rs. 25. The inventory carrying cost is estimated at
20% of the unit value. Find the total cost of the existing inventory policy. How much
money can be saved by using Economic Order Quantity?
(28) A Company, for one of the A class items, placed 6 orders each of size 200 in a year.
Given ordering cost Rs. 600, holding cost 40%, cost per unit Rs. 40, find out the loss to
the Company by not operating scientific inventory policy. What are your recommendations
for the future?
(29) A manufacturer has to supply his customers 600 units of his product per year. Shortages
are not allowed and the inventory carrying cost amounts to Rs. 0.60 per unit per year.
The set up cost per run is Rs.80. Find
(30) A purchase manager has decided to place order for minimum quantity of 500 numbers of
a particular item in order to get a discount of 10%. From the records, it was found that in
the last year, 8 orders each of size 200 number have been placed. Given Ordering cost
Rs. 500 per order, Inventory carrying cost 40% of the inventory value and cost per unit
Rs. 400, is the purchase manager justified in his decision. What is the effect of his
decision on the company?
If a 3% discount is offered by the supplier for purchase in lots of 1000 or more, should the
publishing house accept the proposal?
Labour Cost is another important element of cost in the manufacturing cost. It is important
element of cost eventhough the production is material intensive. The basic factor which gives
rise to the labour cost is the remuneration paid to workers. However, the objective of cost
accounting (i.e. cost ascertainment with respect to the individual cost centre and cost control)
can not be fulfilled properly unless and until the functions performed by the related departments
are properly considered. These functions can be stated as below :
(1) Personnel Department : This ensures the availability of correct workers to perform the
jobs which are best suited for them. This is done by selecting them properly and training
them properly. This department may also be involved with maintenance of records of job
classification/ wage rates payable to workers, preparation of wages sheet and procedural
aspects of wage payment.
(2) Time Keeping Department : This is concerned with recording of workers time. This is
not only for the purpose of wage calculations but also for the purpose of cost analysis
and apportionment of cost over various jobs. The main functions performed by this
department are time keeping and time booking.
(3) Cost Accounting Department : This department accumulates and classifies cost data
with respect to labour cost from the analysis of wages sheet and presents the reports to
management to facilitate the control over labour cost.
The starting point for ascertaining the labour cost is in the form of Time Keeping and Time Booking.
Time Keeping :
This is the process of recording attendance time of the workers. It is the responsibility of Time
Keeping Department which may function as separate department in some cases or else may
function as the part of Personnel Department. Attendance time recording may be necessary
as the payment of wages may depend on the attendance. Even when the payment of wages
does not depend on time attended, say in case piece rate payment, the recording of time
attended may be necessary from the following angles.
(2) Though the regular wages may not depend upon the time attended, in some cases, the
other payments like overtime wages, dearness allowance etc. may be linked with the
attendance.
(3) The fringe benefits like Pension, Gratuity on retirement. Provident Fund etc. may depend
on the continuity of service which will be available only if time attended is recorded
properly.
(4) Attendance records may be required for research and other purposes.
For the purpose of time keeping, various methods may be followed, though the selection of the
method may depend upon nature of organization and policy of management. Main such methods
may be stated as below:
Under this method, names of the workers are recorded in the attendance register with
provision of various columns for various days. The attendance of the worker may be
recorded either by calling out his name or by physical check. Alternatively, the workers
themselves may sign in the attendance register.
This method, though simple, has become outdated. This method can also result in
malpractices with the collusion between workers and time keeping/ personnel department.
Also recording of late coming, overtime, short leave etc. may involve more clerical work
and may be subject to errors.
Under this method, each worker is allotted an identification number and a disc or token
bearing that number. Immediately before the scheduled opening time, all the tokens/
discs will be placed at the factory gate. Every incoming worker will take out his token
and drop it in a separate box or hang it on a separate board. The tokens/discs not
removed will indicate that the said worker is absent. Similar procedure is followed while
the workers leave the factory. In addition to the physical handling of tokens/ discs, it will
be required to record the attendance time separately.
Under this method, every worker is alloted individual ticket number and a clock card
which bears that ticket number. The cards are placed on two racks on either side of the
time recording clock denoting separately ‘In’ rack and ‘Out’ rack. At the opening time, all
the cards are placed in ‘Out’ rack. On arrival, worker takes out his own card, puts it in the
slot available on the time clock recorder which punches the time on that card, and
places the card in ‘In’ rack. All the cards, left in the ‘Out’ rack indicate absent workers.
At the time of departure, he removes the card from In’ rack, gets it punched and places
it in ‘Out’ rack.
Though, this method involves heavy capital outlay initially, it has certain advantages
also.
(2) It is clean, safe and quick and has printed records to avoid disputes.
Time Booking :
The ultimate aim of costing is to decide the cost of each cost centre. As such, recording of
time attended is not sufficient. Equally important is to record the time spent for individual cost
centres. This process is in the form of time booking. The methods followed for this purpose,
may be considered as below :
Under this method, each worker is provided with a daily time sheet on which time spent by
him on various jobs/work orders is expected to be mentioned. If the worker works on various
jobs in a particular day, the daily time sheets move along with the worker. The entries on the
same may be made by the worker himself or by the foreman.
This method may be conveniently used if the worker works on various jobs of short duration.
Say in case of maintenance jobs.
This method is disadvantageous in the sense that it involves considerable paper work. The
form in which the daily time sheets may be prepared is as below :
Name of Employee
ON OFF
Under this method also; one sheet is alloted to each worker but instead of recording the work
done for a day only, record of time for all the jobs during the week is made. These types of time
sheets are useful for intermittent types of jobs like building or construction work. It involves
comparatively less paper work. The form in which weekly time sheets may be prepared is as
below.
Employee No.
TOTAL
Under this method, the details of time are recorded with reference to the jobs or production/
work orders undertaken by the workers rather than with reference to individual workers, and
this facilitates the computation of labour cost with reference to jobs or production/work orders.
There may be two ways in which job card may be maintained.
(1) According to first method, each job or production/work order is alloted a number. When
a worker takes up a job, the time of starting and finishing the job is entered on the card
meant for that worker. The summary of this card states the total time taken by that
worker for that job. In order to compute the total time booked for the job as a whole, all
cards of all the workers with respect to that job are required to be analysed. The form in
which this card may be prepared is as below.
JOB CARD
Employee No.
FRI
SAT
SUN
MON
TUE
WED
(2) According to this method, a job card is prepared for each job production/work order
accepted by the organization for execution. It describes the various operations/stages
involved in the execution of the job. Time taken by the various workers to complete the
job is entered on the card. This provides the information about the time taken by various
workers to complete a particular job.
Job Description
Cutting
1
2
Drilling
1
2
Grinding
1
2
Painting
1
2
Assembly
1
2
3
TOTAL
If a combined time and job card is maintained, the problem of reconciliation will be relatively
simple as both the details will be available on the same card. In other cases, at the end of the
wage period or at a shorter interval also, the total time attended has to be compared with the
time booked on job cards on the various jobs. If the time booked as per the job cards, is less
than the attendance time, this indicates the idle time during which the worker has not done
any work, though he was present in the factory.
Remuneration to workers indicate the reward for labour and services. The remuneration may
be paid in monetary terms (which in turn may be in direct form or indirect form) or non-
monetary terms. The remuneration paid in the monetary form may be by way of basic wages
or salaries and other allowances and may be paid either on time basis or on work basis.
However, payment of only basic wages or salaries may not be sufficient enough to induce the
workers to work efficiently, hence they may be remunerated in the form of some incentives. In
case of remuneration in non-monetary form, the workers may not receive anything in the from
money but they may get facilities which induce them to stay with the organization. It may be
in the form of the provision of health or welfare or recreational facilities, provision of working
conditions and so on. We will discuss these methods of remuneration under the following
heads.
(b) Co-partnership
(1) As a general rule, if the efficiency of the workers can be measured in the objective terms,
the wages receivable by a worker should be in conformity with his efficiency. Otherwise
an efficient worker is likely to be demotivated from working efficiently. At the same time,
the standards fixed to measure the efficiency of a worker should be normal which can be
attained by a normal worker under normal conditions.
(2) The wage payment system should be clearly defined and communicated to the workers
leaving no scope for any ambiguity. At the same time, a good wage payment system
should be simple to understand and easy to operate.
(3) No upper limit should be imposed on the wages which can be earned by an efficient
worker.
(5) A good wage payment system should be reasonably permanent in nature. Frequent
changes in the same should be avoided. If any changes are proposed to be made in
system of wages payment, they should not be thrust upon the workers by force, but
should be implemented by having mutual discussions with and due approval from the
workers.
(6) Wage payment system should be properly tied up with quality control procedures to
ensure that the workers are paid only for good and quality production.
(7) The basic objective of the wage payment system should be to get maximum cooperation
from the workers, improve the morale and productivity of the workers and to minimize the
cost of supervision and labour turnover.
(8) The wage payment system should take into consideration the external obligations to
which the organization may be subjected to. These obligations may be in the form of
various statutes like Minimum Wage Act and the agreement entered into with the workers
and so on.
Under this, a worker is paid on the basis of time attended by him. He is paid at a specific rate
irrespective of the production achieved by him. The pay rate may be fixed on daily basis,
weekly basis or monthly basis.
(a) If the output of the worker is beyond his control e.g. His speed depends upon speed of a
machine or speed of other workers.
(b) If the output can’t be measured or standard time can’t be fixed e.g. Maintenance work.
(d) If quality, accuracy and precision in work is of prime importance e.g. Artist, Ad-agency
person.
The time rate system of remunerating the workers is useful due to the following features :
Under this system, timely wage rate of the workers may be fixed at such a level which is
higher as compared to wages paid to workers in the same industry or locality. Suitable working
conditions are provided. Correspondingly, a high standard of efficiency is expected from the
workers.
Those who are not able to come up to the standard, are taken off the scheme.
Under this method, different hourly rates are fixed for different levels of efficiency. Up to a
certain level of efficiency, normal day rate is applicable which gradually increases as efficiency
increases. This can be illustrated as below :
Under this system, workers are paid according to the production achieved by them. In many
cases, time attended is not material. These methods can be reclassified as below.
Under this method, each job, production or unit of production is termed as a piece and the rate
of payment is fixed per piece. The worker is paid on the basis of production achieved irrespective
of the time taken for its performance. Thus, the earnings of the worker can be computed as :
Wages = No. of units produced x Piece Rate per unit This method can be suitably applied if
the production is of standard or repetitive nature. It can’t be applied if the production can’t be
measured in suitable units.
It can be seen that the crux of this method is to decide the time required to complete a piece.
The fixation of this time should be done in such a way that within that much time, a normal
worker can complete the piece. This can be done either on the basis of previous experience or
on the basis of time and motion study.
Under the straight piece rate system, the remuneration of a worker depends upon the production
achieved. If the production is less due to some factors beyond his control, he is likely to be
penalised. To remove this difficulty, it may be decided that he will be paid on time rate if his
piece rate earnings fall below time rate earnings, so that the worker is assured of minimum
earnings on time basis. However, if this guaranteed time rate payment is too high, the incentive
to increase output to get piece rate payment is less.
Under this system, higher rewards are guaranteed to more efficient workers. The piece rates
are fixed in such a way that normal piece rate is paid for work performed within and upto the
standard level of efficiency. If efficiency exceeds the standard, payment at higher piece rate is
made.
This method offers more inducement to the workers to work more efficiently and earn higher
wages. But it is complicated to understand and expensive to operate.
This was introduced by F.W. Taylor. It provides two piece rates, a low piece rate for output
below standard and a high piece rate for output above standard and does not provide for any
guaranteed time rate payment. Eg. If standard output is 10 units and piece rate is Re.l per
unit, the total wages are :
(i) If actual hourly output is 8 units i.e. below standard, the piece rate is say 80% of normal
piece rate i.e. Re. 0.80. Hence total wages are 8 units x Re. 0.80 = Rs.6.40.
(ii) If actual hourly output is 12 units i.e. above standard, the piece rate is say 120% of
normal piece rate i.e. Rs. l.20.
The basic defect with this system is that eventhough the efficiency of the worker is below
standard even marginally, he is punished heavily and even though the efficiency of the worker
is above standard even marginally, he is benefited to a very great extent.
To remove the defect existing in case of Taylor’s System which heavily punishes the worker
who produces below standard, the Merrick System provides for three piece rates Eg.
Up to 83% Normal
It should be noted that under this method also, no guaranteed time rate payment is provided.
Illustration :
Calculate the wages of the workers on the basis of Merrick’s Differential piece rate system,
when basic piece rate is guaranteed below the standard and workers get 108% of the basic
piece rate between 100% and 120% of the basic piece rate above 120% efficiency.
Solution :
(a) Worker M :
∴ Applicable piece rate - 108% of normal i:e. 6.48 paise per unit.
∴ Total wages : 125 units x 6.48 paise = 810 paise i.e. Rs. 8.10
(b) Worker N :
∴ Applicable piece rate : basic piece rate i.e. 6 paise per unit
∴ Applicable piece rate - 120% of normal i.e. 7.20 paise per unit.
∴ Total wages 150 units x 7.20 paise = 1080 paise i.e. Rs. 10.80
This system is a combination of time rate and piece rate and provides for minimum time rate
payment. A high task or standard is set. The wage structure may be fixed as below.
In case of time rate systems, the losses due to inefficiency of workers or benefits due to
efficiency of workers are suffered or enjoyed by the employer alone. Similarly in case of piece-
rate systems, the losses due to inefficiency of workers or benefits due to efficiency of workers
are suffered or enjoyed by the worker alone. (The employer may be indirectly affected in the
form of increased or decreased per unit overheads.) The incentive systems differ from both
these systems in such a way that the financial advantages arising out of the efficiency of
workers are enjoyed by both employer as well as workers. There are various systems by
which the incentive may be paid to workers. We will consider following main systems.
Under this system, if the actual time taken is equal to or more than standard time, worker is
paid at the time rate. If actual time is less than standard time, the worker, in addition to time
wages for hours actually worked, gets a bonus payment. The bonus is equivalent to the wages
for the time saved in the decided percentage to be shared with the employer The percentage
allowed to worker may vary from 30% to 70% (usually 50%). The total wages payable to the
worker under this system, can be computed as below.
(SH - AH) X HR
AH X HR + Assuming 50% - 50% sharing
2
SH - Standard hours
HR - Hourly rate
This system is a deviation of Halsey Premium System only with the exception that the ratio of
sharing between the worker and the employer is fixed as 1/3 : 2/3. The computation of total
wages is the same as in case of Halsey Premium System, except the change in this ratio.
Under this system also, guaranteed time rate payment is made. The amount of bonus paid is
a percentage of hourly rate which is in proportion to the time saved. The total wages payable
to the workers under this system can be computed as below :
SH - AH
AH X HR + X AH X HR
SH
SH - Standard Hours
HR - Hourly Rate
Comparative study of total wages under both these systems reveals that if time saved is less
than 50% of the standard time. Rowan system assures more wages than those under Halsey
system. But if time saved exceeds 50% of the standard time, Halsey system proves to be
more beneficial. In Rowan System a less efficient worker gets the same bonus as a more
efficient worker. As such Rowan System may be implemented in case of loose fixation of
standards. The fall in bonus as time saved increases, offsets the damage done by loose
standards.
Illustration :
Prepare a comparative table under Halsey Premium System and Rowan Premium System, if
time taken is 9 hours, 8 hours, 6 hours, 5 hours 4 hours and 3 hours. Also calculate the
amount of total wages and labour cost per hour under two methods. What conclusions do you
draw from the table.
Conclusion :
It can be concluded from the above table that so long as time saved is less than 50% of
standard time, the total wages are more under Rowan Premium system than under Halsey
Premium System. If the time saved is more than 50% of standard time, Halsey system proves
to be more beneficial in terms of the total wages.
The other systems for making the payment of premium can be briefly described as below.
Under this system, the wages payable to the workers are computed as below.
2x √10x8
= Rs. 17.89
Under this system the wages payable to the workers are computed as below.
Efficiency Bonus
(2) 66.2/3% to 100% In Addition to time wages, bonus is paid at different percentages
increasing rapidly to 20% at 100% efficiency.
(3) Above 100 % In addition to time wages and bonus @ 20%, 1% bonus for
each 1% increase in efficiency beyond 100% is paid.
Standard Hours
x 100
Actual Hours
Actual output
x 100
Standard output
Standard Hours 10
X 100 = X 100 = 125%
Actual Hours 8
∴ Bonus percentage will be 45%
= 16 + 45% of 16
= 16 + 7.20
= Rs. 23.20
It can be seen that the abovestated system is similar to that of piece rate with guaranteed
time rate. This system may be suitable for non efficient workers for improving their efficiency.
Under this system, the standard time is divided into standard minutes, each standard minute
identified as Bedaux Point or B. The wages payable to the worker are computed as below.
75 % of BS x Hourly Rate
Wages = Actual Hours x Hourly Rate +
60
Where BS indicates the number of B’s saved i.e. the difference between B’s earned and
standard B’s allowed for the job.
= 24 + 75% of 2.50
= 24 + 1.875
= Rs. 25.875.
It should be noted that a very accurate system of work study is required for this system. It is
difficult to understand and involves a lot of clerical efforts.
Under this system, incentive increases at a fast rate with the increase in output. Total wages
payable to the worker are computed as below.
Y = 0.8 X2 where
Y = Earnings X = Efficiency.
125 125
Earnings = 0.8 x x
100 100
= 1.25
∴ Earnings will be 125% of basic wages i.e 100% basic wages, 25% bonus.
This is a combination of Taylor’s differential piece rate system and Halsey system and is also
known as Milwaukee Plan.
In many cases, the output of the individual workers cannot be measured though the output of
a group of workers can be measured. In such cases, the individual time rates or in some
specified proportion depending upon the skill of the workers or equally, can be applied.
According to this method, the workers, are entitled to share in profits earned by an
organisation, in addition to the regular wages, at a specified percentage. The legal
provisions in this regard are enacted by way of Payment of Bonus Act, 1965. According
to the provisions of this Act, all the employees drawing a monthly remuneration of
Rs. 2,500 or less are entitled to a bonus at the minimum rate of 8.33% of wages of the
subject to the maximum ceiling of 20 % of the wages. It should be noted that the statutory
requirement of the payment of bonus does not depend on the profit earned necessarily,
as the bonus is payable eventhough there are no profits. It is also worth noting that the
statutory requirement of payment of bonus is the specific percentage of the wages or
salaries paid to the workers and hence remains unaffected by any changes, either upwards
or downward, in the profits earned by the organisation.
(b) Co-partnership :
According to this method, the workers are granted ownership rights in the operations of
the organisation by which the workers are in the position to control the affairs of the
organisation. In corporate organisations, it may be in the form of offering the shares of
the company to the workers or granting of loans to the workers to buy company’s shares,
according to which the workers get the voting rights to control the affairs of the company.
The workers get dividend on the shares as bonus. With the help of this method, the
morale of the workers is increased. However, certain objections are raised against this
method. First, the increase in earnings is too small. Second, the shareholding of the
workers is too small to control the affairs of the company. Third, the workers are not
rewarded according to the individual efficiency.
The intention of these incentives is to attract better workers, retain the existing workers,
encourage loyalty, reduce labour turnover, provide better working conditions to workers and so
on. Various benefits as stated below may be granted to the workers, either free or at reduced
rates, remaining amount being contributed by the workers.
In every business organisation, the process of employees leaving the organisation and new
workers being recruited is a normal feature. Labour Turnover indicates this change in labour
force showing a highly increasing trend or highly decreasing trend. Labour turnover showing
sharp increasing trend may involve the reduction in labour productivity and increasing costs.
Too low a labour turnover trend may be due to inefficient workers who would not like to leave
the organisation.
(1) Betterment/Personal.
(5) Marriage.
(6) Retirement.
(7) Death.
These refer to all the costs which may be incurred by the organisation to keep
workers happy and discourage them from leaving the job. This, in turn, may include the
costs like :
(1) Cost of Personnel Administration - To maintain good relations with the workers.
(2) Cost of medical services- To keep the workers and their families in healthy condition,
as healthy workers are assets for the organisation who contribute towards higher
efficiency and productivity.
(3) Costs of welfare activities - To give facilities like transport, canteen etc.
(4) Other incentive schemes like pension, provident fund, superannuation fund, Bonus
etc.
These refer to the costs incurred for recruitment and training of new workers and the
resulting losses, wastages and reduced productivity due to the inefficiency and
inexperience of new workers.
Illustration :
From the following data given by Personnel Department, calculate the labour turnover rate by
applying :
During the month, 10 workers left, 40 persons were discharged and 150 workers were recruited.
Of these 25 workers are recruited in the vacancies of those leaving while the rest were for an
expansion scheme.
50
= X 100 = 5
1000
365
Annual Turnover Rate : 5 X = 60.83%
30
25
= X 100 = 2.5%
1000
365
Annual Turnover Rate : 2.5 X = 30.42%
30
50 +25
= = 100 = 7.5%
1,000
365
Annual Turnover Rate : 7.5 X = 91.25%
30
= 1,000
It indicates the time for which wages are paid to the workers but during which no production is
obtained. To exercise proper control on idle time, causes of the same should be analysed
properly and studied from its controllability point of view.
These causes are supposed to be controllable causes and can be controlled if planned
properly.
Some idle time may be caused due to administrative decisions. E.g. the organisation is
having excess machine capacity or during the depression period, it is not having sufficient
work to be performed, but it has decided not to get rid of trained workers temporarily. As
such cost of idle time is accepted.
Economic causes may be of seasonal nature, cyclical nature or industrial nature. E.g. if
the product manufactured is of a seasonal nature, for other periods of the year, the
capacity may remain unused, unless some other product to take care of slack season is
introduced. In case it is not possible to make alternate use of such idle capacity, some
If idle time is normal and uncontrollable, the labour rates should be suitably modified. E.g. if
time attended is 8 hours but time booked is only 7.5 hours and labour cost is Rs. 1.5 per hour,
the hourly labour rate should be computed as -
If idle time payment is uncontrollable and abnormal, it should not be considered as a part of
manufacturing cost but should be written off to Costing Profit and Loss Account.
In today’s world, labour is one of the most important factors of production, and contributing to
a very great extent to the cost of production. As such, it will be the intention of every organisation
to have proper control on the labour cost. The implementation of various Internal Control
Procedures indicate the following of all those methods and procedures which ensures fluent
and smooth running of the operations of the organisation and also of achieving protection of
assets, prevention of errors and frauds, proper recording of information whenever necessary.
The cost of labour may be high due to the various reasons stated below :
After locating the reasons for increasing labour costs, attempts can be made to keep the
same in control after following various internal control measures as discussed below.
(2) To ensure that correct personnel is employed to work in the correct places, care should
be taken to analyse the requirements of the job and then to select the personnel which
suits these requirements. This process may be in the form of ‘job evaluation.’
Selection of the proper personnel may not be enough. To train the selected personnel to
extract maximum of their efficiency is equally necessary.
(3) The problem of setting the excessive rate structure in the form of higher time rate or
piece rates or bonus rates may be avoided by setting the standards in the most scientific
manner. For this purpose, the techniques like time and motion study, work study etc.
may be implemented.
(4) To avoid the clerical errors or fraudulent practices in the areas of wage sheet preparation
or wage payments, proper internal check procedures may be implemented, so that the
work of one person is properly checked by another person. For this, following steps may
be taken :
(a) Time recording clock should be installed, wherever possible. Proper supervision is
required to ensure that one person punches his own card only.
(b) The terms of remuneration should be set and made known to the workers in very
very clear terms.
(c) Proper internal checks should be executed while preparing the wages sheets.
Cashier should not be allowed to handle the wages sheets and the person preparing
the sheets should not be allowed to prepare wage packets. Personnel officer/manager
should check and authorize the wages sheets.
(d) The wages should be paid to workers after they are properly identified. The wages
should not be paid to any other person, unless proper authorization letter is produced
in exceptional circumstances.
(6) If the labour cost is higher due to spoilage of work which in turn may be due to lack of
proper supervision or inspection, it is a cost which can very will be controlled by having
proper supervision or inspection.
(7) The causes of labour turnover should be analysed according to normality. All the avoidable
causes of labour turnover should be paid proper attention. Higher trend of labour turnover
adds to the costs in two ways mainly. It reduces the labour productivity and at the same
time, increases the costs. If the workers have the grievances which are of avoidable
nature, say dissatisfaction with remuneration or other benefits or working hours or working
conditions or job itself or relations with the fellow workers or the supervisors, attempts
can be made to avoid those causes of labour turnover.
ILLUSTRATIVE PROBLEMS
(1) The standard hours for job X is 100 hours. The job can be completed by A in 60 hours, by
B in 70 hours and by C in 95 hours.
Rate of pay per hour is Rs.1 Calculate the total earnings of each worker and also the
rate of earnings per hour.
A B C
(1) Standard Hours 100 100 100
(2) Actual Hours 60 70 95
(3) Hours Saved 40 30 5
(4) % Hours saved 40% 30% 5%
(5) Applicable bonus rate
(% of wages for time saved) 20% 20% 10%
(6) Hourly Rate (Rs.) 1 1 1
(7) Basic wages (Rs.) - 2 x 6
i.e. Actual Hours x Hourly rate 60 70 95
(8) Wages for time saved (Rs.) - 3 x 6
i.e. Hours Saved x Hourly Rate 40 30 5
(9) Bonus (Rs.) - 8 x 5
i.e. Wages for time saved x Bonus Rate 8 6 0.5
(10) Total - (Rs.) 7+ 9 68 76 95.5
Note :
It is assumed that the amount of bonus is not decided on rates of bonus on cumulative basis.
(2) During one week X makes 200 units. He receives wages for a guaranteed 44 hours per
week at a rate of Rs. 1.50 per hour. Estimated time to produce one unit is 15 minutes.
Time allowed is increased by 20% allowance on estimated time, under incentive scheme.
Calculate earnings as per :
Solution :
Hourly Rate
Units produced X
Units per hour
Rs. 1.50
= 200 units X = Rs. 75
4 units
Time Saved
Actual Hours X Hourly Rate + X Actual Hours X Hourly rate
Time Allowed
16 Hours
= 44 Hours x Rs. 1.50 + X 44 Hours X Rs. 1.50
60 Hrs
= Rs. 83.60
= Rs. 66 + Rs. 12
= Rs. 78
Working Notes :
18 minutes
X 200 units = 60 Hours
60 minutes
(3) In a factory under bonus system, bonus hours are credited to the employee in the
proportion of time taken which time saved bears to time allowed. Jobs are carried forward
from one week to another. No overtime is worked and payment is made in full for all units
worked on, including those subsequently rejected. From the following information, you
are required to calculate for each employee.
Employee A B C
Basic wage rate per hour Rs. 5 Rs. 8 Rs. 7.5
Units issued for production 2,500 2,200 3,600
Time allowed for 100 units 2H 36M 3H 1H 30M
Time taken 52H 75H 48H
Rejections 100 units 40 units 400 units
Solution :
The description of the bonus system indicates that it is Rowan system of incentive payment.
A B C
(1) Time allowed for 100 units 156 min. 180 min. 90 min.
(2) Units issued for production 2,500 2,200 3,600
(3) Time allowed for actual production 65 hours 66 hours 54 hours
(4) Time taken 52 hours 75 hours 48 hours
(5) Time saved i.e. 3-4 13 hours - 6 hours
(6) Hourly basic wage rate (Rs.) 5 8 7.5
(7) Basic wages i.e. 4 x 6 (Rs.)
Time taken x Hourly rate 260 600 360
(8) Bonus earned : (Rs.)
Time Hourly Time saved
X X
taken rate Time allowed 52 - 40
(12) Wages per good unit i.e. 9/11 Re. 0.13 Re. 0.28 Re. 0.125
(4) From the following particular, you are required to work out the earnings of a worker under.
Solution :
= Rs. 450
Actual output is more than normal output. Hence, piece rate will be 120% of normal
piece rate.
= Rs. 540
= Rs. 367.50
Time Saved
Actual Hours x Hourly Rate + X Actual Hours X Hourly Rate
Time Allowed
2 hours
= 48 hours X Rs.7.5 + X 48 hours x Rs. 7.50
50 hours
= Rs. 374.40
Note :
(5) In an engineering workshop, 15 persons work in a group. If the weekly production of the
group exceeds 120 units per hour (which is standard), each man gets a bonus in addition
to his hourly earnings.
Bonus regulation - Each worker’s share should be 1/2 of the percentage in excess of
standard production. The bonus shall be payable at this percentage of wage rate Rs.1.50
per hour. There is no relationship between individual workers’ hourly rate and bonus rate.
940 1,35,360
Compute
b. Total earnings of David who worked 40 hours during the week and his basic wage was
Rs. 1.20 per hour and that of Abdulla who worked for 48 hours and his basic wage was
Rs. 1.25 per hour.
Solution :
22,560
Excess production percentage = X 100 = 20%
1,12,800
= 10%
Rs. 54.00
Rs. 67.20
(6) Two fitters, a labourer and a boy, undertake a job on piece rate basis for Rs. 1,290. The
time spent by each of them is 220 ordinary working hours. The rates of pay on time rate
basis are Rs. 1.50 per hour for each of the two fitters. Re. 1 per hour for the labourer and
Re. 0.50 per hour for the boy. Calculate :
(a) The amount of piece-work premium and the share of each worker, when the piece
work premium is divided proportionately to the wages paid.
(b) The selling price of the above job on the basis of following data - Cost of Direct
Materials is Rs. 2,010, works overhead at 20% of Prime Cost, selling overhead at
10% of works cost and Profit at 25% of cost of sales.
Solution :
Rs. 300
Fitters X Rs. 660 Rs. 200.00
Rs. 990
Rs. 300
Boy X Rs. 110 - Rs. 33.33
Rs. 990
Rs. 300.00
(7) A worker, whose daily work wages is Rs. 2.50 an hour, received production bonus under
the Rowan scheme. He carried out the following works in a 48 hours week.
Job 4 - 1,500 items for which no “Standard time” was fixed and it was arranged that
the worker would be paid a bonus of 25%. Actual time taken on the job was
4 hours.
Job 5 - 2,000 items at 8 hours per 1000, each item was estimated to be half finished.
Job No. 2 was carried out on a machine running at 90% efficiency and an extra allowance
of 1/9th of actual time was given to compensate the worker.
Solution :
Job 1 - 6 hours
Job 2 - 6 hours
Job 3 - 54 hours
Job 4 - 5 hours
Job 5 - 8 hours
79 hours
Time saved
Time taken X Hourly rate + X Time taken X Hourly Rate
Time allowed
35 hours
= 44 hours X Rs. 2.50 + X 44 hours X Rs. 2.50
79 hours
= Rs. 158.73
= Rs. 10
= Rs.168.73
(1) The idle time is not treated for computing time taken. For idle hours, the worker will get
the wages at normal hourly rate.
(2) Time allowed for Job 2, Job 4 and Job 5 is calculated as below :
(a) Job 2 :
Time taken for 1,800 units 5.40 hour
Add :Extra allowance 1/9 0.60 hour
Time allowed 0.60 hour
(b) Job 4 :
Time taken for 1500 units 4 hours
Add : Allowance @ 25 1 hour
Time allowed 5 hours
(c) Job 5 :
Time taken for 2000 16 hours
Each item half finished
∴ Equivalent finished units 1,000
∴ Time for equivalent finished units 8 hours
QUESTIONS
1. Explain the various steps in the process of identifying the direct labour cost with the
individual cost center.
2. What do you mean by idle time. Explain in details the cost accounting treatment of idle
time.
3. Explain the term “Labour Turnover”. What are the causes responsible for labour turnover?
Explain the costs of labour turnover. How the Labour turnover is measured?
(1) During the first week of March, 1984 the workman Mr. Saurabh manufactured 300 articles.
He receives wage for a guaranteed 48 hours week at the rate of Rs. 4/- per hour. The
estimated time to produce one article is 10 minutes and under incentive scheme the
time allowed is increased by 20%. Calculate his gross wages according to :
(2) Calculate total monthly remuneration of three workers A, B and C from the following
data.
(d) Additional production bonus is Rs. 10 for each percentage of actual production
exceeding 80% over standard.
(Example 79% Nil, 80% - Rs. 10, 81% - Rs. 20 and so on)
(3) Following are the particulars as regards a worker who worked on jobs No. 122 and 133.
His normal and basic rate of wages was Rs. 28 per day of 8 hours and the dearness
allowance was Rs. 42 per week of 48 hours.
Calculate the amount payable to him by showing your workings on the following basis.
The table should clearly show (a) Bonus payable, (b) Total earnings, (c) Effective rate of
earnings per hour.
(5) Calculate the earnings of a workman under Halsey Premium Plan and Rowan Premium
Plan for executing a piece of work in 60 hours as against 75 hours allowed. His hourly
rate is 25 paise and under Halsey system, he is to be paid bonus at 50% of time saved.
In addition, he gets a dearness allowance for Re. 1 per day of 8 hours worked.
(6) From the following information, calculate the earnings of A, B and C under Halsey and
Rowan premium bonus plans.
A B C
Standard time in hours per 100 units 35 40 42
Wages per unit of output Rs. 2 Rs. 3 Rs. 4
Wage rate per hour Rs. 7 Rs. 8 Rs. 10
Actual hours taken 50 48 46
Actual no. of units produced 200 150 125
(7) The firm employs 5 workers at an hourly rate of Rs. 2.00. During the week they worked
for 4 days for a total period of 40 hours each and completed a job for which standard time
was 48 hours for each worker.
Calculate the labour cost under the Halsey Method and Rowan Method of incentive Plan
Payments.
(8) Compute the total time wages and total earnings of a worker, the rate earned per hour
and the bonus per hour in respect of three workers X,Y, and Z under the Halsey-Weir
bonus plans. The following are the particulars supplied.
(10) A worker takes 6 hours to complete a job under a scheme of payment by results. The
standard time allowed for the job is 9 hours. His wage rate is Rs. 1.50 per hour. Material
cost of the job is Rs. 16 and the overheads are recovered at 150% of the total direct
wages. Calculate the factory cost of the job under - (a) Rowan and (b) Halsey scheme of
incentive payments.
(11) In an engineering concern, the employees are paid incentive bonus in addition to their
normal wages at hourly rates. Incentive bonus is calculated in proportion of time taken to
time allowed, of the time saved. The following details are made available in respect of
employees X, Y and Z for a particular week.
X Y Z
Time Allowed (per 100 units) 0.8 hr. 1.5 hrs. 1 hr.
(13) An operator engaged on a machine, receives an ordinary day rate of Rs. 1.60 per day of
8 hours. The standard output has been fixed at 80 pieces per hour (time as fixed for
premium bonus.) On a certain day, the output of a worker on this machine is 800 pieces.
Find the labour cost per 100 pieces and the wages that should have been actually
earned by the workman under the following -
(14) In a manufacturing concern, 20 workmen work in a group. The concern follows a group
incentive bonus system whereby each workman belonging to the group is paid a bonus
on the excess output over the hourly production standard of 250 pieces, in addition to his
normal wages at hourly rate. The excess of production over the standard is expressed
as a percentage and two thirds of this percentage is considered to be the share of the
workman and is applied to the normal hourly rate of Rs. 6.00 (Considered only for purpose
of computation of bonus.) The output data for a week are stated below.
984 2,81,000
(a) Work out the amount of bonus for the week and the average rate of which each workman
is to be paid the same.
(b) Compute the total wages including bonus payable to Ram Jadhav who worked for 48
hours at an hourly rate of Rs. 2.50 and to Francis Williams who worked for 52 hours at an
hourly rate of Rs. 3.00.
(15) Following data for the month of October 1990 is available for a company.
During the month 10 workers left the company, 70 persons were discharged and 200
workers were recruited. Of these workers, 40 workers were recruited in the vacancies of
those who had left and the remaining were recruited for an expansion programme.
It has already been discussed that the term cost can be basically classified as Direct Cost
and Indirect Cost. Direct Cost indicates all those costs which can be identified with the
individual cost centre and indirect cost indicates all those costs which cannot be identified
with the individual cost centre. The total of indirect costs are termed as overheads.
As the cost can be basically classified as per the Elements of Cost i.e. Material Cost,
Labour Cost and Expenses, the indirect cost i.e. overheads may be classified as per the
elements of cost. This classification of overheads takes the form of :
(a) Indirect Material
(b) Indirect Labour
(c) Indirect Expenses.
The meaning and the type of expenses included in this classification have already been
discussed in the chapter on Cost Sheet.
(i) Fixed overheads : These overheads indicate the costs which remain unaffected
by variations in volume of output. E.g. Rent, Insurance on building, salary to
(ii) Variable overheads : These overheads indicate the costs which vary directly in
proportion to volume of output. E.g. Consumable stores, nuts/bolts, loose tools
etc. Per unit cost of overheads remains the same but total overheads may increase
or decrease as per volume of output.
(iii) Semi-variable overheads : These overheads indicate those which are neither
fixed nor variable in nature. These may remain fixed at certain levels of activity while
may vary proportionately at other levels of activity. E.g. maintenance cost, power,
electricity, supervision cost etc.
Under this classification, the overheads are classified according to their controllable
nature. This classification takes the form of :
Under this classification, the overheads are classified according to the fact as to whether
the overheads are normally incurred at a certain level of output under normal circumstances.
This classification takes the form of :
It should be noted in this connection, that the above classification refers to the classification
of same amount of overheads in different forms to suit the individual requirements. E.g. For the
purpose of preparing the cost statement, overheads may be classified according to functions
while for the purpose of marginal costing applications, overheads may be classified according
to variability.
The basic aim of costing is to find out the cost of each cost centre. The cost of each cost
centre can be either the direct cost or the indirect cost. The direct cost can be identified with
the individual cost centre and hence poses no difficulties. To charge the indirect costs i.e.
overheads to the individual cost centres is the major problem. For this, the following procedure
may be followed.
There can be some overheads which are incurred for the company as a whole, i.e. for all the
departments. i.e. Production as well as Service departments. To identify the common costs
with the individual departments is the first stage problem. This can be solved in two ways.
(1) If at all it is possible to identify some overheads with the individual departments they
should be identified by following the procedure of allocation of overheads.
E.g. Wages paid to the maintenance department workers can be obtained from wages
sheet and can be allocated to maintenance department. Similarly, cost of indirect material
can be allocated to individual departments by pricing material requisition slips.
(2) It may not be possible in all the cases to allocate the overheads, i.e. in case of common
expenses for the entire factory. In this case, they can be apportioned among the various
departments on some suitable basis, i.e. to all production as well as service departments.
This process is in the form of Primary apportionment or distribution of overheads.
The selection of the base on which overheads are or should be apportioned depends on
the following principles :
(a) Service or use basis : If the benefit obtained by various departments from the
overheads can be measured, overheads can be apportioned on that basis.
(b) Survey basis : If amount of services rendered can’t be measured, survey basis
may be applied. E.g. If it can be noted that a supervisor is giving 60% of his services
to department ‘A’ and 40 % to department ‘B’, his wages can be apportioned on
that basis.
(c) Ability to pay basis : In this case, the apportionment may depend upon the factors
like total sales/profitability. It may not be fair in some cases as most efficient
departments may have to bear higher amounts of overheads, though actual overheads
of that department may be lower than those of other departments.
The usual bases which can be selected for Primary Apportionment may be as below :
Illustration :
The Omega Co, is having four departments. A, B, and C are production departments and D is
a servicing department. The actual costs for a period are as follows.
Rs.
Rent 2,000
Repairs 1,200
Depreciation 900
Light 200
Supervision 3,000
Insurance 1,000
Employees Insurance (Employer’s liability) 300
Power 1,800
Apportion the cost to the various departments on the most equitable method.
Apportionment of Overheads
Notes :
It is assumed that the insurance is payable only on stock. Had it been assumed that it is
payable on stock as well as plant, the base would have been the combined value of stock and
plant.
For the apportionment of power cost, Kwh/HP rating would have been an ideal base. As
relevant data is not available, it is apportioned on the basis of value of plant.
Repairs are apportioned on the basis of total wages assuming that repair charges consist of
mainly labour charges.
With the process of primary apportionment or distribution, the loading of overheads for all
the departments i.e. production as well as service departments can be obtained. Next
step is to transfer the overheads of non-production departments to production departments,
as the various cost centres move through the production departments only. This is in the
form of ‘Secondary apportionment or distribution of overheads’.
(A) Ignore the services given by one service department to another. The defects involved with
this method are very obvious.
Illustration :
Following figures are extracted from the accounts of M/s. Vasant Works for the month of
July 1983.
Depreciation at 12% p.a. on capital value of assets to be considered. From the above information
and the following departmental data, prepare overhead recovery rates for the production
departments PI and P2 on the basis of direct labour hours. The expenses of service departments
should be apportioned straight to the production depts. with the information that SI is tool
room, S2 is maintenance dept. and S3 is stores dept.
Solution :
Items Base P1 P2 S1 S2 S3
Rs. Rs. Rs. Rs. Rs.
5,000 3,500
(B) If it is decided to consider the services rendered by one service department to another,
the first problem will be to decide the percentage in which services are given by service
departments inter-se. After such percentage is decided, the secondary apportionment
can be made by either of the following methods.
(i) Simultaneous Equation Method : Under this method the amount of overheads of
each production department can be obtained by solving simultaneous equations.
Illustration :
A company has 3 production depts. and 2 service depts. and for a period departmental
distribution summary has the following totals.
Production Depts. A ..Rs. 800 B Rs. 700 C. Rs. 500
Service Depts. 1 ....Rs. 234 2.. Rs. 300
Solution :
(3) Absorption :
The various methods which can be considered for deciding the rates of overhead absorption
are as below :
This is calculated as :
and Direct materials cost is Rs. 50,000, the absorption rate will be :
25,000
X 100 i.e. 50%
50,000
Now if the direct materials cost of a job is Rs. 500, it will be getting the loading of
overheads to the extent of 50% of direct materials cost, i.e. Rs. 250. This method is
useful if materials cost forms a major part of production cost and is normally used if
materials costs are stable and equipments used remain unchanged.
(i) There can be some situations where material prices vary without any change in the
amount of over heads, in which case, this method may show wrong results.
(ii) If this method is used, a job using expensive material may get high loading of
overheads as compared to a job using cheap material, which may not be fair.
This is calculated as :
E.g. If the production overheads to be absorbed are Rs. 10,000 and direct wages cost is
Rs. 40,000, the absorption rate will be :
10,000
X 100 i.e. 25%
40,000
Now if the direct wages cost of a job is Rs. 400, it will be getting the loading of overheads
to the extent of 25% of direct wages cost, i.e. Rs. 100. This method is useful if labour
cost forms a major part of production cost and also if the work performed by all the
workers is uniform, ratio of skilled and unskilled workers is constant and labour rates do
not fluctuate widely.
The problem with this method is that there is very little relationship between direct wages
and overhead expenses. It may give wrong results if the workers vary in ability.
This is calculated as :
E.g. if the production overheads to be absorbed are Rs. 16,000 and prime cost is
Rs. 80,000, the absorption rate will be :
16,000
X 100 i.e. 20%
80,000
Now if the prime cost of a job is Rs. 250, it will be getting the loading of overheads to the
extent of 20% of prime cost, i.e. Rs. 50.
This method is useful in this sense that it considers both the materials cost as well as
labour cost.
This is calculated as :
E.g. if production overheads to be absorbed are Rs. 50,000 and labour hours worked are
100,000, the absorption rate will be :
Rs. 50,000
i.e. Re. 0.50 per labour hour.
100,000
Now, if a job requires 20 labour hours to complete it, the loading of overheads to the
same will be Re. 0.50 per labour hour i.e. Rs. 10/-.
However, additional records are required to be kept for time booking per job. Further, if
machinery forms a dominant portion in production cost, this method may lead to wrong
results.
This is calculated as :
E.g. if production overheads to be absorbed are Rs. 20,000 and machine hours worked
as 5000, the absorption rate will be
Rs, 20,000
i. e. Rs. 4 per machine hour.
5,000
Now if a job requires 25 machine hours to complete, the loading of overheads to the same will
be Rs. 4 per machine hour, i.e. Rs. 100.
If the machine use accounts for a large element of cost in the overall production cost, then this
method can be used conveniently. This rate can be considered to be useful and ideal especially
in the days of high mechanisation and automation.
While computing the machine hour rate, it is necessary to consider the various overheads
required to be incurred for running a machine or group of machines treating the same as
distinct cost centres.
Illustration :
Following information relates to activities of a production dept. of a factory for a certain period.
Illustration :
The machine occupies 1/4 of the total area of the shop. The supervisor is expected to devote
1/5 of the total time for the supervision of the machine.
Depreciation 7,000.00
Rent and Rates 600.00
General lighting 900.00
Insurance Charges 960.00
Repairs and Maintenance 12,000.00
Shop Supervisor’s salary 1,440.00
Annual standing charges 22,900.00
Annual Machine Hours (Excluding setting up time) 2000
Hourly standing charges Rs. 11.45
Working Notes :
(1) It is assumed that during the setting up time, the machine will not be used for the
intended purpose and hence the said time is ignored for the calculation of machine hour
rate.
Hence, it is calculated as :
(3) It is assumed that the Repairs and Maintenance expenses are incurred only for the
machine.
The overhead absorption rates can be considered on actual basis or predetermined basis. For
computing the absorption rates on actual basis, the actual data for the previous period is
considered, i. e. Actual overheads, actual direct materials/wages cost, actual prime cost,
actual labour hours worked, actual machine hours worked etc. However, the actual overhead
absorption rates have certain limitations.
(1) The actual details are available only after the end of actual accounting period and required
details may not be available either for proper control of overheads or for price fixation.
(2) If the production is of seasonal nature, overhead absorption rates will not be constant
monthwise and comparison of production costs monthwise will be difficult.
If the organization follows the policy of considering predetermined overhead absorption rates,
it may face the problem of under or over absorption of overheads if the actual overheads to be
absorbed or the bases for the absorption, i.e. Materials/ Wages/ Prime cost or Labour/Machine
Hours etc. vary from the assumption. E.g. A Company considers the overhead absorption rate
as a direct materials cost percentage rate. It is decided that predetermined overhead absorption
rate should be considered for the forthcoming year 1989. As such, the predetermined overhead
rate was estimated on the basis of following details.
Now, on this basis all the jobs moving through that department during 1989 will be getting the
loading of overheads @ 20% of Direct Materials Costs.
After the year 1989 ended, the actual details are computed and it is found out that whereas
Direct Materials cost was as estimated, i.e. Rs. 50,000, the actual amount of overheads was
reduced to Rs. 9,000. As such, the rate at which the overheads should have been absorbed,
should have been
Such situation gives rise to the under absorption or over absorption of overheads.
The situation of under absorption arises if the overheads absorbed are less than the actual
overheads. The situation of over absorption arises if the overheads absorbed are more than the
actual overheads.
Causes :
Under absorption of overheads may take place due to the reasons like.
– Actual overheads being more than the estimated overheads or
– Actual output or hours worked being less than those as estimated.
Over absorption of overheads may take place due to the reasons like
– Actual overheads being less than the estimated overheads OR
– Actual output or hours worked being more than those as estimated.
The overheads which are under or over absorbed may be treated in either of the following
ways –
(1) Use of supplementary rate : If the amount of under or over absorbed overheads is
considerably significant, the cost of the cost centres may be adjusted by means of the
use of supplementary overhead absorption rate. This method of treating the over or under
absorption of overheads is most important where the cost is considered as a base for
quoting selling prices, E.g. Cost plus contracts.
E.g. The predetermined overhead absorption rate, for the forthcoming period of months,
was decided as below.
(2) Carrying over to remaining period : In case of seasonal types of organization, the
overheads under or over absorbed during a certain period may be carried over to the
remaining part of the accounting period with the hope that they may be compensated
during the remaining period of time.
(3) Writing off to Costing Profit and Loss Account : In case of the under or over absorption
of the overheads arising out of the abnormal circumstances, they are written off to Costing
Profit and Loss Account.
Illustration :
Solution :
(a) Normal working hours per year – 42 weekly hours per machine
(For all 14 machines) x 14 machines x 48 weeks
= 28,224 machine hours.
(b) Hours lost on maintenance – 5 hours per week x 14 machines
x 48 weeks = 3,360 machine
hours.
(c) Effective machine hours i.e., a - b – 24,864 machine hours.
(d) Estimated annual overheads – Rs. 1,24,320
(e) Machine hour rate i.e., d / c – Rs. 5
(f) Overheads absorbed – 2000 machine hours x Rs. 5
– = Rs. 10,000
(g) Overheads actually incurred – Rs. 10,200
(h) Overheads underabsorbed
i.e., g - f – Rs. 200
WAGES
As the basic intention of cost accounting is to exercise the control over the costs and as the
overheads is a part of cost, cost accounting procedures attempt to control the overheads also.
For this purpose, the following propositions should be remembered :
(1) The success of procedures to control the overheads largely depends upon the correct
classification of the overheads. This classification can be done from the various angles.
(b) Variabilitywise : This takes the form of classification in the form of fixed overheads,
variable overheads and semi-fixed or semi – variable overheads.
(c) Normalitywise : This takes the form of classification in the form of normal overheads
and abnormal overheads.
Fixed overheads normally arise as a result of policy and are largely uncontrollable at the lower
level of management. They can be controlled at the top level of management. However, the
variable overheads can be controlled at the lower or middle level of management as well.
Most of the administration overheads are fixed in nature and can be controlled mainly at top
management level. However, the factory overheads can be controlled at lower or middle
management level also.
(2) After the correct classification of overheads, use may be made of following two techniques
with the intention to exercise proper control over overheads.
(a) Budgetary control
(b) Standard costing
However, both these techniques necessarily involve the following stages in the process
of implementation.
(i) Planning : This lays down the course of action to be taken in future.
In case of budgetary control, it is in the form of the budgets and in case of standard
costing, it is in the form of the standard cost.
(ii) Implementation of plan : This indicates actual steps to execute the plan. For this,
downward communication may be necessary from top management level to lower
management level.
(iv) Analysis of variances and decision making : Variations between actual performance
and planned performance is required to be analysed as to the causes and proper corrective
actions are required to be taken to remove unfavourable variations or maintain favourable
variations.
ILLUSTRATIVE PROBLEMS
(1) Meera Industries Limited is a single product organization having a manufacturing capacity
of 6,000 units per week of 48 hours. The output data vis-a-vis different elements of cost
for three consecutive weeks are given below :
As a cost Accountant, you are asked by the company to work out the selling price assuming
level of 4,000 units per week and a profit of 20% on selling price.
Solution :
It can be observed that an increase in production by 400 units increases the total factory
overheads by Rs. 1,200 indicating that per unit variable overheads are Rs. 3. Hence, at the
activity level of 2,400 units, the total variable overheads are Rs. 7,200 i.e. 2400 units x Rs.3
per unit, out of total overheads of Rs. 37,200. Hence, the balance amount represents fixed
overheads. It should be noted that the direct material cost and direct labour cost represents
the variable cost of production. At 2,400 units, per unit cost is as below :
Direct Labour - Rs. 6000 / 2400 units = Rs. 2.5 per unit
The cost sheet for the production of 4000 units can be worked out as below :
(2) XYZ Ltd., a manufacturing company, having an extensive marketing net work throughout
the country, sells its products through four zonal sales offices viz. A,B,C and D. The
budgeted expenditure for the year are given below :
Rs.
A B C D
Based on the above details, compute zonewise selling overheads, as a percentage to sales.
Solution :
(3) The following yearly charges are incurred in respect of a machine where work is done by
means of 5 machines of exactly same type.
The machine uses 10 units of power per hour. Calculate the machine hour rate.
Solution :
Rs.
(a) Standing charges :
Rent and Rates 960
Depreciation 500
Repairs and Maintenance 200
Electricity charges 90
Attendants salary 280
Supervisor’s Salary 600
Sundry Supplies 90
Annual standing charges 2,720
Annual Machine Working Hours 1,200
Hourly Standing Charges Rs. 2.27
Working Notes :
(f) If total units consumed are 12.000 and if rate of power consumption is 10 units per
hour, it means that the machine must have worked for 1,200 hours.
(4) From the following data, work out the predetermined machine hour rates for departments
A and B of a factory.
Power 15,000 – –
Spare Parts 8,000 3,000 5,000
Consumable Stores 5,000 2,000 3,000
Depreciation on Machinery 30,000 10,000 20,000
Insurance on Machinery 3,000 – –
Indirect Labour 40,000 – –
Building Maintenance 7,000 – –
The final estimates are to be prepared on the basis of above figures after taking into consideration
the following factors :
(2) An increase of 20% in the consumption of spare parts for Department B only.
(3) Increase in the straight–line method of depreciation from 10% on the original value of
machinery to 12%.
Dept. A Dept. B
Working Notes :
(5) The factory overhead costs of four production departments of a company engaged in
executing job orders, for an accounting year, are as follows :
Depts. Rs.
A 19,300
B 4,200
C 4,000
D 2,000
Find out the amount of departmentwise under or over absorbed factory overheads.
Solution :
(6) In a factory, annual average charges for direct wages amount to Rs. 4,80,000. Following
are some of the expenses incurred in factory.
b. Factory Rent Rs. 36,000. The total area is 45,000 Sq. Ft. out of which shop is in
40,000 Sq. Ft.
Solution :
Rent for that area of shop where work order is executed. i.e.
Rs. 10,000
X Rs. 4,800 = Rs. 300
Rs. 160,000
Rs.
Works Manager’s Salary 50,000
Factory Rent (Balance) 4,000
Wages of Peons /Sweepers 7,000
Others 53,000
1,14,000
Rs. 10,000
X Rs. 1,14,000 = Rs. 2,375
Rs. 4,80,000
The following estimated figures for a certain period have been made available.
Rs.
Rent and Rates 10,000
Lighting and Electricity 1,200
Indirect wages 3,000
Power 3,000
Depreciation of machinery 20,000
Other expenses and sundries 20,000
Total X Y Z A B
Floor space (Sq. Mts.) 10,000 2,000 2,500 3,000 2,000 500
Light Points (Nos.) 120 20 30 40 20 10
Direct wages (Rs.) 20,000 6,000 4,000 6,000 3,000 1,000
Horsepower of machines 300 120 60 100 20 –
Cost of Machinery (Rs.) 1,00,000 24,000 32,000 40,000 2,000 2,000
Working Hours – 4,670 3,020 3,050 – –
X Y Z A B
You are required to calculate the overhead absorption rate per hour in respect of the three
production departments.
What will the total cost of an article with material cost of Rs. 50 and direct labour cost of
Rs. 40 which passes through X, Y and Z for 2, 3 and 4 hours respectively.
Expenses Base X Y Z A B
Rs. Rs. Rs. Rs. Rs.
Rent & Rates Floor space 2000 2500 3000 2000 500
Lighting & Electricity Light points 200 300 400 200 100
Indirect wages Direct wages 900 600 900 450 150
Power HP of machines 1200 600 1000 200 -
Depreciation Cost of machines 4800 6400 8000 400 400
Other expenses Direct wages 6000 4000 6000 3000 1000
Direct wages
(Only Service Depts.) Allocation – – – 3000 1000
Total X Y Z
Rs. Rs. Rs. Rs.
Rs.
Direct Material Cost 80
Direct Labour Cost 40
Overheads
(8) The expenses of a machine cost centre for a particular month are as under.
The entire production was to be offered to Government on ‘Cost Plus 20%’ basis. Material
Costs per unit are -
Solution :
Rs.
Power 50,000
Maintenance and Repairs 10,000
Machine operator’s wages 2,000
Supervision 6,000
Depreciation 40,000
1,08,000
On the basis of rate of production and number of units produced of each product, number of
machine hours used can be calculated as below :
Rs. 1,08,000
∴ Machines Hour Rate = = Rs. 480 Machine Hour
225 Machine Hour
1. Discuss the factors which would create unabsorbed factory overheads and overabsorbed
factory overheads.
2. Mention the broad principles on which overhead expenses are generally apportioned.
Upon what basis would you apportion the following expenses to individual cost centres
in an engineering unit?
(a) Rent
(b) Power
(c) Fire Insurance Premium
(d) Lighting
3. Explain the term underabsorption and overabsorption of overheads. Explain any three
methods of absorbing production overheads into the cost of production.
4. Distinguish between actual and predetermined rates for absorption of factory overheads.
Cite the major problems involved in using actual rates and discuss how predetermined
rates eliminate this problem.
5. How do you deal with under or over absorption of overheads? Mention the various items
that go into –
(a) Manufacturing overheads.
(b) Administration overheads.
(c) Selling overheads.
(d) Distribution overheads.
6. What basis would you recommend for the apportionment of the following items of expenses
to production departments, giving justification for the suggested one.
(a) Internal Transport.
(b) Air-Conditioning.
(c) General Factory Maintenance.
(d) Stores.
(e) Rent.
(f) Labour office.
Short Notes :
PROBLEMS
(1) A certain type of factory produces a uniform type of article and has a capacity to produce
1,500 units per week of 48 hours. Following data shows different elements of costs for 3
weeks of 48 hours each when output has changed from one week to another.
You are asked to find out selling price per unit when weekly output is 1,000 units and a profit
of 8.33% on selling price will be made.
(2) A factory is having three production departments A, B and C and two service departments-
Boiler House and Pump Room. The Boiler House has to depend upon the Pump Room
for the supply of water and the Pump room in its turn is dependent on the boiler house for
supply of steam power for driving the pump. The expenses incurred by the production
departments during a period are A – Rs. 8,00,000, B – Rs. 7,00,000 and C - Rs. 5,00,000.
The expenses for boiler house is Rs. 2,34,000 and the pump room is Rs. 3,00,000.
The expenses of the boiler house and pump room are apportioned to the production
departments on the following basis.
Show clearly as to how the expenses of boiler house and pump room would be apportioned to
A, B and C departments. Use an Algebrical equation.
(3) The overheads distribution summary for the month of September 1980 disclosed following
overheads expenses for departments mentioned below :
A B C D E
Overheads Rs. 7,810 Rs. 12,543 Rs. 4,547 Rs. 4,000 Rs. 2,600
A B C D E
D 30% 40% 20% - 10%
E 10% 20% 50% 20% -
You are required to find out the total cost of each production dept. by charging the respective
costs of service depts. by simultaneous equations method.
(4) The primary distribution of expenses disclosed the following details in respect of production
departments PI, P2 and P3 and Service Departments S1 and S2
Dept. P1 P2 P3 S1 S2
Dept. P1 P2 P3 S1 S2
Find out the overheads to production Departments by using simultaneous equations method.
(5) A company has three production cost centres A, B and C and two service cost centres
X and Y. Costs allocated to service cost centres are required to be apportioned to the
X Y
A 80,000 20 20
B 40,000 30 25
C 20,000 40 50
X 20,000 - 5
Y 10,000 10 -
Required -
Work out final overhead costs of each of the production departments including apportioned
cost of service centres using -
a. Continuous Distribution Method
b. Simultaneous Equations Method
(6) The following particulars related to the production department of a factory for the month
of June 1985.
Rs.
Material Used 80,000
Direct Wages 72,000
Direct Labour Hours Worked 20,000
Hours of Machine operation 25,000
Overhead charges allocated to the department 90,000
Cost data of a particular work order carried out in the above department during June 1985 are
given below.
Rs.
Material Used 8,000
Direct wages 6,250
Labour hours booked 3,300
Machine hours booked 2,400
(7) The following information is extracted from the budget of A Ltd. for 1985.
You are required to work out the overhead application rates and ascertain the cost of job 195
by using the following methods of overheads absorption.
(1) Direct Labour Hours Rate, (2) Direct Labour Cost, (3) Machine Hour Rate
(8) Atlas Engineering Ltd. accepts a variety of jobs which require both manual and machine
operations. The budgeted Profit and Loss Account for the period 1996-97 is as follows :
(Rs. in Lakhs)
Sales 75
Cost :
Direct Materials 10
Direct Labour 5
Prime Cost 15
Production Overhead 30
Production Cost 45
Other Overheads 15
60
Profit 15
An enquiry has been received recently from a customer and the production department has
prepared the following estimate of the prime cost required for the job -
a. Calculate by different methods, six overhead absorption rates for absorption of production
overhead and comment on the suitability of each.
b. Calculate the production overhead cost of the order based on each of the above rates.
(9) A company has two production departments and two service departments. The data
relating to a period are as under :
The power requirement of these departments are met by a power generation plant. The said
plant incurred an expenditure, which is not included above, of Rs. 1,21,875 out of which a sum
of Rs. 84,375 is variable and the rest fixed.
c. Calculate the overhead rates per direct labour hour of production departments, given that
the direct wages rate’s of PD1 and PD2 are Rs.- 5 and Rs. 4 respectively.
(10) Following information is extracted from the cost records of Hilton Ltd. which specialises
in the manufacture of automobile spares. The parts are manufactured in Department A
and assembled in Department B.
(11) Strongman Ltd. has three production departments A,B and C and two service departments
X and Y. The data available for the month of March 1991 concerning the organization
Rs.
Rent 15,000
Municipal Taxes 5,000
Electricity 2,400
Indirect wages 6,000
Power 6,000
Depreciation on Machinery 40,000
Canteen Expenses 30,000
Other Labour related costs 10,000
Total A B C X Y
Floor Space (Sq. Mts.) 5,000 1,000 1,250 1500 1,000 250
Light Points (Nos.) 240 40 60 80 40 20
Direct Wages (Rs.) 40,000 12,000 8,000 12,000 6,000 2,000
HP of Machines 150 60 30 50 10 –
Cost of Machines (Rs.) 20,0000 48,000 64,000 80,000 4,000 4,000
Working Hours – 2,335 1,510 1,525 – –
A B C X Y
You are requested to calculate the overhead absorption rate per hour in respect of the three
production departments.
Rs.
Rent and Taxes 25,000
General Lighting 3,000
Indirect Wages 7,500
Power 7,500
Depreciation on Machinery 50,000
Sundries 50,000
Total A B C X Y
A B C X Y
a. Compute the overhead rate of production departments using repeated distribution method.
b. Determine the total cost of a product whose direct material cost and direct labour cost
are Rs. 150 and Rs. 150 respectively and which would consume 4 hours, 5 hours and 3
hours in departments A, B and C respectively.
(13) Universal Ltd. has four production departments A, B, C and D and two service departments
viz. Transport and Power Supply.
A Rs. 2,000
B Rs. 1,800
C Rs. 1,600
D Rs. 1,400
Transport Rs. 1,100
Power Supply Rs. 760
The service department’s expenses are charged out on a percentage basis as given below :
A B C D Transport Power
Using the above information, apportion the service department overheads to various production
departments using
(14) A shop has 2 newly purchased machines, each occupying equal area of space. One is
4 - spindle drilling machine and the other is 6-spindle drilling machine costing Rs. 80,000
and Rs. 1,00,000 respectively. Following are the expenses for one year :
The life of each machine is 10 years without any salvage value. Each machine works for 45
hours a week for 50 weeks in a year. 250 hours per machine are used for repairs. Running and
repairs expenses are shared between two machines on the basis of power expenses.
You are required to prepare statement showing computation of Machine Hour Rate.
(16) You are required to calculate the composite machine hour rate from the following particulars
in respect of a jig boring machine whose scrap value is Rs. 50,000 after its working life of
10 years.
1. Cost of the machine - Rs. 2,00,000
2. Importation charges & Customs duty etc.- Rs. 50,000
3. Working hours per year - 2,000
4. Repairs & Maintenance charges - 50% of depreciation charge.
5. Lubricating oil - Rs. 20 per working day of 8 hours
6. Consumable stores - Rs. 500 per month of 25 working days.
7. Power 10 units per working hour at Re. 0.30 per unit
8. Wages of the operator - Rs. 1,000 per month of 25 working days.
The machine can work for 200 hours in a month and had actually worked for 80% of the normal
working hours. Cost of oils and greases consumed per hour is Rs.4.50,
(18) A dept. is having 3 machines. The figures indicate the departmental expense of these
machines. Calculate the machine hour rate from the data below :
Rs.
Purchase Price of machine 80,000
Installation Expenses 20,000
Rent per Quarter 3,000
General Lighting for the total area 200 per month
Supervisor’s salary 6,000 per quarter
Insurance premium 600 per annum
Estimated repairs 1,000 per annum
Estimated consumable stores 800 per annum
The estimated life of the machine is 10 years and the estimated scrap value is
Rs. 20,000. The machine is expected to run 20,000 hours in its life time. The machine
occupies 25% of the total area. The supervisor devotes l/6th of his time for the machine.
You are required to work out machine hour rate.
(20) From the following particulars, calculate the machine hour rate of machine installed in a
Department.
Departmental rent and rates are Rs. 1,200 per year. The space occupied by the machine
is l/6th of the floor space of the department. Power consumption of the machine is 2
units per hour @ 10 paise per unit.
(21) A machine costing Rs. 20,000 is expected to work for 10 years and at the end of which
the scrap value is estimated Rs. 2,000, installation charges amount to Rs. 200. repairs
over 10 years life is expected Rs. l,800 and the machine is expected to run for 2.190
hours in a year.
Its power consumption would be 15 units per hour at Rs. 5 per 100 units. The machine
occupies l/4th of the area of the department and has two points out of ten for lighting. The
foreman has to devote l/3rd of his time for this machine. The rent for the department is
Rs. 300 p.m. and charges for lighting Rs. 80 p.m. The foreman is paid salary
Rs. 960 p.m. Find out the hourly rate assuming insurance is 1% per annum and expenses
on oil etc. Rs. 9 per month.
Territory
I II III
The company adopts sales basis and quantity basis for application of selling and distribution
costs respectively.
Compute -
(a) The territorywise overhead recovery rates separately for Selling and Distribution costs.
(b) The amounts of selling and distribution cost chargeable to a consignment of 2,000 units
of a product, sold in each territory at Rs. 4.50 per unit.
b. The repair charges will be Rs. 1,080 during the whole period for life of the machine.
c. The power consumption will be 5 units per hour at 6 paise per unit.
2. Light (12 points in the department, 2 points engaged in the machine) 288
5 Cotton Waste 60
Find out the machine hour rate on the basis of above data for allocation of the works expenses
to all jobs for which the machine is used.
The estimated life of the machine is 10 years and the estimated value at the end of 10 years
is Rs. 1,00,000. The machine is expected to run 20,000 hours in its life time. The machine
occupies 25% of the total area. The foreman devotes l/6th of his time for the machine.
a. Budgeted working hours are 2,400 based on 8 hours per day for 300 days. This includes
400 hours for plant maintenance.
b. Electricity used by the machine is units per hour at a cost of Rs. 2 per unit. No current
is drawn during maintenance.
c. The machine requires special oil for heating which is replaced once in every month at a
cost of Rs. 2,500 on each occasion.
d. Estimated cost of maintenance of the machine is 500 per week of 6 working days.
e. 3 operators control the operations of the entire battery of six machines and the average
wages per person amounts to Rs. 450 per week plus 40% fringe benefits.
f. Departmental and general overheads allocated to the operation during the last year were
Rs. 60,000. During the current year it is estimated that there will be an increase of
12.5% of this amount. No incremental overhead is envisaged for the installation of the
new machine.
You are required to compute the machine hour rate for the recovery of the running cost of the
machine.
(26) The following annual charges are incurred in respect of a machine in a shop where
manual labour is almost nil and where work is done by means of five machines of exactly
similar type and specification.
(a) Rent and Taxes (Proportionate to the floor space occupied) for the shop - Rs. 4,803.
(d) Power consumed @ 6.25 paise per unit for the shop Rs. 3,750.
(f) Attendants - There are two attendants for the five machines and they are each paid
Rs. 60 per month.
(g) Supervision - There is one supervisor in the shop for the five machines and he is paid
Rs. 250 per month.
(i) Hire Purchase - Instalment payable for the machine (including Rs. 300/- as interest) -
Rs. 1,200.
(j) The machine uses 10 units of power per hour. Calculate the machine hour rate for the
year.
(27) In a manufactring concern ABC Ltd., die machine shop has 8 identical machines manned
by 6 operators. The machines cannot be worked without an operator wholly engaged on
them. The total cost of the machines are Rs. 8,00,000.
Following information relates to a six monthly period ended 30th June, 1990.
Normal available hours per month 208
Absenteeism (without pay) hours
per month. 18
Leave (with pay) hours per month 20
Normal idle time (unavoidable)
hours per month 10
Average rate of wages per day of 8 hours Rs. 20
Production hours 15% on wages
Power and Fuel consumption Rs. 9,000
Supervision and Indirect Labour Rs. 3,300
Electricity Rs. 1,200
Particulars P1 P2 P3 S1 S2
Apportion general overheads in the proportion of direct wages. Apportion the expenses of S1
according to direct wages and those of S2 in the ratio of 5 : 3: 2 to the production departments.
(29) A Ltd. has 3 production departments A, B and C and 2 service departments D and E.
The following are the figures of the company.
Rs.
Rent and Rates 5,000/-
General lighting 600/-
Indirect wages 1,500/-
Power 1,500/-
Depreciation of Machinery 10,000/-
Sundry Expenses 10,000/-
A B C D E
A B C D E
Find the rate per hour if the working hours are as under :
A Department 6226
B Department 4028
C Department 4066
(30) In a light engineering factory, the following particulars have been collected for the three
monthly period ended 31.12.80. Compute the departmental overhead rates for each of
the production departments assuming that the overheads are recovered as a percentage
of direct wages.
Apportion the expenses of service dept. E proportionate to direct wages and that of service
dept. D in the ratio of 5 : 3 : 2 to depts A, B and C respectively.
In the conventional system of cost ascertainment, the direct cost may be identified with the
individual cost center. However, the indirect costs i.e. the overheads are identified with the
individual cost center on the most equitable basis. This results into some problems in the
process of managerial decision-making.
a. The above process does not take into consideration the behaviour of cost. All the costs
in the practical circumstances do not behave in the same manner. Some of the costs
tend to remain constant despite the changes in the level of activity or volume of operations.
These types of costs are comparatively irrelevant in the managerial decision-making.
b. The above process results into the under absorption or over absorption of overheads.
The said limitations have given rise to a managerial decision making technique that basically
tries to classify the costs based upon the behaviour of cost. The technique is referred to as
Marginal Costing. The basic proposition made by this technique is that the costs should be
classified on the basis of behaviour of the costs. From this angle, the costs can be viewed as
fixed costs and variable costs,
Fixed Cost is the cost that tends to remain constant irrespective of the level of activity or
volume of operations. Fixed Cost tends to vary with time rather than with level of activity. Basic
characteristic feature of fixed cost is that this cost in terms of amount may remain constant at
all the levels of activities, however per unit fixed cost goes on decreasing with the increasing
level of activity and vice-a-versa.
Variable Cost is the cost that varies in direct proportion with the level of activity or volume of
operations. Basic characteristic feature of variable cost is that variable cost in terms of amount
may increase or decrease with the changing level of activity or volume of operations. However,
per unit variable cost remains constant.
In practical circumstances, some costs may not be entirely fixed or entirely variable. They are
technically in the form of semi-fixed costs or semi-variable costs. For the purpose of marginal
costing, the semi-fixed costs or semi-variable costs are required to be classified in the individual
l Analytical method
l Scattergraph method
Based upon the above discussions, let us make some calculations for a manufacturing
organization manufacturing and selling a single product, operating at various levels of activities.
It can be observed from the above calculations that if the fixed cost is included in the calculation
of total cost, per unit total cost becomes non-comparable with the changes in the level of
activity in one cost-period to another cost-period. To avoid this non-comparability, it is necessary
to eliminate the fixed costs while determining the total cost.
As such, the technique of Marginal Costing proposes that fixed cost tends to remain stagnant
at least over a shorter period of time and hence should be ignored in the entire decision
making process. As such, marginal costing considers only the variable cost as the relevant
cost in the decision making process.
The Concept
Marginal Cost is defined as the amount at any given volume of output by which the aggregate
costs are changed if the volume of output is increased or decreased by one unit. The aggregate
cost consists of both fixed cost and variable cost. As in the short run, fixed costs remain
constant irrespective of changes in the volume, aggregate costs may increase or decrease
Marginal Costing is defined as the ascertainment, by differentiating between fixed and variable
costs, of the marginal costs and of the effect on profit of changes in volume and type of output.
The entire technique of Marginal Costing is based upon the following assumptions.
a. Variable Cost varies in direct proportion with the level of activity. However, per unit variable
cost remains constant at all the levels of activities.
b. Per unit selling price remains constant at all the levels of activities.
c. Whatever is produced by the organization is sold off. In other words, there are no variations
due to the stock.
1. The product costs are classified as fixed costs and variable costs. Semi-variable costs
are also classified in their individual components of fixed cost and variable cost.
2. Only variable costs are considered while computing the product costs. The closing stock
of finished goods and semi-finished goods is valued after considering variable costs only.
3. Fixed costs are written off during the period of incurrence and hence do not find the place
in product cost determination or inventory valuation.
The definition of the term “Marginal Costing” requires the computation of-
a. Marginal Cost
As stated earlier, the marginal cost is the additional cost for manufacturing one additional
unit, which is nothing else but the variable cost per unit. Thus the marginal cost or
variable cost includes the direct cost plus the variable overheads. Fixed overheads get
clubbed with the fixed cost.
The intention of every business activity is to earn the profit and to maximize the profit.
Determination of the profits depends upon the interplay between the following factors
and there exists a close relationship among these factors :
(2) Total cost which in its turn may be in the form of variable cost or fixed cost.
The relationships existing among these factors may be basically presented in two forms.
(b) In graphical form, the graphs or charts taking the form of break even chart, contribution
break even chart or profit chart.
Under the marginal costing technique, the operating statement takes the form as specified
below.
Rs.
Sales x
Less : Marginal cost
Direct Material Cost x
Direct Labour Cost x
Direct Expenses x
Variable Overheads x
x
Contribution x
Less : Fixed costs x
Profit x
Sales x x x x
Less : Marginal cost
Direct Material cost x x x x
Direct Labour cost x x x x
Direct Expenses x x x x
Variable Overheads x x x x
Contribution x x x x
Less : Fixed costs x
Profit x
The basic intention of the business is to earn the profit which is the excess of sales over
the total costs.
∴ Profit = Sales - Total Cost
However, total cost can be either fixed cost or variable cost. As such the basic equation
takes the following forms.
∴ Profit = Sales - (Variable Cost + Fixed Cost)
∴ Profit = Sales - Variable cost - Fixed cost
∴ Profit + Fixed cost = Sales - Variable cost.
As discussed earlier, the term contribution can be expressed in two ways basically :
(a) Sales - Variable Cost
(b) Fixed cost + Profit
As in the short period, fixed costs are ineffective due to their stagnant nature, variable
cost becomes the most important cost in deciding the profitability. As such, the situation
which generates higher contribution is treated as profitable situation.
Further, the term contribution, plays an important role in a situation where there are more
than one products and the profits on individual products cannot be ascertained due to
the problems of apportionment of fixed costs to different products. This is due to the fact
that the fixed costs are ignored by marginal costing.
This ratio indicates the contribution earned with respect to one rupee of sales. As such,
it is expressed as
Contribution
X 100
Sales
As in the short run, fixed cost remains the same, if there is any change in profits, that is
only due to change in contribution. Hence P/V ratio may also be expressed as :
Change in Profits
X 100
Change in Sales
E.g. Sales price is Rs. 10 per unit, variable cost is Rs.6 per unit, and fixed costs are
Rs.300, we observe that for 100 and 150 units, P/V Ratio works out as :
The fundamental property of P/V Ratio is that it remains constant at all the levels of
activities, provided per unit sales price and variable cost remains constant. It should be
noted that P/V Ratio remains unaffected by any variation in fixed costs though overall
profits may change due to this variation.
A high P/V Ratio indicates that a slight increase in sales without corresponding increase
in fixed costs will result in higher profits and vice-versa. This is a pointer to increased
sales promotion efforts to increase sales volume.
A low P/V Ratio indicates low profitability so that efforts can be made to increase the
profits by increasing selling price or by reducing variable cost. Overall profitability may
also be increased by concentrating more on products having high P/V Ratio.
Note : The basic expression of P/V Ratio i.e.Contribution/Sales may lead to other useful
conclusion as -
(b) Contribution
= Sales
P/V Ratio
This is a situation of no profit no loss. It means that at this stage, contribution is just
enough to cover the fixed costs i.e. Contribution = Fixed Cost. It also means that
contribution generated by all sales beyond Break Even Point will directly result into
profits. As such, it will be intention of every business to reach the Break Even Point, as
early as possible.
Fixed Costs
(a) In terms of quantity –
Contribution per unit
These are the sales beyond Break even point. A business will like to have a high margin
of safety because this is the amount of sales which generates profits. As such, the
soundness of the business is indicated by the margin of safety. A high margin of safety
indicates that the Break Even Point is much below the actual sales and even if there is
reduction in sales, business will be still in profits. A low margin of safety accompanied
by high fixed cost and high P/V Ratio indicates that efforts are required to be made for
reducing the fixed cost or increasing sales volume. A low margin of safety accompanied
by a law P/V Ratio indicates that efforts are required to be made for reducing the variable
cost or increasing the selling price.
Fixed cost
= Sales -
P/V Ratio
Profit
=
P/V Ratio
Margin of safety may be expressed as a ratio or as a percentage. E.g. If actual sales are
Rs.l,00,000 and Break Even Sales are Rs.60,000, Margin of Safety will be
Calculate variable cost, fixed cost and contribution for each period.
Solution :
Increase in Profits
As P/V Ratio = X 100
Increase in Sales
To summarise,
Period I Period II
Rs. Rs.
Contribution 11,700 12,900
Variable cost 27,300 30,100
Fixed cost 7,500 7,500
Sales Profit
Rs. Rs.
Period I 2,00,000 20,000
Period II 3,00,000 40,000
Solution :
Increase in Profits
We know that P/V Ratio = X 100
Increase in Sales
20,000
P/v Ratio = X 100 = 20%
100,000
Profit
Margin of safety =
P/V Ratio
20,000
For period I, Margin of Safety is = = 1,00,000
20%
Considering Period I,
= 1,00,000
Solution :
At Break Even Point, sales are Rs. 10,000 and contribution Rs. 5,000
Contribution 5,000
P/V Ratio = X 100 = X 100= 50%
Sales 10,000
= 5,000
= 5,000
Solution :
Contribution
X 100 = P/V ratio
Sales
10,000
P/V Ratio = X 100 = 50%
20,000
Profit
Margin of safety =
P/V Ratio
5,000
= = 10,000
50%
Solution :
Sales are Rs. 50,00,000 and Margin of safety is 40% of sales, hence margin of safety is Rs.
20,00,000. As Break Even Sales = Sales – Margin of Safety.
We know that,
Profit
Margin of Safety =
P/V Ratio
Y TS
TC
a
COST/REVENUE
BEP
LOSS
FC
MOS
}
O X
VOLUME SL
Note : It will be observed from the above chart, that the angle formed by total sales line and
total cost line is termed as Angle of Incidence. As the difference between total sales and total
cost is in the form of profits, higher the angle of incidence better will be the situation.
The limitation of Simple Break Even Chart is that contribution cannot be shown separately. As
such, the following type of Break Even Chart may be prepared i.e. Contribution Break Even
Chart.
This is a chart where the contribution is shown more clearly and specifically than in a
simple break even chart. It can be prepared as below.
Y TS
TC
a
COST/REVENUE
BEP FC VC
VC
MOS
}
X
O VOLUME SL
In case of this type of break even chart, horizontal axis represents sales volume and
vertical axis represents profit or loss. The diagonal line represents contribution. The
point where the contribution line cuts horizontal axis indicates sales at the Break Even
Point indicating that at this point, there is no profit or no loss.
PL
BEP P
L SALES
} FC
The technique of marginal costing can be profitably employed in the following situations.
Products
A B C
Rs. Rs. Rs.
Sales 1,00,000 1,50,000 2,50,000
Total Cost
Variable Cost 90,000 1,00,000 1,50,000
Fixed cost (Apportioned
on the basis of sales) 20,000 30,000 50,000
Total Cost 1,10,000 1,30,000 2,00,000
∴ Profit (Loss) (10,000) 20,000 50,000
As product A is incurring the losses, it is decided to close down its production. Advise the
management,
Solution :
It will not be advisable to close down the production of product A, because it is generating the
positive contribution
Closing down of product A will mean loss of contribution generated by it, fixed cost still
remaining the same. Assuming that the production of product A is closed down, what will be
the effect on profitability? Let us verify by applying marginal costing principles.
It means that existing total profits of Rs. 60,000 will reduce to Rs. 50,000 which will affect
profitability adversely.
Marginal costing, through the calculations of P/V Ratio, enables the management to
plan the activities in such a way that the profits can be maximised or to maintain a
specific level of profits. As such, this technique helps the planning of profits.
Illustration :
(1) M/s. C and P Ltd. Produces and sells industrial containers and packing cases. Due to
competition, the company proposes to reduce the selling price. If the present level of
profit is to be maintained, indicate the number of units to be sold if the proposed reduction
in price is (a) 10% and (b) 15%. The following information is available:
Rs. Rs.
Solution :
Sales 20 6,00,000
Variable Cost 12 3,60,000
Contribution 8 2,40,000
Fixed Cost 1,40,000
Net Profit 1,00,000
If the price is reduced by 10% or 15%, the per unit cost structure is going to change
as below :
As such, the number of units which will have to be sold in the above cases of price reduction
will be -
(2) Per Unit cost structure of a single product manufacturing company is as below :
Number of Units sold in the year are 5,035. As per the agreement with the employee’s
union, there will be an increase of 10% in Direct wages.
Work out -
(a) How many more units have to be sold next year to maintain same quantum of
profits.
(b) By what percentage the selling price has to be raised to maintain same P/V Ratio?
In the next year, the per unit Direct Labour Cost will be more by 10% i.e. Rs. 11 per unit which
will reduce the per unit contribution to Rs. 19.
Alternative (a) :
If the same quantum of profits is to be maintained, same amount of contribution will have to be
generated with reduced per unit contribution.
Amount of contribution
=
Revised per unit contribution
Rs. 1,00,700
=
Rs. 19
= 5.300 Units
Hence, the company will have to sell 265 units more (i.e. 5,300 Units - 5,035 Units) to maintain
same quantum of profits.
Alternative (b) :
At present, when selling price is Rs. 100, contribution is Rs. 20 meaning that per unit variable
cost is Rs. 80.
In future, the variable cost is likely to be Rs. 81 per unit instead of Rs. 80. Accordingly, the
selling price will also be required to be increased if it is intended that the same P/V Ratio
should be maintained.
Rs. 81
X 100 = Rs. 101.25
Rs. 80
As such, the selling price has to be raised by 1.25% to maintain the same P/V Ratio.
20.25
X 100 = 20%
101.25
The technique of marginal costing may be applied in the area of price fixation in such a
way that prices fixed should cover atleast the variable cost. As in the short run, the fixed
cost is a stagnant cost, it can be ignored, though it can not be ignored in the long run
because of the simple fact, that it is a cost. In the short run, the prices fixed above the
variable cost may generate some positive contribution which may help in the recovery of
fixed cost. However, if the fixed cost is ignored in the long run, it may put the business
into serious troubles as the business will never be able to earn the profits.
(a) In some exceptional circumstances viz. during the phase of depression, serious
competition in the market, to introduce the new product in the market by keeping
the price as low as possible in the initial stages, to dispose off the product which
may deteriorate in quality etc., it may be necessary to fix the selling price even
below the variable cost, however it is a deliberate decision taken by the management.
(b) The above principle is equally applicable while fixing the export price as well. The
export price over and above the variable cost will result into increased amounts of
profits if the fixed costs can be taken care of by the inland sales and if the home
market is not likely to get affected by the export price fixed. However, if certain
specific costs, either fixed or variable, are required to be incurred specifically for the
execution of the export order, they will have to be recovered while fixing the export
price as if it is a part of the variable cost.
Rs.
Sales (80,000 Units @ Rs. 15) 12,00,000
Costs – Variable
Materials 2,40,000
Labour 3,20,000
Overheads 1,60,000
7,20,000
Fixed 3,20,000
Total Costs 10,40,000
Profit 1,60,000
The plant capacity is 1,00,000 units. A customer from U.S.A. is desirous of baying 20,000
units at a net price of Rs. 10 each unit. Advice the company whether or not offer should be
accepted? Will your advice be different if the customer is a local one?
Solution :
Rs. 7,20,000
80,000 units
So long as the export price is more than Rs. 9, it is going to generate additional contribution
which is going to increase the profits, as the fixed costs are already covered by the local
sales. As the export price offered is Rs. 10 i.e., Re. 1 more than the variable cost per unit, the
company should accept the offer. The advice will be the same even it the customer is a local
one, provided the price discrimination, i.e. Rs. 15 per unit for 80,000 units and Rs. 10/- per unit
for 20,000 units is not going to adversely affect the current market for 80,000 units at the
current price of Rs. 15. If the company accepts the export offer of Rs. 10 per unit, the revised
profitability structure will be as below:
Rs.
Sales : 80,000 units @ Rs. 15 12,00,000
20,000 units @ Rs. 10 2,00,000
14,00,000
The revised amount of profit will be more by Rs. 20,000 as compared to the existing amount of
profits. Hence, the export order should be accepted by the company.
Component A Component B
Rs. per unit Rs. per unit
If manufactured
Variable Cost 30 30
Fixed Cost 25 20
55 50
If purchased 40 25
If the above data is viewed from total cost point of view, without considering the
classification of cost like fixed or variable, it may be concluded that the purchase
proposition may be profitable for both the components A and B. However, the conclusion
may be misleading as the total cost in case of component A, if purchased, is not going
to be only Rs. 40 per unit, but it is going to be Rs. 65 (i.e. Rs. 40 purchase price per unit
plus Rs. 25 fixed cost per unit) which being more than present total cost, manufacturing
proposition will be beneficial. On the other hand, in case of component B, total cost, if
purchased, is going to be Rs. 45/- per unit (i.e. Rs. 25 purchase price per unit plus Rs.
20 fixed cost per unit) which being less than present total cost, buying proposition will be
beneficial.
(1) If buying proposition is beneficial in case of a component or product, the final decision
to buy may depend on other factors also viz. whether the supplier is reliable one,
whether the supplier can assure required quality, whether the supplier can assure
uninterrupted supply etc.
(2) If it is decided to buy a component or a product which was being manufactured till
now, the manufacturing capacity released should be profitably used for some other
purposes. If it is decided to manufacture a companent which was being purchased
till now, there may be two possibilities. One, production capacity used for same
component or product may be diverted to manufacture another component or
product. In this case, the loss of contribution of that another component or product
should be considered as a part of cost. Second, if additional production facilities
are required to be acquired for the manufacturing proposition, the additional fixed
costs attached with the manufacturing proposition should be considered.
Product mix refers to the proportion in which various products of a company can be sold.
If a concern is dealing in a number of products, a problem which usually arises is to
decide a mix or proportion in which the sales of the various products should be made so
that the profits can be maximized. Such a problem can be solved by studying the
contributions generated by the various products individually and by selecting that mix
which generates the maximum total contribution.
Illustration :
Following information has been made available from the cost records of Universal Automobiles
Ltd. manufacturing spare parts
Direct Materials per unit
X Rs. 8
Y Rs. 6
Direct wages
X 24 hours @ 25 paise per hour.
Y 16 hours @ 25 paise per hour.
Variable overheads - 150% of wages
Fixed overheads - Rs. 750
Selling price
X Rs. 25
Y Rs. 20
Solution :
Product X Product Y
Rs. Rs.
Fixed overheads are going to be the same in all these alternatives. As such, the alternative
which generates maximum contribution is the maximum profitable one.As alternative d i.e.
150 units of X and 350 mills of Y generates maximum of contribution, it will be recommended
to the management.
Marginal costing technique and more particularly the classification of costs as fixed and
variable, facilitates the preparation of flexible budgets which is discussed in details in the
chapter ‘Budgetary Control’.
Under the marginal costing technique, profitability is measured in terms of the contribution
and the products generating maximum contribution or having maximum P/V Ratio are treated
as the maximum profitable products. As the intention of every business is to maximize the
profits, the company will concentrate maximum on the products having highest P/V Ratio and
will thus maximize the profits. However, in practice, there may be some factors which may
come into play which may restrict the company’s intention or capability to maximize the
profits E.g. In case of the products having highest P/V Ratio, market may be limited, or in
case of a maximum profitable product, raw material may not be available. These factors are in
the form of ‘Key Factor’ or ‘Limiting Factor’ or ‘Scarce Factor’. A key factor is defined as the
factor which, at a particular point of time or over a period, will limit the volume of output. The
key factor may be in various forms viz. sales/market, material, labour, machine availability and
so on. In order to evaluate the profitability of a product under key factor situations, the contribution
per unit of key factor is the basic criteria. A product generating maximum contribution per unit
of key factor is the maximum profitable product.
From the following details, which product would be recommended if time is the key factor.
Product A Product B
Solution :
Product A Product B
As labour hours is the key factor and contribution per labour hour is more in case of product A,
it will be recommended for production.
In practice, more than one key factors may come into play and any decision regarding product
mix ascertainment or profitability ascertainment will have to be decided on the basis of
consideration of multiplicity of key factors. The situation of multiplicity of key factors is a more
complex situation, the solutions to which may be found in the more advanced techniques like
linear programming.
A B C
Raw material per unit 10 kgs 6 kgs 15 kgs.
Labour Hours required 15 25 20
(Rate Rs. 1 per hour)
Selling price per unit Rs. 125 100 200
Maximum production
Possible Units 6,000 4,000 3,000
1,00,000 kgs of raw material is available at Rs. 10 per kg. Maximum production hours are
1,84,000 with a facility for a further 15,000 hours on overtime basis at twice the normal wage
rate.
Solution :
Considering the contribution per kg of raw material as well as per labour hour, the rankings
among the various products will be as below.
I - Product C
II - Product B
III - Product A
Hence, the available raw material and labour hours will be used for the manufacture of Product
C and Product B respectively.
Hence, the balance of raw material and labour hours available for manufacturing of Product A
will be as below.
Raw Material - Kgs. - 31,000 kgs. (i.e. 1,00,000 kgs - 69,000 kgs)
Labour Hours - 24,000 (i.e. 1,84,000 - 1,60,000)
Plus 15,000 extra hours by paying double the normal wage rate.
If extra labour hours are used for the manufacture of product A by paying double the normal
wage rate, the cost structure of product A will be as below :
As there cannot be the positive contribution generated, it will not be advisable to use the
labour hours which require the payment of wages at double the normal wage rate. As such,
product A will be manufactured by utilising the labour hours which require the payment of
wages at the normal wage rate only i.e. 24,000 hours with the help of which 1,600 units of A
(24,000 Hours/ 15 Hours per unit) can be manufactured. As such, the final product mix will be
as below.
Note : One alternate solution is possible to solve the problem of key factors. If the labour
hours which require the payment of wages at double the normal wage rate can be utilised for
the manufacture of Product C, its cost structure will be as below.
As such, apparently it may be possible to utilise the labour hours carrying double the normal
wage rate for manufacturing product C and utilise the released labour hours carrying the
normal wage rate for manufacturing Product A (i.e. 15,000 hours) In this case, the final product
mix will be as below.
Product A – 2,600 Units
Product B – 4,000 Units
Product C – 3,000 Units
The calculation of total contribution generated under both those alternatives is as below.
Alternative I
A 1,600 10 16,000
B 4,000 15 60,000
C 3,000 30 90,000
1,66,000
Alternative II
A 2,600 10 26,000
B 4,000 15 60,000
C 2,250 30 67,500
C 750 10 7,500
1,61,000
As in the second alternative, the total contribution generated is less than the one generated in
the first alternative, the second alternative can not be accepted. As such, it will be advisable
for the company not to utilise the labour hours requiring the payment of wages at double the
normal wage rate.
(1) The classification of total cost as variable cost and fixed cost is difficult. No cost can be
completely variable or completely fixed. In some cases, the cost which is considered to
be variable, may not be variable in practical terms E.g. Direct Labour Cost. Under normal
situations this cost is treated as variable cost. However, in India, considering the
tremendous legal backing the workers are having, the direct labour cost may not be
variable in nature. As such, it may be necessary to consider the direct labour cost as a
part of fixed cost.
(2) Under the marginal costing, the fixed costs are eliminated for the valuation of inventory of
finished goods and semi-finished goods, inspite of the fact that they might have been
actually incurred. As such, it is not correct to eliminate the fixed costs. Further, such an
elimination affects the profitability adversely.
(3) In the age of increased automation and technological development, the component of
fixed costs in the overall cost structure may be sizeable. Any technique like marginal
costing which ignores the fixed costs altogether, may not be proper under these
circumstances as a major portion of cost is not taken care of.
(4) Marginal costing technique does not provide any standard for the evaluation of performance.
In that sense, the techniques of budgetory control and standard costing may be considered
to be better techniques from cost control point of view.
(5) Fixation of selling price on marginal cost basis may be useful for short term only. Here
also, an undue importance given to only variable cost may result into taking on heavy
business with low margin which in turn may increase the fixed costs. As such, over the
long run, the prices should be decided on total cost basis only. Fixation of selling price
on the marginal cost basis in the long run may be dangerous. Moreover, consideration of
fixed costs may be necessary in price fixation under certain circumstances like cost
plus contracts unless a very high percentage over the marginal cost is considered to
take care of both fixed costs as well as profit margin.
(6) Marginal costing does not take into consideration the fixed overheads, as such the
problem of under or over absorption of fixed overheads can be avoided. But the problem
of under or over absorption of variable overheads cannot be avoided.
(7) Marginal costing can be used for assessment of profitability only in the short run. However,
in the long run, one has to consider the fixed costs also in order to assess the profitability.
Moreover, interpretation of the term ‘short run’ is a subjective concept. For how long the
decision can be taken on the basis of marginal costing principles cannot be decided in
the objective manner.
(1) Profit and sales for the year 1984 are as follows. Profit Rs. 18,000, Sales Rs. 2,40,000.
In 1985, the sales increased by Rs. 40,000 and the profit naturally increased by Rs.
8,000.
Solution :
We know that
Increase in Profits
P/V Ratio = X 100
Increase in Sales
If the company wants to achieve the profit of Rs. 1,00,000 the total contribution which will have
to be generated will be Expected Profit + Fixed cost
i.e. Rs. 1,00,000 + Rs. 30,000
i.e. Rs. 1,30,000
Contribution
We know that Sales =
P/V Ratio
We know that
Fixed Cost
Break Even Point =
P/V Ratio
30,000
∴ Sales at Break Even Point =
20%
= Rs. 1,50,000 …(c)
(2) The Directors of Sports Material Manufacturing Co. gives the following information.
(a) Find out P/V Ratio, Break Even Point and Margin of Safety.
(b) Evaluate the effects on P/V Ratio, Break Even Point and Margin of safety of the
following -
(i) 20% increase in physical sales volume.
(ii) 10% increase in fixed costs.
(iii) 5% decrease in variable costs.
(iv) 10% increase in selling price.
Solution :
Profit 10,000
= = Rs. 16,667
P/V Ratio 60%
(B) Effect of 20% increase in Physical Sales Volume. Revised Profitability structure will be
as below.
Contribution 72,000
X 100 = X 100 = 60%
Sales 1,20,000
Contribution 60,000
X 100 = X 100 = 60%
Sales 1,00,000
Profit = 5,000
= Rs. 8,333
P/V Ratio 60%
(D) Effect of 5% decrease in variable costs. Revised profitability structure will be as below.
Contribution 62,000
X 100 = X 100 = 62%
Sales 1,00,000
Profit 12,000
= = Rs. 19,355
P/V Ratio 62%
(E) Effect of 10% increase in selling price. Revised Profitability structure will be as below.
Contribution 70,000
X 100 = X 100 = 63.64%
Sales 1,10,000
Profit 20,000
= = Rs. 31,426
P/V Ratio 63.64%
Note : The difference between Sales and Break Even Point is not matching with Margin of
Safety, due to the rounding off differences.
(3) From the following figures find out the break even volume.
Solution :
Additional production of 53,000 units is envisaged, which can be classified in two parts for
convenience purposes.
Part I Part II
Selling Price per Unit Rs. 62.55 59.075
Variable Cost per Unit Rs. 35.50 35.500
Contribution per Unit Rs. 27.05 23.575
Number of Units 26,500 26,500
Total Contribution Rs. 7,16,825.00 6,24,737.50
As the fixed cost is already covered till the break even point, the contribution beyond the break
even point will directly result into profit. Hence, additional profit will be Rs. 7,16,825.00 +
Rs. 6,24,137.50 = Rs. 13,41,562.50.
(4) The Quality Product Ltd. manufacture and markets a single product Following data is
available.
Rs. Per Unit
Material 16
Conversion (Variable) 12
Dealer’s Margin 4
Selling Price 40
Fixed Cost - Rs. 5,00,000
Present Sales - 90,000 Units
Capacity Utilisation - 60%
Which of these two suggestions would you recommend if the company desires to maintain
present profits. Give reasons.
Solution :
The present profitability statement will be as below, when 90,000 units are being sold.
Alternative I – To reduce selling price by 5%. In this alternative the profitability structure will be
revised as below.
Selling Price per Unit Rs. 38
Variable Cost per Unit Rs. 32
Contribution per Unit Rs. 06
If the company wishes to maintain the same profits, the total contribution which the sales will
have to generate with the reduced amount of per unit contribution will be Expected Profits +
Fixed Cost. And total number of units to be sold will be -
To increase the dealer’s margin by 25%. In this alternative, the variable cost will be more by
Rs. 1 and the profitability structure will be revised as below.
Selling Price per Unit Rs. 40
Variable cost per Unit Rs. 33
Contribution per Unit Rs. 07
If the company wishes to maintain the same profits, the total contribution which the sales will
have to generate with the reduced amount of per unit contribution will be Expected Profits +
Fixed Cost. And total number of units to be sold will be -
= 2,20,000 + 5,00,000
7
= 1,02,857 Units
Acute competition in the market is the basic problem area. As such, the company will like to
accept the alternative where less number of units will be required to be sold, the profits
remaining the same under both the alternatives.
As Alternative II requires 1,02,857 Units to be sold vis-a-vis 1,20,000 units required to be sold
under Alternative I, the company will prefer Alternative II.
Note : It is assumed that both the alternatives are exclusive alternatives i.e. Even when selling
price is reduced by 5%, the dealer’s margin is unaffected and vice versa.
(5) Frazer Ltd. manufactures and sells a product, the selling price and raw material cost of
which have remained unchanged during the past two years. The following are the relevant
data:
Required :
What quantity in Kgs. the company should have produced and sold in year 2 in order to
maintain the same amount of net profit per Kg. as it earned during the year 1?
Solution :
Year 1 Year 2
Quantity Sold (Kgs.) 100 150
Sales (Rs.) 20,000 30,000
Variable Cost
Raw Material 10,000 15,000
Direct Wages 3,000 6,750
Variable Factory Overheads 2,000 3,000
Total Variable Cost 15,000 24,750
Contribution 5,000 5,250
Fixed Cost 3,000 2,700
Profit 2,000 2,550
Profit per Kg. (Rs.) 20 17
Per Unit Variable Cost in Year 2 works out to Rs. 165 i.e. Rs. 24,750 / 150 Kgs.
Hence, the company should have produced and sold 180 Kgs. in year 2 in order to maintain
the same amount of net profit per Kg. as it earned during Year 1.
Working Note -
Factory Overheads in Year 1 were Rs. 5,000 which became Rs. 5,700 in Year 2 with the
information that there was a saving of Rs. 300 in fixed factory overheads. Assuming that there
was no saving, the factory overheads would have been Rs. 6,000 in Year 2. Hence, the data
would have been as below -
For the increased quantity of 50 Kgs. the overheads would have increased by Rs. 1,000. It
means that the variable factory overheads are Rs. 20 per unit.
(6) Garden Products Limited manufacture the “Rainpour” garden pour. The accounts of the
company for the year 1981 are expected to reveal a profit of Rs. 14,00,000 from the
manufacture of “Rainpour” after charging fixed costs of Rs. 10,00,000. The “Rainpour” is
sold for Rs.50 per unit and has a variable unit cost of Rs. 20. Market sensitivity tests
suggest the following responses to price changes.
Evaluate these alternatives and state which, on profitability consideration, should be adopted
for the forthcoming year, assuming cost structure unchanged from 1981.
Solution :
At present, the expected profit is Rs. 14,00,000 after recovering the fixed cost of Rs. 10,00,000.
Hence, the total expected contribution is Rs. 24,00,000 i.e. Rs. 14,00,000 + Rs. 10,00,000.
If total contribution is Rs. 24,00,000 and per unit contribution is Rs. 30, it means that the
presently expected sales in terms of quantity are 80,000 units.
As profitability is the criteria on which the various alternatives are to be evaluated, Alternative
B will be selected, as it generates maximum contribution, fixed cost remaining the same
under all the alternatives.
(7) Shri Kiron manufactures Lighters. He sells his product at Rs. 20 each and makes profit
of Rs. 5 on each lighter. He worked 50% of his machinery capacity at 50,000 lighters.
The cost of each lighter is as under.
Rs.
Direct Material 6
Wages 2
Works Overheads 5 (50% fixed)
Sales Expenses 2 (25% variable)
His anticipation for the next year is that the cost will go up as under.
Fixed Charges 10%
Direct Labour 20%
Material 5%
There will not be any change in selling price. There is an additional order for 20,000 lighters in
the next year.
What is the lowest rate he can quote so that he can earn the same profit as the current year?
In the next year, material cost will increase by 5% i.e., by 30 paise and direct labour cost will
increase by 20% i.e., by 40 paise. As such, the total variable cost will increase by 70 paise.
Hence, the total variable cost will be Rs. 11.70 per unit. The revised profitability structure for
50,000 unit will be :
In the next year, fixed charges will increase by 10% i.e., total fixed charges of Rs. 2,00,000 in
this year will become Rs. 2,20,000.
As we know that Contribution - Fixed Charges = Profit, the profit generate by 50,000 units will
be –
Rs. 55,000
= Rs. 2.75 per Unit
20,000 units
Hence, the lowest rate which can be quoted will be : Expected variable cost per unit in the
next year + Expected profit per unit in the next year
(8) Following details are available in respect of a single product manufacturing company
operating at 75% capacity.
Units Sold 15,000
Selling Price Per Unit Rs. 12.5
Material Cost Rs. 3 per Unit
Labour hours required 2 per unit
Labour hour rate Re. 1 per hour
Variable expenses 200% of labour cost
Fixed cost Rs. 20,000
The company has received an offer to export 8,000 units. Due to the Government backing, the
material will be available at a price lower by 25% than the existing price. An additional expenditure
of Rs. 10,000 will have to be incurred for execution of this export order. But an export incentive
is available from the Government which will be equivalent to 25% of the export price. What
minimum price should be charged if it is intended that per unit exported should earn a clear
margin of Rs. 2 and the profits from inland sales remaining the same. Ignore the benefits
available as per the provisions of Income Tax Act, 1961 and the time required to receive the
export incentive in cash since the date of actual export. Assume that Selling price in inland
market cannot be increased.
When sales are 15,000 Units, capacity utilisation is 75%. It means that maximum 20,000
units can be sold both in inland or export market. The export order received is for 8,000 units.
Now, the company has two alternatives.
Alternative I : Accept the export order only for 5,000 units which can be manufactured.
Alternative II : Accept the export order for 8,000 units by reducing the inland sales by
3,000 units.
The amounts which export price will have to cover are as below:
The above amount can be covered either by way of export price of the export incentive which
is 25% of export price. If we assume export price to be Rs. x, the following relationship is
established.
x
i.e. x + = 12.25
4
i.e. 5x
= 12.25
4
i.e. x = 9.80
Alternative II :
8,000 units to be exported, inland sales being only 12,000 units.If 8,000 units are to be
exported, inland sales will be less by 3,000 units, which will result in the loss of contribution
of Rs. 10,500 (i.e. 13000 units x Rs. 3.50 per unit) This loss of contribution also will have to be
covered by the units to be exported, as the selling price in the inland market can not be
increased. As such per unit amount to be covered by export price is as below:
Rs. 10,500
= Rs. 1.3125
8,000 units
= Rs. 13.5625
This amount can be covered either by way of export price or by export incentive, which is 25%
of export price. Assuming export price to be Rs. x,
x + 25% of x = 13.5625
∴ x+ x = 13.5625
4
∴ 5x = 13.5625
4
∴ x = 10.85
Factory overheads are absorbed on the basis of machine hour rate which is the limiting factor.
The machine hour rate is Rs. 10 per hour.
The company receives an offer from Japan for the purchase of Product X at a price of Rs. 87.50
per unit. Alternatively, the company has another offer from Bangkok for the purchase of Product
Y at a price of Rs. 77.50 per unit. In both the cases, a special packing charge of Rs. 2.50 per
unit has to be borne by the company. The company can accept either of the two export orders
by utilising the balance of 25% of its capacity.
Advise the company with the detailed workings as to which proposal should be accepted and
prepare a statement showing the overall profitability of the company after incorporating the
export proposal suggested by you.
Solution :
The existing profitability structure as per marginal costing works out as below -
Product X Product Y
Selling Price 115 95
Variable Cost -
Direct Materials 10 20
Direct Labour 20 20
Factory Overheads 15 9
Administration & Selling Overheads 16 10
61 59
Contribution 54 36
Hence, profit i.e. Contribution - Fixed Cost Rs. 90,000. As Factory Overheads as absorbed on
the basis of machine hour rate and as machine hour rate is Rs. 10, Product X takes 2.5 hours
and Product Y takes 1.5 hours. Hence, the total number of hours consumed by the existing
level of activity can be calculated as below:
As 10,500 hours are equivalent to 75% level of activity, balance number of hours available for
the execution of the export order are 3,500 which is equivalent to balance 25% level of activity.
With the balance number of hours available, the maximum number of units which can be
manufactured for export order work out as below:
The contribution generated by the units to be exported can be worked out as below :
Product X Product Y
Selling Price 85 75
(Net of packing charge)
Variable Cost 61 59
Contribution 24 16
Total contribution generated by executing the export order can be worked out as below:
(10) A Ltd. manufactures three different products and the following information has been
collected from the books of account.
Product
S T Y
Sales Mix 35% 35% 30%
Selling Price Rs. 30 Rs. 40 Rs. 20
Variable Cost Rs. 15 Rs. 20 Rs. 12
Total Fixed costs Rs. 1,80,000
Total Sales Rs. 6,00,000
The company has currently under discussion a proposal to discontinue the manufacture of
product Y and replace it with product M, when the following results are anticipated:
Product
S T M
Sales Mix 50% 25% 25%
Selling Price Rs. 30 Rs. 40 Rs. 30
Variable Cost Rs. 15 Rs. 20 Rs. 15
Total Fixed Cost Rs. 1,80,000
Total Sales Rs. 6,40,000
Will you advice the company to changeover to production of M? Give reasons for your answer.
Solution :
PRESENT PROFITABILITY STRUCTURE :
Product
S T Y
Rs. Rs. Rs.
(1) Sales 2,10,000 2,10,000 1,80,000
(2) Selling Price per Unit 30 40 20
(3) Variable Cost per Unit 15 20 12
(4) Contribution per Unit 15 20 8
(5) Units Sold (1/2) 7,000 5,250 9,000
(6) Total Contribution (4X5) 1,05,000 1,05,000 72,000
= Rs. 2,82,000
As the total contribution in the proposed alternative i.e. to change over to production of M is
likely to be more than in the present situation, the company should change over to production
of M.
Fixed overheads for the period were Rs. 1,00,000. The Directors are worried about the results
of the company. They have requested you to prepare a statement showing the amount of loss
expected and recommend a change in the sales of each product or in total mix which will
eliminate the expected loss.
Solution :
We know that -
(1) Sales x P/V Ratio = Contribution
(2) Contribution - Fixed Cost = Profit
Product Sales Value (Rs.) P/V Ratio Contribution
A 50,000 50% 25,000
B 80,000 40% 32,000
C 1,20,000 30% 36,000
2,50,000 93,000
Less Fixed Cost 1,00,000
Profit (-) 7,000
To eliminate the expected loss, the sales of individual products may be increased, depending
upon the P/V Ratio. The additional sales required to be achieved will be calculated as -
Loss to be eliminated
P/V Ratio
As an alternative, the overall sales may also be increased to eliminate the expected loss as
stated below:
Contribution 93,000
X 100 = X 100 = 37.2%
Sales 2,50,000
To cover the expected loss, the additional sales which will be required to be made will be -
These additional sales may be increased in the existing proportion only i.e. 50,000 : 80,000 :
1,20,000. Hence, the productwise additional sales and the contribution generated by these
additional sales will be as below :
Solution :
The variable cost ratio among products X, Y and Z is I : 1.5: 1.75 respectively per unit. If all the
products are expressed in terms of Product X, it can be as below :
Rs. 2,09,000
Product X - = Rs. 4.40
47,500
Product X - Rs. 4.40 X 1.5 = Rs. 6.60
Product Z - Rs. 4.40 X 1.75 = Rs. 7.70
MIX 1 Rs.
X 18,000 x 2 36,000
Y 12,000 x 1 12,000
Z 7,000 x 3 21,000
69,000
Mix 2
X 15,000 x 2 30,000
Y 6,000 x 1 6,000
Z 13,000 x 3 39,000
75,000
Mix 3
X 22,000 x 2 44,000
Y 8,000 x 1 8,000
Z 8,000 x 3 24,000
76,000
As Mix 3 generates maximum contribution, it will be recommended. Fixed cost will be ignored,
as it will be same under all the circumstances.
(13) A firm can produce three different products from the same raw material using the same
production facilities. The requisite labour is available in plenty at Rs.8 per hour for all the
products. The supply of raw material which is imported at Rs.8 per Kg. is limited to
10,400 Kgs. for the budget period. The variable overheads are RS.5.60 per hour. The
fixed overheads are Rs. 50,000. The selling commission is 10% on sales.
a. From the following information, you are required to suggest the most suitable sales
mix which will maximise the firms's profits. Also determine the profit that will be
earned at that level :
b. Assume, in the above situation, if additional 4,500 Kgs of raw material is made
available for production, should the firm go in for further production, if it will result in
Solution :
As availability of raw material is the key factor, the order of preference among the products will
be Y, X and Z.
With 2,400 Kgs. of material, maximum possible production for Z will be 1,600 units i.e.
2,400 / 1.5
Total Contribution generated by these 3,000 units will be Rs. 22,500 i.e. 3,000 units x Rs. 7.50
per unit. As the fixed overheads are also likely to increase by Rs. 20,000, the additional 3,000
units will generate positive contribution of Rs. 2,500. Hence, it is advisible to go for further
production with the additional raw material available.
(14) The following particulars are obtained from the records of a factory manufacturing Products
A and B.
Product A Product B
(Per unit) (Per Unit)
Selling Price 100 200
Material Cost at Rs. 10 per Kg. 20 50
Wages @ Rs. 3 per hour 30 60
Variable overheads 10 20
State which of the product is better to be produced and why in the following cases:
(e) If raw material available is 2,000 kgs. and maximum sales of each product is 500 units,
advice about the sales mix.
Product A Product B
Per Unit Per Unit
Rs. Rs.
(1) Selling Price 100 200
(2) Variable cost :
Material 20 50
Wages 30 60
Variable Overheads 10 20
60 130
(3) Contribution (1 - 2) 40 70
(4) P/V ratio (3/1) 40% 35%
(5) Material consumption 2 Kgs. 5 Kgs.
∴ Contribution per kg. of material 20 14
(3/5)
(6) Labour Hours 10 20
∴ Contribution per labour hour 4 3.5
(3/6)
(a) If total sales in units is the key factor, Product B will be better as its per unit
contribution is more.
(b) If total sales in value is the key factor, Product A will be better as its P/V Ratio is
more.
(c) If raw material is in short supply, Product A will be better as its contribution per Kg.
of material is more.
(d) If labour hours is the limiting factor, Product A will be better as its contribution per
labour hour is more.
(e) If total available raw material is 2,000 Kgs., it will first utilised to manufacture Product
A as its contribution per Kg. of material is more. However the maximum sales
potential of Product A is restricted to 500 units which consumes 1,000 Kgs. of
material (i.e. 500 units x 2 Kgs. per unit). Remaining material of 1,000 Kgs. can be
used for the manufacture of Product B, with the help of which only 200 units of
Product B can be manufactured i.e.,
1,000 Kgs
= 200 Units
5 Kgs. per Unit
(15) Small-Tools Factory has a plant capacity adequate to provide 19,800 hours of machine
use. The plant can produce all A type tools or all B type tools or a mixture of the two
types. The following information is relevant.
Per Type A B
Selling Price Rs. 10 15
Variable Cost Rs. 8 12
Hours required to produce 3 4
Market conditions are such that no more than 4,000 A type tools and 3,000 B type tools
can be sold in a year. Annual fixed costs are Rs. 9,900.
Compute the product mix that will maximize the net income to the company and find
that maximum net income.
Solution :
It is a situation of multiplicity of key factors, first key factor being availability of machine hours
and second one being market conditions. The contribution per machine hour can be computed
as below :
A B
Selling Price Per unit Rs. 10 15
Variable cost per mat Rs. 8 12
∴ Contribution per unit Rs. 2 3
Machine hours required per unit 3 4
∴ Contribution per machine your Rs. 0.66 0.75
Ranking when machine hours availability is key factor II I
As such, tool B will be produced to the maximum possible extent i.e. 3,000 units and the
balance machine hours should be utilised for the production of tool A.
(16) An umbrella manufacturer makes an average net profit of Rs. 2.50 per piece on a selling
price of Rs. 14.30 by producing and selling 6,000 pieces or 60% of the potential capacity.
His cost of sales is as follows:
Per Unit
Direct material Rs. 3.50
Direct wages Rs. 1.25
Works overheads Rs. 6.25 (50% fixed)
Sales overheads Rs. 0. 80 (25% varying)
During the current year, he intends to produce the same number but anticipates that his fixed
expenses will go up by 10% while rate of direct labour and direct material will increase by 8%
and 6% respectively. But he has no option of increasing the selling price. Under this situation
he obtains an offer for a further 20% of capacity. What minimum price will you recommend for
acceptance to ensure the manufacturer an overall profit of Rs. 16,730?
Solution :
Profitability structure
From the above, it can be seen that the present sales of 6,000 units will generate a total profit
(after recovering the fixed cost) of Rs. 10,905. If it is intended that the overall profit should be
Rs. 16,730, there will be a shortfall of Rs. 5,825 which will have to be covered by the additional
2.000 units to be sold. As such, every additional unit to be sold will have to generate a clear
margin of Rs. 2.9125 i.e., Rs. 5,825/2,000 units.
Hence the minimum price to be recommended will be Revised per unit variable cost + Expected
per unit margin i.e., Rs. 8.385 + Rs. 2.9125
(17) The cost profile of a company, manufacturing only one product, is as under :
Rs.
Direct Material 5.60
Direct Labour 1.50
Variable factory overheads 0.40
7.50
Fixed factory overhead is budgeted at Rs. 3,30,000 for an annual sales of 4,00,000 units.Selling,
Distribution and Administration costs are budgeted at Rs. 1,80,000.
Capital employed is Rs. 4,50,000 in fixed assets and 50% of sales in current assets.
Determine a selling price for the product to yield 20% return on capital employed.
Solution :
Let us assume that the selling price per unit is Rs. X. Hence, total sales will be
Rs. 4,00,000 X.
Rs.
Variable Cost - 4,00,000 x 750 30,00,000
Fixed Factory overheads 3,30,000
Selling Distribution and Administration cost 1,80,000
Profit 90,000 + 40,000 x
36,00,000 + 40,000 x
Note :
Hence the selling price for the product should be Rs. 10 per unit.
(18) V Ltd. produces two products ‘P’ and ‘Q’. The draft budget for the next month is as
under.
P Q
Budgeted Production and sales (Units) 40,000 80,000
Selling Price Rs / Unit 25 50
Total Costs Rs / Unit 20 40
Machine Hours / Unit 2 1
Maximum Sales Potential (Units) 60,000 100,000
The fixed expenses are estimated at Rs. 9,60,000 per month. The company absorbs fixed
overheads on the basis of machine hours which are fully utilised by the budgeted production
and cannot be further increased.
The Marketing Director suggested that he could introduce Product ‘C’, each unit of which will
take 1.5 machine hours.
However, a processing vat involving a capital outlay of Rs. 2,00,000 is to be installed for the
processing of product ‘C’. The additional fixed overheads relating to the processing vat was
estimated to be Rs. 60,000 per month. The variable cost of Product ‘C’ was estimated of Rs.
21 per unit.
Required -
(i) Calculate the profit as per draft budget for the next month.
(ii) Revise the product mix based on data given for ‘P’ and ‘Q’ to yield optimum profit.
(iii) The company decides to discontinue either product P or Q whichever is giving lower
profit and proposes to substitute product ‘C’ instead. Fix the selling price of Product ‘C’
in such a way so as to yield 15% return on additional capital employed besides maintaining
the same overall profits as envisaged in (ii) above.
Solution :
Fixed Expenses are Rs. 9,60,000 per month and are absorbed on the basis of utilisation of
machine hours.
Rs. 9,60,000
Hence, Machine Hour Rate = = Rs. 6/Hr.
1,60,000 Hrs.
As such, the fixed overheads absorbed by the product (which must have been included in the
total cost.) are as below :
Product P Product Q
Rs. Rs. Rs. Rs.
Selling Price / Unit 25 50
Less : Variable cost 8 34
Fixed Cost 12 6
Total Cost 20 40
Profit 5 10
(1) Profit as per draft budget for the next month are
The machine hours are available in limited quantity and hence are the key factor of
production.
Prod. P Prod Q.
Selling Price - Rs./ Unit 25 50
Variable Cost - Rs./ Unit 8 34
Contribution Rs./ Unit 17 16
Machine Hours/ Unit 2 1
Contribution Rs./ Machine Hour 8.5 16
As the contribution per unit of key factor i.e. Machine Hour is more in case of Product Q, the
available machine hours will be utilised for the manufacture of Product Q subject to its maximum
sales potential.
Rs. 14,40,000
= Rs. 36/ Unit
40,000 units
(1) As availability of machine hours is the key factor and the contribution per machine hour
is less in case of Product P, it will be discontinued. Production of Product Q will be
continued subject to its maximum sales potential. As such, 1,00,000 units of product Q
will be produced and sold, thus leaving 60,000 machine hours for the production and
sales of product C. As one unit of product C consumes 1.5 Machine Hours, maximum
40,000 units of product C can be produced and sold i.e.,
(2) It is assumed that Product Q will continue to absorb the fixed expenses at the current
rate of absorption. Hence, the profit generated by product Q will be as below:
(a) Sales - 1,00,000 Units x Rs.50/ Unit Rs. 50,00,000
(b) Variable Cost - 1,00,000 Units x Rs. 34/ Unit Rs. 34,00,000
(c) Contribution - a-b Rs. 16,00,000
(d) Fixed Expenses absorbed -
1,00,000 units x Rs. 6/ Machine Hr. Rs. 6,00,000
(e) Profit c-d Rs. 10,00,000
(3) As the fixed overhead relating to the processing vat will be incurred specifically due to
Product C, it will be as if the variable cost of Product C.
1. What do you understand by the terms Break Even Point, Contribution and Margin of
Safety? Explain your answer by drawing a chart with assumed figures.
5. Explain any four circumstances in which the technique of marginal costing will help the
management in taking decisions. What are the limitations of this technique?
6. “The rate of earning profit mainly depends upon the magnitude of the angle of incidence
projected on break even chart.”- Explain as to whether this statement is correct. What
measures can be adopted to increase the magnitude of angle of incidence.
7. Write a critical note about uses, applications, advantages and limitations of Marginal
Costing technique.
8. “The work of separating the overheads into fixed and variable costs is purely academic,
but practically very difficult and as such the technique of Marginal Costing is of very little
use in managerial decisions.” How will yon make out a case for introducing the technique
of Marginal Costing when encountered with the above argument?
9. Discuss the most important areas of managerial decisions opened up by the application
of marginal costing technique.
(1) Following information is made available to you about a company for two periods.
Find out
(a) Profit Volume Ratio
(b) Break Even Point for sales
(c) Profit when sales are Rs. 1,00,000
(d) Sales required to earn a profit of Rs. 20,000
(e) Safety Margin in period II
(2) The sales turnover and profits during two periods are as under.
Assuming stability in price with variable costs carefully controlled to reflect predetermined
relationship and an unvarying figure for fixed costs, calculate :
(a) The profit volume ratio to reflect the rates of growth for profits and sales.
(b) Fixed Costs.
(c) Fixed Cost as % to Sales.
(d) Break even point
(e) Margin of safety for the year 1987 and year 1988.
The demand for the product is 2,00,000 units. State how much should be produced at
each factory.
(5) Calculate the Break Even Point in units and in rupees and also arrive at Margin of Safety
ratio from the following information.
(7) (a) A company budgets a production of 5,00,000 units at a variable cost of Rs. 20
each. The fixed costs are Rs. 20,00,000. The selling price is fixed to yield 25%
profit on cost.
Calculate -
(i) Break Even Point (ii) P/V Ratio
(b) If the selling price is reduced by 20% find -
(i) The effect of the price reduction on the break even point and the P/V Ratio
(ii) The number of units required to be sold at the reduced selling price to obtain
an increase of 20% on the budgeted profit.
(2) Calculate all the above figures, if the company has a fixed overhead of Rs. 1,000 in
addition to the expenses considered above.
(9) The following data are obtained from the records of a company.
First Year Second Year
Rs. Rs.
Sales 80,000 90,000
Profit 10,000 14,000
Calculate :
(a) P/V Ratio
(b) Break Even Point
(c) Profit or loss when sales amount to Rs. 50,000
(d) Sales required to earn a profit of Rs. 19,000
(e) Sales position if company sustained a loss of Rs. 19,000
(10) The following figures relating to the performance of a company for Year I and Year II are
available. Assuming that the ratio of variable costs to sales and the fixed costs are the
same for both the years, ascertain -
a. Profit Volume Ratio
b. Amount of the fixed costs
c. Break Even Point
d. Budgeted profit for Year III if the budgeted sales are Rs. 1 Crore.
Total Sales Total Costs
Year I Rs. 70 Lakhs Rs. 58 Lakhs
Year II Rs. 90 Lakhs Rs. 66 Lakhs
Rs.
Fixed Expenses 50,000
Sales Value 2,00,000
Profit 50,000
During the second half of the year, the company has projected a loss of Rs. 10,000.
Calculate -
(1) The P/V Ratio, Break Even Point and Margin of safety for six months-ending 30th
June 1980.
(2) Expected sales volume for the second half of the year assuming that selling price
and fixed expenses remain unchanged in the second half year also.
(3) The break even point and margin of safety for the whole year 1980.
(12) PQ Limited has been offered a choice to buy a machine between A and B. You are
required to compute :
(b) The level of sales at which both machines earn equal profits.
(c) The range of sales at which one is more profitable than the others.
Machines
A B
Annual output in units 10,000 10,000
Fixed Cost (Rs.) 30,000 16,000
Profit at above level of production (Rs.) 30,000 24,000
The market price of the product, is expected to be Rs.10 pet Unit
(14) A Ltd. manufactures & sells four types of products under the brand names -P, Q, R and
S. Sales mix in value comprises. 33.33%, 41.66%,16.66% and 8.33% of P, Q, R and S
respectively. The total budgeted sales (100%) are Rs. 60,000 per month.
(16) A company produces and sells 100 units of A at Rs. 20. Marginal cost per unit is Rs. 12
and the fixed costs are Rs. 300 per month. It is proposed to reduce the price by 20%.
Find out the additional sales required to earn the same amount of profits as before.
(17) A ball pen manufacturer has developed a new ball pen with unique features. His
development executive has suggested three possible retail price viz. Rs.15 for super
star, Rs.10 for deluxe and Rs. 7.50 for economy model. His marketing manager opines
that the whole sellers and retailers have to be given at least 30% discount.
The estimated fixed cost would be around Rs.70,000 and the variable cost per unit would
be Rs. 3.50
(b) How much should the manufacturer sell in order to make a profit of Rs. 21,000?
Work out for each model of ball pen.
You are required to determine sales at break even both in terms of quantity and value for
the budget year 1986-87 at the above selling price.
(19) The Laila Shoe Company sells five different styles of ladies chappals with identical purchase
cost and selling price. The company is trying to find out the profitability of opening
another store which will have the following expenses and revenues.
Required :
a. Calculate the annual break even point in units and in value. Also determine the
profit or loss if 35,000 pairs of chappals are sold.
b. The sales commissions are proposed to be discontinued, but instead a fixed amount
of Rs. 90,000 is to be incurred in fixed salaries. A reduction in selling price of 5% is
also proposed. What will be the break even point in units ?
c. It is proposed to pay the stores manager 50 paise per pair as further commission.
The selling price is also proposed to be increased by 5%. What would be the break
even point in units?
(20) Speedy Airline can carry a maximum of 10,000 passengers per month on one of its
routes at a fare of Rs. 85. Variable costs are Rs. 10 per passenger and fixed costs are
Rs. 3,00,000 p.m. calculate
(1) Break Even quantity
(2) Break Even sales
(3) Break Even Percentage of capacity.
(4) Suppose that the management sets a profit target of Rs. 2,00,000
What would be the required profit before taxes to achieve this profit target, if the corporate
tax rate of the company is 46%.
(21) Three firms X, Y and Z manufacture the same product. The selling price is Rs.8 per unit
of the product equal for all the firms. The fixed costs for the firms X, Y and Z respectively
are Rs. 80,000 Rs. 2,00,000 and Rs. 3,30,000 while the variable costs per unit are Rs. 6,
Rs. 4 and Rs. 3
(a) Determine the break even point for all the firms in units.
(b) How much profits are earned by the firms if each of them sells 80,000 units?
(c) What will be the impact percentagewise .on profits if sales increase by 20%.
(22) Merry Manufacturers Ltd. has supplied you the following information in respect of one of
its products.
Rs.
Total Fixed costs 18,000
Total Variable Costs 30,000
Total Sales 60,000
Units Sold 20,000
Find out (a) Contribution per unit (b) Break Even Point (c) Margin of Safety (d) Profit (e)
Volume of sales to earn a profit of Rs. 24,000.
Rs.
Total fixed costs 4,500
Total variable costs 7,500
Total sales 15,000
Units sold 5,000 (Units)
Also calculate the volume of sales to earn a profit of Rs. 6,000
(24) Bindra Ltd. is running its plant at present at 50% of capacity. The management has
supplied you the following details.
An exporter offers to purchase 10,000 units per month @ Rs. 13 per unit and the company
is hesitating in accepting the offer due to the fear that it will increase its already large
operating losses.
(25) Mega Corporation manufactures and sells three products to the automobile industry. All
the products must pass through a machining process, the capacity of which is limited to
20,000 hours per annum, both by equipment design and government regulation.
Required - A statement showing the best possible production mix which would provide
the maximum profits for Mega Corporation, together with supporting workings.
(26) (a) A company’s turnover in a year was Rs. 50,00,000, its profit was Rs. 500,000 and
its P/V Ratio was 40% What is the break even point?
August 84 September 84
Output (Units) 50,000 55,000
Total Cost (Rs.) 6,70,000 7,10,000
What is the amount of fixed expenses per month?
(27) (a) Calculate the Break Even Point from the following data.
(i) Sales Price per unit Rs. 10
(ii) Variable cost per unit Rs. 6
(iii) Fixed overheads Rs.20,000
(b) Calculate the revised Break Even Point if -
(i) Sales price is increased to R.11 per unit
(ii) Sales price is reduced to Rs.9 per unit
(iii) Variable cost increased to Rs.7 per unit
(iv) Variable cost reduced to Rs.5 per unit
(v) Fixed overheads rise to Rs.25,000
(vi) Fixed overheads fall to Rs.15,000
(28) The Modern Machine Co. Ltd. places before yon the following figures
(29) The selling price of a product is Rs.40 which yields a margin of 20%. The total fixed
expenditure are Rs. 10,000 a month. What should be the level of sales to yield an annual
profit of Rs.20,000?
(31) You are the company Accountant of Machine Manufacturing Ltd. which was incorporated
in February 1979. The company has started production from 1st January 1980.
It was proposed that the company will produce and sell 8,000 units in the first year of its
operations. Estimated costs of production are given below.
(32) The Asian Industries specialise in the manufacture of small capacity of Motors. The cost
structure of a motor is as under.
Material Rs. 50
Labour Rs. 80
Variable Overheads 75% of labour cost.
Fixed overheads of the company amount to Rs. 2.40 lakhs per annum.
The sale price of the motor is Rs. 230 each.
(a) Determine the number of motors that have to be manufactured and sold in a year to
break even.
(b) How many motors have to be made and sold to make a profit of Rs.1 lakh per year?
(c) If the sale price is reduced by Rs. 15, how many motors will have to be sold to
break even?
(33) Repographics Ltd. manufactures a document reproducing machine which has the variable
cost structure as follows :
Material Rs. 40
Labour Rs. 10
Overheads Rs. 4
Selling price per unit is Rs. 90
Under a wage agreement, an increase of 10% is payable to all direct workers from the
beginning of the forthcoming year, whilst material costs are expected to increase by
7.5%, variable overheads by 5% and fixed overhead costs by 3%.
(34) Cookwell Ltd.manufactures pressure cookers the selling price of which is Rs. 300 per
unit. Currently the capacity utilisation is 60% with a sales turnover of Rs. 18 lakhs. The
company proposes to reduce the selling price by 20% but desires to maintain the same
profit position by increasing the output. Assuming that the increased output could be
made and sold, determine the level at which the company should operate, to achieve the
desired objective.
The following further data are available.
(a) Variable cost per unit Rs.60
(b) Semi variable cost (including a variable element of R1. 10 per unit) Rs. 1,80,000
(c) Fixed cost Rs. 3,00,000 will remain constant Upto 80% level. Beyond this, an
additional of Rs. 60,000 will be incurred.
(35) The MYZ Co. has the following budget for the year 1986-87.
Rs.
Sales (1,00,000 Units a Rs.20) 20,00,000
Variable Cost 10.00,000
Contribution 10,00,000
Fixed cost 4,00,000
Net Profit 6,00,000
(a) The adjusted profits for 1986-87 if the following two sets of changes are introduced
and also suggest which plan should be implemented.
(36) A review made by the top management of Sweat and Struggle Ltd. which makes only
one product, of the result of the first quarter of the year revealed the following details :
The Finance Manager who feels perturbed suggests that the company should at least
break even in the second quarter with a drive for increased sales. Towards this, the
company should introduce a better packing which will increase the cost by Re. 0.50 per
unit.
The sales manager has an alternative proposal. For the second quarter, additional sales
promotion expenses can be increased to the extent of Rs. 5,000 and a profit of Rs. 5,000
can be aimed with increased sales.
The production manager feels otherwise. To improve the demand, the selling price per
unit has to be reduced by 3%. As a result, the sales volume can be increased to attain
a profit level of Rs. 4,000 for the quarter.
The Managing Director asks you as a Cost Accountant to evaluate these three proposals
and calculate the additional sales volume that would be required in each case, in order to
help him take a decision.
(37) Following is the summarised Trading account of a manufacturing concern which makes
two products X and Y.
X Y Total
Rs. Rs. Rs.
Sales 10,000 4,000 14,000
Less : Cost of Sales
(a) Direct costs
Labour 3,000 1,000
Material 1,500 1,000
4,500 2,000 6,500
5,500 2,000 7,500
Indirect costs
(a) Variable Expenses 2,000 1,000 3,000
3,500 1,000 4,500
(b) Fixed Expenses
Common to both
X and Y 1,250 1,250 2,500
Net Profit 2,250 (-)250 2,000
(b) These costs tend to remain constant irrespective of physical outputs of X and Y.
It has been the practice of the concern to allocate these costs equally between
X and Y.
The following proposals have been made by the Board of Directors for your consideration
as financial advisor.
(2) As an alternative to (1), reduce the price of Y by 20%. (It is estimated that the
demand then will increase by 40%.)
(3) Double the price of X (It is estimated that the demand then will reduce by three
fifths.)
You are required to recommend the proposal to be taken after evaluating each of
these three proposals.
Analyse the proposed change and suggest what decision the company should take.
Also state the break even point for the company as a whole in the two situations.
(39) A manufacturer has planned his level of production at 50% of his plant capacity of 30,000
units. At 50% of the capacity, his expenses are as follows.
(a) Direct Labour Rs.11,160
(b) Direct Material Rs. 8,280
(c) Variable and other manufacturing expenses Rs. 3,960
(d) Total fixed expenses regardless production Rs. 6,000
The home selling price is Rs.2.00 per unit. Now, the manufacturer receives a trade
enquiry from overseas for 6,000 units at a price of Rs. 1.45 per unit If you were the
manufacturer, would yon accept or reject the offer? Support your statement with suitable
cost and profit details.
(40) A manufacturer sells his product at Rs.5 each variable costs are Rs.2 per unit and the
fixed costs amount to Rs.60,000.
(a) Calculate the break even point
(b) What would be the profit if he sells 30,000 units?
(c) What would be the BEP if he spends Rs.3,000 on advertisement?
(d) How much should the manufacturer sell to make a profit of Rs.30,000 assuming he
spends Rs.3,000 on advertisement?
(42) The variable cost structure of a product manufactured by a company during the current
year is as under -
Rs. Per Unit
Material 120
Labour 30
0verheads 12
The selling price per unit is Rs. 270 and the fixed cost and sales during the current year
are Rs. 14 Lakhs and Rs. 40.50 Lakhs respectively.
During the forthcoming year, the direct workers will be entitled to a wage increase of 10%
from the beginning of the year and the materials cost, variable overhead and fixed overhead
are expected to increase by 7.5%, 5% and 3% respectively.
a. New selling price in the forthcoming year if the current P/V ratio is to be maintained.
b. Number of units that would be required to be sold during the forthcoming year so as
to yield the same amount of profit in the current year, assuming that the selling
price per unit will not be increased.
Rs.
Sales 32,00,000
Direct Materials 10,00,000
Direct Labour 4,00,000
Variable Overheads 2,00,000
Fixed Overheads 13,00,000
An export order has been received that would utilise half the capacity of the factory. The
order cannot be split i.e. it has either to be taken in full and executed at 10% below the
normal domestic prices or rejected totally.
(44) A company produces a single product which is sold by it presently in the domestic
market at Rs. 75 per unit. The present production and sales is 40,000 units per month
representing 50% of the capacity available. The cost data of the product was as under -
a. to accept an export supply order for 30,000 units per month at a reduced price of
Rs. 60 per month, incurring additional variable costs of Rs. 5 per unit towards the
export packing, duties etc.
b. to increase the domestic market sales by selling to a domestic chain stores 30,000
units at Rs. 55 per unit retaining the existing sales at existing price
Reduce selling price per unit by Rs. Increase in sales expected (units)
5 10,000
8 30,000
11 35,000
Prepare a table to present the results of the above proposals and give your comments
and advice on the proposals.
(45) A company producing a single product sells it at Rs. 50 per unit. Unit variable cost is
Rs. 35 and fixed cost amounts to Rs. 12 Lakhs per annum. With this data, you are
required to calculate the following, treating each independent of the other -
a. P/V Ratio and the Break Even Point
b. “New Break Even Sales if variable cort increase by Rs. 3 per unit, without increase
in the selling price.
c. Increase in sales required if profits are to be increased by Rs. 2.40 lakhs
d. Percentage increase/decrease in sales volume to offset
l An increase of Rs. 3 in the variable cost per unit
l A 10% increase in selling price without affecting existing profits quantum
e. Quantum of advertisement expenditure permissible to increase sales by Rs. 1.20
Lakhs without affecting profits quantum.
(46) A manufacturer of fountain pens selling in the market at Rs.100 per dozen makes an
average net profit of 20% on sales by producing 50,000 dozen per annum against a
capacity of 75,000 dozens. His cost sheet for 1984 was as under.
In 1985, he anticipates his fixed costs to increase by 6%, cost of direct materials by 5%,
and labour (with whom an agreement has been concluded) by 10%. Market enquiries
revealed that the selling price of the product and quantity will remain unchanged in 1985.
(47) The following figures relate to the current year’s position in an engineering industry operating
at 70% capacity level.
Break Even Point - Rs.80 Crores
P/V Ratio - 40%
Margin of Safety - Rs 20 crores
The board at its last meeting have taken a decision to increase the output to 98%
capacity level with the following modifications.
(i) Reduction in selling price by 5%
(ii) Increase in fixed cost by Rs.8 crores (Including depreciation on additions but
excluding interest burden.).
(iii) Reduction in variable cost by 5% of sales.
(iv) Additional finance for capital expenditure and working capital Rs.20 crores.
(a) You are required to determine the revised sales figure necessary to yield the
existing quantum of profits plus additional profit of Rs.4 crores on account of
increased activity and 20% Interest burden on fresh capital inputs.
(b) Also determine the revised -
(i) Break Even point
(ii) P/V Ratio
(iii) Margin of safety.
(48) The following data are obtained from the records of a factory-
Rs. Rs.
Sales 4,000 Units @ Rs.25 each 1,00,000
Materials consumed 40,000
Variable Overheads 10,000
Labour overheads 20,000
Fixed overheads 18,000
88,000
Net Profit 12,000
(1) The number of units by selling which the company will neither loose or gain anything.
(2) P/V Ratio and Margin of Safety at present level.
(3) The extra units which should be sold to obtain the present profit if it is proposed to
reduce the selling price by (a) 20% and (b) 25%.
(4) The selling to be fixed price to bring down its break even point to 500 units under
present condition.
(5) The sales required to earn profit of Rs.60,000 at the present selling price of Rs.25
per unit,
(49) You are given the following data pertaining to a factory.
For the above working purposes, variable cost of sales has been taken at Rs.7 per unit
upto 15000 units and it shall be Rs.8 per unit beyond 15,000 units.
(b) The production manager has agreed that he will try to Work on a cost reduction
programme which will reduce the cost by Re.1 per unit but there will be little impact
on the quality which will be negligible to the customer.
The sales manager opposed the two proposals and suggests that it may be possible to
increase the number of units sold by 20% provided the selling price is reduced by 5%.
Alternatively, if the selling price is increased by 10%, the sales number of units will be
reduced by 5%.
As the Accountant of the company, discuss in detail the various pros and cons of the
proposals and also put forward any other proposal to improve the situation.
(51) Zed Ltd. reported the following figures for 1983 and 1984.
1983 1984
Sales Rs. 50,00,000 Rs. 60,00,000
Total Cost Rs. 45,00,000 Rs. 52,00,000
The company anticipated that in 1985.
(i) Variable cost rates, on the average, would record an increase of 10% over the 1984
levels.
(ii) Sales would record an increase of 20% over the 1984 level in volume.
(iii) Selling prices on the average would be increased by 5%.
(iv) In addition, another Rs.10 Lakhs of sale (1984 level) would be made to Government
at a special discount of 10% thereof.
(v) Fixed costs would increase by Rs. 3,00,000.
Ascertain the expected profit/loss in 1985. If the increase in fixed costs mentioned
above arises only if sales to Government is made, would you recommend the sale to be
made? What is the P/V Ratio for 1985, at normal sales? Give workings.
(52) Two business AB Ltd. and CD Ltd. sell same type of product in the same type of market.
Their budgeted profit and loss account for the year 1984 is as follows :
(53) In a factory producing two different kinds of articles, key factor is the availability of labour.
From the following information for the factory for 1986. show which product is more
profitable.
Product A Product B
cost per Cost per
Unit Rs. Unit Rs.
Material 5.00 5.00
Labour 6 hrs @ Rs. 0.50 3.00 –
3 hrs @ Rs. 0.50 – 1.50
Overheads - Fixed (50% of labour) 1.50 0.75
- Variable 1.50 1.50
11.00 8.75
Selling Price 14.00 11.00
Profit 3.00 2.25
Total Production per month (Units) 500 600
Maximum capacity per month 4,800 hours
Maximum capacity of product B 1,000 Units
Product A Product B
per Unit per Unit
Sales Rs. 1.00 Rs. 1.20
Consumption of material 2 kgs 3 kgs.
Material Cost Rs. 10 Rs. 15
Direct Wages Cost Rs. 15 Rs. 10
Direct Expenses Rs. 5 Rs. 6
Machine hours used 3 : 2
Overhead Expenses
Fixed Rs. 5 Rs. 10
Variable Rs. 15 Rs. 20
Direct Wages per hour is Rs.5. Comment on profitability of each product (both use the
same raw material) When -
(b) Assuming raw material is the key factor, availability of which is 10,000 kgs. and
maximum sales potential of each product being 3,500 units, find out the product
mix which will yield the maximum profit.
A B C
Units Sold 80,000 80,000 2,00,000
Sales Rs. 40,000 Rs. 80,000 Rs. 50,000
Material Cost Rs. 20,000 Rs. 30,000 Rs. 25,000
Labour Cost Rs. 6,000 Rs. 10,000 Rs. 8,000
Variable Expenses Rs. 4,000 Rs. 4,000 Rs. 5,000
Fixed overheads. Rs. 7,000 Rs. 10,000 Rs. 5,000
The key factor of production is an imported raw material and the consumption of the
material in product A is 400 litres. Product B is 1,000 litres and Product C is 600 litres.
The sales manager gives an assurance that it is possible for him to sell whatever produced.
The management of the company has decided to close down one product line and
(56) Ambika Condiments bring out 2 products “SUCHI and RUCHI which are popular in the
market. The management has the option to alter the sales mix of the 2 products from the
following combinations -
Variable factory overheads are 100% of direct labour cost for both products.
Labour rate is Rs. 2 per hour.
Common fixed overheads for both products Rs. 10,000.
You are required to -
a. Prepare a marginal cost statement for the two products.
b. Evaluate options and identify the most profitable sales mix.
(57) From the following particulars, find the most profitable product mix and prepare a statement
of profitability of that product mix.
Product A Product B Product C
Units budgeted to be produced and sold 1,800 3,000 1,200
Selling Price per unit (Rs.) 60 55 50
Requirement per unit :
Direct Materials (Kgs) 5 3 4
Direct Labour (Hours) 4 3 2
Variable Overheads (Rs.) 7 13 8
Fixed Overheads (Rs.) 10 10 10
Maximum possible units of sales 4,000 5,000 1,500
(58) The Skyrock Ltd. produces and sells three types of products P, Q, and R. The
management committee has decided to discontinue the production of Q since there is
not much profit in it. From the following set of information, find out the profitability of the
products and give your short comments on the decision of the management.
(59) You had asked your accountant to prepare fair budgets based on different economic
forecasts. After doing part A the work, he fell sick. Incomplete workings done by him
were as under.
Economic Forecast Depressed Average Good Excellent
Variable Cost (Rs. ‘000) 40 60 90 140
There are fixed costs of Rs.72,000 and P/V Ratio is 60%. Calculate.
(a) The profit or loss at each of the four levels.
(b) The break even point in sales value and
(c) The sales value at which a profit of Rs .15000 would be made.
(60) Following is the abridged Profit and Loss Account of W Ltd. for 1987
(Rs. in Lakhs)
Sales (10 Lakhs Units @ Rs. 2.50 Per unit) 25.00
Less : Variable Cost 16.00
Contribution 9.00
Less : Fixed Costs 9.20
Loss: (-) 0.20
(61) The profit of a company works out to 12.5% on capital employed in 1986. The details are
as follows.
Rs. ‘000s
Sales 500
Direct Material 250
Direct Labour 100
Variable overheads 40
Capital Employed 400
(a) Forecast for 1987 indicates sales will increase by 10%, selling price will go up by
4% and cost elements will go down by 2%. Assuming no change in the capital
employed, calculate the return on capital employed.
(b) The new sales manager who has joined the company recently estimates for the
next year a profit of about 23% on capital employed, provided the volume of sales is
increased by 10% and simultaneously there is an increase in selling price of 4%
and an overall cost reduction in all elements of cost by 2%.
Find out by computing in details the cost and profit for the next year. Whether the
proposal of sales manager can be adopted?
(62) A multi product company has the following costs and output data for the last year.
Products
X Y Z
Sales Mix 40% 35% 25%
Selling Price Rs. 20 25 30
Variable cost per unit Rs. 10 15 18
Total Fixed cost Rs. 1,50,000
Total Sales Rs. 5,00,000
The company proposes to replace Product Z by product S. Estimated cost and output
data are :
(63) The following set of information is presented to you by your client AB Ltd.
(1) Direct Materials ( per unit ) X-Rs. 20 Y- Rs.l8.
(2) Direct Wages (per unit) X - Rs.6 Y- Rs. 4
(3) Fixed expenses during the period are expected to be Rs. 1,600
(4) Variable expenses are allocated to products @ 100% of Direct Wages.
(5) Sales Price (Per Unit) X - Rs.40 Y- Rs.30
(6) Proposed Sales mixes -
(i) 100 Units of X and 200 units of Y
(ii) 150 Units of X and 150 Units of Y
(iii) 200 Units of X and 100 Units of Y
As a Cost Accountant, you are requested to present to the management of AB Ltd. the
following.
(a) The unit marginal cost and unit contribution.
(b) The total contribution and resultant profit from each of the above sales mixes,
(c) The proposed sales mixes to earn a profit of Rs.300 and Rs.600 with the total sales
of X and Y being 300 units.
(64) An enthusiastic marketing manager suggests to his managing director that if only he is
permitted to reduce the selling price of a product by 20%, he would be able to achieve a
30% increase in sales volume. The Managing Director, finding that the sales volume
exceeds in percentage the extent of required reduction in price, gives the clearance. You
are given the following information.
(i) Examine the consequences of the Managing Director’s decision assuming that
30% increase in sales is realised.
(ii) At what volume of sales can the present quantum of profits be achieved after effecting
the price reduction.
(65) SV Ltd. has budgeted the manufacture of 30,000 units of its only product ‘A’ for the next
quarter.
Rs.
Direct Material 48.00
Direct Wages (Rs.4 per hour) 36.80
Factory variable overheads 27.60
Selling variable overheads 18.00
Product A is sold at Rs.200 per unit. Fixed overheads for the quarter are Rs. 15,00,000.
At present, the company manufactures component ‘P’ one unit of which is used in each
unit of Product ‘A’. The cost of this component is already included in the cost structure
of Product ‘A’ as aforesaid. Anyhow, the cost per batch of 1000 units of component ‘P’ is
separately supplied as under.
Rs.
Direct Material 6,000
Direct Wages 4,800
Factory variable overheads 3,600
Fixed overheads apportioned to the component 3,600
18,000
It is proposed to utilise the spare capacity by manufacture of 1,500 units of product ‘B’
for export. The details are as under :
Export selling price Rs. 228 per unit
Direct Material cost Rs. 80 per unit
Direct labour 16 hours per unit
Variable expenses applicable to this product - Rs. 20 per unit.
Factory variable overheads have to be charged, calculated on the basis of Direct Labour
Hour Rate applicable to Product A.
It has to be noted that component ‘P’ is not used in the manufacture of product ‘B’.
(iii) Calculate the contribution on account of accepting the export order of product ‘B’.
(66) A small scale manufacturer produces an article at the operated capacity of 10,000 units
while the normal capacity of his plant is 14,000 units. Working at a profit margin of 20%
on sales realisation, he has formulated his Budget as under -
10,000 14,000
Rs. Rs.
Sales Realisation 2,00,000 2,80,000
Variable overheads 50,000 70,000
Semi- Variable overheads 20,000 22,000
Fixed overheads 40,000 40,000
He gets an order for a quantity equivalent to 20% of the operated capacity and even on
this additional production, profit margin is desired at the same percentage on sales
realisation as for production to operated capacity.
Assuming prime cost is constant per unit of production, what should be the minimum
price to realise this objective?
(67) The executives of B Co., a small manufacturer of one product are developing the annual
profit plan. They have just reviewed the “First Cut” at the annual income statement and
are concerned with the Rs. 1,10,000 indicated profit on a sales volume of 20,000 units.
The fixed cost structure of Rs.9,90,000 appears to be high and they have some doubts
about departing from the unit sale price of Rs.100. There is a general agreement that the
“Profit target should be Rs. 2,20,000”. This case deals with several tentative alternatives
suggested during the meeting of the executive’s committee that just reviewed the tentative
profit plan.
(a) The budgeted break even point in rupees and in units and the number of units that
would have to be sold to earn the target profit?
(b) You are also required to respond directly to each of the following two alternatives
under consideration by the management. Consider each independent of the other
and state any assumptions that you would like to make.
How many units would have to be sold to earn the target profit?
(68) Stoner company uses three different components (Materials) in manufacturing its primary
product. Stoner manufactures two of the components and purchases one (designated
as component 1) from outside suppliers. The company is currently developing the annual
profit plan. Sales are highly seasonal, component 2 cannot be acquired from outsiders,
however component 3 can be purchased. The three components have critical
specifications. The annual profit plan provided data for the following computations.
The Purchase Manager investigated outside suppliers and found one that would sign a
one year contract to deliver “12,000 quality units as needed during the year at Rs.5.20
per unit”. Serious consideration is being given to this alternative. Should Stoner make or
buy component 3? Explain the relevant factors influencing your decision.
(69) From the following data, which product would you recommend to be manufactured in the
factory when-
(1) Time is the key factor.
(2) Raw material is in short supply.
(3) Sales potential in units is a limiting factor.
(4) Sales potential in value is a limiting factor.
INTRODUCTION :
The term ‘Budget’ is defined as a financial and/or quantitative statement, prepared prior to a
defined period of time, of the policy to be pursued during that period for the purpose of attaining
a given objective.
The analysis of this definition reveals the following characteristics of the budget.
(4) It spells out the objects to be attained and the policies to be pursued to achieve that
objective.
The term ‘Budgetary Control’ is defined as the establishment of budgets, relating the
responsibilities of executives to the requirements of a policy and the continuous comparison
of actual with budgeted results, either to secure by individual action the objective of that policy
or to provide the basis for its revision.
The analysis of this definition reveals the following facts about budgetary control.
(2) It deals with the comparison of budgeted results with the actual results.
(3) It deals with computation of the variations and the actions to be taken for maintaining the
favourable variations, removing the adverse variation or revising the Budgets themselves.
(1) It is a powerful tool available to the management for the purpose of cost control and
maximization of profits through the same. It enables the management to utilize the
available resources in the most profitable manner.
(2) A budget sets the plan of action. Plans in respect of various functional areas of operations
are expressed in the form of the budgets. As such, the Budgetary Control systems acts
as a means of declaration of the policies of the management.
(3) It acts a means of communication. The plans and objects laid down by top level
management are communicated to middle level and lower level management by way of
the budgets. As such, each and every person working in the organisation is aware of his
duties and responsibilities in relation to those of the others. This maximizes the utilization
of resources.
(4) It acts as a means of improving the co-ordination. The budgets prepared in the various
functional areas of operations are prepared in such a way that the efforts are co-ordinated
in the direction of achievement of common and defined objective. It develops the team
spirit and help of various people can be sought to solve the common problem.
(5) The comparison between the budgeted results and the actual results may reveal the
areas where there are adverse variations which may be identified as weak areas or
delicate areas. As such, efforts can be made to remove these adverse variations, keeping
aside the areas where there are no variations. This enables the concentration of efforts of
the management on a smaller portion of activities which facilitates ‘Management by
exception.’
(6) Budgetary control system enables the delegation of authority and makes possible the
principles of Responsibility Accounting.
(7) It is a powerful tool available to the management for Performance Appraisal. The executives
responsible for those functions where there is favourable variation may be rewarded,
whereas the executives responsible for those functions where there is adverse variation
may be punished. In this sense, budgetary control system provides a basis for
establishment of the incentive systems.
If the organization decides to install the Budgetary Control system as a cost control technique,
it will have to comply with the following preliminaries.
A Budget Centre is that section of the organization with respect to which the budgets will
be prepared. A Budget centre may be in the form of a product or a department or a
branch of the company and so on. Budget centre should be clearly defined and established
as the budgets will be prepared with respect to each and every Budget Centre.
A Budget Period is that period of time for which the budget will be prepared and operated.
The selection of the Budget Period should be made very carefully- Too long a budget
period makes the correct estimation more difficult while too short a budget period may
prove to be more costly. The selection of Budget Period may depend upon the nature of
operations and the purpose of preparing the budgets. As such, in case of industries like
the ones engaged in generation and distribution of electricity, transport operations etc.
where capital expenditure is too high, budgets may be prepared even for a period of 5 to
10 years, while in case of industries like the ones engaged in manufacturing of motor
vehicles or radios etc., where the customer demand may change more frequently, the
budget period may be shorter. Similarly, a sales budget may be prepared for a period of
5 years, whereas the short term cash budget may be prepared on weekly or even daily
basis.
There should be an efficient and proper system of accounting so that the information and
data as required for the efficient implementation of the Budgetary Control system will be
available in time.
A properly prepared organization chart may make the duties and responsibilities of each
level of executive very clear to himself. The budgetary control organization will be headed
by a senior executive in the form of budget controller or budget officer. In small or medium
sized organizations, he himself will be involved in all types of works involved with the
budgetary control system.
However, in case of large organizations, be may have a budget committee under him
which may consist of Chief Executive, budget officer himself and heads of main
departments. The role of budget committee may be only advisory and its decision may
become binding only if accepted by the Chief Executive. The functions performed by the
budget committee can be broadly stated as below.
(e) To locate the responsibilities and recommend the corrective and remedial action.
The usual and normal organization for the budgetary control may be expressed by way
of the following organization chart.
Chief Executive
Budget Officer
Budget committee
A budget mannual is a document setting out the responsibilities of the persons engaged
in and the forms and procedures required for the budgetary control. A budget manual
enables the standardization of the methods and procedures in relation to the budgetary
control. It should be well written, indexed and divided into the sections. It may be in
bound book form or loose leaf form. A budget mannual may contain the following particulars.
(a) Introduction of principles and objectives of budgetary control and the definitions and
brief explanations.
(b) Duties and responsibilities of the various executives and the organization chart.
(d) Scope of the budget and areas to be covered, whether budget will be a fixed budget
or flexible budget.
(e) Accounts codes, budget center codes and other codes operated.
A budget key factor is that the impact of which should be assessed first before other
functional budgets are prepared to ensure that other functional budgets are capable of
fulfillment. The key factor may take various forms Eg.Sales, Raw material, Labour,
Production capacity, availability of funds and Government restrictions. Once the key
factor is established, the budget with respect to that function will be prepared first and
the other budgets will be prepared to conform to that Eg. If sales is the key factor, the
sales manager will prepare and submit sales forecast first. The production manager will
then decide whether it is possible to produce the quantity to meet sales demand. In
case of the situations where there are more than one key factors, the importance of key
factors themselves will be assessed first. The problem of multiplicity of key factors may
be solved with the help of techniques like linear programming, operations research etc.
TYPES OF BUDGETS :
There can be basically four areas in which management can function and the types of budgets
can be studied with respect to these functional areas of management viz. Sales/Marketing,
production, personnel and finance.
(A) Sales/Marketing :
(1) Analysis of Past Trend : Analysis of the past trend over the last 5-10 years, may
reveal the long term trends, seasonal trends and the cyclical trends. With the help
of this trend analysis, the future trend can be established. For this purpose, reference
can be made to the reports published by trade organizations and Government
publications.
(2) Reports by Salesmen : Being in the actual field, probably the sales staff may be
best able to estimate the quantity which can be sold in the market. Before using
this estimate as an official sales forecast, necessary adjustments may be made
for error of judgment or to avoid the possibility of overestimation on the part of the
salesmen.
(3) Market Research and Market Survey : This is a very specialized technique
available to assess which of the company’s products can be sold, in which market,
(4) General Economic Conditions : General Trade and Business conditions affect
the sales forecast of the company. They may be in the form of competition from
other companies, supply condition for material and labour, trade conditions of the
customers of the company and so on.
Selling price at which products of the company can be sold may depend upon
various factors viz.
(4) Advertisement and other sales promotion efforts carried out by the company.
If the company envisages to sell higher quantity than the past sales or the existing
production capacity, and if some capital investment proposal is involved to increase
the production, then the feasibility of the proposal and the availability of funds may
also be required to be considered. If the sales forecast is less than the past sales
but the top management insists upon a certain amount of additional profits, then
the possibility of increasing the selling price or selling efforts and reduction in the
cost price may be required to be considered.
It shows the selling and distribution cost for selling the quantities considered in sales
budget. The sales manager, the distribution manager, the advertising manager and the
finance manager will be the persons involved in the preparation of this budget. This
budget may be prepared on the principles of flexible budgeting (as discussed later in this
chapter) for each head of selling and distribution costs, on the basis of volume of sales
to be achieved.
This cost is closely associated with sales. The intention of incurring this cost is to
increase the sales. However, the result of incurring this cost i.e. increased sales may
not be immediate and even if there is increase in sales, it is difficult to measure the
portion of increased sales which is due to advertising cost. As such, normally, advertising
cost budget is established in the form of a fixed amount for a specific period.
(1) Percentage of Sales or Profits : Here the advertising cost may be decided as a
fixed percentage of sales or profits. However, the past data may not be suitable in
view of recent business situations.
(2) Funds Available : Here the advertising cost depends upon the capability of the
company to spend on advertising. This may be a hypothetical method and may not
necessarily consider the relationship between advertising cost and benefits there
from.
(3) Competitor’s Policy : Here the advertising cost may depend upon the amount
which the competitors are spending on advertising. This method may pose some
difficulty as the amount spent by competitors may not be known and it may be
wrong to assume that the company may be able to derive the same benefits from
advertising as the competitors derive.
(B) Production :
It is a forecast of production for the budget period. It may be prepared from two angles.
(ii) Production Budget in terms of money i.e. the production Cost Budget further
classified under each element of cost such as Direct Material Cost, Direct Labour
Cost and Overheads Cost.
The material cost can be estimated by preparing the materials budget which indicates
the estimated quantities as well as costs of various materials required for carrying out
production as per production budget.
The labour cost can be estimated by preparing Direct Labour Cost budget which indicates
the direct labour requirements required to produce the quantity as specified in the
production budget. For the purpose of this budget, labour requirement in terms of number
of workers of different grades will be decided first. Afterwards, the rates of pay and
allowances will be considered to decide the labour cost. The production overheads can
be estimated by preparing production overhead budget which indicates all items of
production overheads classified as fixed, variable and semi-variable. The process of
allocation and apportionment can be followed to decide the loading of overheads to each
budget centre. Following factors will have to be considered before preparing the production
budget in terms of quantity’.
(4) Management Policy : Sometimes, the policy decisions taken by the management
are required to be considered before setting the production budget Eg. It will have to
be considered whether certain components are decided to be produced instead of
purchasing or vice versa.
(2) Material already purchased but reserved for some specific purposes.
In this functional area, the budget to be prepared takes the form of a personnel budget, which
indicates the requirement of personnel or labour force, either direct or indirect, to conform to
the sales forecast and the production budget. The labour requirement may be decided in
terms of number and grade of workers, number of labour hours, rupee value etc. Consideration
is also required to be made of the overtime working or shift working. This budget may also
indicate the training plans for new workers.
(D) Finance :
The most important budget which is prepared under this functional area is the cash budget. It
is an estimate of the expected cash receipts and cash payments during the budget period.
Thus by preparing the cash budget, it is possible to predict whether at any point of time, there
is likely to be excess or shortage of cash. If the shortage of cash is estimated, it may be
required to arrange the cash from some other source. If the excess of cash is estimated, it
may be possible to explore the investment opportunities. Before preparing the cash budget,
following principles should be kept in mind.
(i) The period for which cash budget is prepared should be selected very carefully. There is
no fixed rule as to the period to be covered by the cash budget. It may vary from company
to company depending upon the individual requirements. As a general rule, the period
covered by the cash budget should neither be too long or too short. If it is too long, it is
possible that the estimate will not be accurate. If it is too short, the factors which are
beyond the control of management will not be given due consideration.
(ii) The items which should appear in the cash budget, should be carefully decided. Naturally,
all those items which do not involve cash flow will not be considered while preparing the
cash budget. Eg. As the cost of depreciation does not involve any cash outflow, it does
not affect the cash budget, though the amount of depreciation affects the determination
of tax liability which involves cash outflow.
(1) Receipts and Payments Method : This method is useful for short term estimations.
It lists the various estimated sources of cash receipts on one hand and the various
estimated applications of cash on the other.
While preparing the cash budget by this method, the various items appearing on
the same may be classified under the following two categories :
(i) Operating Cash Flows : These are the items of cash flow which arise as a
result of regular operations of the business.
The standard items which may appear on the cash budget prepared by this method may
be stated as below :
Thus, finally cash budget appears in the form of opening cash balance, to which
various estimated cash receipts are added, the estimated cash payments being
deducted from this sum to arrive at the closing cash balance.
(2) Balance Sheet Method : This method is useful for long term estimates. According
to this method, the budgeted Balance Sheet is prepared for the following budget
period, after considering the various terms viz. Capital, Long Term Liabilities, Current
liabilities, Fixed Assets, Current Assets, but except cash. After both the sides of
Balance Sheet are balanced, the balancing figure indicates the estimated cash
balance in hand at the end of that period. This method does not consider the
expenses and assumes the regular pattern of inflow and outflow of cash. Further, it
indicates the cash requirement only at the end of budget period, any excess or
shortage of cash during the budget period are not considered.
(3) Adjusted Profits/Losses Method : This method also is useful for long term
estimates. According to this method, the cash budget is prepared in the following
way to show the estimated cash balance at the end of the budget period.
In addition to the various budgets as described above, which can be prepared in prime
functional areas of marketing, production, personnel and finance, some other types of
budgets may also be prepared.
It indicates the various types of overheads to be incurred during the budget period.
For the correct establishment of overheads cost budget, it will be necessary to
classify the various overheads. In order to exercise proper control on the overheads,
it will be necessary to analyse the overheads as fixed, variable and semi-variable.
The semi-variable overheads are further required to be split into fixed and variable
elements.
It is the plan of proposed investment in the fixed assets. It is closely related to the
sales budget, production budget and cash budget. As such, capital expenditure
budget should be properly coordinated with other functional budgets.
The capital expenditure may be required to be incurred for the replacement purposes
or expansion purposes. The requirements of capital expenditure may be basically
received from the various functional executives viz. production manager, sales
manager, finance manager and so on. If the investment in fixed assets is considered
to be economically and financially feasible, then the arrangement is required to be
made for the acquisition of the same. If the cash budget reveals the excess funds
available, it may not be necessary to arrange the funds for acquiring the fixed
assets from outside source. However, if no excess cash balance is available, then
it may be necessary to borrow the funds from some outside source.
After all the functional budgets are prepared individually and are properly coordinated with
each other, the master budget can be prepared by incorporating all the functional budgets.
The ultimate incorporation of all the functional budgets takes the form of budgeted Profit and
Loss Account and the Budgeted Balance Sheet.
It may involve the presentation of current year’s budgeted figures as well as those of the
previous year showing clearly why there is a change.
Any budget in any functional area of operation can be established as a fixed budget or a
flexible budget. A fixed budget is established for a specific level of activity and is not adjusted
to the actual level of activity attained at the time of comparison between the budgeted and
actual results. Naturally, fixed budget is established only for a short period of time where the
budgeted level of activity is expected to be attained to the maximum possible extent. Fixed
budgets are more suitable for fixed expenses i.e. the expenses which have no relation with the
level of activity. The fixed budgets do not indicate that they cannot be changed at all. A fixed
budget can be revised if the actual level of activity is likely to differ widely from the budgeted
level of activity. The fixed budget cannot be used as a effective tool of cost control while
computing the variations between the budgeted result and the actual result, the variance
cannot be explained properly and it is not possible to say whether the variance is due to the
changes in the level of activity or due to the efficiency or inefficiency of the executive responsible
for the execution of the budget. A flexible budget is designed to change with the fluctuations
in the level of activity and provides a basis for comparison for any level of activity actually
attained. A flexible budget is more elastic, and practical. It can be properly used as an effective
tool for evaluation of performance and cost control. It explains the variations between the
budgeted results and actual results stating the variations which are due to changes in the level
of activity (which is beyond the control of operating executive) and which are due to the
operational efficiency or inefficiency (for which the operating executive is responsible.)
For the purpose of establishment of the flexible budgets, it is necessary to classify the costs
as fixed costs, variable costs and semi-variable costs. The fixed costs remain the same at all
the levels of activity whereas the variable costs change directly in proportion to the level of
activity. So far as the semi-variable costs are concerned, each item of cost is examined and
classified into its fixed and variable elements and a trend is established regarding the nature
and behavior of each item of cost.
ILLUSTRATIVE PROBLEMS
(1) An estimate shows that there is a market for 10,00,000 units of an electric bell. Two big
companies producing this electric bell will probably divide 80% of the market. Among
The bell sells for Rs.30 an unit, with the manufacturing cost as follows. The cost is
worked out with reference to normal working capacity for the production which is 1,50,000
bells a year.
Direct Materials Cost Rs. 15.00
Direct Labour Cost Rs. 7.50
Variable overheads cost Rs. 2.50
Fixed overhead cost Rs. 1,00,000
Prepare a sales budget for the year showing cost of production and gross profit by
calendar quarters. Assume no change in the inventory levels during the year.
Solution :
SALES BUDGET
Note : It is assumed that the fixed overheads are apportioned evenly over the various quarters.
(2) XYZ Ltd. manufactures product C and G. During January, it expects to sell 5,000 Kgs of
C and 20,000 Kgs of G at Rs. 20 and Rs. 10 each respectively.
Direct materials A, B and E are mixed in equal proportion to produce product C. Materials D,
B and E are mixed in the proportion of 5:3:2 to produce product G. There is no loss of weight
in the production.
You are required to prepare (i) the production budget (ii) the materials purchase budget, indicating
the expenditure on raw materials for January.
Solution :
Product C Product G
Anticipated Sales - kgs. 5,000 20,000
Desired closing stock - kgs 500 6,000
5,500 26,000
Less : Opening stock kgs. 1,000 5,000
Production during month kgs. 4,500 21,000
A B D E
(a) Requirement for production
(As per production Budget)
For product C - kgs 1,500 1,500 – 1,500
For product G - kgs. – 6,300 10,500 4,200
Total requirement - kgs. 1,500 7,800 10,500 5,700
(b) Desired closing stock - kgs 1,000 2,000 3,000 6,000
(c) Sub total a +b kgs 2,500 9,800 13,500 11,700
(d) Opening stock kgs 1,500 1,000 10,000 5,000
(e) To be purchased during month kgs. c - d 1,000 8,800 3,500 6,700
(f) Anticipated cost per kg. Rs. 5.50 5.00 1.00 3.50
(g) Anticipated cost of purchases Rs. 5,500 44,000 3,500 23,450
The year 1987 is expected to open with an inventory of 4,000 units of finished product and
close with an inventory of 6,500 units. Production is customarily scheduled to provide for two
third of the current quarter ‘ s sales demand plus one third of the following quarter’s demand.
Thus production anticipates sales volume by about one month.
The standard cost details for one unit of the product is as below
Fixed Overheads 1 hour 30 minutes @Rs. 2 per hour, based on a budgeted production volume
of 90,000 direct labour hours for the year.
a. Prepare a production budget for 1987, by quarters, showing the number of units to be
produced and the total costs of direct material, direct labour, variable overheads and
fixed overheads.
b. If the budgeted selling price per unit is Rs. 17, what would be the budgeted profit for the
year as a whole ?
Solution :
a. Production Budget
Hence, the total production for all the quarters will be 64,000 units.
Total Variable Cost for 64000 units is Rs. 8,00,000. Hence, per unit variable cost is
Rs. 12.50.
c. Calculation of Profit
Per Unit Selling Price is Rs. 17 and Per Unit Varaible Cost is Rs. 12.50. Hence, Per Unit
Contribution Rs. 4.50.
As Fixed Cost is Rs. 1,80,000, Break Even Point in units will be 180000 / 4.50 = 40000
units. This target is achieved by the company in Quarter 3, hence the company is
expected to break even in Quarter Three.
(4) A single product company estimated its sales for the next year quarterwise as under -
The opening stock of the finished goods is 10,000 units and the company expects to maintain
the closing stock of finished goods at 16,250 units at the end of the year. The production
pattern in each quarter is based on 80% of the sales of the current quarter and 20% of the
sales of the next quarter.
The opening stock of raw materials in the begining of the year is 10,000 Kgs. and the closing
stock at the end of the year is required to be maintained at 5,000 Kgs. Each unit of finished
output requires 2 Kgs. of raw material.
The company proposes to purchase the entire annual requirement of raw materials in the first
three quarters in the proportion and at the prices given below -
The value of the opening stock of raw materials in the beginning of the year is Rs. 20,000.
You are required to present the following for the next year, quarterwise -
a. Production Budget in units.
b. Raw Materials consumption budget in quantity.
c. Raw Materials purchase budget in quantity and value.
Solution :
a. Production Budget
We know that Opening Stock + Production - Sales = Closing Stock Hence we know that
Hence, the total production for all the quarters will be 1,60,000 units.
Production Budget is 1,60,000 units. Each unit of the final product requires 2 Kgs. of raw
material. Hence, the raw material consumption budget in quantity will be 3,20,000 Kgs.
(5) A private Limited company is formed to take over a running business. It has decided to
raise Rs.55 Lakhs by issue of Equity shares and the balance of the capital required in
the first six months is to be financed by a financial institution against an issue for Rs.5
Lakhs 8% Debentures (Interest payable annually) in its favour.
Payments on the above items are to be made in the month of incorporation. Sales during
the first 6 months ending on 30th June are estimated as under.
Other information :
(1) Preliminary expenses Rs.50,000 (Payable in February)
(2) General Expenses Rs.50,000 p.m.(Payable at the end of each month)
(3) Monthly wages (payable on 1st day of next month) Rs. 80,000 p.m. for first
3 months and Rs. 95,000 p.m. there after.
(4) Gross Profit rate is expected to be 20% on sales.
(5) The shares and debentures are to be issued on 1st January.
(6) The stock levels throughout is to be the same as the outlay.
Prepare cash budget for the 6 months ended 30th June.
Solution :
Cash Budget
(For 6 month sending 30th June)
(Rs. in Lakhs)
Jan. Feb. Mar. Apr. May Jun
(A) Cash Inflow
Issue of shares 55.00 – – – – –
Issue of Debentures 5.00 – – – – –
Collection from Debtors – – 14.00 15.00 18.50 25.00
60.00 – 14.00 15.00 18.50 25.00
(B) Cash Outflow
Fixed Assets 40.00 – – – – –
Stock (Initial) 6.00 – – – – –
Preliminary Expenses – 0.50 – – – –
Sundry Creditors – 10.40 11.20 14.00 19.05 20.25
General Expenses 0.50 0.50 0.50 0.50 0.50 0.50
Wages – 0.80 0.80 0.80 0.95 0.95
46.50 12.20 12.50 15.30 20.50 21.70
(C) Net cash Inflows
(A-B) 13.50 (12.20) 1.50 (0.30) (2.00) 3.30
Opening Balance – 13.50 1.30 2.80 2.50 0.50
+ Surplus for the month 13.50 (12.20) 1.50 (0.30) (2.00) 3.30
Closing Balance 13.50 1.30 2.80 2.50 0.50 3.80
(2) Assuming that the company is carrying on manufacturing operations, the purchase
say for the month of January are computed as below.
(6) A newly started company “Green Co. Ltd.” wishes to prepare cash budget from January.
Prepare a cash budget for the first 6 months from the following estimated revenue and
expenditure.
Sales commission @ 5% on total sales is to be paid within the month following actual
sales. Rs. 10,000 being the amount of second call may be received in March. Share
premium amounting to Rs. 2,000 is also obtainable with 2nd call.
(7) Prepare a cash budget for the quarter ended 30th September 1987 based on the following
information
Credit sales are collected 50% in the month of sales are made and 50% in the month following.
Collection from credit sales are subject to 5% discount if payment is received in the month of
sales and 2.5% if payment is received in the following month.
Creditors are paid either on a prompt or 30 days basis. It is estimated that 10% of the creditors
are in the prompt category.
Solution :
Cash Budget
(For Quarter ending September 1987)
It is assumed that salaries and wages are paid in the same month.
(8) From the following information you are required to prepare a cash budget for six months
from January 1987 to June 1987, Month by month, showing also the cash credit facility
available from the Bank. Opening overdrawn balance is Rs. 1,50,000.
(1) Out of total sales, 50% are cash sales and balance 50% is received in the month following
month of sale.
(2) Payment for purchase of assets is to be made Rs.16,000 in February, Rs. 25,000 in
March and Rs. 50,000 in April.
(3) Proceeds from sales of scrap are to be received in May, amounting to Rs.6,000.
(5) Sales commission is to be paid at 3% of total sales in same month in which sales are
made.
(6) Suppliers for materials are paid in the month following the month of purchases of materials.
(9) Creditors of Production, Selling & Distribution and Administration expenses are given
one month’s credit period.
Note :
Eventhough, the Cash Credit Facility is granted to the extent of Rs.2,00,000, the company is
not likely to utilise it fully. At the end of June 1987, the overdrawn balance is likely to be only
Rs.5,788.
(9) ABC Co. Ltd. wishes to arrange overdraft facilities with its bankers during the period April
to June 1987 when it will be manufacturing mostly for stock. Prepare a cash budget for
the above period from the following data, indicating the extent of the bank facility the
company will require at the end of each month.
Additional Information :
(1) All Sales are Credit Sales 50% of Credit Sales are realised in the month following the
sales and the remaining 50% in the Second month following.
(2) Creditors are paid in the month following the month of purchases.
Solution :
(10) The manager of a Repairs and Maintenance Department has submitted the following
budget estimates that are to be used to construct a flexible budget to be used during the
coming budget year.
a. Prepare a flexible budget for the department up to activity level of 10,000 repair hours
(use increment of 1000).
Solution :
Working Notes :
a. Employee salaries is a fixed cost as they remain constant for both 6000 repair hours and
9000 repair hours.
c. Miscellaneous costs is a semi-variable cost. This cost neither remained constant nor
increased proportionately the activity level of 6000 hours to 9000 hours. The cost increased
by Rs. 3,600 for the increase of 3000 hours. means that the variable portion of this cost
is Rs. 1.20 hour. Hence, out of total miscellaneous cost of Rs. 13,200 for 6000 hours,
Rs. 7,200 is variable portion and balance 6,000 is the fixed portion.
No costs are incurred in respect of the accompanying teachers (except the allowance of
Rs. 50 per teacher).
a. A flexible budget estimating the total cost for the levels of 30, 60, 90, 120 and 150
students. Each item of cost is to be indicated separately.
c. What will be your conclusions regarding the break even level of students if the school
proposes to collect Rs. 45 per student?
(12) Prepare the flexible budget for overheads on the basis of data given below. Ascertain the
overheads rates at 50%, 60% and 70% capacity.
At 60% capacity
Rs.
Variable Overheads
Indirect Material 6,000
Indirect Labour 18,000
Semi-Variable Overheads
Electricity
(40% fixed, 60% variable) 30,000
Repairs and Maintenance
(80% fixed, 20% variable) 3,000
Fixed Overheads :
Depreciation 16,500
Insurance 4,500
Salaries 15,000
Total Overheads 93,000
Estimated Direct Labour Hours 1,86,000
(13) A Factory can produce 60,000 units per annum at its 100% capacity. The estimated
costs of production are as under.
The factory produces only against orders. If the production programme of the factory is as
indicated below, and the management desires to ensure a profit of Rs.1,00,000 for the year,
work out the average selling price at which each unit should be quoted.
Solution :
Calculation of total cost
Thus, the total cost during the year is likely to be Rs.6,30,000. If it is desired to earn a profit
of Rs. 1,00,000 the total amount to be covered by the units to be sold will have to be Rs.7,30,000
(i.e. Rs. 6,30,000 + Rs. 1,00,000). As the total units produced are estimated to be 43,500,
the above amount will have to be covered by 43,500 units. Hence, the average selling price per
unit will be
Rs.7,30,000
= Rs. 16.78 per unit (approx.)
43,500
Notes :
(2) It is assumed that the production and the incidence of all the indirect expenses is equally
spread during the year.
(3) From the following particulars, prepare a flexible budget for the three months ending
30th September showing the estimated sales, sales cost and profit for 60%, 80% and
100% activity. Assume that all items produced are sold.
Semi-variable expenses remain constant between 41% and 70% activity, increase by 10% of
the above figures between 71% and 80% activity and increase by 15% of the above figures
between 81% and 100% activity. Fixed expenses remain constant whatever may be the level
of activity. Sales at 60% activity are Rs.51,00,000, at 80% activity are Rs. 68,00,000 and at
100% activity are Rs.85,00,000.
Flexible Budget
60% 80% 100%
capacity capacity capacity
Rs. Rs. Rs.
(15) Based on sales foreast for the season, C Ltd. has prepared the following production
scheme for the coming month.
30,000 units of Product A and 20,000 units of product B. the manufacturing specifications
for the products are as follows.
Product A Product B
2 Kgs. Material X @ Rs. 3 3 Kgs. Material W Rs. 8
1/2 Kg. Material Y @ Rs. 2 3/4 Kg. Material Y @ Rs. 2
2 hours direct labour @ Rs. 20 11/2 hours direct labour @ Rs. 20
To the direct labour hours, a 5% allowance for idleness (accounted for as overheads) should
be added. Indirect labour time is estimated to be 5% of direct labour hours (excluding idleness)
and the wage rate for indirect labour is Rs. 15. The overhead estimate (not shown above) is as
follows
Note : This rate includes the cost of idle lime and indirect labour.
It is planned to increase the inventory of raw material X by 4,000 Kgs and to decrease the
inventory of raw material W by 2,000 Kgs. as of the begining after next month.
You are required to prepare and estimate of the amount of cash necessary for manufacturing
operations of the coming month.
Assume that the materials and wages cost are paid in the month of purchase.
Solution :
90% 100%
(a) Sales Rs. 15,00,000 16,00,000
(b) Fixed Expenses Rs. 3,00,500 3,00,500
(c) Semi-Fixed Expenses Rs. 97,500 1,00,500
(d) Semi-Variable Expenses Rs. 1,42,000 1,49,500
Material and Labour Cost per unit are constant under present conditions. Profit margin is
10% at 90% capacity :
(a) You are required to determine the cost of producing an additional 1,500 units.
(b) What would you recommend for an export price for these 1,500 units taking into
account that overseas prices are much lower than indigenous prices?
Solution :
Cost Sheet
90% Capacity 100% Capacity
Variable Cost
Material / Labour 8,10,000 9,00,000
Variable portion of
Semi-Fixed Expenses 27,000 30,000
Variable portion of
Semi-Variable Expenses 67,500 75,000
a. Total Variable Cost 9,04,500 10,05,000
Fixed Cost
Fixed Expenses 3,00,500 3,00,500
Fixed portion of
Semi-Fixed Expenses 70,500 70,500
Fixed portion of
Semi-Variable Expenses 74,500 74,500
b. Total Fixed Cost 4,45,500 4,45,500
c. Total Cost (a+b) 13,50,000 14,50,500
d. Profit 1,50,000 1,49,500
e. Sales 15,00,000 16,00,000
b. Semi-Variable Expenses
With every 10% capacity increase, semi-variable expenses increase by Rs. 7,500. This
means that variable portion of semi-fixed expenses is Rs. 7,500 for 10% capacity. For
90% capacity it will be Rs. 67,500 and for 100% capacity, it will be Rs. 75,000.
(17) Develope the proforma (estimated) income statement for the months of October, November
and December of Ajax Lunatics Ltd. from the following information.
(a) Sales are projected at Rs. 2,50,000, Rs. 3,00,000 and Rs. 2,00,000 for October,
November and December respectively.
(b) Cost of goods sold is Rs. 75,000 plus 20% of sales per month.
(c) Selling Expenses are 3% of sales.
(d) Rent is Rs. 7,500 per month. Administrative Expenses is 15% of sales per month.
(e) The company has Rs. 3,00,000 at 10% loan-The interest is payable monthly.
(f) Corporate tax rate is 60%
Solution :
Proforma (Estimated) Income Statement of Ajax Lunatics Limited.
October November December
(A) Sales 2,50,000 3,00,000 2,00,000
(B) Cost
Cost of goods sold 1,37,500 1,50,000 1,25,000
Selling Expenses 7,500 9,000 6,000
Rent 7,500 7,500 7,500
Administretive Expenses 37,500 45,000 30,000
Interest on Loan 2,500 2,500 2,500
Total Cost 1,92,500 2,14,000 1,71,000
(C ) Profit before tax (A - B) 57,500 86,000 29,000
(D) Income Tax - 60% of C 34,500 51,600 17,400
(E) Profit after tax (C - D) 23,000 34,400 11,600
At 50% capacity, the selling price is Rs. 200 per unit. Whereas the product cost is
Rs. 160 as given below.
Rs.
Materials Cost 80
Direct wages 30
Factory overheads 30 (of which 60% is variable)
Selling and Admn. overheads 20 (of which 50% is fixed).
At 60% capacity, material prices go up by 10% and selling price reduced by 5%.
At 80% capacity, there is increase in labour cost by 10% and variable factory overheads
go up by Rs. 2 per unit. The variable selling and administration overheads increase by
Re. I per unit, the other costs and selling price remain unchanged as at 60%.
Flexible Budget
1. What do you mean by Budget and Budgetary Control? What are the advantages of
Budgetary Control as a cost control technique? What are the prerequisites for the
successful implementation of Budgetary Control System?
2. What is the meaning of Budget and Budgetary Control. State and explain various budgets
which can be established in the following functional areas of operation -
a) Sales/Marketing
b) Production
c) Finance
a) Budget Manual
b) Fixed and Flexible Budgets
c) Cash Budget
(1) The sales manager of a manufacturing company expects to sell 25,000 units of a certain
product.
The production director provides the following information. Two kinds of raw materials X
and Y are required for each unit of final product and 2 units of X and 3 units of Y are
required for one unit of final product. The estimated opening balance at the commencement
of next year are-
(2) A Ltd. manufactures two products X and Y making the use of following raw materials in
the proportion shown.
Raw material Product X Product Y
Rl 80%
R2 20%
R3 50%
R4 50%
The finished weight of products X and Y are equal in weight of their ingredients. During a
month, it is expected that 1200 kgs. of X and 4000 kgs of Y will be sold.
(3) A Ltd. produces a standard product. The estimated cost per unit in given below.
Rs.
Raw materials 10
Direct wages 8
Direct Expenses 2
Variable Overhead 5
Fixed overheads are estimated to Rs. 70,000 selling price per umt is Rs. 40. Prepare a
flexible budget at 50%, 70% and 90% level of activity. Assume that output at 100% level
of activity is 10,000 units.
Administration Costs
Office Salaries Rs. 3,000
General Expenses 1.5% of sales
Depreciation Rs. 1,500
Rates and Taxes Rs. 1,750
Selling Costs
Salaries 4% of sales
Travelling Expenses 1.5% of sales
Sales Office Expenses 1% of sales
General Expenses 1% of sales
Distribution Costs
Wages Rs.3,000
Rent 0.5% of sales
Other Expenses 2% of sales
(5) The expenses budgeted for production of 10,000 units in a factory are furnished below.
Per Unit
Rs.
Materials 70
Labour 25
Variable Overheads 20
Fixed Overheads ( Rs.1,00,000) 10
Variable Expenses (Direct) 5
Selling Expenses (10% Fixed) 13
Distribution Expenses (20% Fixed) 7
Adinimstrative Expenses (Rs.50,000) 5
Total Cost of sale per unit 155
(to make and sale)
Prepare a budget for the production of
a. 8,000 units and b. 6,000 units.
The management expects following estimate in 1986. Sales to increase to 30,000 units,
selling price remaining unchanged. Raw materials prices increase by 10%, wage rate to
increase by 10% but labour productivity improves by 5%.
Fixed overheads are expected to increase by Rs. 2,000. You are required to prepare the
budget for 1986.
(a) The average rate for direct labour remuneration will fall from 90 paise to 75 paise per
hour.
(c) Price per unit of direct material and other materials and services which comprise
overheads will remain unchanged and
Draw up a budget and compute a factory overhead rate, the overheads being absorbed
on a direct wages.
(8) ABC Ltd. manufacturing a single product is facing a severe competition in selling at
Rs. 50 per unit. The company is operating at 60% level of activity at which level sales are
Rs. 12,00,000. Variable costs are Rs.30 per unit. Semi variable costs may be considered
To cope with the competition, the management of the company is considering a proposal
to reduce the selling price by 5%. You are required to :
(a) Prepare a statement showing the operating profit at levels of activity of 60%, 70%
and 80%. Assuming that the selling price remains at Rs.50 per unit.
(b) If selling price is reduced by 5%, show the number of units which will be required to
be sold to maintain the present profits.
(9) A company, producing electronic watches, estimates the following factory overheads
costs for producing 5,000 Units
Indirect labour, indirect material and expendable tools are entirely variable. Heat, light
and power and inspection costs are variable to the extent of 50% and 40% respectively.
Other costs are fixed costs for a month. Prepare a flexible budget for overheads for
production of 4,000 and 6,000 units per month. Also find out the average factory overheads
per unit for these two production levels.
(10) Anil and Avinash Enterprises is currently working at 50% capacity and produces 10,000
units. Estimate the profits of the company when it works at 60% and 70% capacity.
At 60% capacity, the raw materials cost increases by 2% and the selling price falls
by 3%. At 70% capacity the raw materials cost increases by 4% and selling price falls
by 5%.
At 50% capacity, the product costs Rs. 180 per unit and is sold for Rs.200 per unit.
(11) ABC Ltd. manufactures a single product for which market demand exists for additional
quantity. Present sale of Rs. 60,000 per month utilities only 60% capacity of the plant.
Sales Manager assures that with a reduction of 10% in the price, he would be in a
position to increase the sale by about 25% to 30% .
You are required to submit the following statements to the Board showing.
(1) The operating profits at 60%, 70% and 80% levels at current selling price and at
proposed selling price.
(2) The percentage increase in the present output which will be required to maintain
the present profit margin at the proposed selling price.
(12) A manufacturing company has an installed capacity of 1,20,000 units per annum. The
cost structure of the products manufactured is as under :
Materials Rs. 8
Labour Rs. 8
(Subject to a minimum of Rs.56,000 per month)
Overheads Rs. 3
(ii) Fixed overheads are Rs. 1,04,000 per annum.
(iii) Semi variable overheads Rs.48,000 per annum at 60% capacity, which will increase
by Rs.6000 per annum for increase of every 10% of the capacity utilization or any
part thereof.
(13) The monthly budgets for manufacturing overhead of a concern for two levels of activity
were as follows -
Capacity 60% 100%
Budgeted Production (units) 600 1000
(Rs.) (Rs.)
Wages 1,200 2,000
Consumable Stores 900 1,500
Maintenance 1,100 1,500
Power and Fuel 1,600 2,000
Depreciation 4,000 4,000
Insurance 1,000 1,000
9,800 12,000
You are required to -
a. Indicate which of the items are fixed, variable and semi-variable.
b. Prepare a budget for 80% capacity.
c. Find out the total cost, both fixed and variable, per unit of output at 60%, 80% and
100% capacity.
(14) From the following data, prepare a flexible budget for the production of 40,000 units,
60,000 units and 75,000 units, distinctly showing variable and fixed costs as well as
total costs. Also indicate element wise cost per unit.
(16) Excellent Manufacturers can produce 4000 units of a certain product at 100% capacity.
The following information is obtained from the books of accounts -
June 94 July 94
Units produced 2,800 3,600
Rs. Rs.
Repairs and Maintenance 500 560
Power 1,800 2,000
Shop Labour 700 900
Consumable Stores 1,400 1,800
Salaries 1,000 1,000
Inspection 200 240
Depreciation 1,400 1,400
The rate of production is 10 units per hour. Direct Materials cost is Re. 1 and Direct
Wages per hour is Rs. 4. You are required to -
(17) The following data are available for a manufacturing company for a yearly period -
Rs. in Lakhs
Fixed Expenses -
- Wages and Salaries 9 .5
- Rent, Rates and Taxes 6.6
- Depreciation 7.4
- Sundry Administrative Expenses 6 .5
Semi-Variable Expenses (at 50% capacity)
- Maintenance and Repairs 3 .5
- Indirect Labour 7 .9
- Sales Department Salaries 3 .8
- Sundry Administrative Salaries 2.8
Variable Expenses (at 50% capacity)
- Material 21.7
- Labour 20.4
- Other Expenses 7.9
98.0
Assume that the fixed expenses remain constant at all levels of production, semi-variable
expenses remain constant between 45% and 65% of capacity increasing by 10% between
65% and 80% capacity and by 20% between 80% and 100% capacity.
Sales at various levels are -
Rs. in Lakhs
50% capacity 100
60% capacity 120
75% capacity 150
90% capacity 180
100% capacity 200
Prepare a flexible budget for the year at 60% and 90% capacities and estimate the
profits at these levels of output.
(19) On 30th September 1990, the Balance Sheet of Melodies Pvt. Ltd. retailers of musical
instruments, was as under -
The company is developing a system of forward planning and on 1st October 1990, it
supplies the following information.
All trade debtors are allowed one month’s credit and are expected to settle promptly. All
trade creditors are paid in the month following delivery.
(20) Develop Performa income statement for the months of July, August and September for a
company for the following information.
(a) Sales are projected at Rs. 2,25,000, Rs. 2,40,000 and Rs. 2,15,000 for July, August
and September respectively.
(b) Cost of goods sold is Rs.50,000 plus 30% of selling price per month.
(d) Rent is Rs. 7,500 per month, administrative expenses for July are expected to be
Rs. 60,000 but are expected to rise 1% per month over the previous month’s
expenses.
(21) The projected sales and purchases of ABC Ltd. for the months July to November 1983
are
The company anticipates to have an overdraft of Rs. 40,000 on 1st September 1983
(limit sanctioned is Rs. 55,000). Draw a cash budget for September 83 to November 83
for approaching bankers for a short term further credit.
(22) From the following budgeted data of ABC Ltd., prepare cash budget for the quarter
ending 31st December 1984.
Month Sales Purchases Wages Misc. Exp.
August 1,20,000 84,000 10,000 7,000
September 1,30,000 1,00,000 12,000 8,000
October 80,000 1,04,000 8,000 6,000
November 1,16,000 1,06,000 10,000 12,000
December 88,000 80,000 8,000 6,000
Additional information :
Sales – 20% realised in the month of sale. Discount allowed 2%. Balance realised in
subsequent month.
Income from investment - Rs. 5,000 received quarterly April, July, October etc.
Other information :
(1) 25% of the sales are for cash, remaining amount in the month following that of sale.
(3) Delay in the payment of wages and all other expenses one month.
(24) Mr. Ashok Kumar, the Finance Manager of Mazumdar Castings Ltd. is preparing the
cash budget for the first six months of 1982, on the basis of the following information :
(ii) Out of the total sales, cash sales are 25%, the balance being credit sales. 60% of
the credit sales are collected in the month after sales, 30% are collected in the
second month, and the balance 10% in the third month after sale. He does not
expect any bad debts.
(vii) Interest on 20,00,000 8% Debentures was due on June 30, 1982 (half yearly)
(viii) Excise deposit due on March 31, 1982 Rs. 3,00,000.
(ix) Acquisition of plant and equipment planned for May 1982 Rs. 10,00,000.
(x) Miscellaneous Expenses on a cash basis every month at Rs. 15,000 plus 10% of
sale.
(xi) The company will have a cash balance of Rs. 5,00,000 on 31.12,81. Mr. Ashok
Kumar believes that this is a high level and is planning on a continuous balance of
Rs. 4,00,000
(a) Prepare the Cash budget for six months to June 1982 .
(25) A company has its cost of goods of 70% of its sales, 70% of this cost is paid in the
month of the sale and the balance in the next month. Salary and administrative expenses
amount to Rs. 40,000 per month plus 5% of sales. These expenses must be paid during
the month following the month when expenses are actually incurred . The company has
also 10% Debentures of Rs. 1,50,000 and interest has to be paid in 4 quarters from
January onwards. The company gives its actual and forecast sales as below.
(1) Cash sales are 50 per cent of the total sales. The remaining 50 per cent will be
collected equally during the following two months.
(2) Cost of goods manufactured is 70 per cent of sales. 90 per cent of this cost is paid
during the first month after incurrence and the balance is paid in the following
month.
(3) Sales and administrative expenses are Rs. 15,000 per month plus 10 per cent of
sales. All these expenses are paid during the month of incurrence.
(4) Half- yearly interest of 6 per cent on Rs. 4,50,000 Debentures is paid during July.
(5) Rs. 60,000 are expected to be invested in fixed assets during July.
It is the policy of the company to have a minimum cash balance of Rs. 30,000/-.
Accordingly as on 30th April, the actual cash balance was Rs. 30,000/-.
The Management wishes to know whether it will be required to borrow during the quarter
ending on 31st July and if so when and how much.
(27) Prepare a cash budget for the three months ending 30th June 1986 from the information
given below.
Sales/Debtors - 10% of sales are on cash, 50% of the credit sales are collected
next month and balance in the month following
Creditors - Materials - 2 months
Wages - 1/4 month
Overheads - 1/2 month
(c) Cash and Bank balance on 1st April 1986 is expected to be Rs.6,000.
(d) Other relevant information :
(i) Plant and Machinery will be installed in February 1986 at a cost of Rs. 96,000. The
monthly instalments of Rs. 2,000 is payable from April onwards.
(ii) Dividend @ 5% on preference share capital of Rs.2,00,000 will be paid on 1st June.
(iv) Dividends from investment amounting to Rs. 1,000 expected to be received in June
(28) Prepare a cash budget of XYZ Ltd. on the basis of the six months commencing from
April 1989.
(2) Cash sales are 25% of the total sales and balance 75% will be credit sales.
(3) 60% of credit sales are collected in the month following the sales, balance 30%
and 10% in the two following months thereafter. No bad debts are anticipated.
(8) Capital expenditure for plant and machinery planned for September 1989 is
Rs. 1,20,000.
(9) Company has a cash balance of Rs. 4,00,000 as at 31st March, 1989 and will
maintain it in future also at minimum level.
(29) Lal and Company has given the forecast sales for January 1989 to July 1989 and actual
sales for November and December 1988 as under. With the other particulars given,
prepare a Cash Budget for the five months i.e. from January 1989 to May 1989.
(1) Sales
November 88 1.60 Lakhs April 89 2.00 Lakhs
December 88 1.40 Lakhs May 89 1.80 Lakhs
January 89 1.60 Lakhs June 89 2.40 Lakhs
February 89 2.00 Lakhs July 89 2.00 Lakhs
March 89 1.60 Lakhs
(2) Sales 20% cash and 80% credit, payable in the third month (January sales in
March).
(5) Purchases being 60% of the sales of the third month, payment will be made on 3rd
month of purchases.
(6) Rent and other expenses Rs. 6,000 paid every month.
INTRODUCTION :
The determination of the actual cost on the basis of various costing records maintained is no
doubt important, but such actual cost (or historical cost) involves some limitations as to its
utility.
(1) The actual cost information is available only after the completion of the job, process or
service and hence is of no practical utility from control point of view, as no basis is
provided with which the actual costs can be compared.
(2) There are various kinds of managerial decisions where cost is an inevitable basis E.g.
price fixation or submission of quotations. However if the details of actual cost are available
too late, such cost details are of no practical utility for the purpose of price fixation or
submission of quotation.
(3) The actual costs may be affected due to the inefficient functioning. The actual costs may
be excessive due to abnormal expenses, avoidable wastes, inefficient use of labour and
excessive use of materials. As such, actual costs are not useful for providing a yardstick
for measuring efficiency of performance.
The term ‘standard cost’ has been defined as a pre-determined cost which is calculated from
the management’s standards of efficient operation and the relevant necessary expenditure.
The term ‘standard costing’ has been defined as ‘the preparation and use of standard costs,
their comparison with actual costs and the measurement and analysis of variances to their
causes and points of incidence.’
(1) Predetermination of technical data related to production i.e. details of materials and
labour operations required for each product, the quantum of inevitable losses, level of
activity etc.
(2) Predetermination of standard costs in full details under each element of cost i.e. Labour,
Material and Overhead.
(3) Comparison of actual performance and costs with standards and working out the variances
i.e. the difference between the actual and the standards.
(4) Analysis of variances in order to determine the reasons for deviations of actuals from the
standards.
It should be noted in this connection that standard costing is not a separate system of
accounting but only a technique used with the intention of controlling the costs. Though it can
be used in case of all methods of costing like job costing, process costing etc.; it can be more
effective in case industries producing the standard products on continuous basis.
(1) Standard costing provides a yardstick with reference to which the efficiency/inefficiency
in performance may be established. This facilitates the basic management function of
cost control.
(2) Standard costing provides the incentive and motivation to work with greater effort for
achieving the standard.
(3) Standard costs may be used as the basis for the process of price fixation, filing the
tenders and offering the quotations. If the prices are to be quoted on cost plus basis,
actual costs may not be available in which case standard costs can be the base for
fixation of selling prices.
(4) Standard costing system facilitates delegation of authority and fixation of responsibility
for each individual or department. This also tones up the general organization of the
concern.
(6) When constantly reviewed, the standards provide means for and encourage action for
cost reduction. Focus on out of control situations, leads to cost reduction through the
improved methods, improved quality of products, better material and workers, effective
selection and use of capital resource etc.
(7) A properly laid down system of standard costing may facilitate the correct implementation
of the technique of budgetary control which also is a good system of cost control.
(1) Establishment of standard costs is difficult in practice. Even though, standards are fixed
after defining properly, there is no guarantee that the standards established will have the
same tightness or looseness as envisaged.
(2) In the course of time, even in a short period, the standards become rigid. It may not be
possible to maintain the standards to keep pace with the changes in manufacturing
conditions. Revision of standards is costly.
(3) Sometimes, standards set create adverse effects. If standards are set tightly and there
is non-achievement of the same, it creates frustration.
(4) The standard costing may not be suitable in all types of organizations e.g.
(i) In case of small concerns- Where the production cannot be properly scheduled. In
small concerns, personal contacts may be more effective than the standard costing.
(iii) In case of industries having repair jobs which keep changing as per customer
requirements.
(iv) In case of industries where products take more than one accounting period to
complete e.g. contract jobs.
(5) Due to the play of random factors, it may be difficult to properly examine the variance
and distinguish between controllable and uncontrollable variances. e.g. Adverse labour
time variance may be due to poor grade of labour, poor quality of material, defective plant
and machinery and lack of trained workers.
(6) Lack of interest in standard costing on the part of the management makes the system
ineffective and can’t be used as a proper means of cost control.
Both standard costing and budgetary control are the best possible tools available to the
management for the purpose of controlling the costs. Both the techniques involve the process
of setting the targets or standards, measurement of actual performance, comparison of actual
performance with targets or standard set, computation and analysis of variations and the
attempts to maintain favorable variations and remove unfavorable variations. The technique of
budgetary control can be used effectively if the system of standard costing is prevailing. Thus,
both the techniques complement each other but are not necessary dependent upon each
other. On the other hand, in spite of the various similarities, both the techniques differ from
each other in certain respects.
(1) System of budgetary control may be operated even if no standard costing system is in
use in the concern.
(2) Budgets are the ceilings or limits on expenses above which actual expenditure should
not normally exceed and if it does, the planned profits will be reduced. Standard costs
are minimum targets to be attained by the actual performance.
(3) Budgets may be prepared in the various areas of activities like sales, production,
purchases, capital investment etc. Whereas standard costing specifically relates to the
function of production and manufacturing costs.
(4) A more searching analysis is required to be made in case of standard costing variances
than in case of budgetory control variances. Variances in case of budgets may point out
efficiency or inefficiency. But variances in case of standard costing provide material for
further probe and investigation.
(5) The scope of standard costing is much wide than that of budgetary control. Adherence
to budgeted performance may indicate that the business is out of difficulties. A genuine
attempt to attain the standards always provides the scope for improved performance.
(6) Budgets are based upon the future or estimated costs which may be used for forecasting
the requirements of various factors of production like material, labour, finance etc. Standard
costs are planned or ideal costs under the ideal situations as to operating efficiency,
capacity level attainment and so on. Standard costs may not be necessarily useful for
forecasting purposes.
Before the standard costing system is established in an organization, the following preliminaries
will have to be complied with.
As explained before, a cost centre is any unit with respect to which the costs will be
ascertained. If the standard costing system is to be implemented, the cost centres
should be defined very clearly so that the responsibility can be fixed in case of non
standard performance.
As the standard costing essentially involves the process of comparing the actual
performance to standard performance and computation of variances therefrom, the
accounts should be designed in such a way that the information about the actual
performance is available as correctly as possible and as speedily as possible. For this
purpose, the codification of accounts may be considered.
This is probably the most critical part of the implementation of standard costing i.e. to
establish the standards with respect to the individual elements of cost i.e. Direct Material
Cost, Direct Labour Cost and Overheads. It is necessary to exercise maximum care
while establishing the standards as wrongly established standards may defeat the purpose
of standard costing.
(a) Study of technical and operational details of the organization like the manufacturing
process, levels of managements and their responsibilities, units and nature of inputs and
outputs, details regarding wastes and losses, expected efficiency and capacity utilization
etc.
(c) Decision about the types of standards to be used. It may be noted that there may be
various types of standards.
Basic Standards :
These are established for an unaltered use over a longer period of time and they don’t reflect
the current conditions. These types of standards are not useful from the cost control point of
view and can be used in case of industries where technical processes are fully established or
in case of those types of costs which are fixed in nature viz. rent, remuneration to managerial
personnel etc.
These are established for a shorter period of time and are adaptable to change in current
conditions. As current conditions are likely to change, the current standards are also subject
to revision as per the changes in current conditions.
Ideal Standards :
These are the standards which are set which are attainable under the most favourable conditions
possible and assumes the maximum utilization of various factors of production (like men,
material and machines) which is not practicable and attainable. Thus, the ideal standards are
generally theoretical in nature and the variances always show an unfavorable trend. The basic
limitation of these types of standards is that the constant non achievement of these standards
causes frustration among the staff and the constant reporting of unfavorable variances is
presumed which results into lost impact of system itself.
Expected Standards :
These are the standards which are anticipated to be attained during the budget period. These
are based upon the expected performance based upon the conditions which are likely to
prevail during the budget period. Allowances are provided for the unavoidable deviations from
the ideal performance e.g. Labour time wastage, excess material use, break down of machinery
etc. Thus, these standards are more realistic in nature and are more useful from cost control
point of view.
Normal Standards :
These are the standards which may be anticipated to be achieved in future, over a longer
period of time, considering the past performance. As such, the inefficiencies of the past
performance, if any, get reflected in these types of standards. Further, the problems faced in
estimating the future over a longer period of time also restrict the use of these standards for
cost control purposes.
After the consideration of various types of standards which may be used, the process of
establishment of standards with respect to various elements of costs comes into operation.
As discussed above, the standards may be set for the various elements of costs i.e. Direct
Material Cost, Direct Labour Cost and Overheads.
Setting the Standard Cost for Direct Material, involves two stages i.e. To decide Price
Standard and to decide Use Standard.
Along with the basic prices, it may involve the consideration of the factors like discount,
packing charges, insurance, sales tax, octroi etc. It may be the primary responsibility of the
Purchase Department to supply the details required for this purpose.
Use Standard :
It may be the primary responsibility of Engineering or Design Department to supply the details
required for this purpose, on the basis of standard bill of material.This may involve the process
of product study. Sufficient provisions should be made for unavoidable scrap or wastages.
Setting the standard cost for Direct Labour involves two stages i.e. To decide the wage
rate standard and to decide Labour Efficiency standard.
(i) The system of wages payments prevailing i.e. Piece Rate Wages or Time Rate Wages
(iii) The provisions of agreements with workers covering a future period of time.
(iv) Provisions of various laws and guidelines governing the fixation of wage rates
(v) Grades of workers required and likely trends of market conditions in respect of availability
thereof.
(ii) Time and motion study considering the details in respect of an average worker as the
base.
(ii) Estimation of standard level of activity ( in terms of labour hours, machine hours or
units of production)
(iii) Estimation of standard overhead absorption rate which may be decided as below.
Thus, the standard absorption rate may be per unit of production, per labour hour or per
machine hour.
For better control purposes, the standards for overhead cost may be decided separately for
fixed overheads and variable overheads, as fixed overbeads are normally uncontrollable at the
lower level of management.
(a) For effective cost control, the organizational structure should be clearly defined and
responsibility of each individual should be clearly defined.
(b) The reports reporting the variances should be simple, clear and quick.
(c) The computation and analysis of variances in respect of each element of cost
should be accurate. A wrong analysis of variances may result into misleading
conclusions.
(d) For more effectiveness, the variances should be segregated as controllable variances
and non controllable variances. However, the analysis of uncontrollable variances
should be made with the same care as in case of controllable variances.
(e) The reporting of variances should contain a comparison with the planned results.
ANALYSIS OF VARIANCES :
As stated earlier, the process of standard costing involves the establishment of standard
costs and the computation of actual costs under each element of cost and the comparison
between standard costs and actual costs. The difference between standard cost and actual
cost is termed as ‘Variance’. If the actual cost is less than the standard cost, the variance is
a favourable variance. If the actual cost is more than the standard cost, the variance is a
unfavorable or adverse variance. The utility of standard costing as a technique of cost control
is not complete only by the computation of variances unless these variances are further
analysed as to the causes responsible for these variances. The basic objective of variance
analysis is to classify the variances as controllable and uncontrollable ones E.g. If material
actually used is in excess of standard quantity or if time actually taken by the workers is more
than standard time, the variance will be an unfavorable one for which the responsibility can be
assigned on the executives concerned. However if the variances occur due to general strike,
general increase in wage rates, devaluation of currency, change in customers’ demands etc.,
the variances will be uncontrollable ones for which no responsibility can be assigned to any
executive. By concentrating most on controllable and adverse variances, it is possible for the
management to exercise control through exception which is the basic objective of standard
costing. Thus, the stress can be laid on variances only and no further action will be necessary
in cases where standard costs are matching with the actual costs, provided that the conditions
underlying the fixation of standards remain unchanged.
The variances arising in one period may be compared with a variances in the previous period
for a better control.
Thus a detailed analysis of variances, specifically the controllable ones, as to the causes
leading to these variances, and the corrective actions required to be taken to reduce these
variances enables the management to exercise proper cost control. However, it does not
mean that the favourable variances need no investigation. A constant occurrence of favourable
variance may indicate incorrect fixation of standards that need to be revised. A constant
favourable variance may be due to a genuine improvement in performance or due to the
manufacture of sub- standard products.
It is the difference between standard material cost and actual material cost. It may be
further analysed as -
(i) Material Price Variance
(ii) Material Usage Variance
It’s that portion which is due to difference between standard price specified and actual
price paid. It is calculated as -
(3) Rush order to meet shortage of supply or purchase in less favourable market.
From the above, it can be seen that the responsibility for this type of variance may be
normally placed on Purchase Department. However, there may be some situations where
the responsibility for this type of variance can not be placed on purchase department.
E.g. When the purchases are made in uneconomic quantities due to the lack of working
capital.
It is that portion which is due to the difference between standard quantity specified and
actual quantity used. It’s calculated as -
(10) Change in the composition of material mix. If more than one materials are mixed to
get the final product, any change in the standard mix may result into material
usage variance. It may arise in case of textile, chemical, rubber industries etc.
(11) Change in the yield. If a certain amount of standard output is expected from some
inputs, any variance in actual output may result in material usage variance. It may
arise in case of processing industries.
The material usage variances may further be analysed in the following ways:
As stated above, it is that part of usage variance which may arise due to change in the
standard composition of material mix where more than one materials are required to be
mixed together to get the final product. This may be a peculiar feature of the industries
like textile, chemical, rubber etc. The actual mix of materials may be different than the
standard mix due to non - availability of specified material. Increased proportion of costly
material in the mix results into adverse materials mix variance and vice-versa.
As stated above, it is that part of usage variance which may arise due to difference
between standard yield expected and the actual yield obtained, where a certain specified
yield is expected from a given input of materials. This may be a peculiar feature of the
processing industries. A low actual yield indicates consumplion of materials in excess
of standards set resulting into an adverse variance and vice versa.
Illustration : I
Solution :
∴ 5,400 - 5,320
= 80 (Favourable)
When total input is 1,200 Kgs, the Materials A,B, and C are mixed in the proportion of 500
Kgs,, 400 Kgs and 300 Kgs. respectively. When total input is 1,300 Kgs. the materials should
have been mixed in the following proportion.
500
Material A = X 1300 = 541.67 Kgs.
1200
400
Material B = X 1300 = 433.33 Kgs.
1200
300
Material C = X 1300 = 325.00 Kgs.
1200
5 (220 - 130)
= 450 (adverse)
Check :
It is the difference between standard direct wages specified and actual wages paid. It is further
analysed as -
(i) Wage/Labour Rate Variance : It is that portion which is due to difference between
standard pay of wages specified and actual rate paid. It is calculated as -
(2) Variation due to different grades of workers and their wages differing from those
specified.
(3) Use of different methods of payment e.g. Actual payment on time basis whereas
standards are set on piece rate basis.
(7) Composition of gang as regards the skill and rates of wages different than specified
standards.
(ii) Labour Efficiency Time Variance : It is that portion which is due to difference between
standard labour hours specified and the actual labour hours expended.
It is calculated as :
(3) Delays due to waiting for materials, tools, instructions etc, if not treated as idle
time.
(7) Basic inefficiency of workers due to lack of morale, insufficient training, faulty
instructions etc.
(9) Operations not provided for and booking them under direct wages.
The labour efficiency variance may be further analysed in the following manner.
(a) Idle Time Variance : It is the standard cost of actual hours recorded as idle time due to
abnormal circumstances like strike, lock out, power failure, machinery breakdown etc. It is
calculated as -
This type of variance is normally calculated separately and not kept only as a part of efficiency
variance, as the employees should not be blamed for inefficiency when the idle time arises
due to circumstances beyond their control, say power failure. It is needless to state that this
variance is always unfavorable and needs further investigation as to the causes for abnormal
idle time.
It indicates that part at efficiency variance which arises due to change in Actual Gang of labour
from that of Standard Gang of labour if various grades of labour are included in a gang and if
certain grades of labour are not available. It is calculated as :
Where the revised standard hours indicate the actual labour hours divided in the ratio of
standard hours. It should be noted that if the idle time variance is calculated separately, the
idle time hours should be excluded from actual total hours in standard ratio.
In many cases, this variance is calculated separately which indicates the effect on labour cost
of actual yield or output being different from standard yield or output.
In numerical terms, it is equal to revised efficiency variance i.e. after separating Mix Variance
and Idle Time Variance from Efficiency Variance, which is calculated as -
Illustration 2 :
Following details are available from the records of A Ltd. for a month regarding the standard
labour hours and rates of an hour for a product
The actual production for the product was 1,500 units for which the actual hours worked and
rates were as below.
Solution :
Standard Actual
Hours Rate per Hr. Total Hours Rate per Hr. Total Rs.
Skilled 15,000 3.00 45,000 13,500 3.50 47,250
Semi-Skilled 12,000 1.50 18,000 12,600 1.80 22,680
Unskilled 24,000 1.00 24,000 30,000 1.20 36,000
51,000 87,000 56,100 1,05,930
The analysis of overheads variances is different and the most complex task than the calculation
of material and labour variances. It is so due to the fact that establishment of a standard
overhead absorption rate is difficult as a part of total overheads is fixed, which affects the
overhead absorption rate with the change in volume.
It should be noted in this connection that the overhead absorption rate can be computed in the
following way.
As the overheads can be either the variable overheads or fixed overheads, the overhead cost
variances may be seperately calculated for variable overheads and fixed overheads.
It is that amount of overheads which change directly with the level of activity and per unit
variable overheads remain constant. As such, the variable overheads are not affected with the
change in volume of operations.
The common method of analyzing the variable overheads variances is shown in the chart
below.
It is the difference between standard overheads cost absorbed and actual overheads
cost incurred. It is calculated as -
It is the difference between the standard allowance for the output achieved and actual
overheads cost incurred.
It is calculated as -
It is due to the difference between budgeted efficiency of production and actual efficiency
attained. It is calculated as -
Standard Hourly
Rate X [ Standard Hours for
Actual production
– Actual Overheads
In modern times, especially in the days of rapid mechanization of production processes, the
fixed overheads form a major portion of the production cost. As such, it is necessary that the
management is properly informed about the standard fixed overheads or any deviations
therefrom. The common method of analyzing the fixed overheads variances is shown in the
chart below.
As each of the above variances can be computed either on the basis of units of production or
on the basis of hours. We will first study the nature of the above variances and then the
methods of computation.
It is the difference between the total standard overheads cost absorbed in the output
achieved and the total actual overheads cost. Thus, it can be seen that the overheads
cost variance is simply the under or over absorption of overheads.
It is the difference between the standard allowance for the output achieved and the actual
overheads cost incurred.
(2) Change in the labour rates for indirect workers or change in the grade of indirect
workers.
It is that protion of the overhead variance which is due to the difference between the
budgeted level of output and the actual level of output.
It will not be out of place to mention here that in case of the variable overheads, per unit
or per hour overheads remain constant and are not affected by the change in the level of
output. As such, volume variance does not arise in case of variable overheads.
It is that portion of the overhead variances, as a part of volume variance, which is due to
the difference between budgeted efficiency of production and the actual efficiency attained.
The causes of this variance may be as below.
It is that portion of the overhead variances, as a part volume variance, which is due to the
working at higher or lower capacity than standard.
(3) Abnormal idle time due to the reasons like power failures, strikes, lock outs etc.
It is that portion of overhead variances, as a part of volume variance, which is due to the
difference between the number of working days in the budget period and the actual
number of working days in the period in which the budget is applied.
Calender Variance arises only if there is abnormal increase or decrease in the number of
working days, as the normal holidays are already considered while setting the standard.
Thus, the declaration of an unexpected day as holiday may result into calender variance.
As discussed earlier, the fixed overheads variances may be computed on the basis of units of
production or on the basis of hours.
ILLUSTRATION 3 :
Budget Actual
July 1986
No of working days 25 27
Production in Units 20,000 22,000
Fixed overheads in Rs. 30,000 34,000
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were
31,500.
Solution :
Check :
Working Note :
(A)
Budgeted overheads are Rs.30,000, while budgeted fixed overhead rate is Rs. l per hour.
Therefore, budgeted hours are 30,000, while budgeted production is 20,000 units. It
means that one unit requires 1.5 hours.(standard) As actual hours worked are 31.500,
the standard production in those many hours will be -
31,500
= 21,000 Units
1.5
(3) Revised Budgeted Production is calculated as below.
Budgeted Number of working days are 25 while budgeted production is 20,000 units. It
means that standard production in one day is -
20,000 Units
= 800 Units
25 days
As actual number of working days is 27, the standard production in those many days will
be -
800 units x 27 days = 21,600 units
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were
31,500.
Solution :
Check :
Working Notes :
(2) Budgeted Hours are known to be 30,000 for the Budgeted production of 20,000 units,
indicating that standard time required for one unit is 1 1/2 hours.
If the actual production is 22,000 units, the standard time required for actual production
will be 33,000 hours.
(3) The budgeted number of working days are 25 and budgeted hours are 30,000, indicating
that the standard hours available in one day are 1,200.
If the company has actually worked for 27 days, the revised budgeted hours will be
32,400 i.e. 1,200 hours per day x 27 days.
SALES VARIANCES :
While standard costing principles are mainly applied in the area of costs i.e. Material cost,
Labour cost and overheads cost, some companies calculate the sales variances also which is
the difference between budgeted sales and actual sales and its impact on profits.
The common method of analysing sales variances under this method is shown in the
chart below.
Where -
Standard Sales are actual quantity sold at budgeted price. Revised Budgeted sales
are standard sales rearranged in the budgeted ratio.
It is that portion of sales volume variance, which may arise due to the difference between
standard value of actual sales at standard mix and budgeted sales. It is calculated as -
Revised Standard Sales - Budgeted Sales.
Illustration 5 :
Standard Actual
Product Qty. Sale Price Total Qty. Sale Price Total
Rs. Rs. Rs. Rs.
A. 500 5 2,500 500 5.40 2,700
B. 400 6 2,400 600 5.50 3,300
C. 300 7 2,100 400 7.50 3,000
1200 7,000 1500 9,000
Solution :
(A)
Where standard sales are actual quantity at standard price and Revised standard sales are
standard sales rearranged in budgeted ratio.
2500
A - X 100 = 35.71%
7000
B - 2400
X 100 = 34.29
7000
C - 2100
X 100 = 30%
7000
Check :
Sales Value Variance = Sales Price Variance + Sales Mix Variance + Sales Quantity Variance
This method of sales variances measures the effect of actual sales and budgeted sales on
profit. As this method does not consider the cost variances, all costs are assumed to be
standard costs. The common method of analysing sales variances under this method is
shown in the chart below.
Illustration 6 :
Costs per unit of A, B and C were Rs. 40, Rs. 88 and Rs.60 respectively.
STANDARD SALES :
ILLUSTRATIVE PROBLEMS
Material Standard
X 40 kgs. at Rs. 6 240
Y 60 kgs. at Rs. 4 240
480
Material Actual
X 600 kgs. at Rs. 4
Y 400 kgs. at Rs. 6
Actual output is 70% of input i.e. 700 units. Process loss is 30%.
Solution :
Check :
Notes :
If the actual output is 700 units, the standard input for the same will be -
700 X 100
= 875 kgs.
80
The standard proportion of the materials is 40% for X and 60% for Y. As such, for the
standard input of 875 kgs, the standard proportion will be -
Total input is 1000 kgs. The standard proportion of the materials is 40% for X and 60%
for. Y. As such, the revised standard quantity should have been -
Solution :
∴ 79,000 - 88,450
= 9,450 (A)
Note : The standard mix is calculated as below. When total input is 8000 kgs. Chemicals A,
B and C are mixed in the proportion of 1500 kgs, 2500 kgs and 4000 kgs respectively. When
total input is 8500 kgs, the chemicals should have been mixed in the following proportion.
1500
Chemical A - X 8500 = 1593.75 kgs.
8000
2500
Chemical B - X 8500 = 2656.25 kgs.
8000
4000
Chemical C - X 8500 = 4250 kgs.
8000
The normal volume of activity is 10,000 hours. During a period 8,750 hours were utilised for a
total overhead expenditure of Rs. 28,750 of which fixed overheads totalled to Rs. 5,250. The
standard utilisation of labour should have been less by 5%.
Solution :
From the variation of total overheads, it is noted that for the variation of 1,000 hours. The
overheads very to the extent of Rs. 2,500. Thus, indicates that the rate of variable overheads
is Rs. 2.50 per hour. At the normal level of activity, the distribution of overheads will be as
below.
[Standard Hours for Actual Production - Actual Hours] x Standard Hourly Rate
= 450 (F)
Notes :
(a) Total overheads cost actually incurred is Rs. 28,750 out of which fixed overheads are
Rs. 5,250. Hence, balance is variable overheads i.e.
Actual overheads are Rs. 23,500. As the standard hourly rate is Rs.2.50 per hour, the
ideal hours should have been
Rs. 32,500
= 9,400
Rs. 2.50
Hence, standard hours will be 95% of 9,400 hours i.e. 8,930 hours.
(d) Revised budgeted overheads for Actual Hours are worked out as below.
Actual hours are 8,750 and standard hourly rate is Rs. 2.50 per hour.
Hence, the revised budgeted overheads should have been Rs. 21,875 i.e. 8,750 x 2.50.
Notes :
Rs. 5,000
= Rs. 0.50 per hour
10,000
Actual Overheads are Rs. 5,250. As the standard hourly rate is Rs, 0.50 per hour, the
ideal hours should have been 10,500.
However, standard utilisation should have been less by 5%. Hence, standard hours will
be 95% of 10,500 hours i.e. 9,975 hours.,
(d) As the details of capacity variation due to the change in the number of working days is
not known, calender variance cannot be calculated. As such, the calculation of capacity
variance is made on the basis of comparison between actual hours and budgeted hours.
Check :
(4) The sales manager a company engaged in the manufacture and sale of three products P,
Q and R gives you are following information for the month of October 1982.
Budgeted Sales :
Where standard sales are actual quantity at standard price and revised standard sales
are standard sales rearranged in budgeted ratio.
QUESTIONS
Differentiate between Standard Costing and Budgetary Control as cost control techniques.
state the advantages and limitations of standard costing.
What preliminaries will have to be complied with before introducing the technique of
standard costing.
3. Describe the procedure of establishing standard costs in the area of materials cost,
labour cost and overheads cost.
4. What do you mean by variances and variance analysis. Explain the various factors
affecting the variances in the area of materials cost, labour cost and overheads cost.
During the period 100 tones of chemical X were produced from the usage of
35 tonnes of material A for a cost of Rs.9,000 per tonne
42 tonnes of material B for a cost of Rs. 6,000 per tonne
53 tonnes of material C for a cost of Rs. 7,000 per tonne
2. Mixers Ltd. is engaged in producing a standard mix using 60 kgs. of chemical X and 40
kgs of chemical Y. The standard loss of production is 30%. The standard price of X is
Rs.5 per kg. and of Y is Rs. 10 per kg.
The actual mixture and yield were as follows.
X 80 kgs. @ Rs. 4.50 per leg and
Y 70 kgs @ Rs.8.00 per kg.
Actual yield 115 kgs.
Calculate material variances (Price, Usage, Yield, Mix)
3. Given that the cost standards for material consumption are 40 kgs at Rs. 10 per kg.,
compute the variance when the actuals are
a. 48 kgs @ Rs. 10 per kg.
b. 40 kgs @ Rs. 12 per kg.
c. 48 kgs @ Rs. 12 per kg.
d. 36 kgs @ Rs. 10 per kg.
4. The standard cost of material for manufacturing a unit of a particular product FEE is
estimated as follows.
On completion of the unit, it was found that 20 kgs of raw material costing Rs.1.50 per
kg. has been consumed. Compute material variances (price, usage, cost)
Material Used.
6. In a factory 100 workers are engaged and the average rate of wages is 50 paise. Standard
working hours per week are 40 and the standard performance is 10 units per gang hour.
During a week in March, wages paid for 40 workers were at the rate of 50 paise per hour,
10 workers at 70 paise per hour and 40 workers at 40 paise per hour. Actual output was
380 units.
Factory did not work for 5 hours due to breakdown of machinery. Calculate appropriate
labour variances
7. The standard cost of a unit shows the following costs of material and labour
5,700 units of the product were manufactured during the month of March 1987 with the
following material and labour costs.
8. The standard labour component and the actual labour component engaged in a week for
a job are as under.
10. From the following data of A Co. Ltd. relating to budgeted and actual performance for the
month of March 87, compute the Direct Material and Direct Labour cost variances.
11. The following details relating to the Product X during the month of March 1989 are available.
You are required to compute the material and labour cost variance and also to reconcile
the standard and the actual cost with the help of such variances.
13. Dustfree Products manufactures and sells a patented vaccum cleaner for domestic use
and the following data is available for October 1983.
Actual Standard
Direct Labour hours 10,500 10,000
(10 hrs. per unit)
Direct Labour cost (Rs.) 21,500 2.10 per hour
Direct Material (Tonnes) 550 540
Direct Material cost (Rs.) 52,250 100 per Tonne
Actuals Budgeted
(For October) (For the year)
Overheads: Fixed 6,200 72,000
Variable (varies with volume 15,200 216,000
of production)
Overhead is budgeted for normal activity of 1,44,000 hours of direct labour per annum,
equally phased.
14. The budgeted and actual sales of a concern manufacturing and marketing a single product
are furnished below.
Standard Actual
Product Nos. Rate (Rs.) Rs. Nos. Rate (Rs.) Rs.
A 5,000 5 25,000 6,000 6 36,000
B 4,000 6 24,000 5,000 5 25,000
C 3,000 7 21,000 4,000 8 32,000
12,000 70,000 15,000 93,000
18. Budgeted and actual sales for a month of two products A and B were as below
Budget Actual
Units Unit Price Units Unit Price
Rs. Rs.
A 3,000 10.00 2,500 10.00
1,000 9.50
B 5,000 2.00 4,000 2.00
1,200 1.90
Budgeted costs for the products A and B were Rs.8 and Rs. 1.50 respectively. Work out
the following variances.
(a) Sales Value Variance
(b) Sales Volume Variance
(c) Sales Price Variance
(d) Sales Mix Variance
(e) Sales Qunatity Variance
20. The records of an engineering company indicate the following for the month of April 1986
(1) Production during the month of April 1986 has been 6,500 units with no beginning
or ending work in progress inventories.
(2) Materials purchased 32,000 gallons @ Rs. 1.18 per gallon. Used in production
25,600 gallons.
(3) Labour hours worked 20,000. Average hourly wage rate Rs. 1.75
Calculate material variances, labour variances and total variance for factory overheads.
21. A factory supplies the following figures of production and overheads for September 1983
Budgeted Actual
Production (Units) 50,000 52,000
Variable overheads (Rs.) 4,00,000 4,10,000
Fixed overheads (Rs.) 6,00,000 6,20,000
Number of hours 2,00,000 2,20,000
Work out the variances that are involved.
It refers to the use of same costing principles and methods by several undertakings. It’s not a
separate method of cost accounting but only a particular technique which applies the usual
accounting methods like process costing, job costing, standard costing, budgetory costing
and marginal costing. Main feature of uniform costing is that whenever a particular method of
costing is applied it is applied uniformly in a number of concerns in the same industry or even
different but similar industries. This enables cost and accounting data of the member undertakings
to be compiled on a comparable basis so that useful and crucial decisions can be taken. It
attempts to establish uniform methods so that comparison of performances in the various
undertakings can be made to the common advantages of all the constituent units.
(i) In single organisation having a number of branches, each of which may be a separate
manufacturing unit. In this case, the head office controls the operations of the uniform
costing methods.
(ii) In a number of concerns in the same industry bound together through a trade association
or otherwise. In this case, the procedure for uniform costing may be devised and controlled
by the association or any other central body prescribed for this purpose.
(iii) In industries which are similar such as gas and electricity, cotton, jute and woolen
textiles.
(1) There should be a spirit of mutual trust and policy of give and take.
(5) There should be no rivalry, competition or sense of jealousy among the members.
(1) Uniform costing is a useful tool for management control. Performances of individual units
can be measured against norms set for the industry as a whole.
(2) It avoids cut throat competition by ensuring that competition among the members will
proceed on healthy lines.
(3) Weaker units in the industry can take the advantage of the efficient methods of production
and production control of better managed units so as to increase their own efficiency.
(4) The fruits of the research and development programmes which can be carried out only by
the bigger units, may be shared by the smaller units.
(5) By showing one best way of doing things, it creates cost consciousness and provides
the best system of cost control or cost presentation in the entire industry.
(6) Prices based on uniform costing may be taken to be reliable and representative of the
whole industry. This creates customer confidence and improves relations between
customer and business.
(7) It assists in educating the less informed units as regards the cost accounting methods.
(8) In India, where public undertakings operate alongwith the private sector undertakings,
uniform costing enables a comparitive assessment to be made of the two sectors.
(9) Uniform costing enables the furnishing of suitable statistics to the Government wherever
called upon to do so. This may be required by Government for effective price control or to
give protection or subsidy to a particular industry etc.
(10) It simplifies the work of wage boards set up to fix minimum wages and fair wages for an
industry.
(1) The practices and methods followed by various units in the industry may vary from one
unit to another. The factors for such differences like location, age, capital investment and
condition of plant, degree of mechanisation etc. may be so wide from each other that to
have a uniform costing system suitable for big as will as small units becomes impossible.
(2) For small units, cost of installation and operation of uniform costing system may not be
commensurate to the advantages therefrom.
(3) If some reservations are made while giving certain information by some units or if some
information is withheld on the grounds of secrecy or privacy, the statistics presented
cannot be relied upon.
(4) It may create conditions which are likely to develop monopolistic tendencies within the
industry. Prices may be raised arbitrarily and supplies curtailed.
Considering the basic nature of uniform costing as discussed above, it goes without saying
that the success of uniform costing system depends upon the extent to which uniformity can
be brought about in various areas. The various areas in which uniformly can be attempted to
be brought are as discussed below.
(1) Method of cost accounting to be implemented viz. job costing, process costing, unit
costing and so on.
(2) Costing Techniques employed i.e. marginal costing, standard costing etc.
(3) Methods of pricing the issues from stores. viz. FIFO, LIFO, Weighted Average and so
on.
(6) Method followed for charging depreciation viz. written down value, straight line etc.
(8) Treatment given to certain specific types of costs like bonus, idle time wages and so on.
(9) Methods for apportionment and absorption of overheads and treatment given to under or
over absorption of overheads.
(12) Definition of the term capacity for setting overhead absorption rates.
It is a document which lays down the cost accounting plans and procedures to be followed by
the constituent units. This document once circulated among the constituent units helps to
guide them to formulate their system of accounting in such a way that the principles of uniform
costing can be uniformly and correctly applied.
(1) Introduction : This part may state the objects and purposes of uniform cost system,
advantages derived therefrom and the cooperation expected from constituent units.
(2) Organisation : This part may include the organisation for establishing and running the
uniform cost system. E.g. whether the system is to be established and run by outside
cost consultants or by those internal to the various constituent units.
(3) Cost Accounting System : This part includes accounting systems and procedures to
be followed lo bring about uniformity E.g. classification and codification of accounts,
definition of a cost centre and cost unit, relationship between cost and financial accounting,
items to he included in or excluded from cost accounting, collection of various costs viz.
material, labour and overheads and so on.
(4) Presentation of information : This part may include the forms and contents of various
cost and financial ratios, presentation of various production and operation costs and so
on.
(5) Miscellaneous : This part may include any of their information to be communicated to
the constituent units but not included in any of the above mentioned sections.
3. What do you mean by Uniform Costing? What are the various advantages and
disadvantages of Uniform Costing? State the pre-requisites for the success of Uniform
Costing. Explain the various areas where uniform costing can be used.