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Introduction:
Accounting may be broadly classified into two categories – accounting which is
meant to serve all parties external to the operating responsibility of the firms and the
accounting which is designed to serve internal parties who take care of the operational needs
of the firm. The first category which is conventionally referred to as financial accounting,
looks to the interest of those who have primarily a financial stake in the organization’s affairs
– creditors, investors, employees etc. On the other hand the second category of accounting is
primarily concerned with providing information relating to the conduct of the various aspects
of a business like cost or profit associated with some portions of business operations to the
internal parties viz., management. This category of accounting is called as Management
accounting.
In order to perform the primary task of decision making managers of business
enterprises need information about the past, present and future in the functional areas of
management such as personnel, finance, marketing and production. Right decision making
has to be based on quantitative and qualitative information. The management thus constantly
needs accounting information to base its decisions upon. Thus management accounting
provides the information needed by management personnel.
Definition:
The Institute of Chartered Accountants of England has defined management
accounting as: “Any form of accounting which enables a business to be conducted more
efficiently can be regarded as Management Accounting”.
As per American Accounting Association, “Management Accounting includes the
methods and concepts necessary for effective planning, for choosing among alternative
business actions and for control through the evaluation and interpretation of performances.
As per Institute of Chartered Accountants of India, “Such of its techniques and
procedures by which accounting mainly seeks to aid the management collectively have come
to be known as management accounting”.
The Chartered Institute of Management Accounts (UK) defines management
accounting as under:
“Management accounting is an integral part of management concerned with identifying,
presenting and interpreting information used for:
1. Formulating strategy
2. Planning and controlling activities
3. Decision making
4. Optimizing the use of resources
5. Disclosures to shareholders and others external to the entity
6. Disclosure to employees
7. Safeguarding assets.”
Cost: Cost means the amount of expenditure incurred on a particular thing. CAS-1 (Cost
Accounting Standard 1, issued by the ICWA, India) defines Cost as: Cost is a measurement,
in monetary terms, of the amount of resources used for the purpose of production of goods or
rendering services.
Costing: Costing means the process of ascertainment of costs. Costing involves the following
steps (i) Ascertaining or collecting costs (ii) Analysing or classifying costs into basic
elements such as Material, Labour, Expenses etc. and (iii) Allocating total costs to a
‘particular thing’ i.e. a product, a contract or a process. Thus cost can now be defined as the
total expenditure, duly classified into materials, labour, expenses etc. allocated to a particular
product or contract or process.
Cost Accounting: The Institute of Cost and Management Accountant, England (ICMA) has
defined Cost Accounting as – “the process of accounting for the costs from the point at which
expenditure incurred, to the establishment of its ultimate relationship with cost centres and
cost units. In its widest sense, it embraces the preparation of statistical data, the application of
cost control methods and the ascertainment of the profitability of activities carried out or
planned”.
Cost accounting is a term broader than costing. It covers costing plus the reporting and
control of costs. Thus Cost Accounting = Costing + Cost Reporting + Cost Control. Cost
accounting can be defined as the technique of recording, classification, allocation, reporting
and control of costs.
1. To the management and the owners: Cost accounting helps the management of the
concern to ascertain the cost and profitability of each individual product / service/
contract/ process/ division/ branch separately. This also helps in valuation of the
closing stock of goods at the end of the year. It helps the management of the concern
in controlling costs in reducing the avoidable expenditure, and minimizing wastages
and losses. It ensures the reconciliation of quantity of input with the quantities of
output, wastages and scrap. The management is thus able to regulate and monitor the
movement of materials thus preventing theft and loss of materials during processing
and handling. It is of great help to the management in taking several decisions such
as, which products to produce more, how much to produce, whether to make or buy a
component, what price to charge or quote. Thus cost accounting is an invaluable
decision aid to decision making. It also facilitates in preparation of budgets and
implementation of budgetary control in the organization. The end result of all the
above advantages of cost accounting is maximization of profits of the concern thus
benefiting the owners by increasing their net worth or the share prices, higher
dividends etc.
2. To the workers: Cost accounting has an elaborate system of assessing the performance
of workers and rewarding them suitably through incentives and bonus. The increase in
profits due to a cost accounting system also leads to higher remuneration and bonus to
the workers.
3. To the Government / Consumers / Public: In case the products are under price control,
cost accounting furnishes the data required by the government for fixing fair prices.
Consumers benefit since the prices fixed on the basis of the cost data are just and
reasonable and cannot be too high. It also leads to efficiency and productivity in the
industrial sector. It ensure optimum utilization of the scarce economic resources of the
country. Cost accounting leads to maximum profits for an organization. Naturally the
Government also gains by way of more taxes on production, income and sales etc.
The higher revenue is used by the Government for public welfare and economic
development.
However, proper planning and implementation of the cost accounting system will overcome
these criticisms and would stand null and void in view of the objectives, importance and
advantages of the cost accounting system.
All types of manufacturing concerns can broadly be classified into two categories – (i) Mass-
production concerns, (ii) Special order concerns. Mass production concerns such as chemical
plants, flour mills, paper manufacturing, tyre and rubber companies etc., produce uniform
standard products and involve generally a continuous production process. The finished
products are the result of successive operations. On the other hand, special-order concerns
manufacture products in clearly distinguishable lots in accordance with special orders and
individual specifications. Printing shops, construction companies, machine tool
manufacturing, repair shops, wood-working shops etc., come in this category. In case of mass
production concerns the products when produced are of the same type, and involve the same
material and labour and pass through the same set of process. In such industries each process
is designated as a separate cost-centre and the cost per unit is calculated by dividing total cost
of the process with the total number of units produced by the process. The cost of production
of the product is obtained by adding the unit costs of various processes through which the
product has passed. This method of costing is known as process costing.
Job Costing:
In case of special-order concerns products produced or jobs undertaken are of diverse nature.
They involve materials and labour in different quantities and entail different amounts of
overhead costs. In such concerns it is necessary to keep a separate record of each lot of
products or jobs from the time the work on the job or product begins till it is completed. A
separate job card or sheet is maintained for each job or product in which all expenses of
materials, labour, overheads are entered and cost of completing a job or manufacturing a
product is found out. Such a cost system is known as job or terminal or specific costing.
Procedure:
The following is the procedure adopted for costing purposes in a concern using job costing:
1. Job order number: Every order received is allotted a certain number from a running
list maintained for this purpose. Every order or job will be known by its number
throughout its production process in the factory.
2. Production / job order: A production / job order is a written order issued to the
manufacturing department to proceed with a job. It is issued by the production
planning department on receipt of a job order to the foreman of the relevant
department. Instructions to the costing department to collect particulars of costs on
execution of the job are also issued simultaneously. The production order is prepared
with sufficient copies for all the departmental managers or foreman who will be
required to take any part in the production.
3. Bills of materials: The production and planning department also prepares a list of
materials and stores required for the completion of the job. A copy is also sent to the
concerned foreman with the production order which serves as an authority to him for
collecting the materials and stores mentioned from the storekeeper. On the same
pattern a list of tools required is also prepared.
4. Job cost card: Job cost card or job cost sheet is the most important document used in
the job costing system. A separate card or cost sheet is maintained for each job in
which all expenses regarding materials, labour and overheads are recorded directly
from costing records. The method of finding out the cost of these elements in respect
of a particular order is as follows.
a. Materials: The information regarding cost of materials or stores used for a
particular job order can be obtained from materials or stores requisition slips.
In case of large job orders, materials abstracts can be prepared for finding out
the total value of materials issued to different jobs.
b. Labour: The cost of labour incurred on each job can be ascertained with the
help of time and job cards. In case of a large number of jobs, preparation of
wages abstract may considerably help in computing the amount paid as wages
for completion of specific jobs. Wages paid for indirect labour will constitute
an item of factory overheads.
c. Overheads: Every job will be charged with amount of overheads determined
on the basis of the method selected for allocation of overheads. Normally on
the basis of past results an overhead rate is determined and each job is charged
for overheads at the pre-determined rate.
Profit or loss on a job can also be found out by preparing a job account. The job
account is debited with all expenses incurred on the job and is credited with the
job price. The difference of the two sides will be the profit or loss made or
suffered on the job.
5. Work-in-process: The account is maintained in the cost ledger and it represents the
jobs under production. The account may be maintained in any of the following two
ways depending upon the requirements of the business:
a. A composite work-in-process account for the entire factory.
b. A composite work-in-process account for every department. For example, if
the factory has three departments A, B and C, a work-in-process for each of
these three departments will be opened.
The work-in-process account is periodically debited with all costs direct and
indirect incurred in execution of the jobs. At intervals of month or so a summary
of completed jobs is prepared and the work-in-process account is credited with the
cost of completed jobs. In case work-in-progress account for each department of
the factory has been opened, it will be necessary to find out the cost of completed
jobs regarding each department. The balance in work-in-process account at any
time represents the cost of jobs not yet completed.
6. Job ticket: In order to provide information regarding the progress of each job at each
operation, generally a job ticket is issued by the production control department. The
ticket contains detachable portions for different operations. The job ticket is useful for
both production control and costing departments. On completion of an operation, the
relevant portion of ticket is detached and sent to production control department. This
enables production control department in keeping production schedule up-to-date. On
the basis of detached portion a departmental summary of production can be prepared
which is very useful for costing purposes. Moreover, the amount of work-in-process
as shown by the cost ledger can be checked by listing the ticket number of jobs in
process in any department and valuing this list.
7. Progress advice: The foreman of a department may be required to send periodically a
statement regarding the stage of completion of each job to ensure completion of jobs
by scheduled dates. Such a note is called “progress advice”.
Batch Costing:
Batch costing is a modified form of job costing. While job costing is concerned with costing
of jobs that are executed against specific orders of the customers, batch costing is used where
articles are manufactured in definite batches. The articles are usually kept in stock for selling
to customers on demand. The term batch refers to the lot in which the articles are to be
manufactured. Whenever a particular product is required, one unit of such product is not
produced but a lot of say 500 or 1000 units of such product are produced. It is therefore also
known as “Lot Costing”. This method of costing is used in case of pharmaceutical or drug
industries, ready-made garment factories, industries manufacturing component parts of radio
sets, television sets, watches, etc.
The costing procedure for batch costing is similar to that under job costing except with the
difference that a batch becomes the cost unit instead of a job. Separate job cost sheets are
maintained for each batch of products. Each batch is allotted a number. Material requisitions
are prepared batchwise, the direct labour is engaged batchwise and the overheads are also
recovered batchwise. Cost per unit is ascertained by dividing the total cost of a batch by
number of items produced in that batch. Ordinary principles of inventory control are used.
Production orders are issued only when the stock of finished goods reaches the ordering
level. In case the batches are repetitive, the costing work is much simplified.
Since in batch costing production is done in batches and each batch consists of a number of
units, the determination of optimum quantity to constitute an economical batch is all the more
important. Such a quantity can be fixed on the basis of same formulae and principles as are
applicable to economic order quantity of materials.
Standard costing is defined as – “the preparation and use of Standard Costs, their comparison
with actual costs and the analysis of variance as to their causes and point of incidence.
ICWA London had defined Standard Costing as – “the preparation of Standard Costs and
applying them to measure the variations of actual costs from standard costs and analyzing the
causes of variations with a view to maintain maximum efficiency in production”.
Material Variances:
1. Material Cost Variance [MCV]
It is the difference between the standard cost of material specified for the output
achieved and the actual cost of direct material used. It is said to be favourable when
standard cost is more than actual cost and adverse when actual cost exceeds standard
costs. It is further divided into Material Usage Variance and Material Price Variance.
MCV = SC – AC
= (SQ x SP) – (AQ x AP)
4. Verification
Material Cost Variance = Material Usage Variance + Material Price Variance
i.e. MCV = MUV + MPV
Labour Variances:
LCV = SC – AC
= (SH x SR) – (AH x AR)
4. Verification
Labour Cost Variance = Labour Efficiency Variance + Labour Rate Variance
i.e. LCV = LEV + LRV
Standard Costing
1. Given the cost standard for material consumption are 40 kg. @ Rs. 10 per kg.
Compute the material variances when actuals are:
a. 48 kg @ Rs.10 per kg.
b. 40 kg @ Rs.12 per kg.
c. 48 kg @ Rs. 12 per kg.
d. 36 kg for a total cost of Rs.360.
2. Gemini chemical industries provide the following information from their records. For
making 10 kgs of GEMCO standard material requirement is :
Material Quantity (kg) Rate per kg(Rs.)
A 8 6.00
B 4 4.00
During April 1000 kg of GEMCO were produced. The actual consumption of
materials is as under:
Material Quantity (kg) Cost (Rs.)
A 750 5250
B 500 2500
Calculate material variances
4. The standard cost card for one unit of a product shows the following costs for material
and labour:
Material 4 pieces @ Rs. 5.00 and Labour 10 hours @ Rs.1.50
5700 units of product were manufactured during the month of March 2002 with the
following material and labour costs:
Material 23000 pieces @ Rs.4.95 and Labour 56,800 hours @ Rs.1.52
Calculate material and labour variances.
Concepts
1. Sales: This is the total amount of sales made by the firm or entity.
2. Variable cost: This is the cost of the product that keeps changing with the change in
the volume of production.
3. Contribution: It is equal to Sales less variable cost. This is the profit before adjusting
the Fixed Costs. It covers fixed cost and profit.
4. Fixed cost: It is the cost of the product that does not change over a period even with
the change in the volume of production.
5. Profit: It is equal to contribution less fixed costs. This is the profit after adjusting the
fixed costs. Thus, it does not include fixed cost.
6. Profit Volume Ratio: The ascertainment of the impact of changes in volume of output
on profit is done by means of the Profit – Volume Ratio.
Profit – volume ratio [PV Ratio] = Contribution
Sales
Sales, variable cost and contribution vary directly with the number of units. Thus,
when the number of units produced or sold increases, the sales, the variable cost and
the contribution also increase pro-rata. On the contrary, when the number of units
goes down, the sales, the variable cost and contribution are also lower. Thus there is a
direct relationship between volume, variable cost and contribution. This is known as
the volume-cost-profit relationship. The profit-volume ratio indicates this relationship.
7. Break Even Point: It means the point of no profit and no loss. BEP is the volume of
output or sales at which the total cost is exactly equal to the revenue. Below BEP the
concern makes losses, at the BEP, the concern makes neither profit nor loss, above
BEP, the concern earns profits. BEP is calculated in terms of units or value. Thus
BEP (in units) = Fixed Cost = F
Contribution per unit S–V
1. S. Ltd. furnishes you the following information relating to the half year ending 30 th
September 2007. Fixed expenses Rs.50,000, sales value Rs.2,00,000 and Profit
Rs.50,000. During the second half of the same year the company, has projected a loss of
Rs.10,000. Calculate:
a. PV ratio, break-even point and margin of safety for six months ending 30th
September 2007.
b. Expected sales volume for second half of the year assuming that selling price and
fixed expenses remain unchanged in the second half year also.
c. The break-even point and margin of safety of the whole year 2007-08.
2. A company had incurred fixed expenses of Rs.2,25,000 with sales of Rs.7,50,000 and
earned a profit of Rs.1,50,000 during the first half-year. In the second half-year, it
suffered a loss of Rs.75,000. Calculate:
a. The PV ratio, BEP, margin of safety of the first half-year
b. Expected sales-volume for the second half year assuming that selling price and
fixed expenses remained unchanged during the second half-year.
3. A retail dealer in garments is currently selling 24,000 shirts annually. He supplies the
following details for the year ended 31st December 2007.
Selling price per shirt Rs.40
Variable cost per shirt Rs.25
Fixed cost:
Staff salaries for the year Rs.1,20,000
General office costs for the year Rs.80,000
Advertising costs for the year Rs.40,000.
As a management accountant of the firm, you are required to answer each of the
following independently.
a. Calculate the BEP and margin of safety in sales revenue and number of shirts
sold.
b. Assume that 20,000 shirts were sold in a year. Find out the net profit of the
firm.
c. If it is decided to introduce selling commission of Rs.3 per shirt, how many
would require to be sold in a year to earn a net income of Rs.15,000.
d. Assuming that for the year 2008 an additional staff salary of Rs.33,000 is
anticipated and price of a shirt is likely to be increased by 15% what should be
the BEP in number of shirts and sales revenue?
Direct Wages per hour is Rs.5. Comment on the profitability of each product (both
products need the same raw materials) when:
i. Total sales potentials in units is limited.
ii. Total sales potential in value is limited.
iii. Raw materials are in short supply.
iv. Production capacity (in terms of machine hours) is the limiting factor.
Assuming raw materials as the key factor, availability of which is 10,000 kg. and
maximum sales potential of each product being 3,500 units, find the product mix
which will yield the maximum profit.
6. 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 are as under:
Variable costs per unit Rs.50 Fixed costs per month Rs.10
lakhs.
Prepare a table to present the results of the above proposals and give your comments and
advice on the proposals.
A Process means a distinct manufacturing operation or stage. In process industries, the raw
material goes through a number of processes in a sequence before the finished product is
finally produced. For example, production of coconut oil involves the following distinct
processes: 1. Copra crushing 2. Refining and 3. Finishing.
Process costing is defined as “a method of costing used to ascertain the cost of the product at
each stage or operation of manufacture..”
Important calculations
1. Normal loss = Input x % of normal loss
2. Normal output = Input – Normal loss
3. Unit Cost = Cost of process – Sale value of Normal loss
Input – Normal loss
4. Abnormal loss = Normal Output – Actual output
5. Abnormal gain = Actual output – Normal output
6. Cost of actual output = Unit cost x Units of Actual Output
7. Cost of Abnormal Loss = Unit cost x Units of Abnormal Loss
8. Cost of Abnormal Gains = Unit cost x Units of Abnormal Gains
Problems:
1. Assemblers Ltd. have three Assembly shops viz., General Assembly, Lower
Assembly. The Company furnished the following information.
2. A product passes through three processes A, B and C. 10,000 units at a cost of Rs.
1.10 per
Unit were issued to Process A. The other direct expenses were as follows.
Management expenses were Rs. 15,000, selling expenses were Rs. 10,000. Two-third
output of Process A and one-half output of Process B are passed on the next process
and the balance was sold.
You are required to prepare process cost accounts and costing Profit and Loss
Account for the year 2001.
CHAPTER 6: BUDGETARY CONTROL
Controlling costs by making use of budgets is known as budgetary control. Budgetary control
and standard costing together help in achieving the two important functions of management
viz; planning and control.
Budget is a plan quantified in monetary terms, prepared and approved prior to a definite
period of time, usually showing planned income to be generated and / or expenditure to be
incurred during that period and the capital to be employed to attain a given objective. Budget
may also be prepared in quantitative terms. For example Production Budget, Plant utilization
budget etc. Budget is a plan showing expected achievement based on most efficient operating
standards. Against this actual accomplishment is regularly compared.
Budgetary control is a system of planning and controlling costs which involves the following
steps.
1. Establishment of budgets: Functional budgets are prepared based on responsibilities
of individuals. These budgets are then co-ordinated to prepare budgeted P&L A/c and
budgeted balance sheet.
2. Measurement of actual performance.
3. Comparison of actual performance with budgeted performance to develop variances.
4. Analysis of causes of variance and reporting for immediate action.
Problems:
2. Maya Limited has made the following sales estimates for April, May and June of
the year 2009 from which you are required to prepare sales budget by units and
rupees for each of the three months for each sales area and in total
Sales Area April May June
A 40% 30% 30%
B 45% 35% 20%
C 40% 35% 25%
D 30% 40% 30%
The area-wise unit sales expected is as follows:
Sales Area Sales (Units)
A 2,500
B 2,000
C 3,000
D 6,000
Total 13,500
The selling price has been fixed at Rs.6 per unit in Area A, Rs.8 per unit in Area B,
Rs.12 per unit in Area D and Rs.10 per unit in Area C.
3. Calculate the budgeted overhead cost per tonne at production level of 35 tonnes
based on the following details at 80% capacity (40 tonnes)
Particulars Rs. in ‘000
Depreciation 22
Indirect labour 24
Insurance 6
Power (80% variable) 40
Repairs and maintenance (50% fixed) 40
Salaries 20
Stores consumable 8
Also prepare budget for overhead cost at 100% capacity utilization.
4. Prepare Cash budget of Sandeep Ltd. for the months of April, May and June,
2007
Month Sales Purchases Wages Expenses
January 1,60,000 90,000 40,000 10,000
February 1,60,000 80,000 36,000 12,000
March 1,50,000 84,000 44,000 12,000
April 1,80,000 1,00,000 48,000 14,000
May 1,70,000 90,000 40,000 12,000
June 1,60,000 70,000 36,000 10,000
You are informed that:
a. 50% of the purchases and sales are on cash.
b. The average collection period of the company is ½ month and credit purchases
are paid off regularly after 1 month.
c. Time lag in payment of wages is 1 month.
d. Rent of Rs.1000 is payable every month.
e. Cash and bank balance as on 31st march, 2007 was Rs.3,00,000.
f. Dividend received in May Rs.36,000.
g. Professional fees to be paid in June Rs.1,500.
h. Expenses are paid in the same month.