CLASSIFICATION
OF COSTS: Manufacturing
We first
classify costs according to the three
elements of cost:
a)
Materials b) Labour c) Expenses
Product and Period Costs: We also
classify costs as either
1
Product costs: the costs
of manufacturing our products; or
2
Period costs: these are
the costs other than product costs that are charged to,
debited to, or written off to the
income statement each period.
The classification of Product Costs:
Direct costs: Direct costs are generally seen
to be variable costs and they are called direct costs because they are directly
associated with manufacturing. In turn, the direct costs can include:
- Direct materials: plywood, wooden battens, fabric for the seat
and the back, nails, screws, glue.
- Direct labour: sawyers, drillers, assemblers, painters,
polishers, upholsterers
- Direct expense: this is a strange cost that many texts don't
include; but (International Accounting Standard) IAS 2, for example,
includes it. Direct expenses can include the costs of special
designs for one batch, or run, of a particular set of tables and/or
chairs, the cost of buying or hiring special machinery to make a limited
edition of a set of chairs.
Total direct costs are collectively known as Prime Costs and we can see that
Product Costs are the sum of Prime
costs and Overheads.
Indirect Costs: Indirect costs are those costs that are incurred in
the factory but that cannot be directly associate with manufacture. Again
these costs are classified according to the three elements of cost, materials
labour and overheads.
- Indirect materials:
Some costs that we have included as direct materials would be included
here.
- Indirect labour: Labour costs of people who
are only indirectly associated with manufacture: management of a
department or area, supervisors, cleaners, maintenance and repair
technicians
- Indirect expenses:
The list in this section could be infinitely long if we were to try to
include every possible indirect cost. Essentially, if a cost is a
factory cost and it has not been included in any of the other sections, it
has to be an indirect expense. Here are some examples include:
Depreciation of
equipment, machinery, vehicles, buildings
Electricity, water, telephone, rent,
Council Tax, insurance
Total indirect costs are collectively known as Overheads.
Finally, within Product Costs, we have Conversion Costs: these are the costs
incurred in the factory that are incurred in the conversion of materials into
finished goods.
The classification of Period Costs:
The scheme shows five sub classifications for
Period Costs. When we look at different organisations, we find that they
have period costs that might have sub classifications with entirely different
names. Unfortunately, this is the nature of the classification of period costs;
it can vary so much according to the organisation, the industry and so
on. Nevertheless, such a scheme is useful in that it gives us the basic ideas
to work on.
Administration Costs:
Literally the costs of running the administrative aspects of an
organisation. Administration costs will include salaries, rent, Council
Tax, electricity, water, telephone, depreciation, a potentially infinitely long
list. Notice that there are costs here such as rent, Council Tax, that
appear in several sub classifications; in such cases, it should be clear that
we are paying rent on buildings, for example, that we use for manufacturing and
storage and administration and each area of the business must pay for its share
of the total cost under review.
Without wishing to overly extend this listing now,
we can conclude this discussion by saying that the costs of Selling, the costs of Distribution and the costs of Research are all accumulated in a
similar way to the way in which Administration Costs are
accumulated. Consequently, our task is to look at the selling process and
classify the costs of running that process accordingly: advertising, market
research, salaries, bonuses, electricity, and so on. The same applies to
all other classifications of period costs that we might use.
Finance Costs: Finance costs are those
costs associated with providing the permanent, long term and short term
finance. That is, within the section headed finance costs we will find
dividends, interest on long term loans and interest on short term loans.
Finally, we should say that we can add any number
of subclassifications to our scheme if we need to do that to clarify the ways
in which our organisation operates. We will also add further
subclassifications if we need to refine and further refine out cost analysis.
COST SHEET – FORMAT
|
Particulars
|
Amount
|
Amount
|
|
Opening Stock of Raw Material
Add: Purchase of Raw materials
Add: Purchase Expenses
Less: Closing stock of Raw Materials
Raw
Materials Consumed
Direct
Wages (Labour)
Direct
Charges
|
***
***
***
***
***
***
***
|
|
|
Prime cost (1)
|
|
***
|
|
Add :- Factory Over Heads:
Factory
Rent
Factory
Power
Indirect
Material
Indirect
Wages
Supervisor Salary
Drawing
Office Salary
Factory
Insurance
Factory
Asset Depreciation
|
***
***
***
***
***
***
***
***
|
|
|
Works cost Incurred
|
|
***
|
|
Add: Opening Stock of WIP
Less: Closing Stock of WIP
|
***
***
|
|
|
Works cost (2)
|
|
***
|
|
Add:- Administration Over Heads:-
Office
Rent
Asset
Depreciation
General
Charges
Audit
Fees
Bank
Charges
Counting
house Salary
Other
Office Expenses
|
***
***
***
***
***
***
***
|
|
|
Cost of Production (3)
|
|
***
|
|
Add: Opening stock of Finished Goods
Less: Closing stock of Finished Goods
|
***
***
|
|
|
Cost of Goods Sold
|
|
***
|
|
Add:- Selling and Distribution OH:-
Sales
man Commission
Sales
man salary
Traveling
Expenses
Advertisement
Delivery
man expenses
Sales
Tax
Bad
Debts
|
***
***
***
***
***
***
***
|
|
|
Cost of Sales (5)
|
|
***
|
|
Profit (balancing figure)
|
|
***
|
|
Sales
|
|
***
|
Notes:-
1)
Factory Over Heads are recovered as a percentage of direct wages
2)
Administration Over Heads, Selling and Distribution Overheads are recovered as
a percentage of works cost.
MATERIAL
1)
Reorder level = Maximum usage * Maximum lead time
(Or) Minimum level
+ (Average usage * Average Lead time)
2)
Minimum level = Reorder level – (Average usage * Average lead time)
3)
Maximum level = Reorder level + Reorder quantity – (Minimum usage *
Minimum lead time)
4)
Average level = Minimum level +Maximum level (or)
2
Minimum level +
½ Reorder quantity
5) Danger level (or) safety stock level
=Minimum usage * Minimum lead time
(preferred)
(or) Average usage * Average lead
time
(or) Average usage * Lead time for
emergency purposes
6)
EOQ (Economic Order Quantity - Wilson
Where A = Annual usage units
O = Ordering cost per unit
C = Annual carrying cost of one unit
i.e. Carrying cast % *
Carrying cost of unit
7)
Associated cost = Buying cost pa + Carrying cost pa
8)
Under EOQ Buying cost = Carrying cost
9)
Carrying Cost = Average inventory * Carrying cost per unit pa * Carrying cost %
(Or) Average Inventory * Carrying cost per
order pa
10)
Average inventory = EOQ/2
11)
Buying cost = Number of Orders * ordering cost
12)
Number of Orders = Annual Demand / EOQ
13)
Inventory Turnover (T.O) Ratio = Material consumed
Average Inventory
14)
Inventory T.O Period = 365 .
Inventory Turn over Ratio
15)
safety stock = Annual Demand *(Maximum lead time - Average lead time)
365
16)
Total Inventory cost = Ordering cost + Carrying cost of inventory +Purchase
cost
17)
Input Output Ratio = Quantity of input of material to production
Standard material content of actual output
Remarks
:-
1)
High Inventory T.O Ratio indicates that the material in the question is fast
moving
2)
Low Inventory T.O Ratio indicates over investment and locking up of working
Capital in inventories
Pricing
of material Issues:-
1)
Cost price method:-
a)
Specific price method
b) First in First Out method (FIFO)
c) Last in First Out method (LIFO)
d) Base stock method
2)
Average price method:-
a) Simple average price method = Total unit price
Total No. of purchases
b) Weighted average price method = Total cost
Total No. of units
c) Periodic simple average price method =
Total unit price of certain period
Total Number of
purchases of that period (This
rate is used for all issues for that period. Period means a month (or) week (or)
year)
d) Periodic weighted average price method =
Total cost of certain period
Total Number of units of that period
e) Moving simple average price method
= Total of periodic simple
average of certain number of periods
Number of periods
f) Moving weighted average price method
= Total of periodic weighted
average of certain number of periods
Number of periods
3)
Market price method:-
a) Replacement price method = Issues are
valued as if it was purchased now at
current market price
b) Realizable price method = Issues are valued
at price if it is sold now
4)
Notional price method:-
a) Standard price method = Materials are
priced at pre determined rate (or)
Standard rate
b) Inflated price method = The issue price
is inflated to cover the losses incurred
due to natural(or)climatic losses
5)
Re use price method = When materials are returned (or) rejected it is valued at
different price. There is no final
procedure for this method.
ABC
Analysis (or) Pareto Analysis :- In this materials are categorized into
Particulars Quantity Value
“A”
– Important material 10% 70%
“B”
– Neither important nor unimportant
20% 20%
“C”
– UN Important 70%
10%
Note:-
1)
Material received as replacement from supplier is treated as fresh supply
2)
If any material is returned from Department after issue, it has to be first
disposed in the next issue of material
3)
loss in the book balance of stock and actual is to be transferred to Inventory
adjustment a/c and from there if the loss
is normal it is transferred to Over Head
control a/c. If it is abnormal it is
transferred to costing profit and loss a/c.
4) CIF = Cost Insurance and Freight (This
consignment is inclusive of prepaid
insurance and freight)
5)
FOB = Free on Board (Materials moving by sea – insurance premium is not paid)
6)
FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid
by the company or purchase)
7)
For each receipt of goods = Goods Receipt note
8)
For each issue of goods = Materials Requisition note (or) Material Issue note
Accounting
Treatment :-
1)
Normal Wastage = It should be distributed over goods output increasing per unit
cost
2)
Abnormal Wastage= It will be charged to costing profit and loss a/c
3)
Sale
4)
Sale
5)
Sale
6)
Normal Defectives = cost of rectification of defectives should be charged to
specific
7)
Abnormal Defectives = This should be charged to costing profit and loss a/c
8)
Cost of Normal spoilage is to borne by good
units
9)
Abnormal spoilage should be charged to costing profit and loss a/c
LABOUR
Method
of Remuneration:
1)
Time Rate system
a) Flat time Rate
b) High wage system
c) Graduated time rate
2)
Payment by Results
a) Piece rate system
i) Straight piece rate
ii) Differential piece rate
·
Taylor
·
Merrick
system
b) Group Bonus System
i)
Budgeted Expenses
ii)
Towne gain sharing scheme
iii)
Cost efficiency bonus
iv)
Priest man system
c) Combination of Time and Piece rate
i)
Gantt task and Bonus scheme
ii)
Emerson Efficiency system
iii)
Point scheme
·
Bedaux system
·
Haynes manit system
d) Premium bonus plans
i)
Halsey premium plan
ii)
Halsey weir premium plan
iii) Rowan scheme
iv)
Barth scheme
v)
Accelerating premium bonus scheme
e) Other incentive schemes
i)
Indirect monetary incentive
·
Profit sharing
·
Co-partnership
ii) Non-Monetary Incentive
1)
Time rate system = Hours worked * Rate per hour (Basic wages)
2)
Piece rate system:
i) Straight piece rate earnings = Number of
units produced * Rate per unit
ii) Differential Piece rate
a)
F.W.Taylor’s differential rate
system
» 83%
of piece rate when below standard
» 125%
of piece rate when above or at standard
b)
Merrick
differential or multiple piece rate system
Efficiency level Piece rate
» up to 83% »Normal
piece rate
» 83% to 100% » 110% of Normal
rate
» Above 100%
» 120% of Normal rate
iii) Gantt Task and Bonus system
Output Payment
» Below standard » Time rate (guaranteed)
» At standard » 20% Bonus of
Time rate
» Above standard » 120% of ordinary piece
rate
iv) Emerson’s Efficiency system
Efficiency Payment
» Below 66.7% » Hourly Rate
» from 66.7% » Hourly rate (+) increasing bonus
according to degree
to 100% of efficiency on
the basis of step bonus rates
» Above 100% » Hourly rate
(+) 20% Bonus (+) additional bonus of 1%
of hourly rate for every 1% increase in
efficiency
v) Halsey Premium Plan = Basic wages + 50%
of time saved * Hourly Rate
vi) Halsey Weir Premium Plan = Basic wages
+ 30% of time saved * Hourly rate
vii) Rowan Plan = Basic wages + Time
saved * Basic Wages
Time allowed
viii) Bedaus Point system = Basic wages +
75% * Bedaus point/60 * Rate/hr
ix) Barth’s System = Hourly rate * √Std
time *Time taken
Labour
Turnover:-
1)
Separation rate method = Separation
during the period
Average No. of worker’s
during the period
2)
Net labour T.O rate (or) Replacement method
= Number of replacements
Average No. of worker’s during the period
3)
Labour flux rate = No. of separation + No. of replacement
Average No.
of worker’s during the period
Accounting
Treatment
1)
Normal Idle time = Charged to factory overheads
2) Normal but un-controllable = It should be
charged to job by inflating wage rate.
3) Abnormal = It should be charged to costing P
& L a/c
OVER HEADS
Reapportionment
of service department expenses over production department
:-
1)
Direct redistribution method:
- Service
department costs are divided over production department.
- Ignore
service rended by one dept. to another
2)
Step method of secondary distribution (or) Non reciprocal method:
- Service
department which serves largest number of service department is divided
first and go on.
3)
Reciprocal service method:
i) Simultaneous equation method (or)
Algebraic method
- Equation is
formed between service departments and is solved to find the amount due.
ii) Repeated distribution method:
- Service
department cost separated repeatedly till figure of service dept. is
exhausted or too small.
iii) Trial and Error method:
- Cost of
service department is apportioned among them repeatedly till the amount is
negligible and the total is divided among production department.
Treatment
of Over/Under absorption of overheads:-
i)
If under absorbed and over absorbed overheads are of small value then it should
be
transferred to costing profit and loss a/c
ii)
If under and over absorption occurs due to wrong estimates then cost of product
manufactured should be adjusted
accordingly.
iii)
If the same accrued due to same abnormal reasons the same should be transferred
to costing profit & loss a/c
Apportionment
of overhead expenses – Basis
a)
Stores service expenses = Value of materials consumed
b)
Factory rent = Floor area
c)
Municipal rent, rates and taxes = floor area
d)
Insurance on Building and machinery = Insurable value
|
e)
|
Welfare
department expenses
|
|
|
f)
|
Supervision
|
Number
of employees
|
|
g)
|
Amenities
to employee’s
|
|
|
h)
|
Employees
liability for insurance
|
|
j)
Lighting power = Plug point
k)
Stores over heads = Direct material
l)
General over heads = Direct wages
Reapportionment
of service department cost to production department
:-
1)
Maintenance dept. = Hours worked for each dept.
2)
Pay roll and time keeping = Total labour (or) machine hours (or) Number of
employees in each department
3)
Employment (or) Personnel department = Rate of labour T.O (or) No. of employees
of each department
4)
Stores Keeping department = No. of requisitions (or) value of materials of each
department
5)
Purchase department = No. of purchase orders value of materials of each department
6)
Welfare, ambulance, canteen, service, recreation room expenses = No. of employees in each department.
7)
Building service department = Relative area each dept.
8)
Internal transport service (or) overhead crane service = weight, value graded
product handled, weight and distance traveled.
9)
Transport department = Crane hours, truck hours, truck mileage, Number of packages.
10)
Power house (electric power cost) = Housing power, horse power machine
hours, No. of electric points etc.
11)
Power house = Floor area, cubic content.
RECONCILATION
OF COST AND FINANCIAL A/C
Causes
of differences:-
1)
Purely financial items :
i) Appropriation of profits ►Transferred
to reserves, goodwill, preliminary
expenses, dividend paid etc.
ii) Loss on sale of investment, penalties
and fines
iii) Income ►
Interest received on Bank deposits, profit on sale of investments,
fixed assets,
transfer fees.
2)
Purely cost account items: - Notional Rent / Interest / Salary
3)
Valuation of stock:-
i) Raw-material = In financial a/c’s stock
is valued at cost or market value
Whichever is less,
while in cost a/c’s it is valued at LIFO, FIFO etc.
ii) Work in progress = In financial a/c’s
administrative expenses are also
considered while valuing stock, but in cost a/c’s it may be
valued
at prime (or) factory cost (or) cost of production
iii) Finished Goods = In financial a/c’s
it is valued at cost or market price
whichever is less, in
cost a/c’s it is valued at total cost of production.
4)
Overheads: In financial = Actual
expenses are taken
In cost = Expenses are taken at predetermined
rate.
5)
Depreciation: In financial = Charged in
diminishing or fixed balance method
In cost = Charged in machine hour rate
6)
Abnormal Gains: In financial = Taken to profit & Loss a/c
In cost = Excluded to cost a/c’s or charged in
costing
profit
& Loss a/c
JOB AND
BATCH COSTING
With job costing, we are
dealing with one off situations. We are dealing with organisations that carry
out functions and services on a one at a time basis. Good examples of job
costing situations include jobbing builders: the builder who will provide a
householder, or a shop owner, or a factory owner with a service that he
provides for no one else. The jobbing builder will build an extension, or
renovate some property to a design that will probably not be copied anywhere
else at any time: it is a one off job. Job costing can apply in non
manufacturing situations as well as in manufacturing situations.
Even though many jobbing
enterprises are small scale, we are not suggesting that all jobbing enterprises
are small scale enterprises. An engineering shop may be working on a job for a
customer that takes several months and many man and machine hours to complete.
Here
are two definitions:
A
job is “A customer order or task of relatively
short duration”
Job costing is “A form of specific order costing; the attribution of cost to jobs”
Job costing is “A form of specific order costing; the attribution of cost to jobs”
Batch
costing is not normally seen as much of an advance on job costing.
A batch is A group of similar articles which maintains
its identity throughout one or more stages of production and is treated as a
cost unit Batch costing is A
form of specific order costing; the attribution of costs to batches.
Economic
Batch Quantity = EBQ = √2AS/C
Where A = Annual Demand
S = Setting up cost per batch
C= Carrying cost / unit of
production.
PROCESS
COSTING
Format
of process a/c
|
Particulars
|
Unit
|
Rate
|
Rs.
|
Particulars
|
Unit
|
Rate
|
Rs.
|
|
To
Direct material
|
|
|
|
By
|
|
|
|
|
To
Direct Labour
|
|
|
|
By
Units transferred
to
other process
|
|
|
|
|
To
Indirect material
|
|
|
|
||||
|
To
Other Expenses
|
|
|
|
By
Abnormal loss (B/F)
|
|
|
|
|
To
Abnormal gain(B/F)
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Total
|
|
|
|
Format
of Abnormal loss
|
Particulars
|
Unit
|
Rs.
|
Particulars
|
Unit
|
Rs.
|
|
To
Process a/c
|
|
|
By
|
|
|
|
|
|
|
By
costing P & L a/c
|
|
|
|
Total
|
|
|
Total
|
|
|
Format
of Abnormal gain a/c
|
Particulars
|
Units
|
Rs.
|
Particulars
|
Units
|
Rs.
|
|
To
|
|
|
By
Process a/c (names of different process)
|
|
|
|
To
costing P&la/c
|
|
|
|||
|
Total
|
|
|
Total
|
|
|
1)To
find the cost per unit for valuation of units to be trans. to next process and
also for abnormal, loss or gain = Total
process cost – Salvage value of normal spoilage
Total units introduced –
Normal loss in units
2)
To find abnormal loss (or) gain (all in units):
= Units from previous process + fresh
units introduced – Normal loss – units
transferred to next process (If the result is positive then abnormal loss. If
negative then abnormal gain)
3)
In case of opening WIP and closing WIP are given then there are different
methods of valuation of closing WIP
i) FIFO Method
ii) LIFO Method
iii) Average Method iv) Weighted Average
Method
4)
Various statements to be prepared while WIP is given:
i) Statement of equivalent production
ii) Statement of cost
iii) Statement of apportionment of
cost
iv) Process cost a/c
5)
FIFO Method: In these method total units transferred to next process
includes
full opening stock
units and the closing stock includes the units
introduced during
the process. In this method the cost incurred
during the process
is assumed as to be used
a) First to complete the units already in
process
b) Then to complete the newly introduced
units
c) For the work done to bring closing
inventory to given state of completion
6)
LIFO Method = Cost incurred in process is used for:
a) First to complete newly introduced
units
b) Then to complete units already in
process in this method closing stock is
divided into two :
i) Units which represent opening stock but lie at the end of the period
ii) Newly introduced units in closing stock.
7)
Average Method: In this method
a) No distinction is made between opening
stock and newly introduced material.
b) In finding cost per unit, cost incurred
for opening stock is also to be added with
current cost. (This addition is not
done in LIFO & FIFO method as cost
incurred in
that process is only taken)
8)
Weighted average method: This method is only used when varied product in
processed through a
single process. General procedure is adopted here.
a) Statement of weighted average
production should be prepared. Under this
statement output of each products is
expressed in terms of points.
b)
Cost of each type of product is
computed on basis of Points.
Points
of vital importance in case of Abnormal Gain / Loss:
a)
Calculate cost per unit by assuming there is no abnormal loss / gain
b)
Cost per unit arrived above should be applied for valuation of both abnormal
Loss/gain units and output of the process.
c)
Separate a/c for both abnormal loss/gain is to be prepared.
JOINT
PRODUCT AND BY PRODUCT COSTING
Methods
of apportioning joint cost over joint products
:
1)
Physical unit method = Physical base to measure (i.e.) output quantity is used
to separate joint cost. Joint cost can be separated on the basis of ratio of
output quantity. While doing this wastage is also to be added back to find
total quantity.
2)
Average unit cost method = In this method joint cost is divided by total units
Produced of all products and average cost per unit is arrived and is multiplied
With number of units produced in each product.
3)
Survey method or point value method = Product units are multiplied by points or
weights and the point is divide on that basis.
4)
Standard cost method = Joint costs are separated on the basis of standard cost
set for respective joint products.
5)
Contribution margin method = Cost are divided into two categories (i.e.)
variable and fixed. Variable costs are separated on unit produced. Fixed on the
basis of contribution ratios made by different products.
6)
Market value method:-
a) Market value at the point of separation:
Joint cost to sales revenue percentage is found which
is called as multiplying factor = Joint
cost *
100
Sales Revenue
- Joint cost
for each product is apportioned by applying this % on sales revenue of
each product.
- Sales
revenue = Sales Revenue at the point of separation.
- This method
cannot be done till the sales
revenue at the separation point is given.
b) Market value after processing: Joint
cost is apportioned on the basis of total sales Value of
each product after further processing.
c) Net Realizable value method = Form sales
value following items are deducted
i) Estimated profit margin
ii) Selling and distribution expenses
if any included.
iii) Post split off cost
The resultant amount is net realizable
value. Joint cost is apportioned on this basis.
Bi-product
→ Method of
accounting
- Treat as other income in profit and loss a/c
- Net Realizable value of Bi-product is reduced from cost of
main product.
- Instead of standard process, Standard cost or comparative
price or re-use price is credited to joint process a/c.
OPERATION
COSTING
Service costing is “A cost
accounting method concerned with establishing the costs of services rendered”.
Service costing is also applied within a manufacturing setting.
The Differences Between Product Costing and Service
Costing?
- There may be very few, if any, materials to worry about
- Overheads will comprise the most significant portion of any costs
of which, labour costs may well comprise as much as 70%
|
No.
|
|
Cost
per unit
|
|
1.
|
Railways
or bus companies
|
Per
passenger-kilometer
|
|
2.
|
Hospital
|
Per
patient/day, per bed/day
|
|
3.
|
Canteen
|
Meals
served , cups of tea
|
|
4.
|
Water
supply service
|
Per
1000 gallons
|
|
5.
|
Boiler
House
|
1000
kg of steam
|
|
6.
|
Goods
Transport
|
Per
tonne km, quintal km
|
|
7.
|
Electricity
Boards
|
Per
kilowatt – hours
|
|
8.
|
Road
maintenance department
|
Per
mile or road maintenance
|
|
9.
|
Bricks
|
One
thousand
|
|
10.
|
Hotel
|
Per
room/day
|
In this various terms such as passenger km, quintal km,
tonne km, these are all known as composite units and are computed in 2 ways:
a)
Absolute (weighted average): (e.g.) tones km - Multiplying total distance by
respective load quantity.
b)
Commercial (simple average): (e.g.) tonne Km–Multiplying total distance by
average load quantity
All
accumulated cost is classified into 3 categories:
1) Standing charges (or) fixed
cost
2) Running cost (or) variable
cost
3) Maintenance charges (or)
semi variable cost
Running
charges = Fuel, Driver Wages, Depreciation, oil etc.
Maintenance
charges = Supervision salary, Repairs and Maintenance
Note:-
- % of factory
overheads on direct wages
- % of
administration overheads on works cost
- % of selling
& distribution overheads on works cost
- % of profit
on sales
Operating
cost sheet :-
|
|
Particulars
|
Total
cost
|
Cost per km
|
|
A
|
Standing
charges :-
License fees
Insurance Premium
Road tax
Garage rent
Driver’s wages
Attendant-cum-cleaner’s wages
Salaries and wages of other staff
|
|
|
|
|
Total
|
|
|
|
B
|
Running
charges :-
Repairs and maintenance
Cost of fuel (diesel, petrol etc.)
Lubricants, grease and oil
Cost of tires, tubes and other spare parts
Depreciation
|
|
|
|
|
Total
|
|
|
|
C
|
Total
charges [ (A) + (B) ]
|
|
|
CONTRACT
COSTING
Contract costing is “A form of
specific order costing; attribution of costs to individual contracts”.
A contract cost is “Aggregated
costs of a single contract; usually applies to major long term contracts rather
than short term jobs”.
Features of long term contracts:
- By contract costing situations, we tend to mean long term and large
contracts: such as civil engineering contracts for building houses, roads,
bridges and so on. We could also include contracts for building ships, and
for providing goods and services under a long term contractual agreement.
- With contract costing, every contract and each development will be
accounted for separately; and does, in many respects, contain the features
of a job costing situation.
- Work is frequently site based.
We might have problems with contract costing in the
following areas
- Identifying direct costs
- Low levels of indirect costs
- Difficulties of cost control
- Profit and multi period projects
The source of the following has eluded me: my
sincere gratitude for whoever the author might be.
"Contract Costing such jobs take a long time
to complete & may spread over two or more of the contractor's accounting
years”.
Features of a Contract
- The end product
- The period of the contract
- The specification
- The location of the work
- The price
- Completion by a stipulated date
- The performance of the product
Collection of Costs :
Desirable to open up one or more internal job
accounts for the collection of costs. If the contract not obtained, preliminary
costs be written off as abortive contract costs in P&L In some cases a
series of job accounts for the contract will be necessary:
- to collect the cost of different aspects
- to identify different stages in the
contract
Special features
- Materials delivered direct to site.
- Direct expenses
- Stores transactions.
- Use of plant on site
Two possible accounting methods:
Where a plant is purchased for a particular
contract & has little further value to the business at the end of the
contract
Where a plant is bought for or used on a contract,
but on completion of the contract it has further useful life to the business
Alternatively the plant
may be capitalised with Maintenance and running costs charged to the
contract."
Format:-
|
Particulars
|
Rs.
|
Particulars
|
Rs.
|
|
To
Materials
a. Purchased directly
b. Issue from site
c. Supplied by contractee
|
**
**
**
|
By
materials returned
|
**
|
|
By
Material sold (cost price)
|
**
|
||
|
To
Wages and salaries
|
**
|
By
WIP
Work certified
Work Uncertified
|
**
**
|
|
To
Other direct Expenses
|
**
|
||
|
To
Sub-contractor fees
|
**
|
||
|
To
Plant & Machinery (purchase
price/Book value)
|
**
|
By
Materials at site
|
**
|
|
To
Indirect expenditure (apportioned share of overheads)
|
**
|
By
Plant and machinery(WDV)
|
**
|
|
To
Notional profit (Surplus)
|
**
|
|
|
|
Total
|
|
Total
|
**
|
Profit
of Incomplete contract :-
1)
When % of completion is less than or equal to 25% then full Notional profit is
transferred to reserve.
2)
When % of completion is above 25% but less than 50% following amount should be
credited to profit & loss a/c = 1/3 * Notional Profit * {Cash received /
Work certified}
3)
When % of completion is more than or equal to 50% then the amount transferred
to profit is =
2/3 * Notional Profit * {Cash received /
Work certified}
[Balance is transferred to reserve
a/c]
☺ % of completion
= {Work certified/Contract price} * 100
4)
When the contract is almost complete the amount credited to profit & loss
a/c is
a) Estimated total profit * {Work
certified / Contract price}
b) Estimated total profit * {Cash received
/ Contract price}
c) Estimated total profit * {Cost of work
done / Estimated total profit}
d) Estimated total profit*{Cost of work
done*Cash received
Estimated total cost * Work certified}
5)
Work-In-Progress is shown in Balance Sheet as follows:-
Skeleton
Balance sheet
|
Liabilities
|
(RS)
|
Asset
|
(Rs)
|
|
Profit
& loss a/c (will include)
Profit on contract (Specify
the contract number)
Less : Loss on contract
(Specify the contract number)
Sundry
creditors (will include)
Wages accrued
Direct expenses accrued
Any other expenses
(Specify)
|
|
Work-in-progress
Value
or work certified
Cost
of work uncertified
Less
:- Reserve for unrealized profit
Less
:- Amount received from contractee
|
|
6)
Escalation Clause = This is to safeguard against likely change in price of cost
elements rise by and certain % over the
prices prevailing at the time tendering the
contractee has to bear the cost.
MARGINAL
COSTING
Statement
of profit:-
|
Particulars
|
Amount
|
|
Sales
|
***
|
|
Less:-Variable
cost
|
***
|
|
Contribution
|
***
|
|
Less:-
Fixed cost
|
***
|
|
Profit
|
***
|
1)
Sales = Total cost + Profit = Variable cost + Fixed cost + Profit
2)
Total Cost = Variable cost + Fixed cost
3)
Variable cost = It changes directly in proportion with volume
4)
Variable cost Ratio = {Variable cost / Sales} * 100
5)
Sales – Variable cost = Fixed cost + Profit
6)
Contribution = Sales * P/V Ratio
7)
Profit Volume Ratio [P/V Ratio]:-
- {Contribution
/ Sales} * 100
- {Contribution
per unit / Sales per unit} * 100
- {Change in
profit / Change in sales} * 100
- {Change in
contribution / Change in sales} * 100
8)
Break Even Point [BEP]:-
- Fixed cost /
Contribution per unit [in units]
- Fixed cost /
P/V Ratio [in value] (or) Fixed Cost * Sales value per unit
(Sales – Variable cost per
unit)
9)
Margin of safety [MOP]
- Actual sales
– Break even sales
- Net profit /
P/V Ratio
- Profit /
Contribution per unit [In units]
10)
Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit
11)
Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio
12)
At BEP Contribution = Fixed cost
13)
Variable cost Ratio = Change in total cost
* 100
Change in total sales
14)
Indifference Point = Point at which two Product sales result in same amount of
profit
= Change in fixed cost (in units)
Change in variable cost per unit
= Change in fixed cost (in units)
Change in contribution per unit
= Change in Fixed cost (in Rs.)
Change in P/Ratio
= Change in Fixed cost (in Rs.)
Change in Variable cost ratio
15)
Shut down point = Point at which each of division or product can be closed
= Maximum (or) Specific (or)
Available fixed cost
P/V Ratio (or)
Contribution per unit
If sales are less than shut down point
then that product is to shut down.
Note
:-
1)
When comparison of profitability of two products if P/V Ratio of one product is
greater than P/V
Ratio of other Product then it is more
profitable.
2)
In case of Indifference point if Sales
> Indifference point --- Select
option with higher fixed
cost (or) select option with lower fixed
cost.
STANDARD
COSTING
Method
one of reading:-
Material:-
SP * SQ SP
* AQ SP * RSQ AP * AQ
(1) (2)
(3) (4)
a) Material cost variance =
(1) – (4)
b) Material price variance =
(2)–(4)
c) Material usage variance = (1)
– (2)
d) Material mix variance = (3) – (2)
e) Material yield variance = (1) –(3)
Labour
:-
SR*ST SR*AT (paid) SR*RST AR
(1)
(2) (3) (4)
(5)
a) Labour Cost variance = (1)
– (4)
b) Labour Rate variance = (2)
– (4)
c) Labour Efficiency variance = (1) – (2)
d) Labour mix variance = (3)
– (5)
e) Labour Idle time variance = (5)
– (2)
Variable Overheads cost variance :-
SR
* ST SR * AT AR * AT
(1) (2) (3)
a)
Variable Overheads Cost Variance
= (1) – (3)
b)
Variable Overheads Expenditure Variance =
(2) – (3)
c)
Variable Overheads Efficiency Variance
= (1) – (2)
[Where: SR =Standard rate/hour = Budgeted variable OH
Budgeted Hours ]
Fixed Overheads Cost Variance:-
SR*ST SR*AT(worked) SR*RBT SR*BT AR
(1) (2) (3) (4)
(5)
a)
Fixed Overheads Cost Variance
= (1) – (5)
b)
Fixed Overheads Budgeted Variance
= (4) – (5)
c)
Fixed Overheads Efficiency Variance
= (1) – (2)
d)
Fixed Overheads Volume Variance
= (1) – (4)
e)
Fixed Overheads Capacity Variance
= (2) – (3)
f)
Fixed Overheads Calendar Variance
= (3) – (4)
Sales value variance:-
Budgeted Price*BQ BP*AQ BP*Budgeted mix AP*AQ
(1) (2) (3) (4)
a) Sales value variance = (4)–(1)
b)
Sales price variance = (4) – (2)
c)
Sales volume variance = (2) – (1)
d)
Sales mix variance = (2) – (3)
e)
Sales quantity variance = (3) – (1)
Note
:-
i)
Actual margin per unit (AMPU) = Actual sale price – selling cost per unit
ii)
Budgeted margin per unit (BMPU) = Budgeted sale price – selling price per unit
Sales
margin variance :-
BMPU*BQ
BMPU*AQ BMPU*Budgeted mix AMPU*AQ
(1) (2) (3) (4)
a) Sales margin variance = (4) – (1)
b)
Sales margin price variance = (4) – (2)
c)
Sales margin volume variance = (2) – (1)
d)
Sales margin mix variance = (2) – (3)
e)
Sales margin quantity variance = (3)
– (1)
Control
Ratio :-
1)
Efficiency Ratio = Standard hours for actual output * 100
Actual hours worked
2)
Capacity Ratio = Actual Hours Worked * 100
Budgeted Hours
3)
Activity Ratio = Actual hours worked * 100
Budgeted Hours
Verification:
Activity Ratio = Efficiency * Capacity Ratio
STANDARD
COSTING
Method
two of reading:-
Material:-
a) Material cost variance = SC – AC =
(SQ*AQ) – (AQ*AP)
b) Material price variance = AQ (SP –
AP)
c) Material usage variance = SP (SQ – AQ)
d) Material mix variance = SP (RSQ – AQ)
e) Material yield variance = (AY – SY for
actual input) Standard material cost per
unit of output
f) Material revised usage variance
(calculated instead of material yield variance)
=
[standard quantity – Revised standard
for actual output
quantity ] * Standard price
Labour :-
a) Labour Cost variance = SC – AC = (SH*SR)
– (AH*AR)
b) Labour Rate variance = AH (SR - AR)
c) Labour Efficiency or time variance = SR
(SH –AH)
d) Labour Mix or gang composition Variance =
SR(RSH-AH)
e) Labour Idle Time Variance = Idle hours *
SR
f) Labour Yield Variance = [Actual Output –
Standard output for actual input]
* Standard labour cost/unit of output
g) Labour Revised Efficiency Variance
(instead of LYV) =
[Standard hours for actual output – Revised standard hours] * Standard
rate
Notes :- i) LCV = LRV + LMV + ITV + LYV
ii) LCV = LRV + LEV + ITV
iii)
LEV = LMV, LYV (or) LREV
Overhead variance :- (general for both variable and fixed)
a) Standard overhead rate (per hour) = Budgeted
Overheads
Budgeted Hours
b) Standard hours for actual output =
Budgeted hours * Actual Output
Budgeted output
c) Standard OH = Standard hrs for actual output *
Standard OH rate per hour
d) Absorbed OH = Actual hrs * Standard OH rate per
hour
e) Budgeted OH = Budgeted hrs * Standard OH rate per
hour
f) Actual OH = Actual hrs * Actual OH rate per
hour
g) OH cost variance = Absorbed OH – Actual OH
Variable Overheads variance :-
a)
Variable OH Cost Variance =
Standard OH – Actual OH
b)
Variable OH Exp. Variance = Absorbed
OH – Actual Variable OH
c)
Variable OH Efficiency Variance = Standard OH – Absorbed OH
= [Standard hours for –
Actual * Standard rate
actual
output hours] for variable OH
Fixed Overheads variance :-
a)
Fixed OH Cost Variance = Standard OH – Actual OH
b)
Fixed OH expenditure variance = Budgeted OH – Actual OH
c)
Fixed OH Efficiency Variance = Standard OH (units based) – Absorbed OH
(Hours based)
d)
Fixed OH Volume Variance = Standard OH – Budgeted OH
= [Standard hrs for –
Budgeted * standard rate
actual output hours ]
e)
Fixed OH capacity variance = Absorbed OH–Budgeted OH
f)
Fixed OH Calendar Variance = [Revised budgeted hrs – Budgeted hrs]
* Standard rate/hrs
Note:- When there is calendar variance capacity variance is calculated
as follows :-
Capacity
variance = [Actual hours –
Revised * Standard
(Revised) Budgeted hrs] rate/hour
Verification :-
i) variable OH cost variance = Variable OH
Expenditure variance
+ Variable OH Efficiency variance
ii) Fixed OH cost variance = Fixed OH
Expenditure variance + Fixed OH volume
variance
iii) Fixed OH volume variance = Fixed OH
Efficiency variance + Capacity variance
+
Calander variance
Sales variances :-
Turnover method (or) sales value method :-
a) Sales value variance = Actual Sales –
Budgeted Sales
b)
Sales price variance = [Actual Price – Standard price] * Actual quantity
= Actual sales –
standard sales
c)
Sales volume variance = [Actual-Budgeted quantity] *Standard price
= Standard sales – Budgeted sales
d)
Sales mix variance = [Actual quantity – Revised standard quantity] * Standard
price
= Standard sales –
Revised sales
e)
Sales quantity variance = [Revised standard variance – Budgeted quantity]
* Standard price
= Revised
Standard sales – Budgeted sales
Profit
method:-
a) Total sales margin variance = (Actual
Profit–Budgeted price)
= {Actual quantity * Actual profit per
unit}-
{Budgeted quantity * Standard
profit per unit}
b)
Sales margin price variance=Actual profit–Standard profit
= {Actual Profit per unit – Standard
profit per unit} * Actual quantity of sales
c)
Sales margin volume variance = Standard profit – Budgeted Profit
= {Actual quantity – Budgeted
quantity} * Standard profit per unit
d)
Sales margin mix variance = Standard profit – Revised Standard profit
= {Actual quantity – Revised standard
quantity} * Standard profit per unit
e)
Sales margin quantity variance = Revised standard profit - Budgeted profit
= {Revised standard quantity –
Budgeted quantity} * Standard profit per unit
STANDARD
COSTING
Diagrammatic
Representation: -
Material
Variance: -
Material cost variance = SC – AC = (SQ*AQ) –
(AQ*AP)
Labour
Variances:-
Labour Cost variance = SC – AC = (SH*SR) –
(AH*AR)
Fixed
Overhead Variance : -
a) Standard OH = Standard hrs for actual output *
Standard OH rate per hour
b) Absorbed OH = Actual hrs * Standard OH rate per
hour
c) Budgeted OH = Budgeted hrs * Standard OH rate per
hour
d) Actual OH = Actual hrs * Actual OH rate per
hour
e)
Revised Budgeted Hour = Actual Days * Budgeted Hours per day
(Expected hours for actual days worked)
When Calendar variance is asked then
for capacity variance Budgeted Overhead is (Budgeted days * Standard OH rate
per day)
Revised
Budgeted Hour (Budgeted hours for actual days) = Actual days * Budgeted
hours per
day
Variable
Overhead Variance : -
Sales value variance = Actual Sales –
Budgeted Sales
Sales
Margin Variances : -
Total sales margin variance = (Actual
Profit–Budgeted price)
= {Actual quantity * Actual profit per
unit}-
{Budgeted quantity * Standard
profit per unit}
[Where
:-
SC = Standard Cost, AC = Actual
Cost
SP = Standard Price, SQ = Standard
Quantity
AP = Actual Price, AQ = Actual
Quantity
AY = Actual Yield, SY = Standard Yield
RSQ = Revised Standard Quantity, SR = Standard Rate,
ST = Standard
Time AR
AT = Actual Time
RST = Revised Standard Time,
BP = Budgeted Price, BQ = Budgeted
Quantity
RBT = Revised Budgeted Time
BMPU = Budgeted Margin per Unit
AMPU = Actual Margin per Unit
Reconciliation:-
Reconciliation statement is prepared
to reconcile the actual profit with the budgeted profit
|
Particulars
|
Favorable
|
Unfavorable
|
(Rs)
|
|
Budgeted
Profit :
Add
Favorable variances
Less
Unfavorable variances
|
|
|
|
|
Sales
Variances : Sales price variance
Sales mix
variance
Sales
quantity variance
|
|
|
|
|
Cost
variance :-
|
|
|
|
|
Material
: Cost variance
Usage variance
Mix variance
|
|
|
|
|
Labour
: Rate variance
Mix variance
Efficiency variance
Idle time variance
|
|
|
|
|
Fixed
overhead variance : Expenditure variance
Efficiency variance
|
|
|
|
|
Fixed
overhead variance : Expenditure variance
Efficiency variance
Capacity variance
Calendar variance
|
|
|
|
NON-INTEGRATED
ACCOUNTS
Scheme
of journal entries:-
Material:
a)
For material purchases (cash or credit)
i) Material control a/c Dr
To Cost ledger control a/c
ii) Stores ledger control a/c Dr
To Material control a/c
b)
Purchases for a special job
Work-in-progress ledger control a/c Dr
To Cost ledger control a/c
c)
Material returned to vender
Cost ledger control a/c Dr
To Stores ledger control a/c
d)
Material (direct) issued to production
Work-in-progress control a/c Dr
To Stores ledger control a/c
e)
Material (indirect) issued to production
Manufacturing overheads a/c Dr
To Stores ledger control a/c
f)
Material returned from shop to stores
Stores ledger control a/c Dr
To Work-in-progress control a/c
g)
Material transferred from Job 1 to Job 2
Job 2 a/c Dr
To Job 1 a/c
i)
Material issued from stores for repairs
Manufacturing overhead a/c Dr
To Stores ledger control a/c
Labour:
a)
Direct wages paid
i) Wage control a/c Dr
To Cost ledger control a/c
ii) Work-in-progress a/c Dr
To Wage control a/c
b)
Indirect wages paid to workers in Production,
Administration, Selling and Distribution
departments
i) Wage control a/c Dr
To Cost ledger control a/c
ii) Production Overhead a/c Dr
Administrative Overhead a/c Dr
Selling & Distribution Overhead a/c Dr
To Wage control a/c
c)
Direct Expenses on a particular job
Job a/c Dr
To Cost ledger control a/c
Overheads:-
a)
Overhead expenses incurred
Production overhead a/c Dr
Administrative Overhead a/c Dr
Selling & Distribution Overhead
a/c Dr
To cost ledger control a/c
b)
Carriage inward
Manufacturing Overhead a/c Dr
To Cost ledger control a/c
c)
Production Overheads recovered
Work-in-progress control a/c Dr
To Production Overhead a/c
d)
Administrative Overhead recovered from finished goods
Finished goods ledger control a/c Dr
To Administrative Overhead
a/c
e)
Selling and Distribution Overhead recovered from sales
Cost of sales a/c Dr
To Selling & Distribution
a/c
f)
If over/under absorbed amounts are carried forward to subsequent year, the
balance of each Overhead account will have
to be transferred to respective
Overhead suspense (or reserve) Accounts as
follows:
i) For over recovery : Production Overhead a/c Dr
To Production overhead
suspense a/c
ii) For under recovery : Administrative
Overhead Suspense a/c Dr
To Administrative Overhead a/c
Selling & Distribution Overhead
Suspense a/c Dr
To Selling & Distribution
Overhead a/c
g)
In case the Under/Over absorbed overheads are transferred to costing profit
& loss
a/c
then the relevant entries are:
i) For Over recovery: Production Overhead
a/c Dr
To Costing Profit & Loss a/c
ii) For Under recovery: Costing Profit
& Loss a/c Dr
To Administration Overhead a/c
Sales:-
For
sales effected: Cost ledger control a/c Dr
To Costing Profit & Loss
a/c
Profit
/ Loss:
a)
In case of profit the entry is as follows
Costing Profit & Loss a/c Dr
To Cost ledger control a/c
b)
Reverse the entry in case of loss
The
main accounts which are usually prepared when a separate cost ledger is
maintained is as follows:-
i)
Cost ledger control a/c
ii)
Stores ledger control a/c
iii)
Work-in-progress control a/c
iv)
Finished goods control a/c
v)
Wage control a/c
vi)
Manufacturing/Production/Works Overheads a/c
vii)
Administrative Overhead a/c
Viii)
Selling & Distribution Overhead a/c
ix)
Cost of sales a/c
x)
Costing profit & loss a/c
Transfer
Pricing
A transfer price is the amount
of money that one unit of an organisation charges for goods and services to
another unit of an organisation.
One of the key aspects here is that a transfer
price is equivalent to an ordinary selling price and that any department or
division that sets a transfer price is effectively selling its goods and services at a profit or a loss to another
department or division within its organisation. Any part of an organisation
using transfer pricing will be classed as a profit centre: since it is
operating with a view to making a profit (whether positive, profit, or
negative, loss). If goods and services are transferred between departments and
divisions at cost, then no profit or loss arises and the issue of transfer
pricing does not, or should not, arise.
Organisations have a system of transfer pricing,
therefore, in order to assess the efficiency and effectiveness of its
department and divisional managers. This maybe in spite of the fact that
transfer prices may be artificial in the sense that it is felt that there is no
rationale for “selling” between departments and divisions.
Criteria
for fixing Transfer Pricing:-
i)
External Capacity not fully
utilized = Variable Cost
ii)
Capacity fully Utilized
a)
If single product :-
Selling Price (–) Selling Expenses
b)
If multiple product
Variable cost + Opportunity
cost (measured on the basis of Product actually sacrificed)
iii)
If
no market for Intermediate product
Cost of supplying division of optimum level
(-) Cost of the
supplying division at previous output level.
Difference
in Output
(This would be equal to Variable
cost when Fixed Cost is same at all levels)
Note:-
i)
Ignore Variable Selling
expenses on Inter Department Transfer
ii)
In case of (ii) above If
selling expenses is not given we have to assume some % as selling Expenses but
it should not exceed 5% .
Budgetary
Control
Budget
Ratios:-
1)
Capacity usage Ratio
= . Budgeted Hours . * 100
Maximum possible working
hours in budget period
2)
Standard Capacity Employed
Ratio
= Actual
Hours Worked * 100
Budgeted hours
3)
Level of Activity Ratio
= Standard
Hours for Actual Production * 100
Standard Hours for Budgeted
Production
4)
Efficiency Ratio
= Standard Hours for Actual Production *
100
Actual Hours
5)
Calendar Ratio
= Actual Working days *
100
Budgeted working days
Zero Base Budgeting:
The
name zero base budgeting derives from the idea that such budgets are developed
from a zero base: that is, at the beginning of the budget development process,
all budget headings have a value of ZERO. This is in sharp contrast to the
incremental budgeting system in which in general a new budget tends to start
with a balance at least equal to last year's total balance, or an estimate of
it.
Definition of Zero Base Budgeting (ZBB)
“A method of budgeting whereby all activities are
reevaluated each time a budget is set. Discrete levels of each activity are
valued and a combination chosen to match funds available”.
Objectives and Benefits of ZBB
What
zero base budgeting tries to achieve is an optimal allocation of resources that
incremental and other budgeting systems probably cannot achieve. ZBB starts by
asking managers to identify and justify their area(s) of work in terms of
decision packages (qv).
An
effective zero base budgeting system benefits organisations in several ways. It
will
- Focus the budget process on a comprehensive analysis of objectives
and needs
- Combine planning and budgeting into a single process
- Cause managers to evaluate in detail the cost effectiveness of
their operations
- Expand management participation in planning and budgeting at all
levels of the organisation
Activity
Based costing
In Traditional Method we split the
Over Head incurred in production, based on machine hours which are not
acceptable for many reasons.
In ABC method Over Head are splited
according to the related activity, for each type of Over Head. Overhead are
apportioned among various Production cost centers on the basis of Activity cost
drivers.
Relevant Costing - some theory
Introduction:
-
A management decision involves
predictions of costs & revenues. Only the costs and revenues that will
differ among alternative actions are relevant to the decision. The role of
historical data is to aid the prediction of future data. But historical data
may not be relevant to the management decision itself. Qualitative factors may
be decisive in many cases, but to reduce the number of such factors to be
judged, accountants usually try to express many decision factors as possible in
quantitative terms.
Meaning of Relevant Costs:
-
Relevant costs represent those
future costs that will be changed by a particular decision. While irrelevant
costs are those costs that will not be affected by a decision. In the short
run, if the relevant revenues exceed the relevant costs then it will be
worthwhile accepting the decision. Therefore relevant costs playa major role in
the decision-making process of an organization. A particular cost can be
relevant in one situation but irrelevant in another, the important point to
note is that relevant costs represent those future costs that will be changed
by a particular decision, while irrelevant costs are those costs that will not
be affected by that decision. We shall now see what are relevant costs and
revenues for decision-making process. In summary relevant information concerns:
Other Important Terminologies
: -
Relevant costs are costs
appropriate to aiding the making of specific management decisions. Actually, to
affect a decision a cost must be:
Future:
Past costs are irrelevant as they are not affected them by future decisions
& decisions should be made as to what is best now.
Incremental:
This refers to additional revenue or expenditure, which may appear as a result
of our decision-making.
(A cash flow - Such charges as
depreciation may be future but do not represent cash flows and, as such, are
not relevant.)
Sunk costs:
Past costs, not relevant for decision making
Committed costs:
This is future in nature but which arise from past decisions, perhaps as the
result of a contract.
Relevant Costs:
Problem areas:
1 Problems in determining the
relevant costs of materials:
When considering various
decisions, if the any materials required is not taken from existing stocks but
would be purchased on a later date, then the estimated purchase price would be
the relevant material cost. A more difficult problem arises when materials are
taken from existing stock. In this situation the relevant cost of materials for
a particular job (say job X) depends on
Material is in regular use of
the company
Material is not in regular use
of the company
Material is in short supply.
If the material is in regular
use of the company then the material taken from existing stock requires
replacement for the purpose of regular use therefore the relevant cost of
material will be the Replacement cost.
If the material is not in
regular use of the company the relevant cost of the materials depends on their
alternative use. The alternative use of the materials will be either to sell
them or to use them on other jobs. Hence the cost of using the materials
results in an opportunity cost consisting of either
The net sales revenue if the
materials were sold (or) The expense that would be avoided if the materials
were used on some other job Whichever is greater.
If the material is in short supply the only way material
for the job under consideration can be obtained is by reducing production of
some other product / job. This would release material for the order. but
the reduced production will result in loss of contribution which should
be taken in to account when ascertaining the relevant costs for the specific
order. Therefore the relevant cost will be Contribution lost (before the
material cost since the material cost will be incurred in any case) will
be the relevant cost.
labour:
2 Determining the direct labour
that are relevant to short - term decision depends on the circumstances.
Where a company has temporary
sparse capacity and the labour force is to be maintained in the short - term,
the direct labour cost incurred will remain same for all alternative decisions.
The direct labour cost will therefore be irrelevant for short - term decision -
making purposes.
However where casual labour is
used and where workers can be hired on a daily basis; a company may then adjust
the employment of labour to exactly the amount required to meet the production
requirements. The labour cost will increase if the company accepts additional
work, and will decrease if production is reduced. In this situation the labour cost
be a relevant cost for decision - making purposes.
In a situation where full
capacity exists and additional labour supplies are unavailable in the short -
term, and where no further overtime working is possible, the only way that
labour resources could then be obtained for a specific order would be to reduce
existing production. This would release labour for the order. but the
reduced production will result in loss of contribution, which should be
taken in to account when ascertaining the relevant costs for the specific'
order. Therefore the relevant cost will be Contribution lost (before the
labour cost) will be the relevant cost.
PROBLEMS
1. In a firm, material A has no
alternative uses and 200 units of which lie in stock. The information below has
been collected. You are required to find the relevant price of 120 units and
250 units respectively.
Book value
Current price
Rs.2 per kg Rs.3 per kg Rs.2.80
per kg
2.
Assume in the above problem the material is in regular use of the company
3. Assume in the above problem
the material is in short ‘supply and it is not possible to obtain the stock of
material for some more time. At present the material is used in another product
on which a contribution at the rate of Rs.1 O/unit is earned (after meeting the
material cost). Each unit of the product requires 1 KG of Raw material A.
No comments:
Post a Comment