Eco 10 ,B COM, IGNOU-Elements of costing
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IGNOU BCOM ECO-10 (Elements of Costing) Study Material –Dear Learners, The full downloadable free study materials of ECO-10 (Elements of Costing) are listed below to facilitate your studies for securing good marks in upcoming term end examinations. Though, your performance in examination will mostly depend on your efforts only. Even though, I can assure you that the following study materials will proof to be cabalistic in your efforts.
Block- 1 Basic Concepts
Unit-1 Nature and Scope
Unit-2 Concept of Cost and Its Ascertainment
Block- 2 Materials and Labour
Unit-3 Procurement, Storage and Issue
Unit-4 Inventory Control
Unit-5 Pricing the Issue of Materials
Unit-6 Labour
Block- 3 Overheads
Unit-7 Classification and Distribution of Overheads
Unit-8 Absorption of Factory Overheads
Unit-9 Treatment of Other Overheads
Block-4 Methods of Costing
Unit-10 Unit Costing
Unit-11 Reconciliation of Cost Financial Accounts
Unit-12 Job and Contract Costing
Unit-13 Process Costing
1. Cost Accountancy
2. Cost Accounting
2.1 Definition of Cost Accounting2.2 Objectives of Cost Accounting2.3 Importance of Cost Accounting2.4 Advantages of Cost Accounting2.5 Limitations of Cost Accounting2.6 Reports Generated by Cost Accounting Department
3. Installation of Cost Accounting System
3.1 Basic Considerations3.2 Steps in Introduction3.3 Essentials of a Good Cost Accounting System 3.4 Difficulties in Introduction
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3. SYNOPSIS :
1. Cost Accountancy
2. Cost Accounting
2.1 Definition of Cost Accounting
2.2 Objectives of Cost Accounting
2.3 Importance of Cost Accounting
2.4 Advantages of Cost Accounting
2.5 Limitations of Cost Accounting
2.6 Reports Generated by Cost Accounting Department
3. Installation of Cost Accounting System
3.1 Basic Considerations
3.2 Steps in Introduction
3.3 Essentials of a Good Cost Accounting System
3.4 Difficulties in Introduction
6. 6.22 Absolute Cost
6.23 Cost Centre
6.24 Cost Unit
6.25 Cost Allocation
6.26 Cost Apportionment
6.27 Cost Absorption
6.28 Responsibility Centre
7. Elements of Costs
7.1 Material Cost
7.2 Labour Cost
7.3 Expenses
7.4 Overheads
7. 8. Classification of Costs
8.1 By Nature
8.2 By Behaviour
8.3 By Element
8.4 By Function
8.5 By Controllability
8.6 By Normality
8.7 By Time When Computed
9. Types / Techniques of Costing
9.1 Historical Costing
9.2 Uniform Costing
9.3 Standard Costing
9.4 Direct Costing
9.5 Marginal Costing
9.6 Absorption Costing
9.7 Difference Between Various Types of Costing
8. 10. Methods of Costing
10.1 Job Costing
10.2 Batch Costing
10.3 Contract Costing
10.4 Process Costing
10.5 Operating Costing
10.6 Single Output or Unit Costing
10.7 Multiple Costing
9. 1. COST ACCOUNTANCY
The Institute of Cost and Management Accountants of
England defines Cost Accountancy as follows:
"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. It
includes the presentation of information, derived therefrom
for the purpose of managerial decision making."
Thus cost accountancy is a very comprehensive term.
2. COST ACCOUNTING
2.1 Definition of Cost Accounting :
Based on the terminology published by the Institute of Cost and
Management Accountants of England, Cost Accounting is
defined as the process of accounting for cost. This process
begins with the recording of income and expenditure or the bases
on which they are calculated and ends with the preparation of
periodical statements and reports for the purpose of ascending
and controlling costs.
10. 2.2 Objectives of Cost Accounting :
Following are the main objectives of Cost Accounting -
(i) Ascertainment of Cost:
It can be done in two ways, namely,
(a) Post Costing, where the ascertainment of cost is done based on
actual information as recorded in financial books.
(b) Continuous Costing, where the process of ascertainment is of a
continuous nature i.e. where cost information is available as and
when a particular activity is completed, so that the entire cost of a
particular job is available the moment it is completed.
(ii) Determination of Selling Price:
Though there are various other considerations for fixing the selling
price of a product (like the market conditions etc.), cost of the
product is an important factor which cannot be sidelined.
11. (iii) Ascertainment of Profit :
The purpose of any business activity is to earn a profit and profit can
be computed by matching the revenue and cost of that particular
product/activity.
(iv)Cost Control and Cost Reduction:
Cost Control and Cost Reduction are two different concepts.
Cost Control aims at maintaining the costs in accordance
with established standards. It involves the following steps -
Determination of target cost
Measurement of actual cost
Analysis of variation with respect to target cost
Initiation of corrective action.
12. Cost Reduction on the other hand aims at improvement
established targets. It is defined as "the achievement of
real and permanent reduction in the unit cost of
goods manufactured or services rendered without
impairing their suitability for the use intended or
diminution in the quality of the product."
vi) Assisting Management in Decision-making :
Decision-making is a process of choosing between two or
more alternatives, based on the resultant outcome of the
various alternatives. A Cost Benefit Analysis also needs to
be done. All this can be achieved through a good cost
accounting system.
13. Importance of Cost Accounting :
(i) Control of Material Cost :
Normally, material cost constitutes a major portion of the cost of
the product. Hence control of material cost can ensure a good
amount of benefit. Control of material cost can be exercised as
follows :
Maintaining optimum level of stock to avoid unnecessary locking
up of capital
Maintaining an uninterrupted supply of materials
Use of techniques like value analysis, standardisation etc.
(ii) Control of Labour Cost :
Labour cost control can be exercised as follows:
Setting standard time for each activity and keeping adverse
variance to the minimum
Laying down proper remuneration schemes
Control over labour turnover
Control over idle time, overtime
14. (iii) Control of Overheads :
Overheads are nothing but indirect expenses incurred at the
factory, office and sales depots. Again control over overheads will
ensure a control over the total cost of the product and a higher
profit margin.
(iv) Determination of Selling Price :
(v) Budgeting :
Any commercial activity begins with the preparation of budgets for
the same. A budget serves as a guideline against which the actual
performance can be measured and continuous corrective action
can be taken to ensure that the budget is adhered to.
(vi) Measuring Efficiency :
Efficiency can be measured by comparing actuals against
standards and corrective action can be taken.
(vii) Strategic Decision-making:
Cost accounting enables the management to take up various
strategic decisions like "Make or Buy", "Shut down or Continue",
"Replace or Continue", " Status quo or Expansion" etc.
15. Advantages of Cost Accounting
(i) Helps optimum utilization of men, materials and machines
(ii) Identifies areas requiring corrective action
(iii) Identifies unprofitable activities, losses, inefficiencies
(iv) Helps price fixation
(v) Facilitates cost control and cost reduction
(vi) Facilitates use of various cost accounting techniques, like,
variance analysis, value analysis etc.
(vii) Helps management in formulation of policies
(viii)Helps management in making strategic financial
decisions. For eg: the technique of marginal costing helps the
management in making various short term decisions.
(ix) Helps in formation of cost centres and responsibility
centres to exercise control
(x) Marginal Cost having a linear relationship with production
volume enables in formulation and solution of "Linear
Programming Problems".
16. 2.6 Limitations of Cost Accounting :
It is not an exact science and involves inherent element
of judgement.
Cost varies with purpose. Therefore cost collected for
one purpose will not be suitable for another purpose.
Cost accounting presents the base for taking the best
decisions. It does not give an outright solution .
Most of the cost accounting techniques are based on
some pre-assumed notions.
The apportionment of common costs comes under a
lot of criticism.
There are different views held by different experts on
the treatment of certain items of cost.
17. 3. INSTALLATION OF COST ACCOUNTING SYSTEM
The main objectives of introduction of a Cost
Accounting System in a manufacturing organization
are as follows:
Ascertainment of cost
Determination of selling price
Cost control and cost reduction
Ascertainment of profit of each activity
(v) Assisting in managerial decision making
18. Steps in Introduction of Cost Accounting System
The introduction of a cost accounting system will involve
the following steps:
Codification and classification
Establishment of cost centres
Guidelines for separation of fixed and variable costs
Guidelines for allocation of indirect costs
Introduction of standard formats
Specification of reports and their periodicity
Preparation of Cost Accounts Manual
Guidelines for post-installation appraisal of costing
system
19. List down factors that you will consider before installing a costing system.
Nature of business: The system of costing to be introduced should suit the general nature of
business.
Layout aspects: The size and layout of the organisation should be studied by the system
designers.
Methods and procedures : The system designers should also study various methods and
procedures for the purchase, receipts, storage and issue of material.
Management’s expectations and policies: The system of costing should be designed after a
careful analysis of the organisational operations, management’s expectation and the policies
of the concern.
Technical aspects: The technical aspects of the business should be studied thoroughly by the
designers. They should also make an attempt to seek the assistance and support of the
supervisory staff and workers of the concern for the system.
Simplicity of the system: The system of costing to be installed should be easy to understand
and simple to operate. The procedures laid down for operating the system should be easily
understood by operating system.
Forms standardisation: Various forms to be used by the costing system for various
data/information collection and dissemination should be standardised as far as possible.
Accuracy of data: The degree of accuracy of data to be supplied by the system should be
determined.
20. Essentials of a Good Cost Accounting System :
It should be simple and practical.
It should be tailor-made for the requirements of the organisation.
The data to be used by the cost accounting system should be accurate or else
the output will suffer.
The system of costing should not sacrifice the utility by introducing
meticulous and unnecessary details.
The cost of installation should justify the results.
Active co-operation and participation of executives from different
departments ensures in developing a good cost accounting system.
A carefully phased program should be prepared by using network analysis
for the introduction of the system.
3.4 Difficulties Likely to be Experienced in the Introduction of a Cost
Accounting System :
Following initial difficulties are likely to be experienced when a new costing
system is introduced :
Lack of support from other departmental heads
Resistance from accounting staff
Non co-operation from the supervisory staff
Shortage of trained staff
21. 4. ROLE OF A COST ACCOUNTANT IN A MANUFACTURING ORGANISATION
He establishes a cost accounting department in his concern.
He ascertains the requirement of cost information which may
be useful to organisational managers
He develops a manual, which specifies the functions to be
performed by the cost accounting department.
Usually, the functions performed by a cost accounting department
includes -cost ascertainment, cost comparison, cost reduction,
cost control and cost reporting.
Cost ascertainment, requires the classification of costs into
direct and indirect.
Cost comparison is the task carried out by cost accountant for
controlling the cost of the products manufactured by the concern.
Cost analysis may also be made by cost Accountant for taking
decisions like make or buy and for reviewing the current
performance.
Cost accountant also plays a key role in the preparation of cost
reports.
23. 15 Joint Cost
6.16 Period Cost
6.17 Sunk Cost
6.18 Committed Cost
6.19 Shut down Cost
6.20 Relevant Cost
6.21 Replacement Cost
6.22 Absolute Cost
6.23 Cost Centre
6.24 Cost Unit
6.25 Cost Allocation
6.26 Cost Apportionment
6.27 Cost Absorption
6.28 Responsibility Centre
2.
24. Elements of Costs
7.1 Material Cost
7.2 Labour Cost
7.3 Expenses
7.4 Overheads
3. Classification of Costs
8.1 By Nature
8.2 By Behaviour
8.3 By Element
8.4 By Function
8.5 By Controllability
8.6 By Normality
8.7 By Time When Computed
25. 4. Types / Techniques of Costing
9.1 Historical Costing
9.2 Uniform Costing
9.3 Standard Costing
9.4 Direct Costing
9.5 Marginal Costing
9.6 Absorption Costing
9.7 Difference Between Various Types of Costing
5. Methods of Costing
10.1 Job Costing
10.2 Batch Costing
10.3 Contract Costing
10.4 Process Costing
10.5 Operating Costing
10.6 Single Output or Unit Costing
10.7 Multiple Costing
26. . COST - CONCEPTS AND TERMS
6. COST - CONCEPTS AND TERMS
6.1 Cost - Cost represents the amount of expenditure (actual or
notional) incurred on or attributable to a given thing. It represents
the resources that have been or must be sacrificed to attain a
particular objective.
6.2 Pre-determined cost - It is the cost which is computed in
advance, before the production starts, on the basis of specification of
all the factors affecting the cost.
6.3 Standard cost - It is a pre-determined cost which is arrived at,
assuming a particular level of efficiency in utilisation of material,
labour and other indirect services. It is the planned cost of a product
and is expected to be achieved under a particular production process
under normal conditions. It is often used as a basis for price fixing
and cost control.
27. 6.4 Estimated Cost - It is an approximate assessment of what the
cost will be. It is based on past data adjusted to anticipated future
changes.
(Note : Standard cost Vs Estimated cost [Nov'92]
Although pre-determination is the essence of both standard cost and
estimated cost, they differ from each other in the following respects:
Difference in computation
Difference in emphasis
Difference in use
Difference in records
Difference in applicability
6.5 Marginal cost - It is the amount at any given volume of output
by which aggregate cost changes if the volume of output changes
increases/decreases) by one unit.
28. 6.6 Differential cost - It is the difference in the total cost between
alternatives calculated to assist decision making Thus, it represents
the change in total cost (both fixed and variable) due to a change in
the level of activity, technology, process or method of production,
etc.
6.7 Discretionary cost - It is an "escapable" or "avoidable" cost. In
other words, it is that cost which is not essential for the
accomplishment of a particular objective.
6.8 Decision-driven cost - It is that cost which is incurred following
a policy decision and continues to be incurred till that decision is
altered. It does not vary with changes in output or with operational
activities.
29. 6.9 Managed / Policy cost - It is that cost which is incurred as a
matter of policy eg: R & D cost. This cost has two important features :
It arises from periodic (usually annual) decisions regarding the
maximum outlay to be incurred
And
This cost is not tied to a cause and effect relationship between input
and output.
(Note : Decision-driven cost Vs Managed / Policy cost while
managed / policy cost arises from periodic decisions (usually
annual), decision-driven cost has no such fixed frequency).
6.10 Post-ponable cost - It is that cost which can be shifted to the
future with little or no effect on the efficiency of the current
operations.
30. 6.11 Imputed / Notional cost - CIMA defines notional cost as "the
value of benefits where no actual cost is incurred". Thus, imputed
cost is that cost which does not involve any cash outlay. Though it is a
hypothetical cost, it is relevant for decision making. Interest on
capital, the payment for which is not actually made, is an example of
imputed cost.
6.12 Inventoriable / Product cost - It is the cost which is assigned
to the product. For eg : Under marginal costing ® variable
manufacturing cost. Under absorption costing ® total manufacturing
cost (fixed and variable) constitute product or inventoriable cost.
6.13 Opportunity cost - It refers to the value of sacrifice made or
benefit of opportunity forgone in accepting an alternative course of
action. For e.g. If Mr. A works in his brother’s firm instead of working
in X Ltd., then the loss of salary Mr. A suffers by foregoing
employment in X Ltd., is the opportunity cost of working in his
brother's firm.
31. 6.14 Out of pocket cost - It is that portion of total cost which
involves cash outlay. It is a short term cost concept and is used in
short- term decision making like make or buy, price fixation during
recession. Out of pocket cost can be avoided if a particular proposal
under consideration is not accepted.
6.15 Joint cost - It is the cost of the process which results in more
than one main product.
6.16 Period cost - It is the cost which is not assigned to the product
but is charged as an expense against the revenue of the period in
which it is incurred. All the non-manufacturing costs like
administrative, selling and distribution expenses are treated as
period costs.
6.17 Sunk cost - Historical cost which is incurred in the past is
known as sunk cost. This cost is not relevant in decision making in
the current period. For eg. In the case of a decision relating to the
replacement of a machine, the written down value of the existing
machine is a sunk cost and hence irrelevant to decision making.
32. 6.18 Committed cost - It is a fixed cost which results from decisions
of prior period and is not subject to managerial control in the
present. Examples of committed cost are depreciation, insurance
premium and rent.
6.19 Shut down cost - The fixed cost which cannot be avoided during
the temporary closure of a plant is known as shut down cost.
Examples of shut down cost are depreciation and rent.
6.20 Relevant cost - CIMA defines relevant cost as " cost appropriate
to a specific management decision".
6.21 Replacement cost - It is the cost of replacement in the current
market.
6.22 Absolute cost - It is the total cost of any product or process. For
e.g.: in a cost sheet, both absolute cost and cost per unit are depicted.
33. 6.23 Cost centre
Meaning - The term cost centre is defined as a location, person or an
item of equipment or a group of these for which costs may be
ascertained and used for the purposes of cost control.
For the installation of a cost accounting system, the organization is
divided into sub-units.
Cost centre is the smallest organisational sub-unit for which separate
cost collection is attempted.
It is defined as a location, a person or an item of equipment (or group
of these) for which cost may be ascertained and used for the purpose
of cost control.
Cost centres can be personal cost centres, impersonal cost centres,
operation cost centres and process cost centres.
34. Types of cost cente
- Primarily there are two types of cost centres, namely:
Personal cost centre - consisting of a person or a group of persons
Impersonal cost centre - consisting of a location or an item of
equipment (or a group of these).
Functionally, there are two types of cost centres, namely:
Production cost centre - It is a cost centre where both direct and
indirect expenses are incurred for the production. Following are the
examples of production cost centres- machine shop, milling and
turning shop, assembly shop.
Service Cost Centre - A cost centre which renders services to
production cost centres is termed as service cost centre. It serves as
an ancillary unit to the production cost centre.
Powerhouse, boiler plant, repair shop, material service centre, all are
examples of service cost centres.
35. 6.24 Cost unit
- Meaning – The term cost unit is defined as a unit of quantity of
product, service or time (or a combination of these) in relation to
which costs may be ascertained or expressed. It can be for a job,
batch, or product group.
Once the cost of various cost centres is ascertained, the need arises to
express the cost of output (product / service).
A cost unit is defined as a unit of quantity of product, service or time
(or a combination of these) in relation to which costs may be
ascertained or expressed.
Cost units are usually units of physical measurement like number,
weight, time, area, length, volume etc.
36. Examples – 2.A few typical examples of cost units , with Method of
costing used are given below :
Industry Method of costing Unit of cost
(i) Nursing Home Operating Per Bed per week or per day
(ii) Road transport Operating Per Tonne Kilometer or per mile
(iii) Steel Process Per Tonne
(iv) Coal Single Per unit
(v) Bicycles Multiple Each unit
(vi) Bridge constructio Contract Each contract
(vii) Interior Decoration Job Each Job
(viii) Advertising Job Each Job
(ix) Furnitur Multiple Each unit
(x) Sugar company Process Per Quintal/Tonne
37. 6.28 Responsibility centre -
Meaning - When an organisation is divided into different sub-units
according to the responsibility and for each sub-unit, a specified
individual is made responsible, then the sub-unit thus formed is
termed as a responsibility centre. Thus, a responsibility centre is
defined as an activity centre of a business organisation entrusted with
a special task.
The specified individual is held accountable only for those activities
which he directly affects. Under modern budgeting and control,
finance executives tend to apply the concept of responsibility centres
for the purpose of control.
38. Types -
Responsibility centres can be classified as under:
Cost centres - Refer 6.23 above
Profit centres - Centres, which have the responsibility of generating
and maximising profits , are called profit centres. [Nov'97]
Investment centres - Centres which are responsible for earning an
optimum return on investments are termed as investment centres.
Revenue centres - Centres which are devoted to raising revenue with
no responsibility for production are called revenue centres. Eg. Sales
centre.
Contribution centres - Profit centres whose expenditure are reported
on a marginal cost basis, are called contribution centres.
40. 7.1 Material Cost :
According to CIMA, matrial coat is”the cost of commodities
supplied to an undertaking” Material cost includes Cost of
Procurement, frights inwards, taxes, insurance etc. Trade
discount ,rebate, sales taxes etc are deducted from material
cost
Direct Materials - Materials which are present in the finished
product or can be identified in the finished product are called direct
materials.
For eg. Clay in bricks, lather in shoes, steel in Machine, Timber in
furniture, Cloth in garments , coconuts in case of coconut oil , wood
in a wooden cupboard.
Indirect Materials - Indirect materials are those materials which do
not normally form part of the finished products or which cannot be
directly traced to the finished product. For eg. Lubricating oil, Nuts
and bolts, Small tools,stores, oil, grease, cotton wool etc.
41. 7.2 Labour Cost :
CIMA define “This is the cost of remuneration (wages, salaries’,
commission, bonuses, PF,ESI, Gratuity Over time & idle time
wages etc) of employee of an undertaking. “
Direct Labour - Labour which can be attributed wholly to a
particular product, process or job is called direct labour. It is the
labour utilised in converting raw materials into finished products.
For eg. Machine operator, Shoe maker, Cartpenter, Tailor, labour
employed in the crushing department of an oil mill.
Indirect Labour - Labour which cannot be identified with a
particular product, process or job is called indirect labour. Indirect
labour cost is apportioned to cost units or cost centres. For eg. Super
visor, Inspector, Clark, Peon, Watchman, maintenance workers.
42. 7.3 Expenses :
CIMA define “the cost of services provided to an undertaking
and internal coat of the use of owned assets”
Direct Expenses – Direct Expenses are those expenses which can be
identified with and allocated to cost centre or units.
Expenses incurred (except direct materials and direct labour)
specifically for a product, process or job is known as direct expenses.
They are also called "chargeable expenses". For eg. High ring charges
for a machine specifically hired for a particular process, Cost of
drawing and design and lay out.
Indirect Expenses - Expenses incurred other than direct expenses
are called indirect expenses. For eg. factory rent & insurance, power,
general repairs.
43. Overheads
Overheads is the sum total of indirect materials,
indirect labour and indirect expenses. Functionally
overheads can be classified as under -
Production / Works overheads
Administrative overheads
Selling overheads
Distribution overheads
45. 8.1 Classification By Nature :
Direct cost - Direct cost is that cost which can be identified with a
cost centre or a cost unit. For e.g. cost of direct materials, cost of
direct labour.
Indirect cost - Cost which cannot be identified with a particular cost
centre or cost unit is called indirect costs. For e.g. wages paid to
indirect labour.
8.2 Classification By Behaviour :
Fixed cost - Fixed cost is that cost which remains constant at all
levels of production. For e.g. rent, insurance.
Variable cost - The cost which varies with the level of production is
called variable cost i.e., it increases on increase in production volume
and vice-versa. For e.g. cost of materials, cost of labour.
Semi-variable cost - This cost is partly fixed and partly variable in
relation to the output. For e.g. telephone bill, electricity bill.
46. Classification By Function
Production cost - It is the cost of the entire process of production. In
other words it is nothing but the cost of manufacture which is
incurred upto the stage of primary packing of the product.
Administrative cost - It is the indirect cost pertaining to the
administrative function which involves formulation of policies,
directing the organisation and controlling the operations of an
undertaking. This cost is not related to any other functions like
selling and distribution, research and development etc.
Selling cost - Selling cost represents the indirect cost which is
incurred for
(a) seeking to create and stimulate demand
and
(b) securing orders.
47. Distribution cost - It is the cost of the sequence of operations which begins
with making the packed product available for despatch and ends with
making the reconditioned returned empty package, if any available, for re-
use.
R&D cost - "Research Cost" and "Development cost" are two different types
of costs.
Research cost is the cost of researching for new products, methods and
applications. Development cost is the cost of the process which begins with
the implementation of the decision to produce the new product
Pre-production cost - It is that part of the development cost which is
incurred for the purpose of a trial run, before the commencement of formal
production.
Conversion cost - It is the cost incurred for converting the raw material into
finished product. It comprises of direct labour cost, direct expenses and
factory overheads.
Prime cost - Prime cost is the aggregate of direct material cost, direct labour
cost and direct expenses. The term ‘direct’ indicates that the elements of cost
are traceable to a particular unit of output.
48. 8.5 Classification By Controllability : [May'97]
Controllable cost - The cost, which can be influenced by
the action of a specified person in an organisation, is
known as controllable cost. In a business organisation,
heads of each responsibility centre are responsible to
control costs. Costs that they are able to control are called
controllable costs and include material, labour and direct
expenses.
Uncontrollable cost - The cost which cannot be
influenced by the action of the person heading the
responsibility centre is called uncontrollable cost. For e.g.
all the allocated costs and the fixed costs.
49. 8.6 Classification By Normality :
Normal cost - It is the cost which is normally incurred at
a given level of output, under the conditions in which
that level of output is normally attained. Normal cost is
charged to the respective product / process.
Abnormal cost – It is the cost which is not normally
incurred at a given level of output in the conditions in
which that level of output is normally attained.
This cost is charged to the costing profit and loss account
i.e., the product / process does not bear the abnormal
cost.
50. 9. TYPES / TECHNIQUES OF COSTING
9.1 Historical Costing - It is the ascertainment of costs after they
have been incurred. This costing is based on recorded data and the
cost arrived at are verifiable by past events. This type of costing has
limited utility.
9.2 Uniform Costing - CIMA defines it as " the use by several
undertakings of the same costing system, i.e., the same basic costing
methods, principles and techniques."
9.3 Standard Costing - CIMA defines standard costing as " a control
technique which compares standard costs and revenues with actual
results to obtain variances which are used to stimulate improved
performance."
51. 9.4 Direct Costing - Under direct costing, a unit cost is assigned
only the direct cost, i.e., all the direct costs are charged to the relevant
operations, products or processes. The indirect costs are charged to
the profit and loss account of the period in which they arise. As a
result, inventory is valued at direct cost only.
9.5 Marginal Costing - Under marginal costing, marginal cost is
ascertained by differentiating between fixed and variable costs. In
this type of costing, variable costs are charged to cost units and fixed
costs of the period are written off in full against the aggregate
contribution.
Absorption Costing - It is the technique of assigning all costs i.e.
both fixed and variable, to the respective product/service.
52. 10. METHODS OF COSTING & THEIR APPLICABILITY
10.1 Job Costing - The objective under this method of costing is to ascertain the cost of each job
order. A job card is prepared for each job to accumulate costs. The cost of the jobs is determined by
adding all the costs against the job when it is completed.
This method of costing is used in printing press, foundaries, motor- workshops, advertising etc.
10.2 Batch Costing - This method of costing is used where small parts/components of the same
kind are required to be manufactured in large quantities. Here a batch of similar products is treated
as a job and the cost of such a job is ascertained as mention in (10.1) above
For e.g. in a cycle manufacturing unit, rims are produced in batches of 1,000 units each, then the
cost will be determined in relation to a batch of 1,000 units.
10.3 Contract Costing - If a job is very big and takes a long time for its completion, then the
method appropriate for costing is called contract costing. Here the cost of each contract is
ascertained separately.
It is suitable for firms engaged in erection activities like construction of bridges, roads, buildings,
dams etc.
10 4 Process Costing - This method of costing is used in those industries where the production
comprises of successive and continuous operations or processes. Here specific units lose their
identity in the manufacturing operation. Under this method of costing, costs are accumulated by
‘processes’ for a particular period regardless of the number of units produced.
This method of costing is followed by chemical industry, soap industry, rubber industry, paints
industry.
53. 10.5 Operating Costing - The method of costing used in service rendering
undertakings is known as operating costing.
This method of costing is generally made use of by transport companies, gas
and water works departments, electricity supply companies, canteens,
hospitals, theatres, schools etc.
10.6 Single Output/Unit Costing - This method of costing is used where a
single product is produced. The total production cost is divided by the total
number of units produced to get the unit/single output cost.
This method of costing is normally used in marble quarrying, mining, brick-
kilns, breweries, etc.
10.7 Multiple Costing - It is a combination of two or more methods of
costing mentioned above. Suppose a firm manufactures bicycles, including
its components, the parts will be costed by way of batch costing but the cost
of assembling the bicycle will be done by unit costing. This method is also
called composite costing.
Some other industries using this method of costing are those manufacturing
– radios, automobiles, aeroplanes etc.
54. Types of Businesses That Use Cost
Accounting
Manufacturers (Ford, General Motors)
Merchandisers (WalMart, Kmart)
Wholesalers (Beverage Distributors)
For-profit Service Businesses (CPAs, Attorneys)
Not-for-profit Service Agencies (United Way, Red
Cross)
55. The Manufacturing Process
This process involves the conversion of direct
(raw) materials, direct labor, and factory
overhead into finished goods.
Product quality is an important competitive
weapon in manufacturing.
Many companies require their suppliers to be
ISO 9000 certified.
56. Determining Product Costs and
Pricing
Cost accounting is used to determine products costs
and help with marketing decisions.
1. Determining the selling price of a product.
2. Meeting competition.
3. Bidding on contracts.
4. Analyzing profitability.
57. Planning and Control
Planning is the process of establishing objectives or
goals for the firm and determining the means by
which the firm will attain them. Effective planning
is facilitated by the following:
1. Clearly defined objectives of the manufacturing
operation.
2. A production plan that will assist and guide the
company in reaching its objectives.
58. Planning and Control (cont.)
Control is the process of monitoring the company’s
operations and determining whether the objectives
identified in the planning process are being
accomplished. Effective control is achieved through
the following:
1. Assigning responsibility.
2. Periodically measuring and comparing results.
3. Taking necessary corrective action.
59. Reporting
Cost and production reports for a cost center
reflect all cost and production data identified
with that center.
The performance report will include only
those costs and production data that the
center’s manager can control.
A variance is the favorable or unfavorable
difference between actual costs and budgeted
costs.
60. Management Accounting
The Institute of Management Accountants
(IMA) is the largest organization of
accountants in industry. The Certified
Management Accountant (CMA) is
comparable to the Certified Public
Accountant (CPA) for public accountants.
For more information, please visit the IMA’s
website at www.imanet.org
61. Cost Accounting vs. Financial and
Management Accounting
Characteristics Financial Accounting Management accounting
Users: •External Parties
•Managers Managers
Focus: Entire business Segments of the business
Uses of Cost Information: Product costs for calculating
cost of goods sold and
finished goods, work in
process, and raw materials
inventory using historical
costs and GAAP.
•Budgeting
•Special decisions such as
make or buy a component,
keep or replace a facility, and
sell a product at a special
price.
•Nonfinancial information
such as defect rates, % of
returned products, and on-
time deliveries
Cost Accounting
System
62. Cost Accounting vs. Financial and
Managerial Accounting (cont.)
Cost accounting
includes those parts of
both financial and
management
accounting that collect
and analyze cost
information.
63. Cost of Goods Sold
Merchandiser Manufacturer
Beginning merchandise
inventory
Plus purchases
Merchandise available for sale
Less ending merchandise
inventory
Cost of good sold
Beginning finished goods
inventory
Plus cost of goods
manufactured
Finished goods available for
sale
Less ending finished goods
inventory
Cost of good sold
64. Inventories
Most manufacturers maintain a perpetual
inventory system that uses FIFO, LIFO, or
moving average methods of costing.
An inventory ledger is maintained to provide
support for the control accounts.
Some manufacturers may use a factory ledger,
which contain all of the accounts relating to
manufacturing.
66. Prime Cost and Conversion Cost
Direct Materials
Direct Labor
Factory Overhead
Prime
Cost
Conversi
on Cost
Element
s of Cost
67. Flow of Manufacturing Costs
Direct Materials
Direct Labor
Factory Overhead
Work in Process
(Assets)
Finished Goods
(Assets)
Cost of Goods Sold
(Expenses)
68. Job Order Cost System
Direct Materials
Direct Labor
Factory Overhead
Work in Process
Account
Finished Goods
Account
Job Cost Sheets
69. Process Costing System
Work in Process
Dept. 1
Work in Process
Dept. 2 Finished Goods
Factory
Overhead
Direct
Labor
Direct
Materials
Direct
Materials
Direct
Labor
Factory
Overhead
70. Material/ Inventory control
Accounting for Material Cost
Among all the three elements of direct cost material cost is the most significant
element. The term material is a very broad term and could include:
(a)Direct material such as raw material which is converted into finished product.
A product may be made out of single raw material item or multiple material
items may be processed or blended together.
(b)(b) Indirect material such as oil, grease, cleaning material, screws and nuts,
secondary packing. This material does not form part of the final product.
Technically even items like office supplies and stationery may be included as
indirect material.
The classification of material cost into direct and indirect is important as the
control mechanisms for both are different.
71. Scope of Material Control:
. Purchasing of Material
. Receiving and Inspection
. Storing of Materials
. Issue of Material for Use
. Inventory Records
. Inventory Control
. Accounting of Materials
72. Movement of Material
The flow of material routine may involve following:
(a) Planning for material
(b) Procurement of material
(c) Receiving and Inspection of material
(d) Storage of material till it’s required for production and
Issue of material at various stages of production
(e) Store Records
73. Essentials of Material Control
Procedure
Coordination between departments particularly production, purchase,
inspection, stores and accounts.
. Centralized purchasing organization under the supervision of a
competent person.
. Use of standard printed forms for requisitions, order placing, goods
receipt, inspection, and issue for consumption and stock records.
. An effective system of internal check at every stage to keep a check over
transactions.
. Proper storage of all materials.
. System of perpetual inventory recording of stocks for every transaction.
. Regular report on quantity and value of receipt, issue and stock.
. Reconciling reports with corresponding accounting records.
74. The following chart depicts the material cost flow in a
manufacturing concern.
75. Some of these terms
Lead Time: it denotes time expressed in days, weeks, months etc.
between ordering (externally or internally) and replenishment i.e.
when the goods are available for use. The consideration of lead time is
very crucial.
Longer the lead time, more efforts will have to be made at the time of
planning. Action cannot be taken at eleventh hour for the long lead
time items.
In short, short lead time items that are readily available need not be
stocked, whereas long lead time items must be ordered well in
advance.
76. Some of these terms
Demand or Usage: This refers to demand for finished goods by
customers or demand for raw materials by production department or
even demand for stores and spares by maintenance department.
This is usually expressed as number of units required demand or usage
per day, week etc.
Consideration of demand or usage is very crucial for setting up stock
levels.
Physical Stocks: The number of units physically on hand or present at a
given time. The quantity on hand cannot be ignored when new ordering
is to be done.
77. Some of these terms
Free Stock: This is the quantity of stock freely available for
use at any point of time. This will be the quantity on hand
(i.e. physical stock) plus quantity on order minus
reservation if any.
At times the stock quantities may be reserved for a specific
production order because of its importance.
Buffer Stock: Also called as safety stock, it means an
allowance that covers forecasting errors or usage during
lead-time.
78. Pricing of the Issues:
Several methods of pricing issues are:
- First In First Out (FIFO) method
- Last In First Out (LIFO) method
- Simple Average method
- Weighted Average method
- Periodic Average method
- Moving Average method
- Specific Rate method
- Standard Rate method
79. FIFO method:
. This method assumes that materials are issued for consumption in the same
sequence in which it is received. The rate applied to the earliest received material in
stock is the basis.
LIFO method:
. It is based on the hypothesis that materials are stored in leaps; and when
required, the last receipted material is taken out first. The resulting effect is-the stock
is valued at earlier purchased prices.
Simple Average method:
. Where there are many variations in purchase prices, this method is used. In this
method, the rate value of each receipt before the given issue is averaged. This rate is
applied for pricing the issue of material
Weighted Average method:
. This method overcomes the demerits of simple average method. After every
receipt of material, the average rate is calculated by total value and quantity
. Thus, the value of issues and stock is always within the range of highest and
lowest price paid. The issue and stock, at a given time, is valued at the same price. It
avoids price fluctuations.
80. Periodic Average method:
. In this method, the rates of material received during a specific period are
considered for the purpose of calculating average rate for pricing issue, and earlier
rates are ignored. This method can also show unusually high or low prices for issue and
stock.
Moving Average method:
. Under this method, a specific number of rates are considered for the purpose of
average. Whenever there is a new receipt, the rate of earliest receipt is ignored.
Specific rate method:
. When a material is purchased for a special purpose and is issued, the rate
applicable for that item is considered as the issue price. This rate can be applied
under job order method, where the actual material issued can be identified with the
job.
Standard rate method:
. Where standard costing system is followed, the material price is determined in
advance before commencement of an accounting period and applied to issues during
that accounting period.
81. Stock Control Techniques
Stock Control Techniques:
. The Stock or Inventory Control is one portion/part of material control.
Objectives of stock control:
- To minimize investment in stock; this requires funds or capital.
- To ensure adequate availability of material.
- To protect the material and minimize loss due to pilferage, theft, waste, loss, damage,
obsolescence, and unauthorized use.
- To control and minimize accumulation of surplus stock, non-moving and dead
stock.
- To maintain timely records and prepare and submit necessary reports for planning.
- To ensure that no activity suffers interruption due to unavailability of material.
82. Economic Ordering Quantity (EOQ)
This is the purchasing quantity fixed in such a way as to minimize the
total cost of inventory. It basically denotes the order size. There are two
components of inventory costs – cost of acquisition and cost of
possession.
The cost of acquisition is also referred to as Ordering cost which is
expressed as amount per purchase order.
This cost includes clerical and administrative expenses in relation to
purchase requisition, quotations, comparative statements and
handling of purchase orders and supplier bills. If the reference is to
production stocks, then this will cover production set up time costs.
83. Economic Ordering Quantity (EOQ)
The cost of possession means the cost of maintaining or carrying
inventory. This is normally expressed as a percentage of the material
cost.
This normally covers interest, handling and upkeep, stores rent. It is
important to understand the relationship between these two categories
of costs. The relationship between ordering costs and carrying costs is
reverse.
So if the purchase quantity per order increases, the ordering costs will
reduce but the carrying costs will increase and vice versa. The tradeoff
between these two costs will represent the most economical ordering
quantity.
85. Limitations of EOQ
EOQ is a very powerful tool which suggests the ordering quantity
which will minimize the overall inventory
management costs.
These limitations emerge from the assumptions based on which this
formula is worked out. These are:
(a) The ordering and carrying costs are known with certainty.
(b) The rate of consumption is uniform throughout the year.
(c) The price per unit is constant throughout the year.
(d) The replenishment of the stocks is done instantaneously i.e. the
whole quantity ordered arrives at once.
86. Material control Limitations of EOQ
Certain stock levels are fixed up for every items or stores so that the
stock and purchases can be efficiently controlled. These are:
Maximum Level: this represents the maximum quantity above
which stock should not be held at any time.
Minimum Level: This represents the minimum quantity of stock
that should be held at all times.
Danger Level: Normal issue of stock are usually stopped at this
level and made only under specific instructions.
Ordering level: it is the level at which indents should be placed
for replenishing stock.
Ordering Quantity: it is the quantity that is ordered.
87. ABC Analysis:
ABC Analysis:
Category A
Items are of Low quantity with High Value
Category B
Items are of Medium quantity and Value
Category C
Items are of High quantity and Low Value
. 'A' group items should be closely controlled at all stages of material
handling.
. 'B' group items also need elaborate control.
. 'C' group items are not subjected to detailed control procedures.
88. VED Analysis:
. Vital, Essential, and Desirable (VED) analysis is based on criticality of raw
materials.
. According to this analysis, items are divided into three categories in descending
order.
- The stock of vital items requires more action; because without it, the production
is held up.
- The items that come under 'V' should be stored adequately for smooth
production.
- V class items are vital for smooth functioning of the production system.
- In the absence of such items, the plant and machinery would stop running and
production would come to a halt
- Essential items are necessary for efficient running of production; and without it,
the production will be held up; but a reasonable care is taken for E items to ensure
they are always in stock.
- Desirable items are useful to increase efficiency, and non-availability of these
items do not affect the production immediately.
- D class items do not have an immediate effect upon the production.
- However, their availability reduces tiredness and enhances the efficiency.
89. FNSD Analysis:
. Under FNSD analysis, items are divided into four categories on the basis of their
usage rate in descending order.
F = Fast moving items
N = Normal moving items
S = Slow moving items
D = Dead stock
. Fast moving items are consumed regularly, and the stock of these items must be
observed constantly, and replenishment order be placed in time to avoid stock-out
situations.
. Normal moving items are exhausted over a period of year or so.
. Slow moving material, on the other hand, is consumed less frequently, i.e. it has low
turnover rate.
. Dead stock is the existing stock for which no demand can be foreseen.
90. SED/SOS/HML
SDE Analysis:
. This technique is used to exercise control over materials depending upon their ready
availability.
S = Scarce Items
D = Difficult Items
E = Easy Items
SOS Analysis:
S = Seasonal materials
OS = Off-seasonal materials
HML Analysis:
H = High-cost Items
M = Medium-cost Items
L = Low-cost Items
91. Stock Control Levels:
. Maximum Level
Reorder level - (Minimum consumption X Minimum reorder period) + Reorder
quantity
. Minimum Level
Reorder level - (Average rate of consumption X Average time of inventory delivery)
. Reorder Level
Average daily usage rate X Lead time in days
Stock Control Level:
. Safety Stock
- It is the minimum stock to be kept, so that the Production doesn't stops.
. Danger Level
- It indicates the level of stock when the normal issue should be stopped.
- It indicates the need of urgent attention and emergency steps to replenish the
stock by procuring materials.
- The quantity of this level is between minimum and nil stock level.
92. Perpetual Inventory:
. Perpetual inventory system is a system which continuously updates a
record, showing stock or inventory of an item at any time.
. This system establishes correctness of stock records and facilitates the
verification of stock.
. The system lays down physical verification of different items in such a way
that it does not cause interruption in production or operating activity.
Continuous Verification System:
. Under this system, a number of items are physically verified daily, with
reference to bin-card balances.
. A physical verification program is drawn to cover each item by rotation.
. The frequency of physical verification of a particular item depends upon
its nature and annual usage value.
93. Perpetual Inventory System VS Continuous Stock Taking:
. Perpetual Inventory System is a system of stock control followed by the
stores department.
. Under this system, a continuous record of receipt and issue of material
is maintained by the stores department.
. Continuous Stock Taking means physical verification of store's items on
a continuous basis to reveal the position of actual balances.
. Such verification is conducted round the year, thus covering each item
of stores at least twice or thrice.
Periodic Stock Taking:
. Under this method, the stocks are verified once in a year, usually
immediately before the annual closing of accounts so that value of the stock
to be taken into account in the Balance Sheet and Profit and Loss Account
can be worked out by pricing the quantities found on physical verification.
94. Budgeting And Budgetary Control System
Budgeting:
A financial and/or quantitative statement, prepared and
approved prior to a defined period of time, of the policy to be
pursued during that period for the purpose of attaining a give
objective. It may include income, and the employment of capital.
One of the primary objectives of management accounting is to
provide useful information to management for planning and
control.
Budgeting acts as a tool for both planning and control.
Budgeting is a formal process of financial planning using
estimated financial and accounting data.
Forecasting is a process of predicting or estimating future
happening.
Forecasting is an essential part of the budgeting process.
95. Features Of A Budget:
One-year Duration
. Estimation of Business Unit's Profit Potential
. Appraisal of Performance
. Monetary Terms
. Alteration of Approved Budget Under Specific
Conditions
. Review and Approval by Higher Authority
. Managerial Committee
96. Role Of A Budget Officer:
The Budget Committee acts through the Budget Officer
whose responsibilities include the following:
. Functional Budget Preparation
. Communication to Responsibility Centres
. Co-ordination
. Follow-up
. Budget Committee Review
. Board Review
97. Steps Involved In Preparation Of
Budgets:
Definition of Objectives
. Identification of Key Factor
. Budget committee and controller
. Budget Manual
. Budget Period
. Standard of Activity
98. Elements of Successful Budgeting
Plan:
- Accurate Forecasting of Business Activities
- Coordinating Business Activities
- Communicating the Budgets
- Acceptance and Cooperation
- Reasonable Flexibility
- Providing a Framework for Evaluation
99. Budget Centers:
Budget Centers:
. An organization is usually broken down into different
budget centers for administrative and control purposes.
. CIMA's definition 'a section of the organization of an
undertaking defined for the purposes of budgetary control.'
. Separate budgets are prepared for each section of the
organization.
Budget Manual:
. Budget manual is a document of schedules which shows in
written form the procedures to be followed for budgeting
activities.
. A copy of the manual is given to each departmental head for
guidance.
100. Types of Budgets:
Time Period
- Long Term
- Short Term
. Conditions
- Basic Budget
- Current Budget
. Capacity
- Fixed Budget
- Flexible Budget
. Coverage
- Functional Budget
- Master Budget
101. Fixed Budgeting:
Fixed Budgeting:
. A fixed budget is the budget which is designed to remain unchanged irrespective of
the level of activity actually attained.
. It is based on a single level of activity.
. A fixed budget performance report compares data from actual operations with the
single level of activity reflected in the budget.
. However, in practice, fixed budgeting is rarely used.
. The main reason is that actual output is often significantly different from the
budgeted control.
Flexible Budgeting:
. It is a budget, which by recognizing the difference between fixed, semi-variable, and
variable costs, is designed to change in relation to the level of activity.
. A flexible budget is prepared for a range, i.e. for more than one level of activity.
. It is a set of alternative budgets to different expected levels of activity.
Characteristics Of Flexible Budgets:
. Cover a range of activity
. Dynamic in nature
. Facilitate performance measurement
102. Functional Or Operating Budget
Functional Or Operating Budget:
. Broad Categorization
- Physical Budgets
- Cost Budgets
- Profit Budgets
- Financial Budgets
. Budgets provide information in terms of physical units and cost information
. Commonly Used
- Sales Budget
- Production Budget
- Plant Utilization Budget
- Direct Material Usage Budget
- Purchase Budget
- Direct Labour Budget
- Selling Costs Budget
- R & D Budget
- Capital Expenditure Budget
103. Operating Budgets:
Sales Budget
. Production Budget
. Direct Labour Budget
. Direct materials usage budget
. Direct materials purchase budget
. Factory overhead budget
. Inventory budget
. Cost of goods sold budget
. Budgeted profit and loss statement
. Budgeted balance sheet
104. Rolling Budget:
Rolling Budget:
. A rolling budget is a budget which is continuously updated by
adding a further period, say a month or a quarter, and deducting the
earliest period.
. It is also known as continuous budgeting.
. The environment is full of risk and uncertainty. Rolling Budgets
help to overcome this problem.
Cash Budget:
. Cash budgets are a tool for forecasting short-term cash
requirements of a firm.
. They provide a blueprint of the cash inflows and outflows that are
expected to occur in the immediate future.
. They assist the management in determining the surplus or
shortage of funds.
105. Budgetary Control System:
Budgetary Control System:
. Budgetary control is a systematic and formalized approach for
accomplishing the planning, coordination, and control responsibilities of
management.
. CIMA, - 'Budgetary control is 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 a basis for its
revision.'
Prerequisites:
. Top Management Support
. Proper Organizational Structure
. Realistic Nature of Goals
. Flexibility
. Participative Process
. Conducive Environment
106. Budgetary Control System
Features:
. Objectives
. Activities
. Plans
. Performance Evaluation
. Control Action
Objectives:
. Definition of Goals
. Defining Responsibilities
. Basis for Performance Evaluation
. Optimum use of Resources
. Co-ordination
. Planned Action
. Basis for Polic
107. Budgetary Control System
Advantages:
. Efficiency
. Cost Control
. Performance Evaluation
. Standard Costing and Variance Analysis
. Policy Formulation
Limitations:
. Estimates
. Rigidity
. False sense of Security
. Lack of Co-ordination
. Time and Cost
108. Zero-Base Budgeting:
. .
Features:
. Holistic
. Analytical
. Priority Based
. Review Based
. Rational
Modus Operandi:
. Objectives
. Coverage
. Decision Areas
. Ranking
. Budgeting
Advantages:
. Priority Allocation
. Maximum Efficiency
. Cost-Benefit Analysis
. Goal Congruence
. Management by
Objective
Limitations:
. Lack of Co-ordination
. Old-is-gold Attitude
. Time Consuming
Zero-base budgeting (ZBB) is an expenditure control device where each
divisional head has to justify the requirement of funds for each head of
expenditure and prepare the budget accordingly, without reference to the past
budget or achievements
109. Planning, Programming And Budgeting System:
. PPBS is used in nonprofit or non-commercial organizations to enable them to make more
informed decisions about resource allocation.
. PPBS differs from traditional non-profit and non-manufacturing budgets
. In PPBS, budgets for line or functional items for whole department are not presented. Instead,
the expenses associated with specific program are detailed.
Stages:
. Identify and define the objectives of program.
. Select performance or output measures.
. Identify and evaluate alternative methods of achieving the objectives
. Select the appropriate program on the basis of cost-benefit
. Implement the selected alternative and monitor its performance
Advantages:
. Leads to more effective allocation of resources
. Compels the management for evaluation
. Provides adequate information to management
. Helps management to consider long-term perspective
Government Budgeting:
. Governmental budgeting differs from private-sector budgeting.
. A governmental budget is a legal document adopted in accordance with procedures specified by
applicable laws.
. A governmental budget must be complied by the administrators of the governmental unit for
which the budget is prepared.
110. Marginal Costing and CVP Analysis
Marginal Costing:
. The term cost can be viewed from two angles basically.
- Direct Cost and Indirect Cost
- Fixed Cost and Variable Cost
. If fixed cost is included in the total cost, the per-unit
cost varies from one cost period to another with the
fluctuations in level of activities in two cost periods.
. Thus, per unit cost becomes incomparable between
two periods.
. To avoid this, it will be necessary to eliminate the fixed
costs from the determination of total cost.
. This has resulted into concept of Marginal Costing
111. Basics of marginal costing:
. Marginal cost - cost of producing an additional
unit or output or service
. Marginal costing differentiates the fixed and
variable costs
Features Of Marginal Costing:
. Semi-variable costs are included in comparison of
cost
. Only variable costs are considered
. Fixed costs are written off
. Prices are based on variable and marginal
contribution
112. Basic equation of Marginal Costing:
. Profit = Sales - Total cost
. Profit = Sales - (Variable cost + Fixed cost)
. Profit + Fixed cost = Sales - Variable cost
. Sales - Variable cost = Contribution = Fixed cost + Profit
. Contribution - Fixed cost = Profit
Marginal Cost:
. Marginal cost is defined as the amount at any given volume
of output by which aggregate costs are changed if the volume of
output is increased or decreased by one unit.
Determination Of Marginal Cost:
. Marginal cost is the additional cost for manufacturing one
additional unit, which is nothing else but the variable cost per
unit, and per-unit variable cost remains the same at all the levels
of activity.
113. Techniques or Methods of Determination of Marginal Cost:
. Two-point method
. Range Method
. Scatter Diagram Method
. Least-squares Method
Value of Marginal Costing To Management:
. It integrates with other aspects of management accounting.
. Management can easily assign the costs to products.
. It emphasizes the significance of key factors.
. The impact of fixed costs on profits is emphasized.
. The profit for a period is not affected by changes in
absorption of fixed expenses.
. There is a close relationship between variable costs and
controllable costs classification.
. It assists in the provision of relevant costs for decision-
making.
114. Limitations of Marginal Costing:
. To segregate the total cost into fixed and variable
components is a difficult task
. Under marginal costing, the fixed costs are eliminated
for the valuation of inventory , in spite of the fact that they
might have been actually incurred.
. In the age of increased automation and technological
development, the component of fixed costs in the overall
cost structure may be sizeable.
. Marginal costing technique does not provide any
standard for the evaluation of performance.
. Fixation of selling price on marginal cost basis may be
useful for short term only.
. Marginal costing can be used for assessment of
profitability only in the short run.
115. CVP Analysis:
. The intention of every business activity is to earn profit and maximize it.
. CVP analysis, also known as CVP relationship aims at studying the
relationships existing among following factors and its impact on the amount of
profits:
- Selling price per unit and total sales amount
- Total cost, which may be fixed or variable, and
- Volume of sales
Relationship of Costs and Profits with Volume:
. In Management Accounting, it is very important to find out how costs and
profits vary in relation to changes in volume, i.e. quantity of the product
manufactured and sold. Under certain assumptions, the relationships are
usually found to be linear.
. This means that if we draw a graph with volume on the X-axis and costs or
profits on the Y-axis, the graph will be a straight line.
Relationship of Costs and Profits with Volume:
. Assumptions for linear relationships
- Every cost can be classified as fixed or variable
- Selling price remains same
- There is only one product and in case of more than one product, product
mix is assumed to be same.
116. Contribution:
. Contribution = Sales - Variable Cost
. Contribution = Fixed Cost + Profit
Profit Volume (P/V) Ratio:
. This ratio indicates the contribution earned with respect to one rupee of sales.
. It is also known as Contribution Volume or Contribution sales ratio.
. Fixed costs remain unchanged in the short run, so if there is any change in profits,
that is only due to change in contribution.
. P/V Ratio = Contribution / sale x 100
. P/V Ratio = Changes in profit / Changes in Sales x 100
Break-even Point (BEP):
. This is a situation of no profit and no loss. It means that at this stage, contribution is
just enough to cover the fixed costs, i.e. Contribution = Fixed cost
Margin Of Safety:
. These are the sales beyond the break-even point.
. A business will like to have a high margin of safety because this is the amount of
sales which generates profits.
. Margin of Safety = Sales - Break-even Sales
117. Uses of CVP Analysis:
. It enables the prediction of costs and profits for different volumes
of activity.
. It is useful in setting up flexible budgets.
. It helps in performance evaluation for the purpose of control.
. It helps in formulating price policies by projecting the effect on
costs and profits.
. The study of CVP analysis is necessary to know the amount of
overhead costs, which could be charged to products costs at various
levels of operation.
Limitations of CVP Analysis:
. Variable cost per unit may not be constant.
. Fixed costs may stabilize at higher levels as volume increases.
. Selling prices may be lower at high volumes because of sales
discounts allowed.
. Changes in efficiency will affect the CVP relationship.
118. Standard Costing And Variance
Analysis
Standard Costing:
. Standard costing is a technique which is used in many industries, where
production is of repetitive nature.
. Standard costing is developed due to the shortcomings of historical
costing.
. CIMA, London, - standard costing 'as the predetermined cost based on
technical estimates of materials, labour and overheads for selected period of
time and for the prescribed set of working conditions'.
. The word standard means a criterion.
. A standard figure is one against which one can measure an actual figure to
see the deviation.
Standard Cost:
. Standard cost is 'a predetermined cost which is compared in advance of
production on the basis of specifications of all the factors affecting costs and
used in standard costing.'
. In other words, standard cost is a predetermined cost that should be
attained under a given set of operating conditions.
119. Objectives Of Standard Costing:
. To establish control
. To set standards for various elements of cost
. To fix responsibility
. To make budgetary control more effective
Establishing A System of Standard Costing:
. Setting up cost centers
. Classification of accounts
. Determination of size of the standard
- Current
. Ideal
. Expected
- Basic
. Setting up of standard
. Standard cost card
120. Need For Standards:
. Cost control
. Pricing decisions
. Performance Appraisal
. Cost awareness
. Management by objective
Application Of Standard Costing:
. Process industries
. Service industries
. Engineering industries
. Textile industries
. Extraction industries
121. Advantages of Standard Costing:
. Formulation of price and production policies
. Comparison and analysis of data
. Management by exception
. Delegation of authority and responsibility
. Cost consciousness
. Better capacity to anticipate
. Better economy, efficiency, and productivity
. Preparation of periodical financial statements
. Facilities budgeting
Limitations Of Standard Costing:
. high degree of technical skill
. segregation of variances into controllable and non-
controllable factors
. duplication in recording,
. either too strict or too liberal.
. lacks the dynamic approach.
122. Variance Analysis:
. The deviation of actual from standard is called
variance.
. When the actual cost is less than standard cost or
actual result is better than standard set, it is known
as favorable variance.
. On the other hand, when actual cost exceeds
standards cost or actual result is not up to standard, it is
known as unfavorable or adverse variance.
Classification Of Variances:
. Functional Basis
. Measurement Basis
. Result Basis
. Controllability Basis
126. I M POSSIBLE
1
I M POSSIBLE
Bibek Prajapati
(FCMA, CS , MBA, M COM, ).
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