Cost Accounting: Concepts, Cost Units, and Overhead Allocation, Lecture notes of Cost Accounting

Download Cost Accounting: Concepts, Cost Units, and Overhead Allocation and more Lecture notes Cost Accounting in PDF only on Docsity!

INDEX

S.NO. Title

Page No.

1 INTRODUCTION TO COST ACCOUNTING 4 - 15

2 MATERIAL COST CONTROL 16 - 23

3 LABOUR COST CONTROL 24 - 27

4 OVERHEAD COST CONTROL 28 - 36

5 RECONCILIATION TO COST AND FINANCIAL ACCOUNTS 37 - 41

6 PREVIOUS YEAR’S QUESTION PAPER 42 - 51

CHAPTER -1 INTRODUCTION TO COST ACCOUNTING

ACCOUNTING AS AN INFORMATION SYSTEM:-

Accounting serves the purpose of providing financial information relating to activities of a business. Such information is provided to shareholders, managers, creditors, tax authorities and others

Accounting may be divided into 3 categories

 Financial accounting  Cost accounting  Management accounting

Accounting

Financial accounting Cost accounting Management accounting

 Financial accounting : it is mainly concerned with recording business transactions in the books of accounts and prepare (a) Profit and loss account showing the net profit or loss during the year. (b) Balance sheet showing the financial position of the company at a point of time.

 Cost accounting : it is a branch of accounting which specializes in the ascertainment of cost of product and services.

 Management accounting: - it is the modern concept of accounts as a tool of management. It is concerned with all such accounting information that is useful to management.

Meaning and definition of cost, costing and cost accounting

 COST: Institute Of Cost and Management Accountants (ICMA) defines cost as ―the amount of expenditure (actual or notional) incurred on or attributable to a given thing.‖

Thus, cost is the amount consisting of a) Actual expenditure incurred on a given thing and b) Notional expenditure attributable to a given thing, notional expenditure is not actually incurred, rather it is deemed to have been incurred. It is also

called imputed cost, for example rent of the owned factory and interest on owned capital.

 Costing : The Charted Institute Of Management Accountants (CIMA) of UK has defined costing as ― the techniques and processes of ascertaining cost ― Thus costing simply means cost finding by any process or technique. It consists of principles and rules which are used for determining: a) The cost of manufacturing a product, e.g: motor car , furniture, chemical , salt , paper etc. b) The cost of providing a service e.g.: electricity, transport, education etc.

 Cost accounting: cost accounting is a formal system of accounting for cost in the books of accounts by means of which cost of products & services are ascertained and controlled. The Charted Institute Of Management Accountants (CIMA) of UK has defined cost accounting as ―the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost center and cost units. In its widest usage, it embraces the preparation of statistical data, the application of cost control methods and ascertainment of profitability of activities carried out or planned.

Functions and objectives of cost accounting

1. Ascertainment of the cost of each product,job, operation process, department or services.
2. Determining the selling price with the help of cost data.
3. To help the management in ascertaining the profitability of each product , sales area and division
4. Preparation of financial statements -- interim profit and loss account and balance sheet without stock taking
5. Helping the management in decision making: a) Whether to purchase or buy b) Comparative merits and demerits of different methods of production, profitability of new lines of production.
6. Cost control becomes possible with the help of budgetary control and standard costing
7. Even the government, wage boards, and trade unions are helped by costing in as much as it helps in price fixation price control.

Format of presenting information

It has a single uniform format of

presenting information.i.e. profit and

loss A/C,balance sheet.

Cost accounting has varied forms of

presenting cost information and

lacks a uniform format.

DESIGNING AND INSTALLING A COST ACCOUNTING SYSTEM.

There is no ready-made cost system to suit each and every business. However, before a costing system is installed a preliminary investigation must be made as to the desirable conditions for the success of the system.

The following are the steps to be taken while introducing cost accounting system.

1. The objectives of the system must be ascertained.
2. Further it is necessary to ascertain the significant factors which affect the costing system and this system must cover all the functions, namely production administration, distribution etc.
3. Technical aspects must be studied thoroughly.
4. Another pre requisite to successful operation of the system is the co-ordination from the staff and from all levels of management in the organization.
5. It is necessary to standardize the forms to be used by foreman, workers etc, inorder to ensureminimum clericalwork.
6. Effective arrangement is to be made to present the cost data to different levels.
7. Survey of accounting system and supervision of installation.
8. Proper supervision of the installation is also to be ensured.
9. There should be proper reconciliation of cost and financial accounts.
10. The procedures must be as simple as possible.

COST CONCEPTS

Some concepts which are used in cost accounting are as follows:

COST: It is the amount of resources given up in exchange for some goods or services. The resources given up are expressed in monetary terms. Cost is defined as ―the amount of expenditure (actual or notional) incurred or attributable to a given thing.‖

1. Expense: Expenses are cost which has been applied against revenue of particular accounting period in accordance with the principle of matching cost to revenue.
2. Loss: loss is defined as ―reduction in firm’s equity, other than from withdrawals of capital for which no compensating value has been received.
3. Cost Centre: A cost centre is defined by CIMA of UK as ―a location,person, or item of equipment (or group of these) for which cost may be ascertained and used for the purpose of control.‖ Thus, a cost center refers to a section of the businessto which cost can be charged. it may be a location ( a department , a sales area), an item of equipment ( a machine , a delivery van) , a person ( a salesman , a machine operator) or a group of these ( 2 machines operated by one workman). The main purpose of ascertaining the cost of a cost centre is control of cost.
4. Profit centre: A profit centre is that segment of activity of a business which is responsible for both revenue and expenses and discloses the profit of a particular segment of activity. Profit centers are created to delegate responsibility to individuals and measure their performance.

CLASSIFICATION OF COST:

1. Classification Into Direct And Indirect Cost:

(a) Direct Cost - these are those costs which are incurred for and conveniently identified with a particular cost unit, process or department. Cost of raw material used and wages of machine operator are common examples of direct costs.

(b) Indirect Costs: These Costs cannot be conveniently identified with a particular cost unit or cost centre. Depreciation of machinery, insurance, lighting,power,rent, managerial salaries are common examples of indirect cost.

2. Classification Into Fixed And Variable Costs :

(a) Fixed cost: These costs remain constant in total amount over a wide range of activity for a specified period of time. i.e. these do not increase or decrease when the volume of production changes. Examples- rent and lease, managerial salaries, building insurance, municipal taxes are common examples of fixed cost. (b) Variable costs : these cost tend to vary in direct proportion to the volume of output in general, variable costs shows the following characteristics.

COST UNIT

A cost unit is defined by CIMA as ― a unit of product , service or time in relation to which cost may be ascertained or expressed .‖ cost units are the things that the business is set up to provide of which cost is ascertained.

ELEMENTS OF COST:

A cost is composed of three elements i.e materials, labor and expenses. Each of these elements may be direct or indirect.

Total Cost

Direct Cost Indirect Cost

Material labour Expenses Material labour Expenses

Material cost : According to CIMA, UK material cost is ―The cost of commodities supplied to an undertaking.‖ material may direct or indirect.

(a) DIRECT MATERIAL : direct material cost is that which can be conveniently identified with and allocated to cost units. Direct materials generally become a part of finished product .for eg clay used in bricks,leather in shoes , cloth in garment, steel in machine. (b) INDIRECT MATERIAL : These are those materials which cannot be conveniently identified with individual cost units.

Labour Cost: This is ―the cost of remuneration (wages, salaries, commission bonus etc) of the employees of an undertaking‖.

(a) DIRECT LABOUR: direct labourcost consists of wages paid to workers directly engaged in converting raw materials into finished product.

(b) INDIRECT LABOUR: it is of general character and cannot be conveniently identified with a particular cost unit. Foreg: wages paid to supervisor,clerk,peon, watchman, cleaner etc.

Expenses: All costs other than material and labour are termed as expenses. It is defined as ―the cost of services provided to an undertaking

(a) DIRECT EXPENSES: According to CIMA, UK, ―direct expenses are those expenses which can be identified with and allocated to cost centres or units.‖

(b) INDIRECT EXPENSES : All indirect cost , other than indirect materials and indirect labour costs, are termed as indirect expenses.

ITEMS EXCLUDED FROM COST

The following items are of financial nature and thus not included while preparing a cost sheet

1. Cash discount
2. Interest paid
3. Preliminary exps
4. Goodwill written off
5. Provision for tax
6. Provision for bad debts
7. Transfer to reserves
8. Donations
9. Income tax paid
10. Dividend paid
11. Profit/loss on sale of fixed assets
12. Damages payable at law.

DETAILED COST SHEET

UNITS PRODUCED

PARTICULARS TOTAL COST

Opening stock of direct materials

Add: purchases

Add : carriage inward

Drawing office salaries

Technical directors fees

Laboratory expenses

Works telephone expenses

Internal transport expenses

Less: sale of scrap

Add: operating stock of work in progress Less: closing stock of work in progress

Work cost

Add: office and administration overheads Office salaries

Directors fees

Office rent and rates

Office stationery and printing

Office expenses

Depreciation and repairs of office equipment Depreciation of office furniture

Subscription to trade journals

Office lighting

Establishment charges

Directors travelling expenses

Postage

Legal charges

Audit fees

Cost of production

Add: opening stock of finished stock

Less: closing stock of finished goods

Cost of goods sold

Add: selling and distribution expenses

Advertising

Showroom expenses

Bad debts

Salesmen’s salaries and expenses

Packing expenses

Carriage outward

Commission of sales agents`

Expenses of delivery van

Sales managers salaries

Depreciation and repairs of delivery vans Expenses of sales branches

Sales office expenses

Cost of sales or total cost

Profit

Sales

PROBLEMS

Q.1 THE X Ltd supplies you the following information and requires you to prepare a cost sheet

Particulars Amount

Direct wages 52500

Prime cost 103500

Add: opening work in progress 1st^ sept 28000

Factory overheads:

Indirect wages 2750

Factory rent, rates and power 15000

Depreciation of plant and machinery 3500 21250

Less: closing stock of work in progress (35000)

Work cost 117750

Office and administration overheads

Office rent and taxes 2500

Cost of production 120250

Add: opening stock of finished goods 54000

174250

Less closing stock of finished stock (31000)

Cost of goods sold

Selling and distribution overheads

Carriage outward 2500

Advertising 3500

Travelers wages and commission 6500 12500

Cost of sales 155750

Profit 44250

Sales 200000

Q.2 E.ltd furnish the following for 10000 units of a product manufactured during the year 2013

Material 90000

Direct wages 60000

Power and consumable stores 12000

Indirect wages 15000

Factory lighting 5500

Cost of rectification of defective work 3000

Clerical salaries and management expenses

Selling expenses 5500

Sale proceeds of scrap 2000

Repairs , maintenance and depreciation of plant

The net selling price was Rs 31.60 per unit sold. As from 1-1-2014, the selling price was reduced to 31per unit. It was estimated that production could be increased in 2014by 50%due to spare capacity. Rates for materials and direct wages will increase by 10%. Assume that 15000 units will be produced and sold during the year and factory overheads will be recovered as a percentage of direct wages and office and selling expenses as a percentage of work cost. Cost sheet for the year 2013 Output: 10000units Particulars Total cost Per unit

Material 90000 9

Wages 60000 6

Prime cost 150000 15

Factory overheads

Power and consumable stores 12000 1.

Factory indirect wages 15000 1.

Factory overheads = 45000/60000 x100 = 75 % of wages Office overheads =39000/195000 x100 =20% of work cost.

CHAPTER 2 MATERIAL COST CONTROL

Meaning of materials: the term material refers to all commodities consumed in the process of manufacturing. According to CIMA of UK, material cost is ―the cost of commodities supplied to an undertaking.‖

Techniques of material control.

ABC TECHNIQUE: ABC technique is a value based system of material control.  ― A” items - these are high value items which may consist of only small percentages of the total items handled. On account of their cost, these materials should be under the tightest control and the responsibility of the most experienced personnel.

 “B” items - these are medium value materials which should be under the normal control procedures

 “C” items- these are low value materials which may represent a very large number of items. These materials should be under the simple and economic methods of control. The purpose of classifying stock into A, B, and C categories is to ensure that material management focuses on A items where sophisticated controls should be installed. B items may be given less attention and C items least attention.

VED ANALYSIS

In addition to the conventional ABC analysis, VED analysis also plays an important role in material management. In VED analysis materials are classified as follows:

(a) V stands for vital material items in the sense that when these are out of stock or when not readily available, the production activity comes to a complete halt or is drastically affected. (b) E stands for Essential items without which temporary losses of production or dislocation of production work occurs. Their stock -out cost is very high. (c) D stands for Desirable itemsi.e. all other items of materials which are necessary but do not cause any immediate effect on production.

This classification is usually applied for spare parts to be stocked for maintenance of machines and equipment based on the critically of the spare parts. However, VED analysis can be applied to any industry.

Stock levels: One of the major objectives of material control is to ensure that there is no understocking and overstocking. A scientific approach to achieve this objective is to adopt a system of stock levels. These levels are maximum levels, minimum levels and reorder quantity.

A. Maximum level : The maximum stock level is the level above which stocks should not normally be allowed to rise. It is the maximum quantity of a material that may be held in store. Formula: Maximum level = Reorder level +Reorder quantity- (Minimum X Minimum Consumptionreorders period) B. Minimum level: Minimum level is that level below which stock should not normally be allowed to fall. In case any item of material falls below this level, there is a danger of stoppage in production and top priority should be given to the purchase of new material. Minimum level = Reorder level- (NormalX Normal reorder period) Consumption C. Reorder level : This is that level of material at which a new order for material is placed. This level is above minimum level and below maximum level.

Reorder level = Maximum consumption X maximum reorder period.

D. Danger level: This is a level at which normal issues of material s are stopped and urgent action is taken for purchase of materials so that production is not interrupted due to stoppage of materials. Danger level = = (Average or normal consumption X maximum reorder periodfor emergency purchase)

Average stock level: Average stock level is calculated by the following formula: Average stock level = Minimum level +Maximum level / 2

Average stock level may also be computed by the following formula: Average stock level= Minimum level +1/2 (reorder quantity)