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Acknowledgement I, Shah Vatsal , sincerely acknowledge that these notes of Cost & Management Accounting have been prepared by me with due care and effort. The content has been compiled for academic learning purposes and is based on standard references, class lectures, and self-study. I express my gratitude to my teachers, mentors, and peers for their guidance and support in the preparation of these notes. Prepared by: Shah Vatsal (Cost & Management Accounting Notes)
DECLARATION
I, Shah Vatsal , hereby declare that the Cost & Management Accounting notes compiled in this document are prepared solely for my personal study and reference purposes. Every effort has been made to ensure that the content is accurate, original, and simplified for easy understanding. This material is intended only for educational use and is not meant for any commercial distribution or professional consultation. Shah Vatsal
Overview of Chapter:
1. Overheads - Expenses other than direct material and direct labor. 2. Types of Overheads - Production Overheads – Costs related to manufacturing. - Administrative Overheads – Costs of managing the organization. - Selling & Distribution Overheads – Costs of selling and delivering products. 3. Accounting & Control of Overheads - Ensures proper recording, allocation, and control of all overheads. 4. Components under Control - Distribution of Overheads – Assigning costs to different departments or products. - Overhead Rates – Rates used to apportion overheads. - Concepts related to Capacity – Understanding production capacity to manage overheads effectively.
Introduction:
Definition:
- Expenditures that cannot be conveniently traced to a particular cost unit.
- Incurred for output generally , not for a specific work order. Examples:
- Wages for watch and ward staff
- Heating & lighting of factory Importance:
- Crucial cost element along with direct materials & direct employees.
- Often, overheads exceed direct wages/materials combined.
- Ignoring overheads leads to incorrect product cost or wrong total expenditure control. Characteristics:
- Represent expenses for ancillary facilities/services that support production.
- Alone, these services have no direct use (e.g., boiler house generates steam for machines).
- If production doesn’t need these services, the costs become waste. Scope:
- Overheads are incurred in: o Factory/production o Administration o Selling & distribution
Type of Overhead Description Examples directly related to production, selling, or distribution.
- Depreciation of office assets
- Postage & stationery
- Operating lease rentals
- Accounting & audit fees Selling & Distribution Overhead Costs incurred to market and deliver the product to customers.
- Selling Overhead: Costs related to securing sales.
- Distribution Overhead: Costs related to moving and storing finished goods. Selling:
- Salesmen commission
Advertisement cost
- Sales office expenses Distribution:
- Delivery van expenses
- Transit insurance
- Warehouse & cold storage costs
- Secondary packing expenses 2. By Nature (Behavior in Relation to Activity Level) This method classifies costs based on how they change as business activity (output) changes.
Type of Overhead Description Examples Fixed Overhead Costs that remain constant for a period , regardless of changes in the level of activity or output (within a certain range).
- Salaries of permanent staff
- Depreciation (building, plant)
- Interest on capital
- Insurance premiums Variable Overhead Costs that vary directly and proportionally with the volume of activity. They increase as output increases and decrease as output decreases.
- Indirect materials
- Power and fuel (for production)
- Lubricants for machines
- Tools and spares Semi- Variable Overhead Costs that contain both a fixed and a variable component. They change with the level of activity, but not proportionally.
- Electricity bills (fixed line rent + variable usage)
- Water bills
- Telephone & internet expenses
Type of Cost Description Examples
- Power and fuel (through conservation) Uncontrollable Costs Costs that cannot be influenced or changed by management in the short term.
- Rates and taxes (set by government)
- Depreciation (based on accounting policy)
- Interest on borrowing (set by loan agreement) 2.1 Advantages of Classifications of overheads into fixe3d and variable: 1. Core Concept The primary objective is to ascertain marginal costs by segregating semi-variable expenses into their fixed and variable components. 2. Key Advantages & Applications a) Controlling Expenses
- Fixed Costs: Policy costs, incurred irrespective of output. Generally non- controllable.
- Variable Costs: Vary directly with the level of activity/output. Controllable by management (e.g., by setting allowances based on output). b) Preparation of Budget Estimates (Flexible Budgeting)
- Allows for the estimation of costs at different levels of activity (e.g., 1, units vs. 1,200 units).
- Prevents the common mistake of assuming total costs increase proportionally with output.
- Example from Text: o Original Output (Oct): 1,000 units | Total Cost: ¥15,00, o New Output (Nov): 1,200 units o Incorrect Budget: Proportional increase to ¥18,00,000 (¥15,00,000 * 1.2) o Correct Flexible Budget: ▪ Fixed Costs: Remain unchanged (e.g., ¥5,00,000 + fixed part of semi-variable). ▪ Variable Costs: Scaled up (Variable rate * 1,200 units). ▪ Result: Correct total is ¥16,52,000 (less than ¥18,00,000). c) Decision Making Segregation is critical for informed decisions on:
- Pricing: During depression/recession or for export markets.
- Make or Buy
- Shut Down or Continue
- Evaluating Changes: Any change in production volume, manufacturing process, or distribution requires understanding the impact on cost/revenue, which is impossible without this segregation. 3. Supporting Techniques This classification is the foundation for:
- Marginal Costing
- Cost-Volume-Profit (CVP) Analysis
- Break-Even Analysis 4. How to Handle Semi-Variable Costs
- They must be split into fixed and variable elements.
- Example: A semi-variable cost of ¥600,000 (40% fixed). o Fixed Part: 40% of ¥600,000 = ¥240,000 (remains constant). o Variable Part: 60% of ¥600,000 = ¥360,000 for 1,000 units.
- Variable Manufacturing Overheads: Absorbed based on actual production.
- Fixed Manufacturing Overheads: Absorbed based on normal capacity.
- A pre-determined overhead absorption rate is used throughout the period. Step 4: Treatment of Under/Over-Absorption
- At year-end, the Actual Overheads are known.
- Under-Absorption: Absorbed Overheads < Actual Overheads
- Over-Absorption: Absorbed Overheads > Actual Overheads
- **The difference must be investigated and adjusted in the accounts.
- Key Definitions**
- Allocation: Direct assignment of a cost to a cost object.
- Apportionment: Indirect distribution (allotment) of a cost to multiple cost centres/departments.
- Re-apportionment: Re-assigning service department costs to production departments.
- **Absorption: Recovering a department's overheads from its output.
- Ultimate Purpose of the Whole Process
- To charge products with an equitable share of total factory overheads.
- To charge overheads to a product immediately upon its completion, without waiting for actual cost figures.**
Steps for distribution of overheads: Estimation of overheads:
1. Estimation of Overheads - Purpose: The total amount of overheads must be determined in advance. - Method: Estimation is primarily based on historical data (past records). - Adjustment: These historical figures are then adjusted for known future changes (e.g., expected price increases, new equipment, changes in production volume). 2. Collection of Overheads via Standing Orders - System Used: Overhead expenses are collected and organized through a formal system called Standing Orders (also known as Service Orders). - Definition of Standing Orders: A "Standing Order" is a formal, pre- approved sanction or authorization for indirect expenses. o They are the equivalent of "work orders" for direct materials and labour, but are used for indirect costs. 3. Function and Use of Standing Orders - Identification: The core of the system is that a unique number is assigned to each individual item of expense. - Consistency: This numbering system is maintained consistently from year to year, allowing for easy comparison and tracking.
o Department-specific expenses can be estimated more accurately, leading to higher overall overhead estimation accuracy.
- b) Better Control: o Enables control by comparing budgeted vs. actual spending for each department. o Without departmental data, it's impossible to identify which specific department is overspending.
- c) Ascertainment of Cost for each Job/Product: o Essential for charging jobs with their appropriate share of indirect expenses. o Since jobs pass through different departments (and for varying amounts of work), knowing departmental overheads ensures accurate product costing.
- d) Facilitates Suitable Costing Methods: o Different costing methods can be applied to different departments based on their function (e.g., batch costing for parts manufacturing, output/unit costing for assembly).
Apportioning overhead expenses over various department:
. Basic Definitions - Overheads: Indirect costs related to more than one department (e.g., rent, power, lighting, insurance, depreciation). - Apportionment: The process of distributing/common overhead costs among different departments on a fair basis. - Allocation: The process of charging the entire cost of an overhead to a single department that incurred it. 2. Key Difference: Allocation vs. Apportionment Basis Allocation Apportionment Meaning Charging whole items of cost to a single department. Distributing proportions of an item of cost to multiple departments. Process Direct process. Indirect process (requires finding a fair basis). Example Indirect wages of a department paid separately. Dividing the cost of a canteen (service dept.) among all production departments. Scope A wider term. A part of the overall process of charging overheads. Key Point: It's the relationship between the expense and the cost centre (not the nature of the expense) that decides if it is allocated or apportioned.
4. Other (Secondary) Bases of Apportionment 1. Analysis or Survey: Used when the benefit cannot be easily measured (e.g., distributing lighting cost based on a count of light points in each department). 2. Ability to Pay: Costs are distributed based on the income or sales of the department. Criticism: Can be unfair, as easy-selling items bear a higher cost that may not relate to the actual effort to sell them. 3. Efficiency or Incentive: Costs are distributed based on a pre-determined level of production/sales. o If output > Target: Overhead cost per unit decreases. o If output < Target: Overhead cost per unit increases. o Purpose: Rewards efficient departments with higher reported profits and management appreciation. **Re-apportionment of Service Department Overheads over production department:
- Purpose of Re-apportionment**
- The process of allocating service department costs to production departments is called secondary distribution.
- This is necessary to assign all overheads to the units of product **eventually.
- Suggested Bases for Re-apportionment Common service departments and the bases used to apportion their costs:** Service Department Cost Basis for Re-apportionment
- Maintenance & Repair Direct Labour Hours, Machine Hours
Service Department Cost Basis for Re-apportionment
- Planning & Progress Direct Labour Wages, (Asset Value × Hours Worked)
- Tool Room (Not specified in excerpt, often Direct Labour/Machine Hours)
- Canteen & Welfare Number of Direct Workers
- Hospital & Dispensary Number of Employees
- Personnel Department Number of Employees
- Time-keeping Number of Cards Punched, Number of Employees
- Computer Section Computer Hours, Specific Allocation
- Power House (Lighting) Floor Area, Cubic Content, No. of Electric Points, Wattage
- Power House (Power) Horse Power, Kwh, (H.P. × Machine Hrs), (Kwh × Machine Hrs)
- Stores Department Number of Requisitions, Weight/Value of Materials Issued
- Transport Department Crane/Truck Hours, Mileage, Tonnage, Ton-Hours, No. of Packages
- Fire Protection Capital Values of Assets
