Cost Accounting As Per BCom CBCS Curriculum, Bangalore University

Semester IV 4.4

Cost Accounting As Per BCom CBCS Curriculum, Bangalore University

M C SHUKLA

BA, BCom (Birmingham), Bar-at-Law Retd. Professor of Commerce and Director of Correspondence Courses University of Delhi

T S GREWAL

MA (Com) Former Director of Studies, Coaching Board, Institute of Chartered Accountants of India, New Delhi

M P GUPTA

MCom, PhD Director Jagran College of Art, Science and Commerce, Kanpur Former Head of Commerce Department, VSSD (PG) College, Kanpur Former Dean, Faculty of Commerce, Kanpur University, Kanpur Visiting Faculty Member, Central India Regional Council of Institute of Chartered Accountants of India, Kanpur and Kanpur Chapter of the Institute of Company Secretaries of India

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PREFACE It gives us immense pleasure to present this textbook, especially designed as per the Choice Based Credit System (CBCS) curriculum of Bangalore University for BCom Cost Accounting subject. The textbook aims to present the fundamental concepts in an informative and systematic manner. It acquaints the students with basic concepts of cost accounting, elements of cost, various methods involved in cost ascertainment as well as cost accounting book keeping systems. Lucidly divided into 8 chapters, the textbook comprehensively discusses the core concepts of cost accounting: Chapter 1 introduces the students with the subject of cost accounting. It briefly discusses the various elements of cost as well as costing methods and techniques. It also draws the importance of installation of a cost accounting system. Chapter 2 familiarizes the students with the first element of cost, i.e., materials costs, which involves purchase and storage of materials. It comprehensively discusses the concept of materials control which ensures monitoring the process of procurement, stock and inventory control. Further, it discusses the various methods of pricing material issues. Chapter 3 details the second element of cost, i.e., labour costs, which discusses recording of labour cost, payment of wages as well as various incentive schemes and system of wage payment and incentives. Chapter 4 acquaints the students with the importance of direct or chargeable expenses. Chapter 5 deals with the third element of cost, i.e., overheads, which details allocation and apportionment of overhead, methods and application of absorption of overhead as well as basic concepts of capacities. Chapters 6 and 7 deal with the unit costing, which details the method of single or output costing as well as calculation of tender price or estimates/quotations. Chapter 8 deals with the reconciliation of cost and financial accounts, which details the items causing differences between cost and financial profits and their reconciliation. Written in a concise and self-explanatory style, this textbook has numerous illustrations and solved problems to aid understanding of the concepts as well as theoretical questions and numerical problems to test students’ understanding of the concepts. We are thankful to the Management and the Editorial team at S. Chand for their support in publication of this book. Favourable reviews and constructive criticism would be highly appreciated as both would go a long way to make this text better.

Authors

SYLLABUS BANGALORE UNIVERSITY 4.4 COST ACCOUNTING

OBJECTIVE The objective of this subject is to familiarize students with the various concepts and elements of cost.

Unit I: INTRODUCTION TO COST ACCOUNTING Introduction – Meaning and Definition of Cost, Costing and Cost Accounting – Objectives of Costing – Comparison between Financial Accounting and Cost Accounting –Designing and Installing a Cost Accounting System – Cost Concepts – Classification of Costs – Cost Unit – Cost Center – Elements of Cost – Preparation of Cost Sheet – Tenders and Quotations.

Unit II: MATERIAL COST CONTROL Meaning – Types: Direct Material, Indirect Material. Material Control – Purchasing Procedure – Store Keeping – Techniques of Inventory Control –Levels settings– EOQ – ABC Analysis – VED Analysis – Just In-Time – Perpetual Inventory System – Documents used in Material Accounting – Methods of Pricing Material Issues: FIFO, LIFO, Weighted Average Price Method and Simple Average Price Method – Problems.

Unit III: LABOUR COST CONTROL Meaning – Types: Direct Labour, Indirect Labour - Timekeeping – Time booking – Idle Time – Overtime – Labour Turn Over. Methods of Labour Remuneration: Time Rate System, Piece Rate System, Incentive Systems (Halsey plan, Rowan Plan & Taylor’s differential Piece Rate System) – Problems

Unit IV: OVERHEAD COST CONTROL Meaning and Definition – Classification of Overheads – Procedure for Accounting and Control of Overheads – Allocation of Overheads – Apportionment of Overheads – Primary Overhead Distribution Summary – Secondary Overhead Distribution Summary – Repeated Distribution Method and Simultaneous Equations Method – Absorption of Factory Overheads – Methods of Absorption (Theory Only) – Machine Hour Rate – Problems on Machine Hour Rate.

Unit V: RECONCILIATION OF COST AND FINANCIAL ACCOUNTS Need for Reconciliation – Reasons for differences in Profit or Loss shown by Cost Accounts and Profit or Loss shown by Financial Accounts – Preparation of Reconciliation Statement and Memorandum Reconciliation Account.

 Meaning and Definition – Classification of Overheads – Procedure for Accounting and Control of Overheads Chapter 5: Overheads – Allocation of Overheads – Apportionment of Overheads – Primary Overhead Distribution Summary – Overhead Cost Secondary Overhead Distribution Summary – Repeated Distribution Method and Simultaneous Equations Control Method – Absorption of Factory Overheads – Methods of Absorption (Theory Only) – Machine Hour Rate – Problems on Machine Hour Rate.

Reconciliation of Cost and Financial Accounts

3

4

5

Additional Chapter in this Book

 Meaning – Types: Direct Labour, Indirect Labour - Timekeeping – Time booking – Idle Time – Overtime – Chapter 3: Labour Labour Turn Over. Methods of Labour Remuneration: Time Rate System, Piece Rate System, Incentive Systems (Halsey plan, Rowan Plan & Taylor’s differential Piece Rate System) – Problems

Labour Cost Control

2

Chapter 4: Direct or Chargeable Expenses

Chapter 8: Reconciliation of Cost and Financial Accounts

 Meaning – Types: Direct Material, Indirect Material. Material Control – Purchasing Procedure – Store Keeping Chapter 2: Materials – Techniques of Inventory Control –Levels settings– EOQ – ABC Analysis – VED Analysis – Just In-Time – Perpetual Inventory System – Documents used in Material Accounting - Methods of Pricing Material Issues: FIFO, LIFO, Weighted Average Price Method and Simple Average Price Method - Problems.

Material Cost Control

1

 Need for Reconciliation – Reasons for differences in Profit or Loss shown by Cost Accounts and Profit or Loss shown by Financial Accounts – Preparation of Reconciliation Statement and Memorandum Reconciliation Account.

Chapter 1: Introduction  Introduction – Meaning & Definition of Cost, Costing and Cost Accounting – Objectives of Costing - Comparison Chapter 6 : Unit Costing I: Single or Output Costing between Financial Accounting and Cost Accounting –Designing and Installing a Cost Accounting System – Cost Concepts - Classification of Costs – Cost Unit – Cost Center – Elements of Cost – Preparation of Cost Sheet – Chapter 7: Unit Costing II: Calculation of Tender Price or Estimates/ Tenders and Quotations. Quotations

Introduction to Cost Accounting

Shukla & Grewal’s COST ACCOUNTING Table of Contents

Topic

Unit

Detailed Content

Chapters in this Book vis-à-vis Bangalore University, CBCS Curriculum

ROAD MAP

BRIEF CONTENTS

1. Introduction

1.1–1.38

2. Materials

2.1–2.70

3. Labour

3.1–3.68

4. Direct or Chargeable Expenses

4.1–4.2

5. Overheads

5.1–5.96

6. Unit Costing I: Single or Output Costing

6.1–6.50

7. Unit Costing II: Calculation of Tender Price or Estimates/ Quotations 8. Reconciliation of Cost and Financial Accounts

7.1–7.26 8.1–8.28

DETAILED CONTENTS 1. INTRODUCTION

Chapter Outline 1.1 Objectives of Cost Accounting 1.3 Difference Between Cost Accounting, Financial Accounting, Management Accounting and Financial Management 1.3 Advantages of Costing 1.4 Control Over Expenditure 1.5 Key to Economy 1.6 Service Rendered by Cost Accounting to the Management Service Rendered to Employees 1.6 Cost Accounting and Creditors 1.7 Interest of Public in Cost Accounting 1.7

Objections to Cost Accounting 1.7 Installation of a Cost Accounting System

1.8

Factors to be Considered Before Installations Difficulties in Installation of a Costing System

1.8 1.9

1.10

Elements of Costs and Classification of Expenditure Direct and Indirect Expenses Treatment of Stock 1.14

Types of Costing Costing Terms

1.6

1.10

1.25 1.26

Cost Units 1.26 Cost Centre 1.26 Cost Allocation and Cost Apportionment 1.27 Cost Estimation and Cost Ascertainment 1.27 Responsibility Centre 1.28 Profit Centre 1.28 Opportunity Cost 1.28 Imputed Costs or Hypothetical Cost 1.28 Sunk Cost and Shut Down Cost 1.28 Replacement Cost 1.29 Incremental Cost or Differential Cost or Marginal Cost Avoidable and Unavoidable Cost 1.29 Conversion Cost 1.29 Controllable and Uncontrollable Cost 1.29 Estimated Costs and Standard Costs 1.29 Product Costs and Period Costs 1.30 Cost Control 1.30 Cost Reduction 1.30 Activity Based Costing (ABC) 1.31 Cost Drivers 1.31

Functions of Cost Accounting or Cost-Accountant Methods of Costing 1.32 Job Costing 1.32 Batch Costing 1.32 Contract or Terminal Costing 1.33 Unit (Single or Output) Costing 1.33 Process Costing 1.33 Operation Costing 1.33 Operating Costing 1.33 Departmental Costing 1.33 Multiple Costing 1.34

Theoretical Questions Numerical Questions

1.34 1.34

1.32

1.29

1.1–1.38

2. MATERIALS

2.1–2.70

Chapter Outline 2.1 Direct and Indirect Materials Materials Control 2.1

2.1

Material Purchase Procedure

2.3

Definition of Materials Control 2.2 Objectives of Material Control 2.2 Important Requirements of Materials Control (Management Expectations) The Purchase Department 2.3 Co-operation between Purchase Manager and Others—Standard List Purchase Routine 2.6 Fixation of Stock Levels 2.8

2.10

Economic Order Quantity (EOQ)

Choosing a Supplier and Inviting Tenders Placing of Order 2.14 Receipt of Goods 2.14

Costing of Incoming Materials Storing of Materials 2.20 Issue of Materials 2.22

2.15

Inventory Records and Control

2.24

Bill of Materials

2.23

The Record 2.24 Forms to be used in Inventory Taking

2.27

Selective Inventory Management

2.26

A.B.C. System of Selective Inventory Management Inventory Turnover Ratios

2.29

2.27

2.29

2.31

At Cost or First in First out or FIFO Method 2.31 Last in First out or LIFO Method 2.33 Average Cost Method 2.35 Conditions Favouring the Weighted Average Method: Replacement Cost or Market Price on the Date of Issue Fixed Price 2.37 Standard Price 2.37 Inflated Price 2.37 Highest in First Out (HIFO) Method 2.38 Next-in-First Out (NIFO) Method 2.38 Moving Average Method 2.38 Base Stock Method 2.38 Choice of Pricing Method 2.39

Control of Issue of Materials

2.4

2.13

Ved Analysis or Vital Essential Desirable Analysis Pricing of Issue of Materials

2.2

2.40

2.40

Materials Abstract or Materials Issue Analysis Sheets Return of Stores or Transfer to Other Jobs 2.41 Purchase Journal 2.41

Materials Losses, Wastages and Control

2.35 2.36

2.42

Normal and Abnormal Losses 2.42 Control Over Wastage of Materials in a Workshop 2.42 Control Over the Use of Indirect Materials and Spares 2.43 Just in Time (JIT) Inventory System 2.44

Solved Problems 2.45 Theoretical Questions 2.66 Numerical Questions 2.66

3. LABOUR

Chapter Outline 3.1 Direct and Indirect Labour 3.1 Labour Cost Control 3.3 Important Factors for the Control of Labour Cost

3.1–3.68

3.4

Assessment of Manpower Requirement 3.4 Control Over Time Keeping and Time Booking

3.4

3.5

Methods of Recording Attendance and Time Analysis of Time of Direct Workers 3.6

Time and Motion Study

3.7

Control Over Idle Time

3.9

Payment for Overtime

3.11

Procedure in Time Study 3.9 Importance of Time and Motion Study to the Management 3.11

Control Over Abnormal Idle Time Control Over Overtime 3.12 Treatment of Overtime Premium

Methods of Wages

3.13

3.13

Criteria for Judging a Wage System 3.14 Wages on Time Basis 3.15 Circumstances Where Time Rate is Suitable Advantages of Time Rate 3.15 Limitations of Time Rate 3.16 Wages on Piece Basis 3.16 Precaution in Piece Rate Method 3.16 Circumstances Favouring Piece Rate Method Advantages of Piece Rate Method 3.17 Limitations of Piece Rate Method 3.17 Choice Between Time and Piece Rate System 3.18 Balance of Debt System

Incentive Plans

3.15

3.18

3.18

Halsey Premium Plan 3.19 Rowan Plan 3.20 Barth Variable Sharing Plan 3.23 Taylor’s Differential Piece Rate System Merrick Differential Plan 3.25 Emerson’s Efficiency Plans 3.26 Gantt’s Task and Bonus Plan 3.28 Hayne’s Plan 3.28 The Bedeax Plan 3.28 Priestman’s Production Bonus 3.29 Group Bonus 3.29 Profit Sharing 3.31

Wages and Cost of Production

Payment of Wages 3.32 Wage Rate for Costing Purposes

3.23

3.31

3.34

Control Over Casual, Contract and Other Workers Labour Turnover 3.35 Causes of Labour Turnover 3.36 Cost of Labour Turnover 3.36 How Labour Turnover Can be Reduced

Job Evaluation

3.16

3.39

Advantages to the Employer 3.40 Advantages to Employees 3.40 Limitations of Job Evaluation 3.40 Steps of Job Evaluation 3.40 Methods of Job Evaluation 3.41

Merit Rating (Performance Appraisal)

3.37

3.41

Advantages of Merit Rating 3.42 Shortcomings and Limitations of Merit Rating

Solved Problems 3.42 Theoretical Questions 3.65 Numerical Questions 3.65

3.35

3.42

3.9

4. DIRECT OR CHARGEABLE EXPENSES

4.1–4.2

Chapter Outline 4.1 Definition of Direct Expenses 4.1 Characteristics of Direct Expenses 4.2 Control of Direct Expenses 4.2 Theoretical Questions 4.2

5. OVERHEADS

Chapter Outline 5.1 Classification of Overheads

5.1–5.96 5.2

Other Classifications 5.2 Fixed Overheads 5.2 Variable Overheads 5.3 Semi-Variable Overheads 5.3 Advantages of Making the Distinction between Fixed and Variable Expenses The Process of Distinguishing Variable and Fixed Costs 5.6 Collection and Absorption of Overheads 5.7

Factory or Works Overheads

5.8

Items Constituting Works or Factory Expenses 5.8 Collection of Factory Overheads 5.8 Departmentalisation of Factory Overheads 5.9 Production and Service Departments 5.12 Apportioning of Service Department Costs to Production Departments Basis for Apportioning Service Department Expenses 5.13 Direct Material and Direct Labour Cost of Service Department 5.13 Methods of Apportionment of Service Department Overheads 5.14 Some Important Factory Overheads 5.20 Depreciation 5.20 Interest 5.25 Rent 5.27 Royalties 5.27 Repairs 5.27 Fuel and Power 5.27

5.27

Absorption of Factory Overheads

Method of Absorption of Factory Overheads Hourly Rate Basis 5.33

Over and Under-absorption of Overheads 5.53

Importance of Other Overheads Control Over Other Overheads

5.53 5.54

Office and Administrative Overheads

5.12

5.28

5.50

Reasons for Over or Under Absorption 5.50 Treatment of Over or Under Absorption of Overheads

Other Overheads

5.54

Absorption of Office and Administrative Overheads

5.50

5.55

Selling and Distribution Overheads 5.56 Absorption of Selling Overheads 5.58 Overheads Apportionment Book 5.62 Research and Development Costs 5.62 Absorption of fixed Overheads Over Output–Actual or at Normal Capacity Items Excluded From Cost Accounts 5.65 Activity-based Costing (ABC) 5.66 Solved Problems 5.66 Theoretical Questions 5.91 Numerical Questions 5.91

6. UNIT COSTING I: SINGLE OR OUTPUT COSTING Chapter Outline Statement of Cost

6.1 6.1

5.5

5.63

6.1–6.50

Cost Sheet

6.2

Specimen 1: Simple Cost Sheet 6.5 Specimen 2: Comparative Cost Sheet 6.5 Specimen 3: Detailed Cost Sheet 6.6

6.22

Production Account

Specimens of Production A/c

Solved Problems 6.30 Theoretical Questions 6.45 Numerical Questions 6.45

6.23

7. UNIT COSTING II: CALCULATION OF TENDER PRICE OR ESTIMATES/QUOTATIONS Chapter Outline 7.1 Tenders of Similar Type Commodity Tenders for Different Product 7.3 Solved Problems 7.16 Numerical Questions 7.22

7.1

8. RECONCILIATION OF COST AND FINANCIAL ACCOUNTS Chapter Outline

8.1

Remodelling of Financial Books

Reconciliation of Profits Method of Reconciliation

8.2 8.3

8.1

Items to be Added to Profit as per Cost Account 8.3 Items to be Deducted from Profit as per Cost Accounts

Solved Problems 8.15 Theoretical Questions 8.26 Numerical Questions 8.26

7.1–7.26

8.3

8.1–8.28

CHAPTER

1

INTRODUCTION CHAPTER OUTLINE ✦ Objectives of Cost Accounting ✦ Difference between Cost Accounting, Financial Accounting, Management Accounting and Financial Management ✦ Advantages of Costing ✦ Objections to Cost Accounting ✦ Installation of a Cost Accounting System ✦ Elements of Costs and Classification of Expenditure ✦ Types of Costing ✦ Costing Terms ✦ Functions of Cost Accounting or Cost-Accountant ✦ Methods of Costing

Costing has been defined as classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and for the presentation of suitably arranged data for the purposes of control and guidance of the management. It includes ascertainment of the cost of every order, job, contract, process, service or such unit of output as may be appropriate. It deals with the cost of production, selling and distribution. Costing means an analysis of information to enable management to know the cost of producing and selling, that is, the total cost of various products and services and also to know how the total cost is constituted. For example, it is not sufficient to say that the cost of producing a pair of shoes is `275. The management must know how much out of that sum is due to material, labour and other expenses which have to be incurred to keep a factory going. Only with proper analysis of various elements of cost, this objective can be achieved. Such an analysis is the purpose of cost accounting. Costing is a branch of accounting which has developed because of limitations of Financial Accounts. It is developed because of the needs of management which financial account could not meet. Costing has a vital role to play in almost any activity which involves expenditure of money, whether it is a business house or a charitable concern or whether it is a Government department. Costing can throw a good deal of light on unnecessary losses and wastages. In public enterprises, that is to say, enterprises owned by the Government, normally the profit motive is absent and,

1.2 Cost Accounting therefore, whatever indication the usual profit and loss account gives in case of private enterprise, is unavailable in case of public enterprises. The efficiency of public enterprise, therefore, can be maintained only by a systematic collection of costing data and its study. Costing, therefore, has even a more important role to play in public enterprise than in private enterprise. To understand the meaning of Cost Accounting, there is need of explaining certain related terms also. (1) Cost: Cost has been defined in the terminology given by the Chartered Institute of Management Accountants (CIMA) as ‘the amount of expenditure incurred or attributed on a given thing'. More simply, it can be defined as that which is given or sacrified to obtain something. Thus the cost of an article is its purchase or manufacturing price, i.e. it would consist of its direct material cost, direct labour cost, direct and indirect expenses allocated or apportioned to it. (2) Cost Accountancy: The Chartered Institute of Management Accountants in England (CIMA) has defined Cost Accountancy as ‘the application of costing and Cost Accounting principles, methods and techniques to the science, art and practice of cost and the ascertainment of profitability. It includes the presentation of information derived therefrom for the purpose of management decision-making’. Cost Accountancy is, thus the science, art and the practice of cost accountant. Cost Accountancy is science because it is the systematic knowledge which a cost accountant should possess so that he may properly discharge his responsibility and functions. Cost Accountancy is also an art because it includes the ability and skill with which a cost accountant becomes able to apply his knowledge to the various problems like ascertainment of costs, control of costs, ascertainment of profitability, replacement of plants and technology, marginal costing, etc. Cost Accountancy is also practising the practice of a cost accountant. It includes his continuous efforts in presentation of information for the purpose of managerial decision-making. Cost Accountancy consists of several subjects, such as Cost Accounting, Costing, Cost Control and Cost Audit. (3) Cost Accounting: The Chartered Institute of Management Accountants in England (CIMA) has defined Cost Accounting as, ‘the process of accounting for cost from the point at which expenditure is incurred or committed to establishment of its ultimate relationship with cost centres and cost units. In its widest usage, it embraces the preparations of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried or planned’. It is a formal mechanism by means of which costs of products or services are ascertained and controlled. It is concerned with accumulation, classification, analysis and interpretation of cost data for three major purposes (a) ascertainment of cost, (b) operational planning and control, and (c) decision-making. (4) Costing: Costing has been defined by the Institute as, ‘the technique and process of ascertaining cost’. Wheldon defines costing as follows: “Costing is the classifying, recording, and appropriate allocation of expenditure for the determination of the costs of products or services; and for the presentation of suitably arranged data for the purposes of control and guidance of the management. It includes the ascertainment of the cost of every order, job, contract, process, service or unit as may be appropriate. It deals with the cost of production, selling and distribution.” Thus, costing means such an analysis of information as to enable management to know the cost of producing and selling, that is the total cost of various products and services and also to know how the total cost is constituted. (5) Cost Control: Cost control has been defined as ‘the guidance and regulation by executive action of costs of operating on undertaking’. It is primary job of a cost-accountant,

Introduction

1.3

besides ascertainment of cost, to furnish different types of statements and information as to enable the management to control the cost of operating their business. Cost control is exercised through a number of techniques such as Standard Costing and Budgetory Control. Standard Costing is a system which seeks to control the cost of each unit through determining beforehand what should be the cost and then its comparison with actual cost and also analysis of variances together with their causes. Budgetory Control means laying down in monetary and quantitative terms what exactly has to be done and how exactly it has to be done over a coming period and then to ensure that actual results do not diverge from the planned course more than necessary. (6) Cost Audit: Cost Audit has been defined by the Institute as ‘the verification of cost accounts and a check on the adherence to the cost accounting plan. It is an independent expert examination of the cost accounts of different outputs of an undertaking and a verification whether such accounts of the different output, serve the purpose intended.’ OBJECTIVES OF COST ACCOUNTING The definition given by the CIMA brings out the vital point that the Cost Accounting has the following objectives: (i) Ascertainment of cost and determining the selling price. (ii) Cost control i.e. keeping costs under check; (iii) Ascertaining profitability and profits earned on each activity including ascertaining causes that lead to a particular figure; and (iv) Collection and presentation of such information or statements as are required by management in its task of planning and making decisions. The decisions to be made may be of various types, some examples of which are: ● fixing prices under normal and special circumstances; ● determining priorities for products; ● deciding whether a component will be bought from the market or made within the factory itself; and ● deciding on the best processes of manufacture etc. A particular firm may not desire to realise all the aims stated above and may, therefore, design its Cost Accounting system only for a particular purpose. But, in general, Cost Accounting has a wide role to play. The nature of cost accounting can be summarised as “analysing, recording, standardising, forcasting, comparing, reporting and recommending. It is the business of the cost accountant to fill in turn the role of historian, news agent and prophet. As historian he must be meticulously accurate and sedulously impartial. As news agent he must be up to date, selective and pithy. As prophet he must combine knowledge and experience with foresight and courage”. DIFFERENCE BETWEEN COST ACCOUNTING, FINANCIAL ACCOUNTING, MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT Cost Accounting is a branch of accounting, which has been developed because of the limitations of Financial Accounting from the point of view of management control and internal reporting. Financial accounting performs admirably, the function of portraying a true and fair overall picture of the results of activities carried on by an enterprise during a period and its financial position at the end of the year. Also, on the basis of financial accounting, effective control can be exercised on the property and assets of the enterprise to ensure that they are not misused or misappropriated. To that extent financial accounting helps to assess the overall progress of a concern, its strength and weaknesses by providing the figures relating to several previous years.