CHAPTER 1: MANAGEMENT ACCOUNTING

Introduction:Accounting may be broadly classified into two categories – accounting which is

meant to serve all parties external to the operating responsibility of the firms and the accounting which is designed to serve internal parties who take care of the operational needs of the firm. The first category which is conventionally referred to as financial accounting, looks to the interest of those who have primarily a financial stake in the organization’s affairs – creditors, investors, employees etc. On the other hand the second category of accounting is primarily concerned with providing information relating to the conduct of the various aspects of a business like cost or profit associated with some portions of business operations to the internal parties viz., management. This category of accounting is called as Management accounting.

In order to perform the primary task of decision making managers of business enterprises need information about the past, present and future in the functional areas of management such as personnel, finance, marketing and production. Right decision making has to be based on quantitative and qualitative information. The management thus constantly needs accounting information to base its decisions upon. Thus management accounting provides the information needed by management personnel.

Definition:The Institute of Chartered Accountants of England has defined management

accounting as: “Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting”.

As per American Accounting Association, “Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business actions and for control through the evaluation and interpretation of performances.

As per Institute of Chartered Accountants of India, “Such of its techniques and procedures by which accounting mainly seeks to aid the management collectively have come to be known as management accounting”.

The Chartered Institute of Management Accounts (UK) defines management accounting as under:“Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for:

1. Formulating strategy2. Planning and controlling activities3. Decision making4. Optimizing the use of resources5. Disclosures to shareholders and others external to the entity6. Disclosure to employees7. Safeguarding assets.”

Nature of management accounting:Managerial personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the managerial personnel at three levels of management viz., top, middle and lower levels of management. It provides the management with the tools for an analysis of its administrative action that can lay suitable emphasis on the possible alternatives in terms of costs, prices and profits. The decisions made by management are based on

quantitative information and common sense, foresight, knowledge and experience. Management accounting includes financial accounting information and raw material from several other disciplines such as costing, statistics, mathematics, political science, sociology, psychology, management economics, law etc. With all these data he can ensure optimum utilization of all the resources including employees by maintaining sound morale of the employees, maximization of output and minimization of inputs, analyze the managerial questions in terms of costs, revenues, profits and growth. It is thus a highly personalized service with the help of which management can explore and exploit business opportunities and take sound and correct decisions. It is not a precise science as it uses its own conventions rather than standardized principles. Therefore the inferences drawn from the facts provided, depends on the skill, judgment and common sense of different management accountants. Thus it is said that management accounting serves as a management information system which enables the effective management of an enterprise.

Scope of management accounting:Management accounting is a wide and diverse subject. As stated earlier it includes various branches of knowledge such as psychology, sociology, economics, laws, political science, mathematics, statistics, finanacial accounting, cost accounting etc. It is thus very difficult to define its scope, as it is a dynamic and ever growing discipline of knowledge. The important techniques and systems used by management accounting are briefly stated below.

a. Historical cost accounting: Maintenance of books of cost accounting enables to know the actual costs incurred by the firm.

b. Standard costing: The standard costs laid down by experts are compared with the natural costs in order to know the deviations

c. Marginal costing: The costs are divided into fixed and variable costs which help is making vital decisions.

d. Decision accounting: Decisions are made after studying the impact of decisions in terms of costs, resource, profits, growth etc.

e. Budgetary control: It is a system of controlling the cost with the help of budgets.f. Control accounting: It includes the techniques such as standard costing, budgetary

control, control reports, internal check, internal audit and reports.g. Revaluation accounting: It is based on current costs to ensure that the investment

is intact and profits from investment are kept in mind.h. Financial planning & policies: It consists of raising the long term and short term

finance and invest it on optimum basis and enhance the profitability of the firm.i. Capital expenditure: The large amounts of future capital expenditure and future

profits are analysed to take important decisions.j. Break even analysis: This is an important technique which is used to analyse the

behavior of costs viz., fixed and marginal costs, indicating the level of activity at which the total costs would equal the total revenue and also the margin of safety.

k. Inter-period comparison: It is a technique of comparing the present performance with the past performance.

l. Techniques of forecasting: Some techniques like decision tree, probability and sensitivity analysis are used by management accountants for forecasting which forms a base for planning.

m. Operations research: It consists of statistical and mathematical techniques that are increasingly used in decision making process.

n. Statistics: The statistical techniques used by management accountant are correlation, regression, probability, time series, standard deviation, linear programming, control charts etc.

o. Other techniques: Other techniques employed are: Financial reporting, data processing, project management and appraisal, management audit, efficiency audit, cost audit, performance budgeting, tax planning, social accounting & audit, human resource accounting, responsibility accounting and divisional performance.

Functions of management accounting:1. Modification of data: The management accounting system modifies the data furnished

by financial accounting to serve the managerial needs in such a way that the process of classification and combination which enables to retain similarities without eliminating dissimilarities.

2. Validating the data: To make reliable decisions valid data should be made available to managers. The effectiveness of managerial function depends too much upon the accuracy and adequacy of the data. It is the function of management accounting to present before the management the required data with some sort of reasonable accuracy and it need not be with perfect accuracy.

3. Analysis and interpretation of data: Though management accounting is concerned with recording of business transactions, the analysis and interpretation of such data, in analyzing and interpreting the data lies the essence of management accounting. To discharge this function management accounting uses a number of tools like Marginal costing, budgeting, standard costing etc.

4. Communicating the data: The collected and interpreted data must be communicated to those who are interested in it or to whom it has some meaning. Otherwise these data may not yield any meaningful result and the whole process of collecting, validating and interpreting would amount to be a futile exercise. The communication of the data should be done within a reasonable time. Data delayed is decision delayed and a delayed decision may delay the prosperity of its concern. To accomplish this function of management accounting several reports and statements are being used.

Functions of a management accountant: Although it is understood that all the functions of management accounting are to be performed by the management accountant, the following may be said to be the important role of the management accountant in the management of a company.

1. Collection of data: The management accountant has to collect data about the problems faced by the management through primary and secondary sources.

2. Analysis of data: After the collection of data, the management accountant has to analyse it for the purpose of interpretation using various tools and techniques.

3. Presentation of data: The management accountant is required to present the data to the management in columns and rows to facilitate proper understanding.

4. Planning: The management accountant assists the management in long range planning as well as in formulation of policies of the organisation.

5. Controlling: The management accountant follows different techniques like standard costing, budgetary control etc to ensure adequate control for implementation of plans and achievement of objectives.

6. Reporting: Reporting being a very important function of a management accountant, he has to prepare different types of reports periodically and communicated to the concerned departments to meet the requirements at different levels of management for necessary action.

7. Co-ordinating: The management accountant has to co-ordinate the various activities of the organization for the preparation of master budget and other such activities.

8. Decision making: The management accountant has to assist the management in taking realistic decisions through analysis and interpretation of data that suggests a particular course of action with the help of various tools of management accounting.

Management accounting vs. financial accountingFinancial accounting and management accounting are two interrelated facets of the accounting system. They are not independent of each other but they are interdependent. Financial accounting provides the basic data which are analysed and interpreted suitably and in the required manner by management accounting. Although there exists close relationships between financial accounting and management accounting, distinction is always drawn between financial accounting and management accounting since they differ in their emphasis and approaches.

Dimension Management Accounting Financial Accounting1. Objective To provide information for

internal managementTo make periodical reports to shareholders, creditors, debenture holders and the Government.

2. Structure Varies according to use of the information

Unified structure

3. Sources of principles Whatever is useful to management

Generally accepted accounting principles (GAAPs)

4. Need Optional Statutory obligation

5. Time-orientation Historical and estimates of the future

Historical

6. Report entity Responsibility centers Overall organization

7. Purpose A means to the end of assisting management

External reporting / statements for outside users

8. Users Relatively small group: known identity

Relatively large group: mostly unknown

9. Information content Monetary and non-monetary Primarily monetary

10. Information precision

Many approximations Few approximations

11. Report frequency Varies with purpose, monthly and weekly.

Quarterly and annual

12. Report timeliness Reports issued promptly after end of period covered

Delay of weeks or even months

13. Period of reporting Reports are for shorter durations. The data is also collected for preparing long term plans for five or more years.

Generally adopts twelve months period for reporting financial performance.

14. Liability potential Virtually none. Few lawsuits but threat is always present.

15. Record maintenance & reporting

Costs and revenues reported by responsibility centres or cost centres

Records maintained in the form of personal, property and nominal accounts.

16. Role of accountant Transcends beyond book-keeping into the managerial process of planning, organizing, control and evaluating and also to different functional areas.

Limits the role to a book-keeper.

Management accounting vs. cost accountingCosting has been defined as classifying, recording and appropriate allocation of

expenditure for the determination of the costs of products or services. Cost accounting will tell the management as to how the business has fared at each stage of operation. But cost accounting will not tell them anything about the future policy to be adopted. It is here that management accounting differs from cost accounting. The aim of management accounting is not to collect information as such but to utilize the information collected in order to help the management to formulate their future policy and to make important policy decisions.

Though there is a difference between management accounting and cost accounting in their objective yet their functions are complementary in nature. Management accounting depends heavily on cost data and other information derived from cost records. In one way, management accounting is an expansion of cost accounting. Like cost accounting, management accounting involves reporting at frequent intervals rather than at the end of a year or half-year.

Cost accounting deals primarily with cost data. But management accounting involves the consideration of both costs and revenues. It is a broader concept than cost accounting. It not only reports costs but also uses them to assist management in planning possible alternate courses of action.

Conceptually speaking management accounting is a blending together of cost accounting, financial accounting and all aspects of financial management. It has a wider scope as a tool of management. But it is not a substitute for other accounting functions. It is a continuous process of reporting cost and financial data as well as other relevant information to management.

CHAPTER 2: COST ACCOUNTING, JOB COSTING & BATCH COSTING

Cost: Cost means the amount of expenditure incurred on a particular thing. CAS-1 (Cost Accounting Standard 1, issued by the ICWA, India) defines Cost as: Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

Costing: Costing means the process of ascertainment of costs. Costing involves the following steps (i) Ascertaining or collecting costs (ii) Analysing or classifying costs into basic elements such as Material, Labour, Expenses etc. and (iii) Allocating total costs to a ‘particular thing’ i.e. a product, a contract or a process. Thus cost can now be defined as the total expenditure, duly classified into materials, labour, expenses etc. allocated to a particular product or contract or process.

Cost Accounting: The Institute of Cost and Management Accountant, England (ICMA) has defined Cost Accounting as – “the process of accounting for the costs from the point at which expenditure incurred, to the establishment of its ultimate relationship with cost centres and cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.

Cost accounting is a term broader than costing. It covers costing plus the reporting and control of costs. Thus Cost Accounting = Costing + Cost Reporting + Cost Control. Cost accounting can be defined as the technique of recording, classification, allocation, reporting and control of costs.

Objectives of cost accounting: Cost accounting has the following basic aspects or objectives:

1. Costing: It involves the following basic aspects or 5 ‘A’s: a. Ascertain costs relating to a particular period, b. Analyse or classify costs under different heads of accounts such as material,

labour, expenses etc.,c. Allocate costs fully to the direct expenses or the specific costs such as raw

materials, labour to the relevant products, contracts or processes, d. Apportion or distribute common costs to each product, contract or process on a

suitable basis and e. Absorb the total expenses of a department over its products so as to finalise the

cost of each product that is then reported to the management.2. Cost reporting: Cost reporting has the following aspects:-

a. What to report or the nature of information to be presented should be relevant and precise.

b. Whom to report will determine the scope of the report to be submitted to the top management.

c. When to report – daily, weekly, monthly, quarterly or yearly etc. d. How to report or the format will depend on the factors mentioned above. Once

the cost report is received, management can take action to control the costs.3. Cost Control: Cost control has been defined by the ICMA as “the guidance and

regulation by executive action of the costs of operating an undertaking”. Thus cost control means the control of costs by management. Following are the aspects or stages of cost control.

a. Set targets for cost, production, profits etc. for each period.b. Measure Actual Performance relating to cost, production profits for the period

concerned.c. Compare targets with actuals to find out the variationsd. Analyse variations, the causes for variations whether favourable or adverse are

to be investigated. While adverse variations denote wastages and loses, favourable variations may indicate the targets fixed are very low. In both cases the exact reasons for the variations are to be known.

e. Take action once the causes are known to eliminate avoidable losses etc.4. Other aspects: The other aspects or objectives of cost accounting are as follows:

a. Provide required data for fixing sales price for submitting tenders, quotations etc.

b. Assist the management in controlling inventory for raw materials, goods in process, finished goods, spares and consumables etc.

c. Advice management on future policies regarding expansion, growth, capital investment etc.

d. Install labour incentive system for getting maximum productivity from labour at optimum cost.

e. Advice management in deciding optimum product-mix, merits and demerits of alternative courses of actions (make or buy etc.,) introduction of automation, mechanization, rationalization of system of production etc.

Thus the objectives can be summarized as follows:1. Ascertainment of costs2. Estimation of costs3. Cost control4. Cost reduction5. Determining selling price6. Facilitating preparation of financial and other statements7. Providing basis for operating policy

Importance and advantages of Cost Accounting:Cost accounting is not only important to the management and owners but also to many others like the workers, the Government, the consumers, the public at large and so on. The advantages are as follows.

1. To the management and the owners: Cost accounting helps the management of the concern to ascertain the cost and profitability of each individual product / service/ contract/ process/ division/ branch separately. This also helps in valuation of the closing stock of goods at the end of the year. It helps the management of the concern in controlling costs in reducing the avoidable expenditure, and minimizing wastages and losses. It ensures the reconciliation of quantity of input with the quantities of output, wastages and scrap. The management is thus able to regulate and monitor the movement of materials thus preventing theft and loss of materials during processing and handling. It is of great help to the management in taking several decisions such as, which products to produce more, how much to produce, whether to make or buy a component, what price to charge or quote. Thus cost accounting is an invaluable decision aid to decision making. It also facilitates in preparation of budgets and implementation of budgetary control in the organization. The end result of all the above advantages of cost accounting is maximization of profits of the concern thus

benefiting the owners by increasing their net worth or the share prices, higher dividends etc.

2. To the workers: Cost accounting has an elaborate system of assessing the performance of workers and rewarding them suitably through incentives and bonus. The increase in profits due to a cost accounting system also leads to higher remuneration and bonus to the workers.

3. To the Government / Consumers / Public: In case the products are under price control, cost accounting furnishes the data required by the government for fixing fair prices. Consumers benefit since the prices fixed on the basis of the cost data are just and reasonable and cannot be too high. It also leads to efficiency and productivity in the industrial sector. It ensure optimum utilization of the scarce economic resources of the country. Cost accounting leads to maximum profits for an organization. Naturally the Government also gains by way of more taxes on production, income and sales etc. The higher revenue is used by the Government for public welfare and economic development.

Criticisms of Cost accounting:1. Duplication: It is argued that cost accounting is duplication when a good financial

accounting system is already in operation. Cost accounting takes its basic data from books of accounts and just rearranges it in a different way.

2. Inapplicable: In a concern producing a single product involving no complex processes, cost accounting is inapplicable. It is also of no use in non-profitable organizations or in agriculture etc.

3. Not useful for decision making: In many cases, the decisions of the management are not based on cost accounting data. Thus the decision regarding which item to produce and how much to produce depends on the license given by the Government and the market forces of demand and supply.

4. Expensive and routine: A cost accounting system is quiet expensive to install and operate. At times the cost accounting systems become mere routing of filling the forms and submitting standard reports. Non-cooperation from staff also may lead to failure of the system in many concerns.

However, proper planning and implementation of the cost accounting system will overcome these criticisms and would stand null and void in view of the objectives, importance and advantages of the cost accounting system.

Functions of Cost Accountant:The main functions of a cost accountant can be summarized as follows:

1. Determining cost and analyzing income: A cost accountant determines the cost of a job, product or process as the case may be. He analyses and classifies costs according to different cost elements, viz., materials, labour and expenses. Such analysis enables him to tell the management the significance of the different cost elements and fixation of the selling prices of the products manufactured by the business. He advises the management about the profitability or otherwise of each job, product or process. Thus, he helps the management in maximizing business profits.

2. Providing cost data for planning and control: A cost accountant collects, classifies and presents in appropriate form suitable data to the management for planning and controlling the operations of the business. He makes constant endeavour to control and reduce the cost by the following techniques:

a. He submits regular reports to the management regarding wastage of material, idle time, idle capacity, etc. He identifies the causes and suggests suitable controlling measures to prevent or reduce losses on account of these causes.

b. He makes product-wise or process-wise comparisons to identify non-profitable products or processes.

c. He develops cost consciousness in the organization by adoption of budgetary control and standard costing techniques.

d. He maintains an even flow of materials and at the same time prevents unnecessary investment of materials through different material control techniques e.g. ABC analysis, perpetual inventory system, materials turnover ratios, fixation of different levels of materials etc.

e. He organizes various cost reduction programmes with the co-operation and co-ordination of different departmental heads.

3. Undertaking special cost studies for managerial decision-making: A cost accountant undertakes special cost studies and carries out investigation for collecting and presenting suitably the data to the management for decision-making regarding the following areas:

a. Introduction of new products, replacement of manual labour by machines etc.b. Make or buy decisions, replacing or repairing old machines, accepting orders

below cost, etc.c. Expansion plans, installation of new capital project, etc.d. Utilisation of idle capacity and development of a proper information system to

provide prompt and correct cost information to the management.e. Installation of a cost audit system.

All types of manufacturing concerns can broadly be classified into two categories – (i) Mass-production concerns, (ii) Special order concerns. Mass production concerns such as chemical plants, flour mills, paper manufacturing, tyre and rubber companies etc., produce uniform standard products and involve generally a continuous production process. The finished products are the result of successive operations. On the other hand, special-order concerns manufacture products in clearly distinguishable lots in accordance with special orders and individual specifications. Printing shops, construction companies, machine tool manufacturing, repair shops, wood-working shops etc., come in this category. In case of mass production concerns the products when produced are of the same type, and involve the same material and labour and pass through the same set of process. In such industries each process is designated as a separate cost-centre and the cost per unit is calculated by dividing total cost of the process with the total number of units produced by the process. The cost of production of the product is obtained by adding the unit costs of various processes through which the product has passed. This method of costing is known as process costing.

Job Costing:In case of special-order concerns products produced or jobs undertaken are of diverse nature. They involve materials and labour in different quantities and entail different amounts of overhead costs. In such concerns it is necessary to keep a separate record of each lot of products or jobs from the time the work on the job or product begins till it is completed. A separate job card or sheet is maintained for each job or product in which all expenses of materials, labour, overheads are entered and cost of completing a job or manufacturing a product is found out. Such a cost system is known as job or terminal or specific costing.

Objectives of job costing:

1. It helps in finding out the cost of production of every order and thus helps in ascertaining profit or loss made out on its execution. The management can judge the profitability of each job and decide its future courses of action.

2. It helps management in making more accurate estimates about the costs of similar jobs to be executed in future on the basis of past records. The management can conveniently and accurately determine and quote prices for orders of a similar nature which are in prospect.

3. It enables management to control operational inefficiency by comparing actual costs with the estimated ones.

A system of job costing should be adopted after considering the following two factors.a. Each order or job should be continuously identifiable from the raw material stage to

the stage of completion.b. The system is very expensive because it requires a lot of clerical work in estimating

costs, designing and scheduling of production. It should, therefore, be adopted when absolutely warranted.

Procedure:The following is the procedure adopted for costing purposes in a concern using job costing:

1. Job order number: Every order received is allotted a certain number from a running list maintained for this purpose. Every order or job will be known by its number throughout its production process in the factory.

2. Production / job order: A production / job order is a written order issued to the manufacturing department to proceed with a job. It is issued by the production planning department on receipt of a job order to the foreman of the relevant department. Instructions to the costing department to collect particulars of costs on execution of the job are also issued simultaneously. The production order is prepared with sufficient copies for all the departmental managers or foreman who will be required to take any part in the production.

3. Bills of materials: The production and planning department also prepares a list of materials and stores required for the completion of the job. A copy is also sent to the concerned foreman with the production order which serves as an authority to him for collecting the materials and stores mentioned from the storekeeper. On the same pattern a list of tools required is also prepared.

4. Job cost card: Job cost card or job cost sheet is the most important document used in the job costing system. A separate card or cost sheet is maintained for each job in which all expenses regarding materials, labour and overheads are recorded directly from costing records. The method of finding out the cost of these elements in respect of a particular order is as follows.

a. Materials: The information regarding cost of materials or stores used for a particular job order can be obtained from materials or stores requisition slips. In case of large job orders, materials abstracts can be prepared for finding out the total value of materials issued to different jobs.

b. Labour: The cost of labour incurred on each job can be ascertained with the help of time and job cards. In case of a large number of jobs, preparation of wages abstract may considerably help in computing the amount paid as wages for completion of specific jobs. Wages paid for indirect labour will constitute an item of factory overheads.

c. Overheads: Every job will be charged with amount of overheads determined on the basis of the method selected for allocation of overheads. Normally on

the basis of past results an overhead rate is determined and each job is charged for overheads at the pre-determined rate.

Profit or loss on a job can also be found out by preparing a job account. The job account is debited with all expenses incurred on the job and is credited with the job price. The difference of the two sides will be the profit or loss made or suffered on the job.

5. Work-in-process: The account is maintained in the cost ledger and it represents the jobs under production. The account may be maintained in any of the following two ways depending upon the requirements of the business:

a. A composite work-in-process account for the entire factory.b. A composite work-in-process account for every department. For example, if

the factory has three departments A, B and C, a work-in-process for each of these three departments will be opened.

The work-in-process account is periodically debited with all costs direct and indirect incurred in execution of the jobs. At intervals of month or so a summary of completed jobs is prepared and the work-in-process account is credited with the cost of completed jobs. In case work-in-progress account for each department of the factory has been opened, it will be necessary to find out the cost of completed jobs regarding each department. The balance in work-in-process account at any time represents the cost of jobs not yet completed.

6. Job ticket: In order to provide information regarding the progress of each job at each operation, generally a job ticket is issued by the production control department. The ticket contains detachable portions for different operations. The job ticket is useful for both production control and costing departments. On completion of an operation, the relevant portion of ticket is detached and sent to production control department. This enables production control department in keeping production schedule up-to-date. On the basis of detached portion a departmental summary of production can be prepared which is very useful for costing purposes. Moreover, the amount of work-in-process as shown by the cost ledger can be checked by listing the ticket number of jobs in process in any department and valuing this list.

7. Progress advice: The foreman of a department may be required to send periodically a statement regarding the stage of completion of each job to ensure completion of jobs by scheduled dates. Such a note is called “progress advice”.

Advantages of job costing:1. Job costing enables the management to identify spoiled and defective work in respect

to particular production orders, departments or groups of workers and hence the management can fix up responsibility for inefficiency.

2. Management can determine the trends in costs and compare the operating efficiency of men and machines in each cost centre. It can also determine the completion cost of each job.

3. It enables the preparation of estimates of costs of jobs before production.4. It enables comparison of estimated costs with actual costs as the costs are analysed on

the basis of costs, services and production.5. It makes available to the management a complete file of production orders which

contains valuable statistics on cost.6. It enables ascertainment of profit or loss on each job immediately after their

completion.7. It enables the management to identify unprofitable jobs.8. In case of cost plus contracts, job costing enables to provide precise quotations.

9. It helps in production planning.10. It facilitates fixation of selling price.

Limitations of job costing:1. Job costing involves a lot of clerical work in identifying materials, labour and

overheads with specific jobs and departments.2. Management cannot evaluate precisely the operating efficiency of men and machines.3. Since costs ascertained and compiled are historical costs, they are not of much utility

to the management.4. It does not apply budgetary control to important cost elements such as labour,

materials and overheads.5. Job costs over any period of time cannot be compared if major economic changes take

place in between.6. It is expensive to operate and errors are possible due to increased clerical work.

Batch Costing:Batch costing is a modified form of job costing. While job costing is concerned with costing of jobs that are executed against specific orders of the customers, batch costing is used where articles are manufactured in definite batches. The articles are usually kept in stock for selling to customers on demand. The term batch refers to the lot in which the articles are to be manufactured. Whenever a particular product is required, one unit of such product is not produced but a lot of say 500 or 1000 units of such product are produced. It is therefore also known as “Lot Costing”. This method of costing is used in case of pharmaceutical or drug industries, ready-made garment factories, industries manufacturing component parts of radio sets, television sets, watches, etc.The costing procedure for batch costing is similar to that under job costing except with the difference that a batch becomes the cost unit instead of a job. Separate job cost sheets are maintained for each batch of products. Each batch is allotted a number. Material requisitions are prepared batchwise, the direct labour is engaged batchwise and the overheads are also recovered batchwise. Cost per unit is ascertained by dividing the total cost of a batch by number of items produced in that batch. Ordinary principles of inventory control are used. Production orders are issued only when the stock of finished goods reaches the ordering level. In case the batches are repetitive, the costing work is much simplified.

Since in batch costing production is done in batches and each batch consists of a number of units, the determination of optimum quantity to constitute an economical batch is all the more important. Such a quantity can be fixed on the basis of same formulae and principles as are applicable to economic order quantity of materials.

Economic Batch Quantity = 2U x P S

Where:U = Annual demandP = Setting up and order placing costs per batchS = Storage or inventory carrying over cost per unit per annum

CHAPTER 3: STANDARD COSTING

Standard costing is defined as – “the preparation and use of Standard Costs, their comparison with actual costs and the analysis of variance as to their causes and point of incidence.ICWA London had defined Standard Costing as – “the preparation of Standard Costs and applying them to measure the variations of actual costs from standard costs and analyzing the causes of variations with a view to maintain maximum efficiency in production”.

Material Variances:1. Material Cost Variance [MCV]

It is the difference between the standard cost of material specified for the output achieved and the actual cost of direct material used. It is said to be favourable when standard cost is more than actual cost and adverse when actual cost exceeds standard costs. It is further divided into Material Usage Variance and Material Price Variance.

MCV = SC – AC= (SQ x SP) – (AQ x AP)

2. Material Usage Variance [MUV]It is that portion of the Material Cost Variance which is due to the difference between the Standard Quantity specified for the actual output and the Actual Quantity used for the actual output. It is said to be favourable when standard quantity is more than actual quantity and adverse when actual quantity exceeds standard quantity.

MUV = (SQ – AQ) x SP

3. Material Price Variance [MPV]It is that portion of the Material Cost Variance which is due to the difference between the Standard Price specified for the Actual Output and the Actual Price paid. Material Price Variance is said to be favourable when the actual price is less than the standard price and adverse when the actual price is more than the standard price.

MPV = (SP – AP) x AQ

4. VerificationMaterial Cost Variance = Material Usage Variance + Material Price Variancei.e. MCV = MUV + MPV

Labour Variances:

1. Labour Cost Variance [LCV] It is the difference between the standard cost of labour specified for the output achieved and the actual cost of direct labour used. It is said to be favourable when standard cost is more than actual cost and adverse when actual cost exceeds standard costs. It is further divided into Labour Efficiency Variance and Labour Rate Variance.

LCV = SC – AC= (SH x SR) – (AH x AR)

2. Labour Efficiency Variance [LEV]It is that portion of the Labour Cost Variance which is due to the difference between the Standard Hours specified for the actual output and the Actual Hours used for the actual output. It is said to be favourable when standard hour is more than actual hour and adverse when actual hour exceeds standard hour.

LEV = (SH – AH) x SR

3. Labour Rate Variance [LRV]It is that portion of the Labour Cost Variance which is due to the difference between the Standard Rate specified for the Actual Output and the Actual Rate paid. Labour Rate Variance is said to be favourable when the actual rate is less than the standard rate and adverse when the actual rate is more than the standard rate.

LRV = (SR – AR) x AH

4. VerificationLabour Cost Variance = Labour Efficiency Variance + Labour Rate Variancei.e. LCV = LEV + LRV

Standard Costing

1. Given the cost standard for material consumption are 40 kg. @ Rs. 10 per kg. Compute the material variances when actuals are:

a. 48 kg @ Rs.10 per kg.b. 40 kg @ Rs.12 per kg.c. 48 kg @ Rs. 12 per kg.d. 36 kg for a total cost of Rs.360.

2. Gemini chemical industries provide the following information from their records. For making 10 kgs of GEMCO standard material requirement is :

Material Quantity (kg) Rate per kg(Rs.)A 8 6.00B 4 4.00

During April 1000 kg of GEMCO were produced. The actual consumption of materials is as under:

Material Quantity (kg) Cost (Rs.)A 750 5250B 500 2500

Calculate material variances

3. Using the following information of department X, calculate all possible labour variances.

Actual wage rate per hour Rs.3.40Standard hours for production 8640 hoursStandard rate per hour Rs.3.00Actual hours worked 8200 hours.

4. The standard cost card for one unit of a product shows the following costs for material and labour:

Material 4 pieces @ Rs. 5.00 and Labour 10 hours @ Rs.1.505700 units of product were manufactured during the month of March 2002 with the following material and labour costs:

Material 23000 pieces @ Rs.4.95 and Labour 56,800 hours @ Rs.1.52Calculate material and labour variances.

5. The standard cost card of a product shows the followingMaterial cost Rs.5 for 2 kg. and Wages Re. 1.00 for 2 hours.The actual which have emerged from business operations are as follows:Production: 8000 units.Material consumed worth Rs.39600 for 16500 kg. and wages paid Rs.7200 for 18000 hours of work.Calculate appropriate material and labour variances.

CHAPTER 4: MARGINAL COSTINGMarginal cost is 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. Thus it is clear that increase / decrease in one unit of output increases or decreases the total cost from the existing level to the new level. This increase or decrease in variable cost from existing level to the new level is called as marginal cost. Suppose the cost of producing 100 units is Rs.200, if 101 units are produced the cost goes up by Rs.2 and becomes Rs.202, if 99 units are manufactured, the cost is reduced to Rs. 198, then the Rs.2 increase or decrease in the cost of production of one unit is the marginal cost. Thus the marginal cost of producing one unit is Rs.2.The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed and variable costs is said to be marginal costing.

Concepts1. Sales: This is the total amount of sales made by the firm or entity.2. Variable cost: This is the cost of the product that keeps changing with the change in

the volume of production.3. Contribution: It is equal to Sales less variable cost. This is the profit before adjusting

the Fixed Costs. It covers fixed cost and profit.4. Fixed cost: It is the cost of the product that does not change over a period even with

the change in the volume of production. 5. Profit: It is equal to contribution less fixed costs. This is the profit after adjusting the

fixed costs. Thus, it does not include fixed cost.6. Profit Volume Ratio: The ascertainment of the impact of changes in volume of output

on profit is done by means of the Profit – Volume Ratio.Profit – volume ratio [PV Ratio] = Contribution

SalesSales, variable cost and contribution vary directly with the number of units. Thus, when the number of units produced or sold increases, the sales, the variable cost and the contribution also increase pro-rata. On the contrary, when the number of units goes down, the sales, the variable cost and contribution are also lower. Thus there is a direct relationship between volume, variable cost and contribution. This is known as the volume-cost-profit relationship. The profit-volume ratio indicates this relationship.

7. Break Even Point: It means the point of no profit and no loss. BEP is the volume of output or sales at which the total cost is exactly equal to the revenue. Below BEP the concern makes losses, at the BEP, the concern makes neither profit nor loss, above BEP, the concern earns profits. BEP is calculated in terms of units or value. Thus

BEP (in units) = Fixed Cost = F Contribution per unit S – V

BEP (in Rs.) = Fixed Cost x Sales = Fixed Cost Contribution per unit PV Ratio

8. Margin of Safety: It is the difference between the Actual Sales and the Sales at the Break-even point. Larger Margin of safety indicates stronger business. Such business can continue to earn profits, even if sales decrease (i.e. in recession). Thus,

Margin of Safety (in Rs.) = Actual Sales – BEP Sales (Rs.)Margin of safety (in units) = Actual Sales(units) – BEP Sales (in units)

Formulae:1. Sales – Variable Cost = Contribution2. Contribution – Fixed Cost = Profit3. Sales – Variable cost = Fixed cost + Profit4. Profit – volume ratio [PV Ratio] = Contribution

Sales

5. BEP (in units) = Fixed Cost Contribution per unit

6. BEP (in Rs.) = Fixed Cost x Sales = Fixed Cost . Contribution per unit PV Ratio

7. Required Sales (Rs.) = Fixed Cost + Desired ProfitPV Ratio

8. Required Sales (Units) = Fixed Cost + Desired ProfitContribution per Unit

9. Actual Sales = Fixed Cost + ProfitPV Ratio

10. Margin of Safety (in Rs.) = Actual Sales – BEP Sales (Rs.)11. Margin of Safety (in units) = Actual Sales(units) – BEP Sales (in units)12. Profit = Margin of Safety x PV Ratio

Problems for Marginal Costing

1. S. Ltd. furnishes you the following information relating to the half year ending 30 th

September 2007. Fixed expenses Rs.50,000, sales value Rs.2,00,000 and Profit Rs.50,000. During the second half of the same year the company, has projected a loss of Rs.10,000. Calculate:

a. PV ratio, break-even point and margin of safety for six months ending 30th

September 2007.b. Expected sales volume for second half of the year assuming that selling price and

fixed expenses remain unchanged in the second half year also.c. The break-even point and margin of safety of the whole year 2007-08.

2. A company had incurred fixed expenses of Rs.2,25,000 with sales of Rs.7,50,000 and earned a profit of Rs.1,50,000 during the first half-year. In the second half-year, it suffered a loss of Rs.75,000. Calculate:

a. The PV ratio, BEP, margin of safety of the first half-yearb. Expected sales-volume for the second half year assuming that selling price and

fixed expenses remained unchanged during the second half-year.3. A retail dealer in garments is currently selling 24,000 shirts annually. He supplies the

following details for the year ended 31st December 2007.Selling price per shirt Rs.40Variable cost per shirt Rs.25Fixed cost:Staff salaries for the year Rs.1,20,000General office costs for the year Rs.80,000Advertising costs for the year Rs.40,000.As a management accountant of the firm, you are required to answer each of the following independently.

a. Calculate the BEP and margin of safety in sales revenue and number of shirts sold.

b. Assume that 20,000 shirts were sold in a year. Find out the net profit of the firm.

c. If it is decided to introduce selling commission of Rs.3 per shirt, how many would require to be sold in a year to earn a net income of Rs.15,000.

d. Assuming that for the year 2008 an additional staff salary of Rs.33,000 is anticipated and price of a shirt is likely to be increased by 15% what should be the BEP in number of shirts and sales revenue?

4. Present the following information to show to the management a. The marginal product cost and the contribution per unit.b. The total contribution and profits resulting from each of the following sales

mixtures:

Product Rs. Per Unit

Direct materials A 10B 9

Direct wages A 3B 2

Fixed expenses Rs.800Variable expenses are allocated to products as 100% of direct wages.Sales price A 20

B 15Sales mixtures:i. 1000 units of product A and 2000 units of B

ii. 1500 units of product A and 1500 units of Biii. 2000 units of product A and 1000 units of B

Which product mix is most profitable?

5. The following particulars are extracted from the records of a company:Particulars Per Unit

Product A Product BSales Rs.100 Rs.120Consumption of raw materials 2 Kg. 3 Kg.Material Cost Rs.10 Rs.15Direct Wages Cost Rs.15 Rs.10Direct Expenses Rs.5 Rs.6Machine hours used 3hrs. 2hrs.Overhead expenses:Fixed Rs.15 Rs.10Variable Rs.15 Rs.20

Direct Wages per hour is Rs.5. Comment on the profitability of each product (both products need the same raw materials) when:

i. Total sales potentials in units is limited.ii. Total sales potential in value is limited.

iii. Raw materials are in short supply.iv. Production capacity (in terms of machine hours) is the limiting factor.

Assuming raw materials as the key factor, availability of which is 10,000 kg. and maximum sales potential of each product being 3,500 units, find the product mix which will yield the maximum profit.

6. A company produces a single product which is sold by it presently in the domestic market at Rs.75 per unit. The present production and sales is 40,000 units per month representing 50% of the capacity available. The cost data of the product are as under:

Variable costs per unit Rs.50 Fixed costs per month Rs.10 lakhs.

To improve the profitability, the management has 3 proposals on hand as under:a. To accept an export supply order for 30,000 units per month at a reduced price of

Rs.60 per unit, incurring additional variable costs of Rs.5 per unit towards export packing, duties etc.

b. To increase the domestic market sales by selling to a domestic chain stores 30,000 units at Rs.55 per unit, retaining the existing sales at the existing price

c. To reduce the selling price for the increased domestic sales as advised by the sales department as under:

Reduce selling price per unit by Rs. Increase in sales expected (in units)

5 10,0008 30,00011 35,000

Prepare a table to present the results of the above proposals and give your comments and advice on the proposals.

7. A company manufactures three products by processing materials through machine shop and finishing departments. Standard product costs are based on the following figures.

Particulars A B CMaterial Cost Rs.2.30 Rs.3.50 Rs.5.00Labour Hours:Machine shop @50paise per hourFinishing department @60paise per hour

2 hrs2 hrs

2 ½ hrs1 ½ hrs

3 hrs1 hr

Selling price Rs.8.50 Rs.10.20 Rs.12.00Overhead rates based on normal production are Machine shop @Re.1 per hour and Finishing department @60 paise per hour. At the budgeted level of production half of the total overheads charged to each department is variable and the other half is fixed. Present the information to the management to assess the profitability of the products when there is a shortage of any of the three factors viz., time, labour and raw materials.

CHAPTER 5: PROCESS COSTING

A Process means a distinct manufacturing operation or stage. In process industries, the raw material goes through a number of processes in a sequence before the finished product is finally produced. For example, production of coconut oil involves the following distinct processes: 1. Copra crushing 2. Refining and 3. Finishing.

Process costing is defined as “a method of costing used to ascertain the cost of the product at each stage or operation of manufacture..”Important calculations

1. Normal loss = Input x % of normal loss2. Normal output = Input – Normal loss3. Unit Cost = Cost of process – Sale value of Normal loss

Input – Normal loss4. Abnormal loss = Normal Output – Actual output5. Abnormal gain = Actual output – Normal output6. Cost of actual output = Unit cost x Units of Actual Output7. Cost of Abnormal Loss = Unit cost x Units of Abnormal Loss8. Cost of Abnormal Gains = Unit cost x Units of Abnormal Gains

Problems:1. Assemblers Ltd. have three Assembly shops viz., General Assembly, Lower

Assembly. The Company furnished the following information.

General Lower HigherRaw Material ( in Litres) 5,000 1,920 3,576Material Cost per litre Rs. 60 40 80Labour cost Rs. 4,28,000 1,06,000 2,10,000Direct Expenses Rs. 88,000 2,85,000 1,04,800Wastage as percentage of total input 4% 5% 10%a) Output transferred : To Lower Assembly To Higher Assembly

60%-----

-----40%

----------

b) Output sold in market : Sale price per litre Rs.

40%200

60%205

100%250

Administration overhead Rs.36,000 and Marketing overhead Rs.48,000.Prepare various Assembly Accounts and Costing Profit and Loss Account.

2. A product passes through three processes A, B and C. 10,000 units at a cost of Rs. 1.10 per Unit were issued to Process A. The other direct expenses were as follows.

Process ARs.

Process BRs.

Process CRs.

Sundry MaterialsDirect LabourDirect Expenses

1,5004,5001,000

1,5008,0001,000

1,5006,5001,503

The wastage of Process A was 5% and in Process B 4% of inputs. The Wastage of Process A was sold at Rs. 0.25 per unit and that of Process B at Rs. 0.50 per unit and that of Process C at Rs. 1.00 per unit. The overhead charges were 160% of direct labour. The final product was sold at Rs. 10 per unit fetching a profit of 20% on sales. Prepare all process accounts.

3. A product of a company passes through 3 processes viz., Process A, Process B and Process C, to obtain three consecutive grades of the product. Details relating to its production for the year 2001 are as follows.

Particulars Process – A Process - B Process – CRaw materials usedCost per tonneManufacturing Wages and ExpensesWeight LostScrap Sold at Rs. 50/- per tonne Sale price per tonne

1,000 tonnesRs. 200Rs. 75,0005%50 tonnes400`

------Rs. 41,00010%30 tonnes500

------Rs. 11,00020%51 tonnes800

Management expenses were Rs. 15,000, selling expenses were Rs. 10,000. Two-third output of Process A and one-half output of Process B are passed on the next process and the balance was sold.You are required to prepare process cost accounts and costing Profit and Loss Account for the year 2001.

CHAPTER 6: BUDGETARY CONTROL

Controlling costs by making use of budgets is known as budgetary control. Budgetary control and standard costing together help in achieving the two important functions of management viz; planning and control.

Budget is a plan quantified in monetary terms, prepared and approved prior to a definite period of time, usually showing planned income to be generated and / or expenditure to be incurred during that period and the capital to be employed to attain a given objective. Budget may also be prepared in quantitative terms. For example Production Budget, Plant utilization budget etc. Budget is a plan showing expected achievement based on most efficient operating standards. Against this actual accomplishment is regularly compared.

Budgets may be time based o Short-term ando Long-term

Based on functions also known as functional budgets o Sales budgeto Production budgeto Production cost budgeto Purchase budgeto Personnel budgeto Plant Utilisation budgeto Administrative cost budgeto Selling and Distribution cost/ overhead budgeto Capital expenditure budgeto Cash budgeto Research and Development cost budget.

Budgets may be based on behavior o fixed budget and o flexible budget.

Budgetary control is a system of planning and controlling costs which involves the following steps.

1. Establishment of budgets: Functional budgets are prepared based on responsibilities of individuals. These budgets are then co-ordinated to prepare budgeted P&L A/c and budgeted balance sheet.

2. Measurement of actual performance.3. Comparison of actual performance with budgeted performance to develop variances.4. Analysis of causes of variance and reporting for immediate action.

Problems:

1. A company manufactures product A and Product B. During the year ending December 2008, it is expected to sell 15,000 kgs of product A and 75,000 kgs of product B at Rs.15 and Rs.8 per kg respectively. The direct materials P, Q, and R are mixed in the proportion of 3:5:2 in the manufacture of product A. Material Q and R are mixed in the proportion of 1:2 in the manufacture of product B. the actual and budgeted inventories for the year are given below:Material / Product Opening Stock

in kgs.Expected closing stock in kgs.

Anticipated Cost per Kg. in Rs.

Material P 4,500 3,000 6/- Q 3,000 6,000 5/- R 30,000 9,000 4/-Product A 3,000 1,500 - B 4,000 5,500 -

Prepare production budget and material purchase budget, showing the expenditure for the materials for the year ending 31-12-2008.

2. Maya Limited has made the following sales estimates for April, May and June of the year 2009 from which you are required to prepare sales budget by units and rupees for each of the three months for each sales area and in total

Sales Area April May JuneA 40% 30% 30%B 45% 35% 20%C 40% 35% 25%D 30% 40% 30%

The area-wise unit sales expected is as follows:Sales Area Sales (Units)A 2,500B 2,000C 3,000D 6,000Total 13,500

The selling price has been fixed at Rs.6 per unit in Area A, Rs.8 per unit in Area B, Rs.12 per unit in Area D and Rs.10 per unit in Area C.

3. Calculate the budgeted overhead cost per tonne at production level of 35 tonnes based on the following details at 80% capacity (40 tonnes)Particulars Rs. in ‘000Depreciation 22Indirect labour 24Insurance 6Power (80% variable) 40Repairs and maintenance (50% fixed) 40Salaries 20Stores consumable 8Also prepare budget for overhead cost at 100% capacity utilization.

4. Prepare Cash budget of Sandeep Ltd. for the months of April, May and June, 2007

Month Sales Purchases Wages ExpensesJanuary 1,60,000 90,000 40,000 10,000February 1,60,000 80,000 36,000 12,000March 1,50,000 84,000 44,000 12,000April 1,80,000 1,00,000 48,000 14,000May 1,70,000 90,000 40,000 12,000June 1,60,000 70,000 36,000 10,000

You are informed that:a. 50% of the purchases and sales are on cash.b. The average collection period of the company is ½ month and credit purchases

are paid off regularly after 1 month.c. Time lag in payment of wages is 1 month.d. Rent of Rs.1000 is payable every month.e. Cash and bank balance as on 31st march, 2007 was Rs.3,00,000.f. Dividend received in May Rs.36,000.g. Professional fees to be paid in June Rs.1,500.h. Expenses are paid in the same month.