Mgmt study material created/ compiled by - Commander … Costs are the costs which change in direct...

Mgmt study material created/ compiled by - Commander RK Singh [email protected]

of 60 - Cost Management

Jamnalal Bajaj Institute of Mgmt Studies

COST ACCOUNTING AND COST MANAGEMENT By Mr RS Sardesai

Syllabus

1. Cost analysis and preparation of cost statement

2. Marginal costing and decision making

3. Standard costing calculation and variances

4. Budgetary control and various functional budgets

5. Job costing and apportionment of service dept’s cost

6. Contract costing

7. Process costing

1. Cost Analysis and Preparation of Cost Statement.

(a) Cost. Cost is all expenditure incurred to bring the goods or services in

the present condition or location.

- Implies that all expenditure is not cost

- Cost to be calculated with some reference point

- There is a change in location or condition or change in both.

(i) Raw Material Stock Cost (to be valued at cost)

- Supplier’s price

- Loading Charges

- Transportation

- Transit insurance

- Import duty or octroi etc

- Unloading charges

- Godown charges - X

(a) Godown charges are some times not considered as

cost as there is no change in location or condition

(b) Godown charges are considered only after the item

is shifted from godown. In case of using godown during the

transit, the charges are to be included.

(ii) Finished Goods Stock

- Raw material cost




- Wages

- Factory expenses

(a) Water

(b) Electricity

(c) Shed rent

(d) Depreciation on asset for production

(e) Factory taxes

- Packing

- Excise duty

- Sales tax X (not to be included)

- Advertising X

(iii) Semi finished goods

- Raw material

- Wages On proportionate basis

- Factory expenses

Analysis of Costs. There are three methods adopted for cost analysis.

1. Direct and Indirect Costs method.

2. Variable, Fixed and Semi Variable Costs method

3. Production, Admin, Sales & Finance Costs method

Direct Cost is the cost which is directly related to a particular activity. In

converse way, it is the expenditure which can be avoided if the particular activity

is not undertaken. Eg. The raw material used for manufacturing an item. If a

particular item is not manufactured, the raw material and consequential cost of

raw material is saved/not spent. It is mostly on proportionate basis to the activity

level.

Indirect Cost is that cost which does not have one to one relation with the

activity. It is not directly related to activity. In other words it is the cost which has

to be incurred irrespective of activity progressing or not. Such costs normally

cover much wider range of activities like Administrative costs. These costs do not

have one to one relationship with activity level.




Variable Costs are the costs which change in direct proportion with the

quantum of activity. In such cases there is direct fixed relation between quantum

of activity and the cost incurred. Eg. Fuel expenditure of your car which is

directly proportional to the usage of the car.

Fixed Costs are the costs which remain constant (subject to a pre-specified

maximum limit of activity, after which it will change) irrespective of the quantum

of activity. Eg. Depreciation cost of Machinery, Insurance and finance costs of

your vehicle which remain constant irrespective whether the machinery/vehicle is

run or not.

Semi Variable Costs are the costs which do change as the activity level changes

but the variation is not in direct proportion to the activity level variation. These

costs have a fixed component as well as a variable component. Eg. Hiring of a car

which has a fixed daily hiring charges and in addition, per kilometre running

charges applicable. Same is the case of mobile post paid charges. Rental charges

are fixed costs while per unit call charge is the variable cost.

Mathematical Model of Fixed and Variable Costs

Sl Item 2000 Units 5000 Units 3000 units Remarks

(a) Depreciation Rs 10000/- Rs 10000/- Rs 10000/- Fixed Cost

(b) Raw Material

@ Rs25/-per

unit

Rs 50000/- Rs 125000/- Rs 75000/- Variable Cost

(c) Advertisement Rs 20000/- Rs 26000/- Rs 22000/- Semi Variable

Fixed Compo Rs 16000/- Rs 16000/- Rs 16000/-

Variable Comp

@Rs2/-per unit

Rs 4000/- Rs 10000/- Rs 6000/-

In case of Fixed costs, unit rate is constant.

In case of Variable costs, amount is constant.

Example.

A factory can produce 15000 units per month. The following is their data

for Apr and May: -

Sl Item Apr (Units) May (Units)

(a) Total Production 9000 12000

(b) Direct Material Cost Rs 108000/- Rs 144000/-

(c) Direct Labour Cost Rs 81000/- Rs 108000/-

(d) Depreciation Rs 20000/- Rs 20000/-

(e) Production Overheads Rs 35000/- Rs 44000/-

(f) Admin Overhead Rs 15000/- Rs 16500/-

(g) Sales Overhead RS 30000/- Rs 36000/-




The factory is expecting to produce and sell 10000 units in Jun at a selling price to

earn a profit of 20% on the cost. Prepare a cost statement and selling price for Jun.

Cost Analysis Statement

Sl Item Apr May Jun

(a) Total Production 9000(Units) 12000(Units) 10000(Units)

(b) Direct Material Cost Rs 108000/- Rs 144000/- Rs 120000/-

(c) Direct Labour Cost Rs 81000/- Rs 108000/- Rs 90000/-

(d) Depreciation Rs 20000/- Rs 20000/- Rs 20000/-

(e) Production Overheads Rs 35000/- Rs 44000/- Rs 38000/-

Fixed cost Rs 8000/- Rs 8000/- Rs 8000/-

Variable Cost @ 3/- Rs 27000/- Rs 36000/- Rs 30000/-

(f) Admin Overhead Rs 15000/- Rs 16500/- Rs 15500/-

Fixed Cost Rs 10500/- Rs 10500/- Rs 10500/-

Variable Cost @0.50 Rs 4500/- Rs 6000/- Rs 5000/-

(g) Sales Overhead RS 30000/- Rs 36000/- Rs 32000/-

Fixed Cost Rs 12000/- Rs 12000/- Rs 12000/-

Variable Cost @2/- Rs 18000/- Rs 24000/- Rs 20000/-

Cost Statement for Jun

Sl Item Jun Unit Cost

(a) Total Production 10000(Units)

(b) Direct Material Cost Rs 120000/- Rs 12/-

(c) Direct Labour Cost Rs 90000/- Rs 9.00

(d) Depreciation Rs 20000/- Rs 2.00

(e) Production Overheads Rs 38000/- Rs 3.80

(f) Admin Overhead Rs 15500/- Rs 1.55

(g) Sales Overhead Rs 32000/- Rs 3.2

(h) Total Production Cost Rs 315500/- Rs31.55

(j) Profit 20% Rs63100/- Rs 6.31

(k) Selling Price Rs 37.86

Cost Sheet of a Product

1. Production Cost (a) Direct Cost (Also called Prime Cost)

(b) Indirect Cost (Also called Prodn

O/H)

includes indirect material, indirect labour,

power, fuel and depreciation on machinery

etc.

2. Admin Cost is also called Admin O/H.




3. Selling and Distribution Cost called Selling and Distribution O/H.

4. Financial Costs are called Financial O/H. (Not included in cost sheet as this cost

varies between project to project and it is difficult to arrive at a proper figure). But this cost is

fully adjusted/factored while calculating selling price of an article or service.

Purpose of Preparing a Cost Sheet.

1. To plan cost of a new product

2. To fix selling price

3. To control cost of an existing product

4. To find profitability of a product

Cost sheet is a profit and loss account of a product.

Principles of a Profit and Loss Account

1. Relate to a period (an account is applicable for a specified period only).

2. Relate to a product (for every individual and specific product)

3. Relate to a level of activity (Production rate).

While preparing Cost Sheet of a product, it is necessary to have opening stock of: -

(a) Raw Material

(b) Work in progress (ie, Stock of semi finished products)

(c) Finished products

Cost Sheet Model of a Product X

Period: _____________

Production = 1000 units Sale = 9500 units

Sl Item Total Per Unit

(a) Direct Material Cost

(i) Opening Raw Material stock xx

(ii) Add: Purchased during period xx

(iii) Less: Closing stock xx Xxxx x

(b) Direct Wages Xxxx x

1. Prime Cost Xxxx x

Production Overhead Xxxx

2. Factory Cost = production cost of the period Xxxx

Add: Opening WIP Stock Xxxx

Less: Closing WIP Stock Xxxx

3. Works Cost (Prodn

cost of finished product) Xxxx x

Admin O/H = Cost of production of 10000 Xxxx x




units`

Add: Opening finished goods stock Xxxx x

Less: Closing finished goods stock Xxxx x

4. Cost of Goods Sold – Xxxx

Selling O/H (Selling & Distribution Expenses) Xxxx x

5. Cost of Sales Xxxx x

Profit or Loss Xxxx x

6. Sales (Money realised through sales) Xxxx x




Practice Problems – Cost Sheet

Q1. When the selling price of a product ‘P’ for the year 2003 was Rs 10/-, the total

sales were Rs 1,00,000/-. For the year 2004, the selling price has been increased by 10%.

The total sales are expected to increase by 21%.

For the year 2003, the materials cost was 40%, labour cost was 30% and total

overheads were 20% of sales.

For the year 2004, the material rates have increased by 10%, labour rates by 5%

and total overheads by Rs 3100/-

Prepare the cost sheet for the year 2003 and 2004 and find out the profitability.

Solution: -

COST SHEET 2003 2004

SL NO ITEM TOTAL PER UNIT INCREASE

PER UNIT TOTAL

Derived Information

Sales 100000 10 10% 11 121000

Units produced 10000 11000

(a) Material Cost Variable Cost 40000 4 10% 4.40 48400

(b) Labour Cost Variable Cost 30000 3 5% 3.15 34650

Prime Cost Variable Cost 70000 7 7.55 83050

(c) Over Heads Semi Variable 20000 2 ???? 2.1 23100

Cost of Sales 90000 9 9.65 106150

Selling Price 100000 10 11 121000

Profit 10000 1 1.35 14850

Q2. A Ltd company manufactures and sells electrical ovens. The selling price of the

same for the year 2003 was Rs 2500. For the year 2003, the material was 40%, labour

30% and total overheads were 30% of the cost of sales.

For the year 2004, the material rates have increased by 5 %, labour rates by 10%

but no change in overheads.

If the management fixes the same selling price of Rs 2500 for the year 2004, there

shall be a reduction in the profit of 2004 by 20% of such profits. The management wants

you to suggest such a price for 2004 so that same percentage of profit shall be

maintained.




Sol: -

COST SHEET 2003 2004

SL NO ITEM % Rs % Rs

Material 40 800 42 840

Labour 30 600 33 660

Prime Cost 70 1400 75 1500

Overheads 30 600 30 600

Cost of Sales 100 2000 105 2100

Profits 25 500 25 525

Selling Price 125 2500 130 2625 (See comments on attached excel sheet for sequence of putting the figures in the table)

It is seen from above table that cost of sales in 2004 is 5% more than the cost of sales in

2003.

But it is given that if the selling price is kept same as 2003,

Selling price remaining same, increase in cost = Reduction in profits

That means 5% of the cost of sales = 20 % Profits.

ie Cost of sales = 4 x profits

But cost of sales + profit = selling price = 2500

Therefore 4x profits + profit = 2500

5 profits = 2500

Profit = 500

Cost of sales = 4 x 500 = 2000

Percentage of profits = 25%

Cost of sales in 2004 = 2100

Therefore Selling price for having same level of profit = 2625

Q3. X Ltd has a capacity to manufacture 25000 units per annum. For the year 2003,

they produced and sold 20000 units in domestic market and the data for same is as

under:-

Material Rs 600000

Labour Rs 360000

Production Overheads

(50% fixed)

Rs 200000

Adm Overheads

(50% variable)

Rs 50000

Sales Overhead

(75% variable)

Rs 100000

Cost of sales Rs 1310000

Profit Rs 190000

Sales Rs 1500000




Additional information is as follows: -

(a) For 2004, the domestic demand shall reduce by 10%, but the company is

expected to utilise 100% of capacity by exporting the units of balance

capacity.

(b) The rates of all the variable costs shall increase by 10% but the fixed costs

are not expected to change.

(c) The variable sales overheads rate for the export is expected to be 50% of

the similar rate for domestic sale.

(d) The company is expected to maintain same level of profit also for 2004.

(e) Prepare the cost sheet for 2004 and find out what selling price shall be

charged for exports if domestic selling price is not expected to change for

2004.

Sol: -

Prepare a work sheet as follows: -

ITEM TOTAL COST UNIT RATE

2003 2003 2004

CHANGE

Material 600000 30 10% 33

Labour 360000 18 10% 19.8

Production O/H

Fixed 100000 -- NIL 100000

Variable 100000 5 10% 5.50

Adm O/H

Fixed 25000 -- NIL 25000

Variable 25000 1.25 10% 1.375

Sales O/H

Fixed 25000 NIL 25000

Variable Domestic 75000 3.75 10% 4.125

Variable Export --- 2.062

Now Prepare a cost sheet

SL ITEM DOMESTIC

18000

EXPORT

7000

TOTAL

25000

1 Material 33 594000 33 231000 33 825000

2 Labour 19.8 356400 19.8 138600 19.8 495000

Prime Cost 52.8 950400 52.8 369600 52.8 1320000

Production O/H

Fixed 4 72000 4 28000 4 100000




Variable 5.5 99000 5.5 385000 5.5 137500

Works cost 62.3 1121400 62.3 4361000 62.3 1557500

Adm O/H

Fixed 1 18000 1 7000 1 25000

Variable 1.375 24750 1.375 9625 1.375 34375

Cost of Prodn 64.675 1164150 64.675 452725 64.675 1616895

Sales O/H

Fixed 1 18000 1 7000 1 25000

Variable 4.125 74250 2.062 14434 3.547 88684

Cost of sales 69.8 1256400 67.737 47415 69.222 1730559

Profit 5.2 93600 13.771 96400 190000

Sales 75 1350000 81.508 570559 1920559




MARGINAL COSTING

Marginal Costing is an important tool for decision making.

While arithmetically it is correct to say that if profit on one unit is Rs 10/- then profit on

100 units would be Rs 1000/-, in actual business environment, it is not so. The profit

earned on 100 units would rarely be arithmetic calculation of one unit in actual

conditions. It could be Rs 500 or Rs 2000.

Def. Marginal cost is the change in total cost for the change in activity by one unit.

In actual scenario, Marginal cost = Variable cost.

Therefore, Marginal Costing is a decision making technique by use of calculation of

marginal costs.

Marginal Cost Table (Very Very Important Table – Should be remembered

by heart)

Per Unit Total

Sales X XX

(-) Variable Cost X XX

Contribution X XX

(-) Fixed Costs X XX

Profits/Loss X XX

Per Unit Total

Sales 100 100000

(-) Variable Cost 60 60000

Contribution 40 40000

(-) Fixed Costs 30 30000

Profits/Loss 10 10000

Contribution = Difference in sales and variable cost at any level.

= Sales – variable cost

= Qty x (SP) – Qty (Variable cost per unit)

= Qty x (SP – variable cost per unit)

PV Ratio = Profit Volume Ratio

= Contribution/Sales

Note – Contribution and sales should always be taken for the same activity

level.




PV Ratio does not change due to change in

(a) Qty

(b) Fixed Costs

(c) Change in both in same proportion

PV Ratio changes when

(a) Selling Price is Changed (Total Sales Revenue is affected due to change in

SP. Thus denominator in the ratio changes)

(b) Variable Cost changes (Numerator changes due to change in Variable

cost)

(c) Change in both at differential proportion.

Break Even Point – The production level at which there is no profit or loss.

Contribution at BEP = Fixed Costs

Qty = Fixed cost/Contribution per unit

Qty = 30000/40 = 750 units

(Contribution)BEP = Fixed Costs

(Divide both sides by (Sales)BEP)

(Contribution)BEP = Fixed Costs

(Sales)BEP = (Sales)BEP

PV Ratio = Fixed Costs

(Sales)BEP

(Sales)BEP = Fixed Costs

PV Ratio

= 30000

0.4

= 75000

Margin of Safety = Actual level – BEP

= 1000 – 750

= 250 UNITS

Level does not mean only quantity. It could also mean sales

= 100000 – 75000

= 25000 (Sales Value)

Q1. X Ltd sells product P having SP of Rs 150 and variable cost/per unit of Rs 60. The

fixed cost for year 2004 is 3,60,000 and the total sales Rs 12 lakhs.

(a) Calculate

(i) PV Ratio




(ii) BEP (in Qty and Sales Value)

(iii) Margin of Safety

(iv) Profit at present level

(b) Calculate profit or loss if activity is 950 units

(c) Find out how the activity for

(i) How many units to be sold for a profit of Rs 90000

(ii) What would be the sales value

Sol: - (a)

Sales = 1200000/150 = 8000 Units

Fixed Cost per unit = 360000/8000 = 45

Contribution = SP – Variable Cost

= 150 – 60 = 90

Table Per Unit Total

Sales 150 1200000

(-) Variable cost 60 480000

Contribution 90 720000

(-) Fixed Costs 45 360000

Profits 45 360000

(i) PV Ratio = Contribution /Sales

= 90/150

= 0.60

(ii) BEP Contribution = Fixed Cost

(90 x BEP) = 360000

BEP = 360000/90

BEP = 4000 units

= 150x4000 = Rs 600000

(iii) Margin of Safety Actual Level – BEP

8000 – 4000 = 4000

1200000 – 600000 = 600000

(iv) Profit at present level Profit = (SP-Fixed Cost – Var Costs)x Qty

= (150 – 45 – 60) x 8000

= 45 x 8000

= 360000

(b) Profit or loss if activity is 950 units

Contribution per unit = 90

Total contribution = Contribution per unit x total units

90 x 950 = 85500




Loss = Fixed cost – contribution

= 360000 – 85500= 274500

Profit or loss for sales of Rs 450000 Total Contribution = PV Ratio x Sales

= 0.60 x 450000

= 270000

Loss = Fixed cost – contribution

Loss = 360000 – 270000

= 90000

(c) (i) Activity for profit of Rs 90000

Total Contribution = Profit + Fixed Costs

= 90000 + 360000

= 450000


Total contribution = No of units x contribution per unit

450000 = 90 x X

X = 5000

(ii) Contribution = Fixed Cost – Loss

= 360000 – 60000

= 300000

PV Ratio = Contribution / Sales

0.6 = 300000/X

X = 500000

Q. With above basic data, the management is expecting an increase of Rs 60000 in

fixed costs with the decrease in selling price by 20% and decrease in Variable cost/unit

by 10%. Calculate what would be change in profit/loss.

Sol: -

The new Selling Price = 150 – 20% = Rs 120

The new Variable Cost = 60 – 10% = Rs 54

New fixed cost = 360000 +60000 = 420000

Sales (unit SP) = 120

(-) Var Costs = 54

Contribution = 66 528000

(-) Fixed Costs= 420000

Profit (New) 108000

Profit (Old) 360000

Change in profit = 252000

New contribution per unit = New SP – New Variable Cost

= 150 – 54 = 66

No of units sold earlier = Earlier Sales/Earlier SP




= 1200000/150 = 8000

Total Contribution = 8000 x 66 = 528000

New profit = New contribution – New Fixed Cost

= 528000 – 420000

= 108000

Reduction in profit = Earlier profit – new profit

= 360000 – 108000

= 252000

Q. Under the new circumstances the management wants to achieve same sales value.

How much would be the effect on profits?

Sol. Sales Qty = Sales Value/SP per unit

= 1200000/120 = 10000 Units

Total Contribution = Contribution per unit x no of units

= 66 x 10000

= 660000

New Profit = New Contribution – New fixed costs

= 660000 – 420000

= 240000

Reduction in profits = Old Profit – New Profit

= 360000 – 240000

= 120000

Q. How much should be the sales level under the changed circumstances to earn the

same profit as before?

Desired Contribution = Desired Profit + New fixed cost

= 360000 + 420000

= 780000


No of units = 780000/66

= 11819

Sales Value = No of units x SP

= 11810 x 120

= 1418280

Q. The following are the financial results of X Ltd for the years 2002 and 2003: -

2002 2003

Sales 20,00,000 25,00,000

Profits 5,00,000 6,50,000

The fixed costs for the year 2003 were higher than that for 2002 by 50000.

Calculate for both years




(a) PV Ratio

(b) Fixed Costs

(c) Break Even Point

(d) Margin of safety

Sol.

2002 2003 Change

Sales 20,00,000 25,00,000 5,00,000

- Variable Costs 12,00,000 15,00,000 3,00,000

= Contribution 8,00,000 10,00,000 2,00,000

- Fixed Costs 3,00,000 3,50,000 50,000

= Profit 5,00,000 6,50,000 1,50,000

(To solve this problem, CHANGE has to be calculated and work the figures from there since all the rules of

normal Marginal Costing table apply on change figures also. Data in “Blue colour, italics and bold” is

given in the problem.

Change in Contribution = Change in Fixed costs + Change in Profits

= 50,000 + 1,50,000 = 2,00,000

PV Ratio = Change in Contribution /Change in Sales

= 2,00,000/5,00,000 = 0.4

Contribution = PV Ratio X Sales

= 0.4 X 20,00,000 = 8,00,000 (2002)

= 0.4 X 25,00,000 = 10,00,000 (2003)

Fixed Costs = Contribution – Profits

= 8,00,000 – 5,00,000 = 3,00,000 (2002)

= 10,00,000 – 6,50,000 = 3,50,000 (2003)

Break Even Point = Fixed Costs/PV Ratio

= 3,00,000/0.4 = 7,50,000 (2002)

= 3,50,000/0.4 = 8,75,000 (2003)

Margin of Safety = Actual Level – BEP

= 20,00,000 – 7,50,000 = 12,50,000 (2002)

= 25,00,000 – 8,75,000 = 16,25,000 (2003)

Q. Can BEP be calculated without calculating the fixed costs?

Sol: - PV Ratio = Change in total contribution/Change in sales

Change in sales = Change in total Contribution/PV ratio

= Change in Profits/PV Ratio

20,00,000 – (Sales)BEP= (5,00,000 – 0)/0.4

= 12,50,000




(Sales)BEP = 7,50,000

Q. X Ltd has planned the following performance for the year 2004: -

Production 20,000 units

Sales (In Lakhs) 25

Less cost of sales

Raw Mat 06

Labour 03

Production Exp 02

(40% fixed)

Admin Exp 02

(90% fixed)

Sales Exp 05 18

(40% variable)

Net Profit 07

The company achieved the planned results for the half year ending Jun 04. Due to Union

Budget in Jul 04, following changes are expected:-

(a) Raw Material rates shall increase by 10%.

(b) All variable costs except labour shall increase by 10%.

(c) All fixed costs shall increase by 20%.

(d) The company has production capacity of 25000 units pa.

Is it possible to maintain planned profitability for 2004 in the changed circumstances? If

so, at what level?

Profitability Statement

Variable Costs Fixed

Costs

PerUnit

Cost in

Rs

Total in Lakhs

Unit

(Rs)

Total in

Lakhs

Sales (20000 units) 30 6.0 125 25

Labour 15 3.0

Production 06 1.2 0.80

Admin Exp 09 1.8 0.20

Sales Exp 10 2.0 3.00

Total 70 14.0 4.00 70 14

Total 2nd

Half

Contribution 55 11 5.9

Fixed Cost 04 2.4

Profit 07 3.5




The planned profits for the year = Profit for 1st half + expected profits for 2

nd half

7 = 3.5 + (expected profits for 2nd

half)

Expected profits for 2nd

half = 7 – 3.5 = 3.5 lakhs

Expected Fixed Cost for 2nd

Half = 4/2 x 120% = 2.4 lakhs

Expected Contribution in 2nd

Half = Exp Profit + Fixed Costs

= 3.5 + 2.4 = 5.9 lakhs

Expected Contribution /unit =

Selling Price 125

-Variable Costs

Raw Material (30 + 3) 33

Labour 15

Other Expenses (25+2.5) 27.5 75.5

Contribution/unit 49.5

Expected activity for the second half of year

= Expected contribution/contribution per unit

= 5,90,000/49.5

= 11920 units

Since the production level required is only 11920 units which is less than balance

production capacity for the remaining half year ie 12500 units, it is feasible to achieve the

planned target.

Sales Value = 11920 x 125 = 14,90,000

Q. What would be minimum selling price that can be fixed for the 2nd

half year

to maintain the planned profits?

Sol. The minimum SP can be achieved when full capacity ie 12500 units is utilised.

The expected contribution = 5.9 lakhs as calculated above

Contribution per unit = 590000/12500

= 47.2

Variable cost as calculated earlier = 75.5

Selling price = 47.2 + 75.5 = 122.70

Q. The management wants to sell 10000 units in domestic market and export

balance capacity at a selling price lesser by 5% than domestic SP. To earn the same

profit what domestic price should be fixed?

Sol. The expected contribution = 5,90,000

Expected Variable Costs = 12500 x 75.5

= 9,43,750

Expected total sales = 15,33,750




Equivalent Units of Sale

Units Wt Equi Units

Domestic 10000 1 10000

Export 2500 0.95 2375

Total 12375

Expected Domestic Selling Price = 15,33,750/12375

= 123.94




APPLICATIONS OF MARGINAL COSTING

There are four major applications of Marginal Costing in Management:

1. Priority for profit maximisation

(a) Under normal circumstances

(b) Under key factor

2. Export Pricing

3. Manufacture Vs Outsource (Make Vs Buy) decision

4. Shutdown point of a factory

PRODUCT A B C D E

Material Cost 10 12 15 8 6

Labour Cost 8 6 8 4 6

Variable Cost 4 4 6 3 2

Fixed Overheads 5 4 6 2 3

Total Cost 27 26 35 17 17

Profit 4 4.5 2 3.5 4.6

Selling Price 31 30.5 37 20.5 21.6

Priority by Company III II V IV I

Contribution 9 8.5 8 5.5 7.6

Priority by Me I II III V IV

The above priority assessment is when there are no constraints of material, labour, market

etc.

To maximise the profit, fixed costs remaining constant, the product which facilitates

maximum contribution per unit should be given priority.

Now suppose that material cost is Rs 5/- Kg and labour cost is Rs 2 per hour.

PRODUCT A B C D E

Material Cost (Rs 5/- per Kg) 10 12 15 8 6

Labour Cost (Rs 2/- per Hr) 8 6 8 4 6

Variable Cost 4 4 6 3 2


Total Cost 27 26 35 17 17

Profit 4 4.5 2 3.5 4.5

Selling Price 31 30.5 37 20.5 21.6

Contribution per unit 9 8.5 8 5.5 7.6

Consumption - Kg/unit 2 2.4 3 1.6 1.2

Contribution per Kg 4.5 3.54 2.67 3.43 6.33




Priority per material limitation II III V IV I

Consumption - Hours per unit 4 3 4 2 3

Contribution per Hr 2.25 2.83 2 2.75 2.53

Priority with Lab constraints IV I V II III

Export Pricing

Product P Cost/Unit Export

Raw Material 50 40 (20% Excise duty concession)

Labour 35 35

Total O/H 20 12 (Only variable taken into a/c)

(60% Var) 3 (Special packing cost)

Total Cost 105 90

Domestic Profit 20 (-) 8 (Rebate against FE earnings)

Selling Price 125 82 (Minimum Export Price – without

any profit)

Min Export Price = Additional Cost (Variable Cost) – Incentives for Export

Make Vs Buy Decision

COMPONENT P Q R S T

Material Cost 6 3 2 5 4

Labour Cost 4 3 4 1 3

Variable O/H 2 2 1 3 2


Total Cost 15 10 9 12 10

Mkt Price 16 7 8 10 12

Savings - 1 3 1 2 - 2

Buy/ Manufacture (Co Decision) M B B B M

Var Cost 12 8 7 9 9

Mkt Price 16 7 8 10 12

SAVINGS - 4 1 - 1 - 1 - 3

Decision Make Buy Make Make Make (Since Fixed Overheads are sunk cost and will have to be incurred even when purchasing from outside,

they are added to the procurement cost from outside for Make or Buy decision. Thus, products R and S

which appeared to be profitable when outsourced from market, turn out to be loss making proposition).

Other Considerations regarding buy/manufacture decisions:

1. Price Stability in market

2. Quality assurance of supplier




3. Criticality of component

4. Loss of contacts with existing suppliers of raw material etc.

5. Assurance regarding timely supply of component.

Shut Down Point.

Sales 20,00,000

Var Cost 10,00,000

Contribution 10,00,000

Fixed Cost 15,00,000

Loss 5,00,000

If the factory is closed down, 50% of the fixed costs can be saved. Whether factory

should be closed?

If the factory is not closed, the loss is Rs 5 lakhs as shown above. If the factory is

closed:

Sales 0

Contribution 0

Fixed Cost 7,50,000 (50% of costs of Rs 15 lakhs)

Loss 7,50,000

Therefore, it is better to continue operations.

Shut Down point is that point at which the loss if continued is equal to loss if

discontinued.

Sales 15.0

- Var cost 7.5 (50% of Sales – Calculated from given figures)

Contribution 7.5 (Calculated )

- Fixed Cost 15.0 (When operational - Given)

Loss 7.5 (if discontinued - Given)

If the factory is continuing, the expected loss is 7.5 lakhs at shut down point.

The fixed cost if continued = 15 lakhs

Contribution at Shut down point = Fixed cost – loss

= 7.5 lakhs

PV Ratio = Sales

onContributi

= 10,00,000

20,00,000

= 0.5

Therefore, Sales at Shut Down Point = Contribution at SD Point

PV Ratio

= 7.5

0.5

= 15 lakhs




STANDARD COSTING

Standard Costing is setting of the standard and comparison of the actual with the

standards for the purpose of control. It involves taking the remedial measures for the

variances or to set or revise the obsolete standards.

Calculation of variances

Variable Cost Related Fixed Cost Related

1. Raw Material 1. Fixed Overhead

2. Labour

3. Variable Overhead

Raw Material Cost Variances

Raw Material Price Variance Raw Material Usage Variance

The methodology used for calculating the Raw Material Variances is also used for

calculating the Labour and Variable Overhead variances.

Q. Calculate Raw Material variances:

Standard 1000 units of finished product

2000 Kg of Raw Material @ Rs 15/Kg Rs 30000/-

Actual 8500 Units of finished goods

16800 Kg of Raw Material @ 15.50/Kg Rs 260400/-

Sol.

1. Raw Material Cost Variance = (Actual RM Cost – RM cost for actual production

at Standard Rates)

= 260400- 8500x30

= 5400 (Adverse Variance denoted as ‘A’)

2. RM Price Variance = Actual Qty (Actual Price – Standard Price)

= 16800 (15.5 – 15)

= 8400 (A)




3. RM Usage Variance = Standard Price (Actual Qty – Standard Qty for actual

production)

= 15 (16800 – 8500x02)

= 15 (16800 – 17000)

= 3000 (Favourable Variance denoted as ‘F’)

Q. Calculate RM, Labour and Variable Overhead Variances

Standard for 100 Units of Finished Goods

RMs 1500 Kgs @ Rs 3/- = Rs 4500/-

Labour 600 Hrs @ Rs 4/- = Rs 2400/-

Variable Overhead 600 Hrs @ Rs 1.50= Rs 900/-

Total Variable Cost for Standard 100 Units = Rs 7800/-

Actual for 2500 Units of Finished goods

RMs 37250 Kgs @ Rs 3.10 = Rs 115475/-

Labour 15260 Hrs @ Rs 4.15 = Rs 63329/-

Variable Overhead 15260 Hrs @ Rs 1.40 = Rs 21364/-

Total Variable Cost for Actual production = Rs 200168/-

Sol.

Raw Material Cost Variance = (Actual RM Cost – RM cost for actual production

at Standard rates)

= (115475 – 2500x15)

= 2975 (F)

Raw Material Rate Variance= Actual Quantity (Actual Rate – Standard Rate)

= 37250 (3.1 –3.0)

= 3725 (A)

Raw Material Usage Variance = Standard Rate (Actual RM Usage – Standard

usage for actual production)

= 3.0 (37250 – 2500 x 15)

= 750 (F)

Labour Cost Variance = (Labour Cost for Actual Production – Labour

cost for actual production at standard rates)

= (63329 – 2500 x 6 x 4)

= 3329 (A)




Labour Efficiency Variance = Standard Labour Rate (Actual hrs – Standard Hrs

for actual production)

= 4 (15260 – 2500 x 6)

= 1140 (A)

Labour Rate Variance = Actual Hours (Actual Rate – Standard Rate)

= 15260 (4.15 – 4)

= 2289 (A)

Variable overhead Variance = Actual Variable Overheads – Overheads for

actual production at standard rates)

= (21364 – 2500 x 6 x 1.5)

= 1136 (F)

Variable Overhead Rate Variance = Actual Hrs (Actual Rate – Standard Rate)

= 15260 (1.5 – 1.4)

= 1526 (F)

Variable Overhead Efficiency Variance = Standard Rate (Actual Overhead Hours –

Hrs required at Standard Rate for Actual Production)

= 1.5 (15260 – 15000)

= 1.5 (260)

= 390 (A)

Statement of Variances

Material Cost Variance Rs 2975/- (A)

Material Price Variance Rs 3725/- (A)

Material Usage Variance Rs 750/- (F)

Labour Cost Variance Rs 3329/- (A)

Labour Rate Variance Rs 2289/- (A)

Labour Efficiency Variance Rs 1040/- (A)

Variable Overhead Cost Variance Rs 1136/- (F)

Variable Overhead Rate Variance Rs 1126/- (F)

Variable Overhead Eff. Variance Rs 390/- (A)

(Please note that in all cases, where Rate/price is outside the brackets, it is always

STANDARD)




Q. Calculate Material, Labour and Variable Overhead Variances from the following

data:

Standard for 10000 units

Raw Material 15000 Kgs @ Rs 9/Kg Rs 135000/-

Labour 30000 Hrs @ Rs 3/Hr Rs 9000/-

Variable Overhead 30000 Hrs @ Rs 1.8/Hr Rs 54000/-

Actuals for 9000 Units

Raw Material 13500 Kg @ Rs 8.75/Kg Rs 118125/-

Labour 27260 Hrs @ Rs 3.10/Hr Rs 84506/-


Sol.

Material Cost Variance = (Actual cost – Cost at Standard Rates for actual production)

= (118125 – 1.5 x 9 x 9000)

= 3375 (F)

Material Rate Variance = Actual Mat consumed (Actual Rate – Standard Rate)

= 13500 (9 – 8.75)

= 3375 (F)

Material Usage Variance = Standard Rate (Actual Mat consumed– Standard

material for actual production)

= 1.80 (13500 – 13500)

= 000

Labour Cost Variance = Actual Cost – Cost at Standard Rate for actual production

= 84506 – 9000 x 3 x 3

= 3506 (A)

Labour Rate Variance = Actual hrs (Actual Rate – Standard Rates)

= 27260 (3.10 – 3)

= 2726 (A)

Labour Eff. Variance = Standard Rate (Actual Hrs – Standard hrs for actual

production)

= 3 (27260 – 9000 x 3)

= 3 x 260 = 780 (A)




Variable Overhead Variance= Actual Overhead – Overhead at Standard Rate for actual

production

= 47705 – 9000 x 3 x 1.8

= 47705 – 48600

= 895 (F)


= 27260 (1.75 – 1.8)

= 1363

Variable Overhead Eff Variance = Standard Rate (Actual Hrs – Standard Hrs for

actual production)

= 1.8 (27260 – 9000 x 3)

= 1.8 (260) = 468 (A)




Material Usage Variance Rs 000/- (-)










FIXED OVERHEAD VARIANCES

Fixed Overhead Cost Variance

Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

Calendar Variance Capacity Variance Efficiency Variance

Example 1:

Calculate Fixed Overhead Variances from the following details: -

Standard Rs

Fixed Overhead 2,00,000

Production (Units) 50,000

Hrs 1,00,000

Days 25

Actual



Hrs 1,02,500

Days 26

Solution

Working Notes

(Standard)

Fixed Overhead per unit = 200000/50000 = Rs 4/-

Fixed Overhead per hr = 200000/100000 = Rs 2/-

Fixed Overhead per day = 200000/25 = Rs 8000/-

Hrs available per day = 100000/25 = 4000

No of Hrs per unit = 100000/50000 = 2

1. Fixed Overhead Cost Variance

= Actual Overhead Expenditure – Fixed overheads recovered

= 2,08,000 – 51200x4

= 208000 – 204800 = 3200 (A)

2. Fixed Overhead Expenditure Variance

= Actual Overhead Expenditure – Standard Overhead Expenditure

= 208000 – 200000 = 8000 (A)




3. Fixed Overhead Volume Variance

= Fixed Overhead Recovered – Standard Fixed Overhead

= 51200 x 4 – 200000

= 204800 – 200000

= 4800 (F)

3(a) Fixed Overhead Calendar Variance

= Standard Fixed Overhead per day (Actual Days – Standard Days)

= 8000 (26 –25)

= 8000 (F)

3(b) Fixed Overhead Capacity Variance

= Standard Fixed Overhead per hr (Capacity Available – Capacity

Utilised)

= Standard Fixed Overhead per hr (No of days worked x hrs per day –

Actual hrs utilised)

= 2 (26 x 4000 – 102500)

= 2 (104000 – 102500)

= 2 (1500)

= 3000 (A)

3(c) Fixed Overhead Efficiency Variance

= Standard Fixed Overhead per hr (Hrs actually taken – Standard Hrs for

actual production)

= 2 (102500 – 2x51200)

= 2 (102500 – 102400)

= 2 (100)

= 200 (A)

Fixed Overhead Cost Variance 3200 (A)

Fixed Overhead Expenditure Variance 8000 (A)

Fixed Overhead Volume Variance 4800 (F)

Fixed Overhead Calendar Variance 8000 (F)

Fixed Overhead Capacity Variance 3000 (A)

Fixed Overhead Efficiency Variance 200 (A)

Example 2:


Standard Rs


Production (Units) 2,50,000

Hrs 4,00,000

Days 25




Actual


Production (Units) 2,46,800

Hrs 3,96,500

Days 24

Solution

Working Notes


Fixed Overhead per hr = 200000/100000 = Rs 1.25

Fixed Overhead per day = 500000/25 = Rs 20,000/-

Hrs available per day = 400000/25 = 16,000

No of Hrs per unit = 400000/250000 = 1.6


= Actual Overhead Expenditure – Fixed Overheads recovered

= 4,97,500 – 2,46,800 x 2

= 4,97,500 – 4,93,600 = 3,900 (A)



= 4,97,500– 5,00,000 = 2,500 (F)



= 246800x2– 500000

= 493600 – 500000

= 6400 (A)



= 20000 (25 –24)

= 20000 (A)



Utilised)


Actual Hrs Utilised)

= 1.25 (24 x 16000 – 396000)

= 1.25 (384000– 396000)

= 1.25 (12000)

= 15000 (F)






actual production)

= 1.25 (396000 – 1.6x246800)

= 1.25 (396000–394880)

= 1.25 (1120)

= 1400 (A)

Fixed Overhead Cost Variance 3900 (A)

Fixed Overhead Expenditure Variance 2500 (F)

Fixed Overhead Volume Variance 6400 (A)

Fixed Overhead Calendar Variance 20000 (A)

Fixed Overhead Capacity Variance 15000 (F)


Example 3:


Standard Rs



Hrs 70,000

Days 28

Actual



Hrs 75,000

Days 29

Solution

Working Notes


Fixed Overhead per hr = 560000/70000 = Rs 8/-

Fixed Overhead per day = 560000/28 = Rs 20000/-

Hrs available per day = 70000/28 = 2500

No of Hrs per unit = 70000/14000 = 5


= Actual Overhead Expenditure – Fixed Overheads recovered

= 612000 – 14900 x 40

= 612000– 596000 = 16000(A)






= 612000 – 5,60,000= 52000 (A)



= 14900 x 40 – 560000

= 596000 – 560000

= 36000 (F)



= 20000 (29 –28)

= 20000 (F)



Utilised)


Actual Hrs Utilised)

= 8 (29 x 2500 – 396000)

= 8 (72500 – 75000)

= 8 (2500)

= 20000 (F)



actual production)

= 8 (75000 – 5x14900)

= 8 (75000–74500)

= 8 (500)

= 4000 (A)

Fixed Overhead Cost Variance 16000(A)

Fixed Overhead Expenditure Variance 52000 (A)

Fixed Overhead Volume Variance 36000 (F)

Fixed Overhead Calendar Variance 20000 (F)

Fixed Overhead Capacity Variance 20000 (F)





PROCESS COSTING

Cost Pursuit in a particular process

Further step to cost sheet

Conditions: -

1. The whole process should be distinguishable into various identifiable processes

2. The output of earlier process is input for the next process.

3. Various processes are to be conducted in a particular sequence.

DR CR

INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT To material @ Rs 10 1000 10000

To wages 6000 By Transfer to Process - II @ Rs 20

1000 20000

To Manufacturing Expenses

4000

Total 1000 20000 1000 20000

Process Loss

Loss in weight Scrap

(No realisable Value) (There is realisable value)

Material Scrap Defective Goods

Abnormal Loss Normal Loss Abnormal Gain

(Output = 930 units) Eg 5% inputs Output = 955 units

950-930 = 20 Units Input = 1000 955-950= 5 units

(Loss beyond 5% = 50 units (Output beyond normal output)

normal loss) Normal Output

950 units

Normal Loss

DR CR

INPUT UNITS AMOUNT OUTPUT UNITS AMOUNT

To material @ Rs 10 1000 10000 By Normal Loss – (5% of 1000 units at

50 500




Re 1)


950 19500


4000

Total 1000 20000 1000 20000

Abnormal Loss

DR CR


To material @ Rs 10 1000 10000 By Normal Loss – (5% of 1000 units at Re 10)

50 500

By Abnormal Loss @ Rs 21 (20000/950)

20 420


930 19080


4000

Total 1000 20000 1000 20000

Abnormal Loss A/c

DR CR


To process - I A/c 20 420 By Scrap Value 20 20

By Profit and Loss A/c

400

Total 20 420 20 420

Abnormal Gain

DR CR


To material @ Rs 10 1000 10000 By Normal Loss – (5% of 1000 units at Re 10)

50 500


955 19605




To abnormal gain @ Rs 21

5 105


4000

Total 1005 20105 1005 20105

Abnormal Gain A/c

DR CR


To Scrap Value @Re 1

5 5 By Process I 5 105

To Profit and Loss A/c

100

Total 105 5 105

Example 1. Product P is manufactured by sequential process I, II, III. From the

following information, prepare process I, II, and III A/cs and abnormal loss/gain A/c.

ITEM PROCESS - I PROCESS - II PROCESS - III

Misc material 8000 10000 3000

Wages 25000 18000 20000

Mfg Expenditure 15000 12000 10000

Normal Loss (% of Input 5% 8% 6%

Scrap Value of Normal Loss Rs 8/unit - Rs 12/unit

Actual output 925 850 805

1000 units were introduced to process I @ Rs 40 per unit.

Solution.

Working Notes - Process I A/c

1. Normal Quantity = Input – Normal Loss

= 1000 – 50 = 950 units

2. Net Cost = Input Cost – Scrap Value of Normal Loss

= 88000 – 400 = 87600

3. Cost/unit = Net Cost /Normal Quantity

= 87600/950 = 92.21

4. Abnormal Loss = Normal Qty – Actual Qty

= 950 – 925 = 25 units




Process I A/c

DR CR


To units introduced @ Rs 40

1000 40000 By Normal Loss – (5% of 1000 units at Rs 8)

50 400

To Misc Material 8000 By Abnormal Loss @ Rs 92.21

25 2305

To wages 25000 By Transfer to Process - II @ Rs 92.21

925 85295


15000

Total 1000 88000 1000 88000

Working Notes - Process II A/c


= 925 – 74 = 851 units


= 125295– 0 = 125295


= 125295/851 = 147.23

4. Abnormal Loss = Normal Qty – Actual Qty

= 851 – 850 = 1 unit

Process II A/c

DR CR


To units Transferred from process I @ Rs 92.21

925 85295 By abnormal Loss – (8% of 925 units)

74 0

To Misc Material 10000 By Abnormal Loss @ Rs 147.23

1 147

To wages 18000 By Transfer to Process - III @ Rs 147.23

850 125148


12000

Total 925 125295 925 125295




Working Notes - Process III A/c


= 850 – 51 = 799 units


= 158148 – 612 = 157536


= 157536/799 = 197.17

4. Abnormal gain = Normal Qty – Actual Qty

= 799 – 805 = 06 units

Process III Account

DR CR


To units Transferred to Process - III @ Rs 147.23

850 125148 By normal Loss @ Rs 12/- for 6% of 850 units

51 612

To Misc Material 3000 By Transfer to finished goods @ 197.17

805 158719

To wages 20000

To Mfg Expenses 10000

To abnormal gain @ 197.17

6 1183

Total 856 159331 856 159331

Abnormal Loss A/c

DR CR


To process I A/c 25 2305 By scrap value @ Rs 8/-

25 200

To process II A/c 1 147 By scrap value 1 NIL

By Profit & Loss A/c 2252

Total 26 2452 26 2452

Abnormal Gain A/c

DR CR


To Scrap Value Process I A/c @ Rs 12

6 72 By Process III A/c 6 1183

To Profit and Loss A/c

1 1111

Total 6 1183 6 1183




Example 2. Product P is manufactured by sequential processes X, Y, Z. From the

following information, prepare process X, Y, and Z accounts and abnormal loss/gain

account.


Misc material 6000 5000 2000

Wages 12000 15000 10000

Mfg Expenditure % of wages 50% 80% 30%

Normal Loss (% of Input 10% 8% 5%

Scrap Value of Normal Loss 10% 15% 20%

Actual output 925 840 800

1000 units were introduced to process X @ Rs 20 per unit.

Example 1. A Ltd Co manufactures three chemicals X, Y and Z. Chemical X is

manufactured by process I, Chemical Y by processes I & II and chemical Z by process I,

II and III. The company sells part of output of each process in market at a profit of 10%

above cost. From the following details prepare process accounts I, II and III.


Input material (Kg) 10000 600 3000

Rate per Kg Rs 15 30 25

Wages 38000 21000 26000


Output (Kg) 9600 6800 3750

Qty Sold 1/3rd

3800 3750

Qty Transferred to next Process

2/3rd

3000 000

The loss of input has no realisable value.

*** (Unless abnormal loss or gain is given, normal situation is assumed.)

Solution.

Working Notes - Process A/c I

1. Output = 9600 Kg


= 201000 – Zero = 201000

3. Cost/unit = Net Cost /Output

= 201000 / 9600 = 20.94

4. Selling Price = Cost + Profit

= 20.94 + 2.09 = 23.03

5. Qty Sold = 1/3 x 9600 = 3200




6. Qty Transferred = 2/3 x 9600 = 6400

Process A/c I

DR CR



10000 150000 By Loss in Wt (10000 - 9600)

400 000

To wages 38000 By Sales @ 23.03 3200 73696


13000 By Transfer to

process II @ Rs

20.94

6400 134016

To Profit and loss A/c (3200 x 2.09)

6712

Total 10000 207712 10000 207712

Working Notes - Process A/c II

1. Output = 6800 Kg


= 183016 – Zero = 183016


= 183016 / 6800 = 26.91


= 26.91+ 2.69 = 29.6

5. Qty Sold = 3800

6. Qty Transferred = 3000

Process A/c II

DR CR



600 18000 By Loss in Wt (7000 - 6800)

200 000

To units introduced from Process I

6400 134016

To wages 21000 By Sales @ 29.60 3800 112480


10000 By Transfer to

process III @ Rs

3000 80730




26.91


10194

Total 7000 193210 7000 193210

Working Notes - Process A/c III

1. Output = 3750 Kg


= 183016 – Zero = 183016


= 183016 / 3750 = 48.8


= 48.8 + 4.88 = 53.68

5. Qty Sold = 3750


Process A/c III

DR CR



1000 25000 By Loss in Wt (4000 - 3750)

250 000

To units introduced from process II

3000 80730

To wages 26000 By Sales @ 53.68 3750 201316.5


8000


61586

Total 4000 201316.5 4000 201316.5

Example 2. A Ltd Co manufactures three minerals P, Q and R. Mineral P is

manufactured by process I, Mineral Q by process I & II and mineral R by process I, II

and III. The company sells part of output of each process in market at specified selling

prices. From the following details prepare process accounts I, II and III.


Input material (Kg) 8000 200 300

Rate per Kg 50 70 100

Wages 125000 83000 51000





Loss (% of input) 10% 12% 8%

Qty Sold (Kg) 1/3 1/2 100

Qty Transferred to next Process

2/3rd

1/2 000

Selling Price 80 120 150

The loss out of process I is sold @ Rs 15, Process II @ Rs 20 and Process III @ Rs 25.

Solution.

Working Notes - Process A/c I

1. Output = 8000 – 10% = 7200

2. Loss = 800 Kg


= 567000 – 12000 = 555000


= 555000 / 7200 = 77.08

5. Selling Price = 80

6. Qty Sold = 1/3 x 7200 = 2400

7. Qty Transferred = 2/3 x 9600 = 4800

Process A/c I

DR CR



8,000 4,00,000 By sale of scrap of Normal Loss (10%) @ Rs 15

800 12,000

To wages 1,25,000 By part production sales @ Rs 80.

2,400 1,92,000


4,200 By Transfer to process II @ Rs 77.08

4,800 3,69,984


6,984

Total 8,000 5,73,984 8,000 5,73,984

Working Notes - Process A/c II

1. Output = 5000 – 12% = 4400





= 487984 – 12000 = 475984

3. Loss = 600


= 475984 / 72000 = 77.08


6. Qty Sold = 2200


Process A/c II

DR CR



200 14000 By sale of scrap of Normal Loss (12%) @ Rs 20

600 12000

To units introduced from Process I

4800 369984

To wages 83000 By part production sales @ 125

2200 275000


21000 By Transfer to process III @ Rs 108.18

2200 237996


37012

Total 5000 524996 5000 524996

Working Notes - Process A/c III

1. Output = 2500 – 8% = 2300 Kg


= 333996 – 5000 = 328996

3. Loss = 200


= 328996/ 2300 = 143.04


6. Qty Sold = 2300

Process A/c III

DR CR



300 30000 By sale of scrap of Normal Loss (8%) @ Rs 25

200 5000




To units introduced from Process II

2200 237996

To wages 51000 By Sales @ 150 2300 345000


15000


16004

Total 2500 350000 2500 350000

Process Profit Statement Process – I = Rs 6964

Process – II = Rs 37012

Process – III = Rs 16004

Rs 60000




CONTRACT COSTING

Contract Costing. This method is followed in case of construction contracts to find

the profitability of the each construction job. It is related to a particular site.

Contract Account of Site X (Profit and Loss A/c)

Dr Cr

Expenditure

To opening Material Stock

To opening uncertified work

To material sent to site

To wages

To depreciation on eqpt

To supervision charges

To notional profit

To (profit and loss A/c)

To Closing reserve for contingencies

Income By opening reserve for contingencies

By work certified

By uncertified work

By materials returned

By closing stock

By net loss

By Notional Profit

Expenditure – Direct

1. Materials – Sand, Cement, Bricks, Steel, Water, Wooden Blocks, etc

2. Labour

3. Equipment – Depreciation

Expenditure – Indirect

1. Supervision Charges

Case Study- Suppose a project was started on 01 Jan 04. Since the money is paid in

case of construction contracts for part job completed (although some money out of the

total due is always retained by the person giving contract (contractee) to have some

leverage on the contractor so that he does not leave the contract mid way and run away,

running bills are submitted for payment according to the percentage of the work

completed. Veracity of all such claims of the work completion are usually assessed by a

third party who certifies the amount of work completed and his decision is binding on

both the parties. The payment is made at a pre agreed rate for the percentage of work

certified as completed.

Income statement of the Project

From – to Work Done Claim Certification Date

1st Running Bill 01-01-04 1,00,000 02.02.04

31-01-04

- 10% Retention Money 10,000

90,000 Cash Paid

2nd

Running Bill 01.02.04 1,80,000 (Addl 80,000) 3.3.04

29.02.04




- 10% Retention Money 18,000 (Addl 8,000)

1,62,000 Payment entitled

-90,000 (Paid Last Month)

Cash to pay 72,000

3rd

Running Bill 01.03.04 2,50,000 (Addl 70,000) 4.4.04

31.03.04 (Cost = 58,000)

By Principle of conservatism, loss is never carried forward. However, profit is carried

forward and it is called NOTIONAL PROFIT.

Contract Account

Notional Profit (Depends on Stage of Completion) Loss

(To be written off )

Net Profit Reserve for contingency

Stage of Completion

Contract Value - Rs 10 Lac

Work Completed Cum Work SOC

1st Year 3,00,000 3,00,000 30%

2nd

Year 5,00,000 8,00,000 80%

3rd

Year 2,00,000 10,00,000 100%

SOC = Cumulative Work Certified

Total Contract Value

Empirical Rule for Notional Profit Sharing

Stage of Completion Formula for Profit Sharing

Less than 25% Nil

From 25% to less than 50% 1/3 x Notional Profit x %Cash Received

Work Certified

.

From 50% to less than 90% 2/3 x Notional Profit x %Cash Received

Work Certified

.

From 90% to less than 100% Notional Profit x Cumulative Work Certified

Total contract value

.




100% Completed Notional Profit

As the stage of completion increases, more and more notional profit is accrued to the

profit.

Question. X Ltd commenced construction job on 01.07.01 for a total value of Rs 25

Lac to be completed within 3 years. The contract was completed on 31.12.03. From the

following details, prepare contract A/c for the years ended 31 Mar 02, 31 Mar 03 and

31 Mar 2004 and show relevant items in the company balance sheet on these dates.

Item 31.3.02 31.3.03 31.3.04

Work Certified 7,00,000 10,00,000 8,00,000

Closing Uncertified Work 45,000 59,000 000

Material Sent to site 2,45,000 4,31,000 3,15,000

Material returned form site 12,000 14,000 10,000

Closing Stock of material 21,000 25,000 000

Wages paid 1,83,000 3,49,000 2,75,000

Closing outstanding wages 17,000 21,000 000

Supervisory Charges 1,20,000 1,50,000 1,60,000

The company commenced the contract with equipment worth 5 Lac. They purchased

following equipment further: -

Date Value of Equipment 1.1.02 3,00,000

1.10.02 2,00,000

1.07.03 1,00,000

Equipment is to be depreciated at the rate of 10% per annum on SLM.

The contractee pays 75% of work certified immediately on cash and balance only on

completion of contract.

Solution.

Depreciation for Year Ending 31.3.02

Date Cost % Depreciation

1.07.01 5,00,000 7.5% 37,500

1.01.02 3,00,000 2.5% 7,500

45,000



1.04.02 8,00,000 10% 80,000

1.10.02 2,00,000 5% 10,000

90,000






1.04.03 10,00,000 7.5% 75,000

1.07.02 1,00,000 5% 5,000

80,000

Wages for the year 31.3.02 31.3.03 31.3.04

Wages Paid 1,83,000 3,49,000 2,75,000

Closing Outstanding 17,000 21,000 000

Total 2,00,000 3,70,000 2,75,000

- Opening Outstanding 000 -17,000 21,000

Total Wages 2,00,000 3,53,000 2,54,000

Supervisory charges

31.3.02 31.3.03 31.3.04

Per Annum 1,20,000 1,50,000 1,60,000

No of months 9 12 9

For the year 90,000 1,50,000 1,20,000

Contract Account for Year Ending 31 Mar 02

Dr

To material sent to site 2,45,000

To wages 2,00,000

To supervisory charges 90,000

To depreciation 45,000

Notional Profit 1,98,000

Total 7,78,000

To Net Profit 49,500

To Closing reserves for 1,48,500

Cr

By Work certified 7,00,000

By uncertified work 45,000

By Material Returned 12,000

By Closing Stock of Material 21,000

Total 7,78,000

By Notional Profit 1,98,000

Stage of Completion = Cumulative Work Certified


= 7,00,000

25,00,000

As the stage of completion is between 25 and 50%,

Net Profit = 1/3 x Notional Profit x %Cash Received

Work Certified

= 1/3 x 198,000x75%

= Rs 49,500




Balance Sheet as on 31.3.02

Liabilities

Reserves

Profit and loss Account 49,500

For contingencies 1,48,500

Current Liabilities

Outstanding Wages 17,000

Assets

Fixed Assets

Eqpts

Opening Cost 5,00,000

Addition 3,00,000

less Accrued Dep 45,000

7,55,000

Current Assets

Material Stock 21,000

Cl uncertified Work 45,000

Contractee Account 1,75,000

(25% of 7 lakhs)


Dr

To Opening Mat Stock 21,000

To Opening uncertified work 45,000


To wages 3,53,000

To supervisory charges 1,50,000


Notional Profit 1,56,500

Total 12,56,500


To Closing reserves for 78,250

Contingency

Cr

By Opening reserves for 1,48,500

contingency


By uncertified work 59,000


By Closing Stock of Material 25,000

_______________________________

Total 12,56,500

By Notional Profit 1,56,500

Stage of Completion = Cumulative Work Certified


= 17,00,000 = 68%

25,00,000




As the stage of completion is between 50 and 90%,

Net Profit = 2/3 x Notional Profit x Cash Received

Work Certified

= 2/3 x 1,56,500x75%

= Rs 78,250

Balance Sheet as at 31.3.04

Liabilities

Reserves

Profit and loss Account 1,27,750

(49,500 + 78,250)

For contingencies 78,250

Current Liabilities

Outstanding Wages 21,000

Assets

Fixed Assets

Eqpts


Addition 2,00,000

10,00,000

- Accrued Depreciation 1,45,000

8,65,000

Current Assets

Material Stock 000

Closing uncertified Work 59,000

Contractee Account 4,25,000

(25% of 17 lakhs)


Dr

To Opening Mat Stock 25,000

To Opening uncertified work 59,000


To wages 2,54,000

To supervisory charges 1,20,000


Notional Profit 35,250

Total 8,88,250


Cr

By Opening reserves for 78,250

contingency



By Closing Stock of Material 000

________________________________

Total 8,88,250

By Notional Profit 35,250




Balance Sheet as at 31.3.04

Liabilities

Reserves

Profit and loss Account 1,63,000

(1,27,750 + 35,250)

Assets

Fixed Assets

Eqpts


Addition 1,00,000

11,00,000

- Accrued Depreciation 2,15,000

8,85,000


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STOCK VALUATION

FIFO. The issues are charged on the basis of procurement prices starting from the

oldest procurement. The closing stock is valued at the procurement prices starting from

latest procurement rates.

Advantages. The stock valuation is current (on the basis of latest available rates).

Limitations.

1. The customer may not be properly charged especially in case of jobs where

selling price = cost + margin.

2. Accounting method is cumbersome as each lot of procurement is maintained

separately in the stock Register.

LIFO. The issues are charged on the basis of procurement prices starting from the

last procurement. The closing stock is valued at the procurement prices starting from oldest

procurement rates.

Advantages. The charging to the customer is always appropriate.

Limitations.

1. The Balance sheet does not reflect the true value of the inventory.

2. This accounting method is also equally cumbersome as FIFO as each lot of

procurement is maintained separately in the stock Register.

Question.

Record the following transactions in the stock records of the company.

1.1.04 - Opening Stock 200 Kg @ Rs 40/-

3.1.04 - Purchased from X & Co 500 Kg @ Rs 42/-

5.1.04 - Issued for Job 101 300 Kg


3.1.04 - Purchased from Y & Co 400 Kg @ Rs 43/-

3.1.04 - Purchased from X & Co 200 Kg @ Rs 42/-




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Solution.

STOCK REGISTER (FIFO)

Date Details Receipts Issues Balance

Kg @ Value Kg @ Value Kg @ Value

1.1.04 Opening Stock 200 40 8000

3.1.04 Purchased X & Co 500 42 21000 200 40 8000

500 42 21000

700 29000

5.1.04 Issued to Job 101 200 40 8000

100 42 4200

300 12200 400 42 16800

6.1.04 Issued to Job 103 300 42 12600 100 42 4200

8.1.04 Purchased Y & Co 400 43 17200 100 42 4200

400 43 17200

500 21400

11.1.04 Purchased X & Co 200 42 8400 100 42 4200

400 43 17200

200 42 8400

700 29800

13.1.04 Issued to Job 102 100 42 4200 200 43 8600

200 43 8600 200 42 8400

300 12800 400 17000

15.1.04 Issued to Job 102 200 43 8600 200 42 8400

STOCK REGISTER (LIFO)

Date Details Receipt Issues Balance


1.1.04 Opening Stock 200 40 8000

3.1.04 Purchased X & Co 500 42 21000 200 40 8000

500 42 21000

700 29000

5.1.04 Issued to Job 101 300 42 12600 200 40 8000

200 42 8400

400 16400


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6.1.04 Issued to Job 103 200 42 8400

100 40 4000

300 12400 100 42 4200

8.1.04 Purchased Y & Co 400 43 17200 100 40 4000

400 43 17200

500 21200

11.1.04 Purchased X & Co 200 42 8400 100 40 4000

400 43 17200

200 42 8400

700 29600

13.1.04 Issued to Job 102 200 42 8400 100 40 4000

100 43 4300 300 43 12900

300 12700 400 16900

15.1.04 Issued to Job 102 200 43 8600 100 40 4000

100 43 4300

200 8300

STOCK REGISTER (SIMPLE AVERAGE)



1.1.04 Opening Stock 200 40 8000

3.1.04 Purchased X & Co 500 42 21000 700 41 29000

5.1.04 Issued to Job 101 300 41 12300 400 41 16700

6.1.04 Issued to Job 103 300 41 12400 100 41 4400

8.1.04 Purchased Y & Co 400 43 17200 500 42 21600

11.1.04 Purchased X & Co 200 42 8400 700 42 30000

13.1.04 Issued to Job 102 300 42 12600 400 42 17400

15.1.04 Issued to Job 102 200 42 8400 200 42 9000


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STOCK REGISTER (WEIGHTED AVERAGE)



1.1.04 Opening Stock 200 40 8000

3.1.04 Purchased X

& Co

500 42 21000 700 41.43 29000

5.1.04 Issued to Job

101

300 41.43 12429 400 41.43 16571


103

300 41.43 12400 100 41.43 4142

8.1.04 Purchased Y

& Co

400 43 17200 500 42.68 21342

11.1.04 Purchased X

& Co

200 42 8400 700 42.46 29742


102

300 42.46 12738 400 42.46 17004


102

200 42.46 8492 200 42.46 8512


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APPORTIONMENT OF O/H OF SERVICE DEPTTS TO PRODDEPTTS.

P1 P2 P3 S1 S2

Overheads 30000 25000 20000 5000 4000

No of Hrs 10000 8000 12000 8000 8000

% of Service Rendered

S1 50% 20% 20% -- 10%

S2 30% 40% 20% 10% ---

P1 P2 P3 S1 S2

Overheads 30000 25000 20000 5000 4000

S1 2500 1000 1000 -5000 500

32500 26000 21000 0 4500

S2 1350 1800 900 450 -4500

33850 27890 21990 450 0

S1 225 90 90 -450 45

34075 27890 21990 0 45

S2 14 18 9 4 -45

34089 27908 22000 0 0

Hrs 10000 8000 12000

Rate/Hr 3.41 3.48 1.83

Job 501

(Overheads) Labour

Deptt Hrs Rate Total Hrs Rate Total

P1 20 3.41 68.20 20 10 200

P2 15 3.48 52.20 15 10.75 161

P3 25 1.83 45.75 25 6 150

166.15 511

Job Cost Sheet (Job 501)

Material 1050

Labour 511

Overheads 166

1727

Margin 173

1900


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Q. Calculate Raw Material variances:

Standard 1000 units of finished product

2000 Kg of Raw Material @ Rs 15/Kg Rs 30000/-

Actual 8500 Units of finished goods

16800 Kg of Raw Material @ 15.50/Kg Rs 260400/-

Sol.

1. Raw Material Cost Variance = (Actual RM Cost – RM cost for actual production at

Standard Rates)

= 260400- 8500x30

= 5400 (Adverse Variance denoted as ‘A’)

2. RM Price Variance = Actual Qty (Actual Price – Standard Price)

= 16800 (15.5 – 15)

= 8400 (A)

3. RM Usage Variance = Standard Price (Actual Qty – Standard Qty for actual

production)

= 15 (16800 – 8500x02)

= 15 (16800 – 1700)

= 3000 (Favourable Variance denoted as ‘F’)

Q. Calculate RM, Labour and Variable Overhead Variances

Standard for 100 Units of Finished Goods

RMs 1500 Kgs @ Rs 3/- = Rs 4500/-

Labour 600 Hrs @ Rs 4/- = Rs 2400/-


Total Variable Cost for Standard 100 Units = Rs 7800/-

Actual for 2500 Units of finished goods

RMs 37250 Kgs @ Rs 3.10 = Rs 115475/-

Labour 15260 Hrs @ Rs 4.15 = Rs 63329/-


Total Variable Cost for Actual production = Rs 200168/-


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Sol.

Raw Material Cost Variance = (Actual RM Cost – RM cost for actual production at

Standard rates)

= (115475 – 2500x45)

= 2975 (F)

Raw Material Rate Variance = Actual Quantity (Actual Rate – Standard Rate)

= 37250 (3.1 –3.0)

= 3725 (A)

Raw Material Usage Variance = Standard Rate (Actual RM Usage – Standard usage


= 3.0 (372350 – 2500 x 15)

= 750 (F)

Labour Cost Variance = Labour Cost for Actual Production – Labour cost for actual

production at standard rates)

= (63329 – 2500 x 6 x 4)

= 3329 (A)

Labour Efficiency Variance = Standard Labour Rate (Actual hrs – Standard Hrs


= 4 (15260 – 2500 x 6)

= 1140 (A)

Labour Rate Variance = Actual Hours (Actual Rate – Standard Rate)

= 15260 (4.15 – 4)

= 2289 (A)

Variable overhead Variance = Actual Variable Overheads – Overheads for actual

production at standard rates)

= (21364 – 2500 x 6 x 1.5)

= 1136 (F)



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= 15260 (1.5 – 1.4)

= 1526 (F)

Variable Overhead Efficiency Variance = Standard Rate (Actual Overhead Hours –

Hrs required at Standard Rate for Actual Production)

= 1.5 (15260 – 15000)

= 1.5 (260)

= 390 (A)




Material Usage Variance Rs 750/- (F)







Q. Calculate Material, Labour and Varible Overhead Variances from the following

data:

Standard for 10000 units

Raw Material 15000 Kgs @ Rs 9/Kg Rs 135000/-

Labour 30000 Hrs @ Rs 3/Hr Rs 9000/-


Actuals for 9000 Units

Raw Material 13500 Kg @ Rs 8.75/Kg Rs 118125/-

Labour 27260 Hrs @ Rs 3.10/Hr Rs 84506/-



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Sol.

Material Cost Variance = (Actual cost – Cost at Standard Rates for actual

production)

= (118125 – 1.5 x 9 x 9000)

= 3375 (F)

Material Rate Variance = Actual Mat consumed (Actual Rate – Standard Rate)

= 13500 (9 – 8.75)

= 3375 (F)

Material Usage Variance = Standard Rate (Actual Mat consumed– Standard

material for actual production)

= 1.80 (13500 – 13500)

= 000

Labour Cost Variance = Actual Cost – Cost at Standard Rate for actual production

= 84506 – 9000 x 3 x 3

= 3506 (A)

Labour Rate Variance = Actual hrs (Actual Rate – Standard Rates)

= 27260 (3.10 – 3)

= 2726 (A)

Labour Eff. Variance = Standard Rate (Actual Hrs – Standard hrs for actual

production)

= 3 (27260 – 9000 x 3)

= 3 x 260 = 780 (A)

Variable Overhead Variance = Actual Overhead – Overhead at Standard Rate for

actual production

= 47705 – 9000 x 3 x 1.8

= 47705 – 48600

= 895 (F)


= 27260 (1.75 – 1.8)

= 1363

Variable Overhead Eff Variance = Standard Rate (Actual Hrs – Standard Hrs for

actual production)


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= 1.8 (27260 – 9000 x 3)

= 1.8 (260) = 468 (A)




Material Usage Variance Rs 000/- (-)







Mgmt study material created/ compiled by - Commander … Costs are the costs which change in direct...

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