Methods and Techniques of Cost Accounting: Theory, Problem and Solutions 9781642876109, 9789350245415

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METHODS AND TECHNIQUES OF

COST ACCOUNTING (THEORY, PROBLEM AND

SOLUTION~)

M N ARORA MCom, FICWA

Reader in Commerce Hans Raj College, Delhi Uni'Jersity DELHI - 110007

~ GfIimalaya G"PublishingGflouse MUMBAI • DELHI • NAGPUR • BANGALORE • HYDERABAD

© M.N. Arora

No part of this publIcatIOn should be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior wntten permission of the author. Breach of this will be liable for legal action.]

ISBN

: 978-93-5024-541-5

Revised Edition 2010

Published by

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CONTENTS I.

Methods of Costing - Job and Batch Costing Methods of costing 1.1 Techniques of costing 1.3 Job Costing - ObjectIyes and costing procedure 1.3 Batch costing - Objec·tive and costing procedure 1.7 Problems and solutIOns 1.10 Short answer questions 1.23 Essay type questions 1.24 Practical questions. 1.25

1.1-1.27

2.

Contract Costing Contract costing and job costing - distinction Features of contract costing 2.1 Contract costing procedure 2.2 Profit on incomplete contracts 2.4 Escalation clause 2.5 Cost-plus contracts 2.6 Problems and solutions 2.7 Short answer questions 2.25 Essay type questIOns 2.25 Practical questions 2.26

2.1-2.32 2.1

3.

Transport Costing Introduction 3.1 Operating cost sheet 3.1 Problems and solutions 3.3 Short answer questions 3.20 Essay type questions 3.20 PractIcal questions 3.20

3.1-3.25

4.

Process Costing, Joint and By-Products Essential characteristics of process costing 4.1 Process costing and job costmg-comparison 4.1 Process losses - Normal and Abnormal 4.3 Abnomlal gam 4.6 Joint products and by-products 4.10 Problems and solutions 4.16 Short answer questions 4.39 Essay type questions 4.40 Practical questions 4.40

4.1-4.45

5.

Marginal Costing Meaning of marginal cost and marginal costing 'i. I Distinction between absorption and marginal costJ\1'..~ 5.3 Cost-volume-profit analysis and break-even analy ..;i~ 5.6 Contribution and profit volume ratio 5.8 Calculations in break-even analysis 5.9 Margin of safety 5.14 Limiting or key factor 5.16 Angle of Incidence 5.17 Break-even chart 5.21 Advantages and disadvantages of margmal costing 5.21 Summary of formulae and abbreviatIOns 5.22 Problems and solutions 5.23 Short Answer questions 5.47 Essay type questions 5.47 Practical questions 5.47

5.1-5.53

6.

Standard Costing Meaning of standard cost and standard costing 6.1 Application of standard costing 6.2 Standard costs and estimated ~osts - comparison 6.2 Advantages and disadvantages of standard costing 6.2 Variance analysis 6.4 Material variances 6.4 Labour variances 6.9 Summary of formulae 6.12 Problems and solutions 6.13 Short answer questions 6.32 Essay type questions 6.33 Practical questions 6.33

6.1-6.40

7.

Budgetary Control Meanmg of budget and budgetary control 7.1 ObjectIves and advantages of budgetary control Limitations of budgetary control 7.3 Standard costing vs. budgetary control 7.3 Essentials of effective budgeting 7.4 Classification of budgets 7.5 Functional budgets 7.5 Cash budget 7.8 Master budget 7.1I Fixed and flexible budgets 7.11 Problems and Solutions 7.12 Short answer questions 7.25 Essay type questIOns 7.26 Practical questions 7.26

7.1-7.31

Appendix - Skill Development

7.2

A.I-A.7

Methods of Costing -

Job and Batch Costing

INTRODUCTION TO METHODS OF COSTING The methods or types of costing rerer to the methods employed in the ascertainment of costs. Several methods have been designed to suit the needs of different industries. These methods of costing to be applied in a particular concern depends upon the type and nature or industry B~sically, there are two methods of c·osting : I. Job costing or job order costing, and 2. Process costing. All other methods are variations of either job costing or process costing. The various methods given here are in outline only and detailed discussion of these is given in later chapters. 1. Job order costing. This method "applies where work is undertaken to customers' special requirements ". *Cost unit in job order costing is a job or work order for which costs are separately collected and accumulated. A job, big or small, comprises a specific quantity of a product to be manufactured as per customer's specifications. The industries where this method is used include printing press, repair shops, interior decorators, painters, etc. 2. Contract costing or terminal costing. This is a variation of job costing and, therefore, principles of job costing apply to this method. The difference between job and contract is that job is small and contract is big. It is well said that a 'contract is a big job and a job is a small contract'. The cost unit here is a 'contract' which is of a long duration and may continue over more than one financial year. Contract costing is most suited to construction of buildings, dams, bridges and roads, ship-building, etc. 3. Batch costing. Like contract costing, this is also a variation of job costing. In this method, the cost of a batch or group of identical products is ascertained and therefore each batch of products is a cost unit for which costs are ascertained. This method is used in companies engaged in the production of readymade garments, toys, shoes, tyres and tubes, component parts, etc. 4. Process costing. As distinct from job costing, this method is used in mass production industries manufacturing standardised products in continuous processes of manufacuring. Costs are accumulated for each process or department. Here raw material has to pass through a number of processes in a particular sequence to completion stage. In order to arrive at the unit cost, the total cost of a process is divided by the number of units produced.The finished product of one process is passed on to the next process as raw material. Textile mills, chemical works, sugar mills, refineries, soap manufacturing, etc., may be cited as examples of industries which employ this method. S. Operation costing. This is nothing but a refinement and a more detailed application of process costing. A process may consist of a number of operations and operation costing involves cost ascertainment for each operation Instead of a process. 6.· Single, output or unit costing. This method of cost ascertainment is used when production is uniform and consists of a single or two or three varieties· of the same product. Where the product is

* CIMA.

UK Terminology.

1.2

Methods and Techlliques of Cost Accoulltillg

produced in different grades, costs are ascertained grade-wise. As the units of output are identical, the cost per U111t IS found by dividing the total cost by the number of units produced. This method is applied in mines, quarries, brick-kilns, steel production, flour mills, etc. 7. Operating or service costing. This method should not be confused with operation costing. Ope ratmg costing is used in undertakings which provide services instead of manufacturing products. For example, transport undertakings (road transport, railways, airways, shipping companies), electricity companies, hotels, hospitals, cinema, etc., use this method. The cost units are passenger-kilometre or tonne-kilometre, kilowatts hour, a room per day in a hotel, a seat per show in cinema, etc. This method is a variation of process costing. 8. Multiple or composite costing. It is an application of more than one method of cost ascertainment in respect of the same product. This method is used in industries where a number of components are separately manufactured and then assembled into a final product. For example, in a television company, manufacture of different component parts may require different production methods and thus different methods of costing may have to be used. Assembly of these components into final product still requires another method of costing. Other examples of industries which make use of this method are air-conditioners, refrigerators, scooters, cars, locomotive works, etc. Costing Techniques

Costing MethQds Fig. 1.1. Costing Method and Techniques.

1.3

Methods ofCostillg - .Joh and Batch Costlllg

TECHNIQUES OF COSTING It is the type of industry which determines which of the eight methods of costing discussed above will be u~ed in a particular business. However, in addition to these methods, there are certain techniques of costing which are not alternatives to the methods discussed above. These techniques may be used for special purpose of control and policy in any business irrespective of the method of costing heing used there. These techniques are briefly explained below. 1. Standard costing. This is a very valuable technique to control the cost. In this technique, standan;i cost is predetermined as a target of performance and actual performance is measured against the standard. The difference between standard and actual costs are analysed to know the reasons for the difference so that corrective actions may be taken. 2. Budgetary control. Closely allied to standard costing is the technique of budgetary control. A budget is an expression ofa firm's plan in financial form and budgetary control is a technique applied to the control of total expenditure on materials, wages and overhead by comparing actual performance with planned performance. Thus, in addition to its use in planning, the budget is also used for control and coordination of busipess operations. 3. Marginal costing. This is a technique of profit planning. In this technique, separation of costs into fixed and variable (marginal) is of special interest and importance. This is so because marginal costing regards only variable costs as the cost of the products. Fixed cost is treated as period cost and no attempt IS made to allocate or apportion this cost to individual cost centres or cost units. It is transferred to costing profit and loss account of the period. This technique is used to study the effect on profit of changes in volume or type of output. 4. Total absorption costing. It is a traditional method of costing whereby total costs (fixed and variable) are charged to products. This is in complete contrast to marginal costing where only variable costs are charged to products. Although until recently this was the only technique employed by cost accountants, it is now-a-days considered to have only a limited application. 5. Uniform costing. This is not a separate technique or method of costing like standard costing or process costing. UnifOlID costing simply denotes a situation in which a number of firms adopt a uniform set of ~osting principles. It has been defined by CIMA as "the use by several undertakings of the same costing principles alld/or practices ". This helps to compare the performance of one firn1 with that of other firms and ti1US to derive the benefit of anyone's better experience and perfOlIDance.

Costing Methods and Techniques are Tools Methods and techniques of costing described above should be regarded as tools of a cost accountant and it should not be thought that a particular method or technique is superior to any other. Just as a skilled workman uses different tools for different tasks, similarly a cost accountant should use these methods and techniques appropriately either individually or in combination. For example, standard costing may be combined with process costing to give 'standard process costing', or standard costing may be combined with marginal costing as well as process costing to give 'standard marginal process costing'. Although this may appear confusing, yet if principles involved in each method or technique are clearly understood, there should not be any difficulty in making the best use of these methods and techniques.

JOB COSTING Job costing (or job order costing) is a method of cost ascertainment used in job order industries. Special features of such industries are as follows : (a) Production is against customer's orders and not for stocks. (b) Each job has its own characteristics and requires special attention. (c) The flow of production from one department to another is not uniform. It is the nature of job which detem1ines the department through which it is to be processed.

Methods and Techlllques orCost ACCOlll1ling

1.4

Objecti"

of Job Costing

Job Costing is used in • Printing press Th, following are the mam objectives of job costing: ( 'ost of each job/order is ascertained separately. This helps in finding • Motor car repair shop • Interior decoration out the profit or loss on each individual job. 2 It enables management to detect those jobs which are more profitable • Dry cleaning • Painters, etc. and those which are unprofitable. ,'S

3. It provides a basis for determining the cost of similar jobs undertaken in future. It thus helps in future production planning. 4. It heIps management m controlling costs by comparing the actual costs with the estimated costs. Job Costing Procedure The following steps are taken in job costing: l. .Job number. When an order has been accepted, an individual job number must be assigned to each such job so that separate jobs are identifiable at all stages of production. Assignment of job numbers also facilitates reference fiJI" costing purposes in the ledger and is conveniently short for use on various forms and document. 2. Production order. The Production Control Department then makes out a Production Order thereby authorising to start work on the job. Several copies of production older are prepared, the copies often being m different colours to distinguish them more easily. These copies are passed on to the following: (i) All departmental foremen concell1ed with the job; (ii) Storekeeper for issuing of materials; and (iii) Tool room for an advance notification of tools required.

Proforma of a Production Order is given m Fig. 1.2. The columns provided in the production order differ widely, depending largely upon the nature of production. Sometimes orders are accompanied by the blue prints and contain a bill of materials and detailed instructions as to which tools and machinery are to be used.

Production Order Nume of ,he Customer. ..

Job No ...................................... .

Date of Commencement..... . ........................... .

Date ..................................... ,.

Dute of Completion ...................................... .

Bill of

Special In~tructlOns ...~ ............... ., ........................ .

Dnm ing attached Yes/No.

---------~------------------~-------------------

{!U{//I! Itr

------+

DeSCription

Machines to he..!,.,sed _

._ _ _ _ _ _ _ _L -____________________.l--_ _ _ _ _ _ _ _ _

~.,I.Jtcrial

No ............... ., .... .

,~I _ ____Tt_o_ol_,'_r_e(_II_II_J'e,_d__--I

----.-L----------------i

(Sign.)., ......... ., ... ., Production authOrised by : Head vf Production Control Deptt. Fig. 1.2. Production Order fer J"b

/

Methods o(Costillg --Joh alld Batch Costll1g

1.5

3. Job cost sheet. The umque accounting document under job costing is the job cost sheet. Receipt of production order is the signal for the cost accountant to prepare a job cost sheet on which he will record the cost of materials used and the labour and machine time taken. Each concern has to design a job cost sheet to suit its needs. A simple proforma of Job cost sheet is given 111 Fig. 1.3. Job Cost Sheet Customer. .............................. Date of Commencemcnt.. ..................

II!

Materwl Cost Date

Materwl Req No

Job No ........................................... Date of CompletIon .......................

II

Labour Cost

Allloullt Ii Date !I Rs. I' I:

Hours

Rate

Amt

Rs

Rs.

I

Factof)1 Overhead (Ahsorbed) Deptt

Hours

I I

Rate

Amt

R.I'.

Rs.

I.

II "

"'I

Ii Total

i!

Total

Total

Profit/Loss

Pnce Quoted

lost SUlllmary

Rs. ....

Less: Cost

... ....

Profit or Loss

.,.

Rs. Matenals Labour

III

Prime Cost Factor overhead Works Cost Adm. overhead Cost of Production Selling and dIstributIOn overhead Total Cost

I,

,I

;1

I'!I

II

II,I

II Fig. 1.3. Job Cost Sheet

Job cost sheets are not prepared for specified periods but they are made out for each job regardless of the time taken for its completion. However, material, labour and overhead costs are posted periodically to the relevant cost sheet. The material, labour and overhead to be absorbed into jobs are collected and recorded in the following way: (a) Direct materials. Material Requisitions or Bill of Materials show the quantities of materials issued to jobs from store. When copies of these documents reach the cost office, they are priced imd entered in the stores ledger account in the "Issues" column. Each requisition shows the job number to which the material is to be charged. (b) Direct wages. Wages payable to workers are calculated on clock cards, job cards, time sheets, etc. The summaries of job cards are made on Wages Abstract or Wages Analysis Sheets, which .shows the direct wages chargeable to each job. The total of wages chargeable to various jobs is debited to work-in-progress control account.

Methods and Techniques of Cost Accollnting

1.6

(c) Direct expenses. These can be identified with specific jobs and are directly charged to these

jobs. (d) Overheads. These comprising of indirect materials, indirect wages and indirect expenses which cannot be identified with specific jobs are distributed to cost centres. Absorption of overhead by the jobs passing through the eost, centres is based upon percentage of direct wages or direct material cost, direct labour hours or machine hours, etc. These methods of absorption have also been discussed in detail in the chapter on Overheads. The direct materials, wages and expenses and the overheads absorbed are totalled to give the total cost. Completion of jobs. When jobs are completed, the cost is transferred to cost of sales account. The total cost of jobs completed during each period is deducted from the sales to determine the profit or toss for the period.

Illustration 1.1 The following direct costs were incurred on Job No. 239 of XYL Co. Ltd. Materials Wages: Deptt.

Rs.6,010 A - 60 hours @ Rs. 30 per hr. B - 40 hours @ Rs. 20 per hr. C - 20 hours @ Rs. 50 per hr.

Overhead for these three departments were estimated as follows: Variable overheads: Deptt.

A-

BC-

Rs. 15,000 for 1,500 labour hours Rs. 4,000 for 200 labour hours Rs. 12,000 for 300 labour hours

Fixed overheads: Estimated at Rs. 40,000 for 2,000 normal working hours. You are required to calculate the cost of Job No, 239 and calculate the price to give profit of 25% on selling price. (B. Com. Madl/rai. Adopted) Solution Job Cost Sheet Job No. 239 Rs. Direct materials AWages Deptt.

B-

Rs. 6,010

60 hrs. x Rs. 30 40 hrs. x Rs. 20 20 hrs. x Rs. 50

1,800 800 1,000

C*Varlable Overheads Deptt. A-60 hrs. @ Rs. 10 B - 40 hrs. @ Rs. 20 (' - 20 hrs. @ Rs. 40 *Flxed Overheads: 120 hrs. @ Rs. 20 per hour

600 800 800

3.600

2,200 2,400

Total Cost

14,210 4,737

Selling Price

18,947

Profit (25% of sales or 33'/, cotal cost)

1.7

Methods o/Costillg - Job alld Batch Costillg

*Working Notes. Overhead rates per hour are calculated as under: Variable overhead: Deptt. A Rs. 15,000 .;- 1,500 hrs. = Rs. 10 per B Rs. 4,000.;- 200 hrs. = Rs. 20 per C Rs. 12,000.;- 300 hrs. = Rs. 40 per Rs. 40,000 .;- 2,000 hrs. = Rs. 20 per Fixed overhead: Total hours worked on the job = 60 + 40 + 20 = 120 hours.

hour hour hour hour

BATCH COSTING This is a variation of job costing. While job costing is concerned with Batch costing is used in costing of jobs that are made to a customer's particular requirements, batch • Readymade garments costing is used when production consists of limited repetition work and a defi- • Shoe manufacture nite number of articles are manufactured in each batch to be held in stock for • Toy manufacture sale to customers generally Thus; a batch is i'cost unit consisting of a group of • Tyres and tubes etc. identical items. Batch costing is a.pplied in the manufacture of shoes, toys, readymade garments, component parts of say, cars, radios, watches, etc. In shoe industry, for example, it IS just not economical to manufacture a pair of shoes to meet the requirements of one customer. On the other hand, batches of say 500 to 5,000 shoes of each size, style, colour, etc., are economically made and held m stock for sale on demand. Batch Costing Procedure Each batch is given a batch number in exactly the same way as a job is given a Job number. Direct materials, direct labour and direct expenses- which can be identified with the batcl];are recorded on the Batch Cost Card. The costing of materials requisitions and time sheets follows norm~ job costing principles. Overheads are absorbed on one of the bases already explained as is done is job costing. When batch is completed, the total cost of the batch is divided by the quantity produced in the batch to arrive at the cost per unit or per dozen et