ECO – 10: ELEMENTS OF COSTING
For July 2015 and January 2016 admission cycle
School of Management Studies
India Gandhi National Open University
Maiden Geri, New Delhi -110068
Elective Course in Commerce
ECO – 10: Elements of Costing
ASSIGNMENT- 2015-16
Dear Students,
As explained in the Programme
Guide, you have to do one Tutor Marked Assignment in this Course.
Assignment is given 30% weightage in the final assessment. To
be eligible to appear in the Term-end examination, it is compulsory for you to
submit the assignment as per the schedule. Before attempting the assignments,
you should carefully read the instructions given in the Programme Guide.
This assignment is valid for two admission cycles (July 2015 and January 2016). The
validity is given below:
1. Those who are enrolled in July 2015, it is valid up to June 2016.
2. Those who are enrolled in January 2016, it is valid up to December 2016.
You have to submit the assignment of all the courses to The Coordinator of your Study Centre. For
appearing in June Term-End Examination,
you must submit assignment to the Coordinator of your study centre latest by 15th March. Similarly for
appearing in December Term-End
Examination, you must submit assignments to the Coordinator of your
study centre latest by 15th September.
Answer of Q.N.1.
Cost Accounting: It is the method of accounting for cost. The process
of recording and accounting for all the elements of cost is called cost
accounting.
I.C.M.A. has defined cost accounting as
follows: “The process of accounting for cost from the point at which expenditure
is incurred or committed to the establishment of its ultimate relationship with
cost centers and cost units. In its widest usage 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”.
Objectives of
Cost Accounting
a) To serve as a guide to price fixing of products.
b) To disclose sources to wastage in various operations of
manufacture.
c) To reveal sources of economy in production process.
d) To provide for an effective system of stores and material.
e) To measure the degree of efficiency of the various
departments or units of production.
f) To provide suitable means and information to the top
management to control and guide the operations of the business organisation.
g) To exercise effective control on the costs, time and
efforts of labour, machines and other factors of production.
h) To compare actual costs with the standard costs and analyse
the causes of variation.
i)
To provide necessary
information to develop cost standards and to introduce the system of budgetary
control.
j)
It enables the
management to know where to economize on costs, how to fix prices, how to
maximize profit and so on.
Role of Cost Accounting in Planning and
Control of business operations:
There cannot be a readymade costing system for every
undertaking. In order to meet the special needs of a business, a costing system
has to be especially devised to give it a blend of efficiency and economy. The
installation of a costing system requires a thorough study and understanding of
all the aspect involved as otherwise the system may be a misfit and enterprise
will not be able to derive full advantage from it. While installing a costing
system it is important to make cost benefit analysis i.e., the benefits from
the system must exceed the amount spent on it. The management must feel the
need for it and should be able to make full use of the information available
from the system in the conduct of business. In other words, the system should
be justified on the basis of its value to management. Costing system is a
useful tool in the hands of management because it helps the management in the
following ways:
1. Helps in Decision
Making: Cost accounting helps in decision making. It provides vital
information necessary for decision
making. For instance, cost accounting helps in deciding:
a. Whether to make a product buy a product?
b. Whether to accept or reject an export order?
c. How to utilize the scarce materials profitably?
2. Helps in fixing
prices: Cost accounting helps in fixing prices. It provides detailed cost
data of each product (both on the
aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis
information for the preparation of tenders, estimates and quotations.
3. Formulation of
future plans: Cost accounting is not a post-mortem examination. It is a
system of foresight. On the basis of past experience, it helps in the
formulation of definite future plans in quantitative terms. Budgets are
prepared and they give direction to the enterprise.
4. Avoidance of
wastage: Cost accounting reveals the sources of losses or inefficiencies
such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By
appropriate control measures, these wastages can be avoided or minimized.
5. Highlights causes:
The exact cause of an increase or decrease in profit or loss can be found with
the aid of cost accounting. For instance, it is possible for the management to
know whether the profits have decreased due to an increase in labour cost or
material cost or both.
6. Reward to
efficiency: Cost accounting introduces bonus plans and incentive wage
systems to suit the needs of the organization. These plans and systems reward
efficient workers and improve productivity as well improve the morale of the
work -force.
7. Prevention of
frauds: Cost accounting envisages sound systems of inventory control,
budgetary control and standard costing. Scope for manipulation and fraud is
minimized.
8. Improvement in
profitability: Cost accounting reveals unprofitable products and
activities. Management can drop those products and eliminate unprofitable
activities. The resources released from unprofitable products can be used to
improve the profitability of the business.
9. Preparation of final
accounts: Cost accounting provides for perpetual inventory system. It helps
in the preparation of interim profit and loss account and balance sheet without
physical stock verification.
10. Facilitates
control: Cost accounting includes effective tools such as inventory
control, budgetary control and variance analysis. By adopting them, the
management can notice the deviation from the plans. Remedial action can be
taken quickly.
Q.2. (a) Two components A and B
are used as follows:
Normal usage
50 units per week each
Minimum usage 25
units per week each
Maximum usage 75
units per week each
Reorder Quantity A: 300 units; B: 500 units
Reorder Period A: 4 to 6 weeks, B: 2 to 4 weeks
Calculate for each component:
(i) Reorder level,
(ii) Minimum Level,
(iii) Maximum level,
Solution:
(i)
Reorder Level = Maximum Rate of Consumption x Maximum Reorder Period.
A = 75 x 6 = 450 units
B = 75 x 4 = 300 units
(ii)
Minimum Level = Reorder Level – (Average Rate of consumption x Average Reorder
Period)
A = 450 – (50 – 5) = 200 units
B = 300 – (50 x 3) = 150 units
(iii)
Maximum Stock Level = (Reorder Level + Reorder Quantity) – (Minimum Consumption
Rate x Minimum Reorder Period)
A = (450 + 300) – (25 x 4) = 650 units
B = (300 + 500) – (25 x 2) = 750 units
Answer of Q.N.2. (b).
Meaning of perpetual inventory system
Perpetual
inventory system is also known as "Automatic Inventory System".
Perpetual inventory system is a technique of controlling stock items by
maintaining store record in a manner such that stock balances at any point of
time are readily available. The terms 'Perpetual Inventory' refer to the system
of record-keeping and a continuous physical verification of stocks, with
reference to store records.
Advantages of Perpetual Inventory System
a) Perpetual inventory system provides
an opportunity to verify the physical stock of materials.
b) Perpetual inventory system helps in rapid
stock checking which, in turn, helps in the preparation of interim accounts.
c) A moral check on the store staff to maintain
proper stock records.
d) The investment in materials and supplies may
be kept at the lowest point.
e) It is not necessary to stop the
production so as to carry out a complete physical stocktaking.
f) Perpetual inventory system helps to avoid
deterioration, obsolescence etc.
g) Perpetual inventory system helps to discover
or find out discrepancies and errors and remedial action can be taken
quickly.
h) Timely replenishment of stock is facilitated
by means of recording the level specified in the bin card.
Answer of Q.N.3.
Meaning of Overheads:
Overhead is those costs required to run a business, but which cannot be directly
attributed to any specific business activity, product, or service. Thus,
overhead costs do not directly lead to the generation of profits. Overhead is
still necessary, since it provides critical support for the generation of
profit-making activities. Overhead is also known as burden or indirect costs. A subset of overhead is manufacturing
overhead, which are all overhead costs incurred in the manufacturing process.
Another subset of overhead is administrative overhead, which are all overhead
costs incurred in the general and administrative side of a business.
The Principles of Apportionment of Overhead Costs in
Cost Accounting
The determination
of a suitable basis is of primary importance and the following principles are
useful guides to a cost accountant:
a) Service or use
or benefit derived: If the service rendered by a particular item of expense to
different departments, can be measured, overhead can be conveniently
apportioned on this basis. Thus the cost of maintenance may be apportioned to
different departments on the basis of machine hours or capital value of the
machines, rent charges to be distributed according to the floor space occupied
by each department.
b) Ability to pay
method: Under this method, overhead should be distributed in proportion to the
sales ability, income or profitability of the departments, territories, basis
of products etc.
c) Efficiency
method: Under this method, the apportionment of expenses is made on the basis
of production targets. If the target is exceeded, the unit cost reduces
indicating a more than average efficiency. If the target is not achieved, the
unit cost goes up, disclosing thereby, the inefficiency of the department.
d) Survey method:
In certain cases it may not be possible to measure exactly the extent of
benefit which the various departments receive as this may vary from period to
period. A survey is made of the various factors involved and the share of
overhead costs to be borne by each cost center is determined. Thus the salaries
of foreman serving two departments can be apportioned after a proper survey
which may reveal that 30% of such salary should be apportioned to one
department and 70% to the other department.
Bases of Apportionment of
overheads:
Suitable bases have to be found out for apportioning the items of
overhead cost to production and service departments and then for
reapportionment of service departments costs to other service and production
departments. The basis adopted should be such by which the expenses being
apportioned must be measurable by the basis adopted and there must be proper
correlation between the expenses and the basis. Therefore, the common expenses
have to be apportioned or distributed over the departments on some equitable
basis. The process of distribution is usually known as ‘Primary Distribution’.
Following are the main bases of overhead apportionment utilised in
manufacturing concerns:
(i) Direct Allocation: Overheads are directly allocated to
various departments on the basis of expenses for each department respectively.
Examples are: overtime premium of workers engaged in a particular department,
power (when separate meters are available), jobbing repairs etc.
(ii) Direct Labour/Machine
Hours: Under this basis, the overhead expenses are distributed to
various departments in the ratio of total number of labour or machine hours
worked in each department. Majority of general overhead items are apportioned
on this basis.
(iii) Value of
Materials Passing through Cost Centres: This basis is adopted for expenses
associated with material such as material handling expenses.
(iv) Direct Wages: According
to this basis, expenses are distributed amongst the departments in the ratio of
direct wages bills of the various departments. This method is used only for
those items of expenses which are booked with the amounts of wages, e.g.,
workers’ insurance, their contribution to provident fund, workers’ compensation
etc.
(v) Number of
Workers: The total number of workers working in each department is taken
as a basis for apportioning overhead expenses amongst departments. Where the
expenditure depends more on the number of employees than on wages bill or
number of labour hours, this method is used. This method is used for the
apportionment of certain expenses as welfare and recreation expenses, medical
expenses, time keeping, supervision etc.
(vi) Floor Area of
Departments: This basis is adopted for the apportionment of certain expenses
like lighting and heating, rent, rates, taxes, maintenance on building, air
conditioning, fire precaution services etc.
(vii) Capital
Values: In this method, the capital values of certain assets like
machinery and building are used as basis for the apportionment of certain
expenses. Examples are: Rates, taxes, depreciation, maintenance,
insurance charges of the building etc.
(viii) Light Points: This is
used for apportioning lighting expenses.
(ix) Kilowatt Hours:
This
basis is used for the apportionment of power expenses.
(x) Technical Estimates: This basis of apportionment is used
for the apportionment of those expenses for which it is difficult, to find out
any other basis of apportionment. An assessment of the equitable proportion is
carried out by technical experts. This is used for distributing lighting,
electric power, works manager’s salary, internal transport, steam, water
charges etc. when these are used for processes.
Answer of Q.N.4.
Reconciliation of Cost and Financial Accounts
When cost accounts and financial accounts are
maintained in two different sets of books, there will be prepared two profit
and loss accounts - one for costing books and the other for financial books.
The profit or loss shown by costing books may not agree with that shown by
financial books. Such a system is termed as, ‘Non-Integral System’ whereas
under the integral system of accounting, there are no separate cost and
financial accounts. Consequently, the problem of reconciliation does not arise
under the integral system.
However, where two sets of accounting systems,
namely, financial accounting and cost accounting are being maintained, the
profit shown by the two sets of accounts may not agree with each other.
Although both deal with the same basic transactions like purchases consumption
of materials, wages and other expenses, the difference of purpose leads to a
difference in approach in a collection, analysis and presentation of data to
meet the objective of the individual system.
Need For
Reconciliation
Reconciliation
between the results of two sets of accounts is necessary due to the following
reasons:
1.
Reconciliation helps to check the arithmetical accuracy of both sets of
accounts.
2.
Management is enabling to know the reasons for the difference in results of
both cost and financial accounts.
3.
Reconciliation explains reasons for difference which facilitate internal
control.
4.
Reconciliation ensures the reliability of cost data.
5.
Reconciliation promotes co-ordination between cost and financial departments.
6.
Reconciliation helps in formulation of policies regarding absorption of
overheads and depreciation and stock valuation method.
7.
Reconciliation ensures managerial decision-making.
PROCEDURE OF PREPARATION ON RECONCILIATION STATEMENT
OR MEMORANDUM RECONCILIATION ACCOUNT
A Reconciliation Statement or a Memorandum
Reconciliation Account should be drawn: up for reconciling profits shown by the
two sets of books. Results shown by any sets of books may be taken as the base
and necessary adjustment should be made to arrive at the results shown by the
other set of books. The technique of preparing a Reconciliation Statement as
well as a Memorandum Reconciliation account is discussed below:
When there is a difference between the profits
disclosed by cost accounts and financial accounts, the following steps shall be
taken to prepare a Reconciliation Statement
1 Ascertain the various reasons of
disagreement (as discussed above) between the profits disclosed by two sets of
books of accounts.
2. If profit as per cost accounts (or loss as
per financial accounts) are taken as the base:
ADD:
(i) Items of income included in financial
accounts but not in cost accounts.
(ii) Items of expenditures (as interest on
capital, rent on owned premises, etc.) included in cost accounts but not in
financial accounts.
(iii) Amounts by which items of expenditure
have been shown in excess in cost accounts as compared to the corresponding
entries in financial accounts.
(iv) Amounts by which items of income have
been shown in excess in financial accounts as compared to the corresponding
entries in cost accounts
(v) Over-absorption of overheads in cost
accounts.
(vi) The amount by which closing stock of
inventory is under-valued in cost accounts.
(vii) The amount by which the opening stock of
inventory is over-valued in cost accounts.
DEDUCT:
(i) Items of income included in cost accounts
but not in financial accounts
(ii) Items of expenditure included in
financial accounts but not in cost accounts.
(iii) Amounts by which item of income have
been shown in excess in cost accounts over the corresponding entries in
financial accounts.
(iv) Amounts by which items of expenditure
have been shown in excess in financial accounts over the corresponding entries
in’ cost accounts.
(v) Under absorption of overheads in cost
accounts.
(vi) The amount by which closing stock of
inventory is over-valued in cost accounts.
(vii) The amount b which the opening stock of
inventory is under -valued in cost accounts.
3. After making all the above additions and
deductions, the resulting figure will be profit as per financial accounts.
Note: If, profit as per financial accounts
(or loss as per cost accounts) is taken as the base, then items added shall be
deducted and items to be deducted shall be added, i.e., the procedure shall be
reversed.
Answer of Q.N.5.
|
Process-A a/c
|
|||||
|
Particulars
|
Units
|
Amount
|
Particulars
|
Units
|
Amount
|
|
To Basic material
|
5000
|
5,000
|
By Normal loss
|
250
|
40
|
|
To Additional material
|
|
6,000
|
By Abnormal Loss
|
50
|
210
|
|
To Labour
|
|
7,000
|
By Process-B
|
4700
|
19,750
|
|
To Mgf. Expenses
|
|
2,000
|
|
|
|
|
|
5000
|
20,000
|
|
5000
|
20,000
|
Here, Value of abnormal loss = {(Total cost – scrap value)/
(Total Input – Normal Loss)} * Units of abnormal loss
= {(20000 – 40)/ (5000-250)} *
50
= (19960/4750)*50
= 210
|
Process-B
|
|||||
|
Particulars
|
Units
|
Amount
|
Particulars
|
Units
|
Amount
|
|
To Process-A
|
4,700
|
19,750
|
By Normal loss
|
470
|
94
|
|
To Material
|
|
3,000
|
By Abnormal loss
|
80
|
542
|
|
To Labour
|
|
4,000
|
By Process-c
|
4150
|
28,114
|
|
To Mgf. Expenses
|
|
2,000
|
|
|
|
|
|
4700
|
28,750
|
|
4700
|
28,750
|
Here, Value of abnormal loss = {(Total cost – scrap value)/
(Total Input – Normal Loss)} * Units of abnormal loss
= {(28750 – 94)/ (4700 - 470)} *
80
=
(28656/4230)*80
= 542